Rethinking Economic Statecraft for a Taiwan Crisis 

Glenn Tiffert: Hello and welcome, I'm Glenn Tiffert, a distinguished research fellow at the Hoover Institution, where I co-chair its program on US, China, and the world. Today we're sitting down in a conversation with the authors of a new report our program sponsored, called Day One, an economic contingency plan for a Taiwan crisis.

This report takes a sober look at our existing toolkit of economic statecraft and judges it, wanting. It then invites us, while we have the luxury of time, to think outside of the box and develop more impactful alternatives, so that in the event of a crisis, we have done the hard strategizing and thought through the second and third order consequences of our choices in advance.

It's a great pleasure for me to introduce the report's authors, Hugo Bromley and Eyck Freymann. Thank you for joining us in this conversation.

Hugo Bromley: Thanks.

Glenn Tiffert: So let me start by asking you all, what is our economic statecraft toolkit, the one we currently have?

Hugo Bromley: Well, right now then, we seem to be caught in a binary, right?

Whenever we're faced with any kind of geopolitical crisis. And that binary is between little to no action, symbolic sanctions designed to show our displeasure but not designed to have significant economic impact, and what we might conventionally call Russia plus. In other words, efforts to weaponize the global economy to the position of the dollar, financial sanctions to punish a country, and above all, to interdict that country's trade with third parties, right?

And our contention in this report is that that hard Russia plus style sanctioning regime is not viable in the case of China in the event of a Taiwan crisis.

Glenn Tiffert: And why not?

Hugo Bromley: It's too big is the simple way of pushing it. But to deal it in more complex terms, China is such an integral part of the global economy that we cannot force third countries not to trade with it.

And if we attempt to do so, and I can speak to this far better than I can, then third countries will shift part of their financial infrastructure onto networks that we don't control. And at that point, we risk fragmenting the global economy and actually ending up in a much weaker position than the one we started with.

Glenn Tiffert: Have we seen that actually happening, for example, with the Russian sanctions in the Ukraine war?

Eyck Freymann: It's already happening at a vast scale. In March and April of 2022, the United States imposed sanctions on Russia that it claimed were unprecedented. It was likened to a financial nuclear bomb.

And in the first weeks after sanctions were imposed, the Russian ruble cratered. Russia's banks teetered on the edge of collapse. But the Russian financial authorities managed to swoop in, stabilize the system and put Russia on a basically stable war footing to dig in for the long haul. Meanwhile, Russia's major trading partners, including countries like Turkey, which are NATO allies, moved off of payment systems that the United States controlled.

And redirected trade, including sensitive dual use components that we wanted to keep from Russia, which are now being used on the battlefield to kill Ukrainian forces. So I think it's been a resounding failure. And not only has it pushed Russia closer to China, it has given China a playbook that it could follow in a Taiwan crisis, but with much more effective resources than Russia had in 2022.

So I think the Russia case forces us to take a hard look at the playbook and consider whether it's still viable.

Glenn Tiffert: So how might we do better?

Hugo Bromley: Well, any conversation about this is going to take a very long time and require bringing together a lot of interests.

And in the report, we think back to the days of the Atlantic charter, right? Where you have FDR in Churchill on a battleship thinking about the principles that could underpin a future economic system. And we think that given the scale of the China crisis, we need to go back to that idea of principles.

And we outlined four in the report, the first is not to attempt the kinds of hard sanctions we've seen in the past and break supply chains on day one. The second is the overwhelming importance of dollar hegemony and the position of the dollar in the global trading system.

The third is that it is not viable to ask third countries to decouple from China. And indeed, in this moment of shock, we talk about World War I in the report and the of it as paralysis, right? In this moment of shock, the us actions need to be about crisis response and economic leadership, not just punishment.

And then the fourth principle, which is perhaps a little bit more complex in its origin, is that in any attempt at decoupling, you'll guys need to do discriminatory trade policy. And that presents you with a problem with what's called transshipment. In other words, I'm a Chinese firm, I make a plastic, I don't know anything you like.

I can't sell it viably to the United States, but I can sell it to a third country who can pretend it's theirs and sell it on. So we need to incentivize countries to hit what we think of as the minimum bar, which is honesty of trade reporting. And we need to do that through a structure of incentives.

So those are the kind of four principles we outline as a starting point for thinking about these issues.

Eyck Freymann: And then in terms of how to operationalize it. We're gonna have to have a conversation across party lines as a federal government interagency, and then between the United States and allies and partners.

If we need to invent new tools that don't currently exist, we're gonna have to game them out. We're gonna have to create new legislative authorities and so forth. This is the beginning of a conversation, not the end of one. But that said, in this report, we have three ideas, and I'll speak to the first two, and then Hugo can speak to the third.

The first idea is, remember, we're talking about a crisis scenario, this is not peacetime. But in this scenario, we ask, how could the United States decouple from China, end its economic relationship with China in a way that matched the principles that Hugo describes. And the way to do it, we imagine, starts with a ratcheting regime.

Either tariffs that ratchet up or quotas that ratchet down. And the idea would be to phase this process in over a reasonable period of time so that businesses that produce in China have time to figure out the best place to reshore. And then pull production back in a way that doesn't lead to the supply chain disruptions, shortages and inflation that we all just had to grapple with in the aftermath of COVID.

The second policy idea is not directly related to trade decoupling, but we think it would accelerate this process and have some positive effects. And that is a currency intervention. Essentially, China is building the infrastructure to try to internationalize its currency very rapidly at the beginning of a crisis and make a compelling argument to third countries and private firms that they should come onto China's systems.

And the idea of the currency intervention is to target the systems that China is trying to build, so they're not viable, so third countries won't want to join them. The message to the world is we are not going to try to expel China from the system on day one, that's not viable.

Instead, we're going to keep China inside the system while we figure out what we're going to do in trade. And that is a process that is likely to take years.

Hugo Bromley: The last thing I'd say on this, right, is that anything you do involves discriminatory trade policy and the transshipment problem I mentioned earlier.

You also have a world in shock looking to the US for leadership. So what we suggest in our third idea is that you would create a thing, call it an economic security cooperation board, and it's gonna have two mandates that you intertwine. The first is it's the US vehicle for economic leadership.

They're providing support to third countries, they're looking at markets, they're providing guidance. But the second is that it's gonna be supporting customs enforcement. And it's also gonna provide a rules based way for the US to say, okay, you have now become a systemic transshipment point, third country for Chinese goods, unless you get your house in order, we get to treat you like China.

But this is a really scary time, and it's important that the US act in a way that can build support and consent across the world. And with many countries who have failed to support us on Russia sanctions, something I, as a Brit, know all too well.

Glenn Tiffert: So let's get to that in a moment, those are very interesting ideas, but let's say that there's a crisis before we're able to action the ideas that you've just described, and we reach for our existing conventional playbook.

We pull the lever, the one we have muscle memory for, the one we did for Russia sanctions, and we do a Russia plus scenario. What happens then, why is that undesirable?

Eyck Freymann: Well, our view is that not only would that fail to blow up China's financial system on day one, it would risk backfiring very badly against our core interests.

In any crisis scenario, especially if China has fired first on US forces. There is going to be a tremendous vindictive interest in throwing the book at China and doing everything we can to punish this regime. But the reality is we are going to have other interests at stake.

We won't want to torpedo global financial stability and cause another great depression. We won't want to disrupt supply chains in ways that create shortages of life saving drugs for seniors in the United States and around the world. We're not going to want to break the rules based trading system, which enables prosperity in the United States and provides a pathway to development for the developing world.

We're not going to want to put the role of the United States dollar, which is what enables the United States to maintain Social Security, Medicare and these kinds of benefits, but also to enforce sanctions on countries like North Korea. We don't wanna put this at risk, and we will have to strike a balance between the need to impose costs on China and the need to protect our other interests.

The other thing that motivated this report was our analysis of Chinese language sources, because you can actually learn a great deal from reading what PRC analysts are saying about this issue. And it's concerning that they have learned the lessons from Russia and they're increasingly convinced that they are building resilience precisely to these sanctions threats.

So the threat to do these sanctions is losing its efficacy as a deterrent. And there is a real risk that if a crisis breaks out and we reach for the usual lever, then we actually fracture our coalition and put China in a much stronger situation.

Hugo Bromley: I'd really emphasize that last point.

I mean, when we're thinking about this, we're thinking about a moment of real fear, but we're also thinking about a geopolitical issue that is hugely complex. The position of Taiwan is complicated, states take different positions. But in a crisis, with so much of the global economy at stake, everyone has huge incentives to reason their way towards China's position, right?

And there's a danger if the US goes too hard in the way you described that Russia plus lever of the US entering simultaneous trading disputes with most of the global economy. In other words, at the very moment when the US needs to be working with partners and building those relationships, we're gonna be fracturing the core relationships on which countries like the US and the UK depend.

We can't force countries to make a binary choice between the United States and the PRC, states don't face binary choices in times of geopolitical competition. We need to accept that, accept those incentives, accept those interests and work with them rather than against them.

Glenn Tiffert: You're both economic historians, can you reflect for a moment on the lessons of history?

Hugo Bromley: I mean, sure, that's our favorite thing to do, my background is in the early modern period, actually. And you can trace these basic problems all the way back to the American revolution itself, right? The incentives of third countries to trade through economic warfare, and in many ways, the reasons for it are basic.

If you sanction a good in a target market, the price of that good goes up and the incentives to try and find a way around the sanctions go up. And that process keeps happening until you find a way around the sanctions, right, as long as there's a demand in the sanctions market.

And we've done other work where we trace this very, very basic fact through a number of conflicts and you get to all kinds of extraordinary anecdotes. The most insane one I've ever seen from British sources was a de facto attempt to resupply Nazi Germany during World War II.

That begins in America, crosses the Pacific Ocean to Vladivostok, hops on a trans Siberian railway and goes all the way across to get around the British blockade, right? These are the lengths people will go to to find profit in a free market if the incentives are there. And those economic incentives are so powerful all through history and despite the massive globalization we've been through in the last 40 years, that's only accelerated those incentives.

So if we're thinking about economic statecraft in this new age of great power competition, we need to understand those incentives, accept them and work with them.

Glenn Tiffert: So how do we operationalize the tools you described, how do you harness those market forces to be in your favor rather than fighting the gravity of economics?

Eyck Freymann: Well, part of it involves the US government speaking clearly, consistently, and with a single voice across party lines. To tell the financial markets, private companies, allied and partner governments, and China, exactly what we are going to do if a crisis breaks out. And projecting confidence requires not just that we brandish threats that may or may not be serious, but that we articulate, that we understand the interest that we have at stake, and we have an I affirmative vision for what the world would look like even if China goes rogue.

This is a vision that's not just about tearing down institutions, it's a story that we will tell about evolving existing institutions to make them more equitable. More equitable for the American middle class, more equitable for developing countries, and that we will sustain this vision in partnership with our core allies.

And we will do it in a way that comes at China's expense, but maintains a world based on rules and norms. A world in which small states rights and sovereignty are respected and protected. And this is a vision for the world which won't be easy to build, we're not talking about setting this up in the days or weeks of a crisis.

But if China does do something so foolish and so dangerous as to attack Taiwan or attack a US treaty ally or shoot at US forces, we need a vision for what the world is gonna look like after the dust settles. And that's what this report is all about.

Hugo Bromley: The only thing I'd add to that is that the more seriously we think about this issue, the more honestly we look at our various interests, the more credible our deterrence becomes. We're entering into an increasingly scary time, those who've been watching European geopolitics closely are already in that very scary time.

And in that world, deterrence is crucial, but deterrence isn't about brandishing the biggest stick you've got. Deterrence is about thinking seriously about what is in all our interests and trying to move forward on the basis of consensus as best you can. Now, the details of something like this are gonna come together late, because building that consensus is hard, but we can be clear about what our guiding principles are.

I go back to the Atlantic charter, and we can have that cool, calm, deliberate thought now, because being cool, calm and deliberate in a moment of crisis is one of the hardest things to do.

Glenn Tiffert: So let's think concretely, what are you asking the United States to do in the heat of the crisis?

What are you asking allies to do in the heat of the crisis, and what are you asking the rest of the world to do?

Hugo Bromley: I think a lot of what we're asking is for what is for them not to do things. We're asking them not to retrench back into their own markets.

And we're asking the US to step forward to show that leadership and to begin the process of putting things in motion. Our report has a very dramatic picture of an avalanche on the front of it, and we find that metaphor really helpful in thinking about what should happen in that moment.

We're talking about taking political steps, whether that's introducing a ratcheting tariff, whether that's stepping forward in terms of crisis response. And that's not just the US, that's also the UK, my own country, Japan, South Korea. We're talking about taking that step forward to make political actions that don't have a negative economic cost on day one, but that build and build and build over time.

And in many ways, that's the opposite of sanctions, where you try and hit them as hard as you can and then it fades. We're looking to set a process in motion on day one through passing legislation. There's a big role for Congress in this, but lots else besides in a way that will then build and develop through time.

Glenn Tiffert: So we've walked around Washington intensively over the last several days. We've had meetings with various bodies in the executive and on the Hill. Tell me, what are your reflections on this weeks of engagements? How have you been received, how has the argument been received?

Eyck Freymann: It's been absolutely extraordinary, Glenn, beyond anything we could have expected.

We have met with representatives from some of the most progressive members of the House to some of the most conservative members of Congress. We've met with folks from across the interagency, we've spoken to people in classified settings, in open settings. We've spoken to people about various aspects of our report, the technical pieces of how this legislation would be operationalized, and we've talked about big picture ideas.

We've talked to representatives from Allen partner governments. And what we see is there is still more work to do. Achieving alignment on these principles will not be easy because this is an entirely new way of thinking about economic coercion and crisis response. And this is a period of history that most people know only in its rough outline.

But we have confidence based on these last few days of conversations, that there is the fundamental basis for a bipartisan consensus here. And not just a bipartisan consensus in Washington, an agreement on principles that can link the US together with its core allies. So, we can't have this conversation by ourselves, we want to be the beginning of a conversation that brings different voices together.

We have a lot of excitement as we come away from this week about the next steps in this process.

Hugo Bromley: I can only completely second that. And Ike and I have been in many, many meetings, and there's a line of Ike's that I would highlight, which is that China is watching what's happening.

And if we can have these conversations in a sober and calm way, that is in itself having a deterrent effect. And that's not for us to do, that's for Congress to do, that's for elected representatives to lead. But if we can be calm and moderate and talk to each other about such a fundamental issue, we can make extraordinary progress.

And everything I have seen and heard over the last week says that the United States is more than capable of doing that and of showing the economic leadership the world wanted to show.

Glenn Tiffert: And bringing the rest of the world along with it.

Hugo Bromley: Absolutely.

Glenn Tiffert: Excellent, I wanna give you the opportunity for any final thoughts that you might have either on the subject matter on the week of engagements.

Eyck Freymann: All that I will say is that the United States is not the aggressive party in the Taiwan Strait. All the United States seeks to do is to defend treaty allies that it committed to defend more than 70 years ago and to maintain peace and stability in the Taiwan Strait.

Peace and stability which has brought vast economic benefits to China, to Taiwan, and to everyone else in the region. China's leader, Xi Jinping, has an idea about how he might disrupt this order for his own personal benefit and for China's coming at the expense of everyone else. And what we need to do is stand up tall because we have the winning side of this argument.

The United States is making a pitch to other countries in the region and around the world that we need to stand together to prevent the worst from happening. The best deterrent is a credible contingency plan about how the United States will work together with allies and partners to create a world that China doesn't want.

And I think after this week, I'm coming away energized and excited that that conversation is gonna continue.

Hugo Bromley: God, I've gotta top that now. Okay, all I would say is this, a lot is talked about in terms of the US and its role in the world and its role in economic leadership.

I have been impressed at every meeting I've gone to this week about the quality of the engagement, the willingness to listen, the openness, the challenging questions we have received. And I think that should reassure a lot of people that on the big topics, when you fly out to the United States and talk to people based on appreciation of US interests and an understanding of the leadership we need, you can have an extraordinarily productive, brilliant, fascinating conversation.

And that speaking from the across the pond, is just enormously energizing and encouraging.

Glenn Tiffert: Thank you, please take that back to Lund.

Hugo Bromley: We will do.

Glenn Tiffert: Eyck, Hugo, I really appreciate the conversation. I wanna encourage our audience to take a look at the report on day one available on hoover.org, thank you.