What Money Can’t Buy

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Anyone who wonders about the potential of economic power need look no further than the response to Russia’s attack on Ukraine. The dramatic measures taken by the United States and its allies illustrate the potency of the purse. The International Monetary Fund has forecast that asset seizures, financial sanctions, oil embargoes, and bans on the sale of military hardware, oil drilling equipment, and commercial airliner parts will cause Russia’s economy to contract by nearly nine percent in 2022, a decline nearly three times as large as the one that Russia suffered in 2020 as a result of COVID-19. It is hard to imagine a more striking demonstration of the power of economic sanctions.

But anyone who wonders about the limits of economic power also need look no further than Russia. For all the damage that Western punitive moves have done, there is no indication that they can persuade the Kremlin to halt its war in Ukraine or even to modify its prosecution of the war.

Two definitions of economic power together demonstrate its strengths and limitations. To paraphrase the economist Richard Cooper, economic power is the capacity to apply economic instruments to punish or reward another party. But another definition, as articulated by the political scientist F. S. Northedge, depicts economic power as the capacity of an individual, group, or government to use economic instruments to influence the decision-making of another actor, thereby causing the targeted party to modify its behavior. The United States and its NATO allies clearly possess economic power in Cooper’s sense, in terms of the ability to use economic instruments to punish another party. It is less clear, however, that they are capable of exercising it in Northedge’s sense, as a means of altering the behavior of an adversary.

The United States has a long history of wielding economic instruments to achieve its foreign policy goals. Precedents can be found at least as far back as the Embargo Act of 1807, when U.S. President Thomas Jefferson blocked imports in an effort to push back against British and French interference in U.S. trade. But there is an equally long history recording the inability of such instruments to alter the fundamental behavior of another party. The 1807 embargo, for instance, failed to hurt British and French interests and fueled, rather than prevented, conflict between the United Kingdom and the United States, culminating in the War of 1812. Nor does exercising economic power necessarily induce political shifts: economic penalties and rewards rarely lead to regime change, for example.

The application of economic power is changing in one crucial respect, however: the growing importance of international coordination. Economic power has always been more effective when exerted by a coalition of countries. But in a multipolar global economy, where essential goods and services can be sourced from an increasing number of national suppliers, the importance of coordination for effective application is greater still. Consider the Trump administration’s tariffs on Chinese exports, which were imposed solely by Washington and produced no significant changes in Beijing’s economic behavior. The Biden administration surely had that failure in mind when it enlisted the support of a broad coalition of like-minded governments before imposing sanctions on Russia. Going forward, U.S. economic power will depend more and more on Washington’s ability to foster unity in an increasingly fractured world.

hammer, not scalpel

Economic power is typically framed as an alternative to military power. Escalating economic sanctions on Russia, for instance, have been presented as an alternative to fulfilling the Ukrainian government’s request that NATO establish a no-fly zone over Ukraine. This formulation is invoked to explain why governments, when embroiled in geopolitical conflicts, have increasingly turned to economic measures in recent decades rather than engaging in direct military conflict. Given the threat of nuclear war, the risk of escalation in a military confrontation between major powers is simply too great. That risk has been sufficient to limit the incidence and extent of such direct confrontations, as well as to weaken the credibility of threats of military action.

Economic measures, in contrast, can be surgically calibrated to limit the danger of escalation—or so say their proponents. They can be aimed at specific banks, politicians, and businesses. They can be tailored to maximize the pain felt by key decision-makers and their political allies while sparing the general public. Few armies can deploy their hardware with comparable precision and avoid inflicting civilian casualties. In his 2009 book, Power Rules, the foreign policy expert Leslie Gelb invoked these dissimilarities as explanations for “two earthquaking historical trends: the declining utility of military power and the concomitant rise of international economic power.”

The United States derives much of its economic power from its engagement with the rest of the world.

In practice, however, the relationship between economic and military power is more complex. For one thing, economic and military measures have sometimes served as complements rather than substitutes. In 1990, for instance, the UN Security Council, responding to Iraq’s invasion of Kuwait, authorized an embargo broadly prohibiting trade with both countries. It later authorized the use of military force in implementing the embargo. A series of subsequent resolutions instructed states to use their armies, navies, and air forces to interdict ships or aircraft carrying cargo to Iraq or Kuwait. More recently, the use of economic sanctions against Russia has not precluded the provision of military assistance to Ukraine; rather, the two go hand in hand as essential components of a larger strategy to punish Russia for its aggression.

Moreover, the idea that high-tech economic weapons will inflict pain exclusively on their intended targets is an illusion. The fact that Russia is on course to experience a nine percent fall in GDP, with an annual rate of consumer price inflation of around 20 percent, is an indication that the West’s economic sanctions will hit not just Russian oligarchs but also ordinary households. In other cases, countries have imposed economic sanctions to purposely inflict widespread pain. During World War I, for instance, the Allies imposed a comprehensive blockade against Germany, seeking to ratchet up pressure on the country by creating economic hardship for ordinary citizens. That blockade is estimated to have caused some 750,000 civilian deaths from malnutrition and disease. Notably, however, there is no evidence that civilian hardship played a role in the German high command’s decision to end the war.

In any case, the current economic sanctions against Russia have not come close to anything on the scale of a World War I–style blockade. They fall short even of the 1990 embargo against Iraq, which exempted only humanitarian assistance. The hope of some Western observers that the country might rise up against Russian President Vladimir Putin rests in part on the idea that Western sanctions will inflict widespread economic pain for which the Russian public will blame its leader, resulting in that leader’s downfall. History suggests that this outcome is unlikely.

sanctions whiplash

The hope, in most cases, is that economic sanctions will serve as a deterrent. Leaders, the logic goes, will hesitate to embark on foreign policy adventures for fear that sanctions will galvanize public opinion against them and that this dissatisfaction will manifest itself on the streets and cost them votes. Unfortunately, authoritarian leaders who control their country’s military, security apparatus, and media landscape are not subject to the whims of public opinion. The scholars Gary Hufbauer, Jeffrey Schott, Kimberly Ann Elliott, and Barbara Oegg found that sanctions are least effective, in the sense of changing a target’s behavior, when levied against autocratic regimes. As the political scientists Jean-Marc Blanchard and Norrin Ripsman put it, sanctions are most likely to work when executive autonomy is limited or when the head of state is answerable to other government branches capable of channeling popular disaffection. The United States has repeatedly directed sanctions and related economic instruments against autocratic regimes, including in China, Cuba, Iran, Iraq, and Russia, among other states. It is not surprising that these efforts have met with limited success.

A further limitation of sanctions, when levied against an important and interconnected economy, is that they inflict damage that reverberates well beyond the targeted country. The EU, for instance, was initially reluctant to sanction Russian banks during the early stages of the Ukraine crisis for fear of harming its own banks that have claims on the country. Germany has likewise resisted banning imports of Russian natural gas for fear of causing a domestic recession.

Building the Nord Stream 2 gas pipeline near Kingisepp, Russia, June 2019

Anton Vaganov / Reuters

Moreover, the impact of many economic measures may also be constrained by the adaptability of the global economy. The effect of a European ban on Russian oil and gas would be limited insofar as energy exports could be rerouted, via tanker or pipeline, to countries not participating in the ban. Russia could ship additional natural gas to China, which is not a party to the sanctions regime, through the Power of Siberia pipeline, the existing natural gas link between the two countries, which was running at less than full capacity before the war. China and Russia have also reached a 30-year deal in which Russia will supply gas to China via a new pipeline—an agreement they formalized when Putin met with Chinese President Xi Jinping during the Beijing Winter Olympics, just days before Russia launched its attack on Ukraine. The deal will have clear geopolitical consequences: China will rely more on Russian energy imports and less on Middle Eastern supplies, whereas western Europe will increasingly look to the Middle East, instead of Russia, to meet its energy needs. But thanks to China, the impact on the Russian economy of a European embargo on Russian energy will be limited.

Commodities at large, beyond oil and gas, are fungible: they can be bought and sold on different markets. The implication is that economic power will be effective only when the countries exerting it form an encompassing coalition—a trick that is easy to attempt but hard to pull off. Although holdouts offering the targeted country alternative sources of supply or demand can be threatened with secondary sanctions, their application would risk igniting a two-front economic war. This could inflict yet more damage on the sanctioning countries.

It helps, of course, when a commodity required by the sanctioned country has only a small number of sources and when the governments of those source countries are allied. Advanced semiconductors and the equipment needed to produce them, for instance, can be sourced only from the Netherlands, South Korea, and Taiwan. Earlier this year, the U.S. Treasury Department worked hard to ensure that their governments were onboard with its sanctions on Russia. (It didn’t hurt that Russia was only a minor market for these places.) But whether lack of access to the latest generation of semiconductors will be enough to effect a change in Russian foreign and military policy is questionable. Sometimes, in a pinch, less advanced semiconductors sourced from other countries will do, as U.S. automakers learned during supply chain disruptions in 2021. This option suggests that even concentrated economic pressure can have limited bite.

hitting a wall

Other developments in the economic war against Russia similarly illustrate the limitations of economic power, given the increasingly multipolar structure of the world economy. Take, for instance, the ban on Russian banks from SWIFT, the communications network that financial institutions use to transmit information about transfers, transactions, and payments. The political scientists Henry Farrell and Abraham Newman, in their work on weaponized interdependence, celebrate SWIFT as an example of how certain states are able to leverage interdependence to coerce others. They observe that SWIFT is an all but exclusive conduit for instructions regarding cross-border financial transfers. Banning a country’s banks, therefore, makes it difficult to pay for imports, whatever their source.

The United States, Farrell and Newman observe, is better able than other countries to wield authority over SWIFT and leverage it as a tool of economic might. U.S. financial institutions are its largest set of national shareholders. The single largest share of bank-to-bank financial transfers is conducted in dollars and therefore involves U.S. banks. SWIFT operates data centers in the United States, exposing it to the long arm of the U.S. legal system. U.S. sanctions against SWIFT itself, which Congress has threatened in the past, would pose an existential threat to the network. Smaller, less financially consequential states, in contrast, find it harder to bend SWIFT to their will. Farrell and Newman therefore refer to SWIFT as an “asymmetric network structure.”

Policymakers continue to believe in the potential of economic pressure to sway foreign regimes and actors.

As they also observe, SWIFT is not an intergovernmental agency, as is the case, for example, with the Universal Postal Union. Rather, it is a cooperative of private financial institutions. Those private-sector entities regulate its economic power. Governments can enlist firms to do their bidding, of course. In wars, they do so by executive order. But whether they can order firms to stop doing business in a country because of, say, unsavory factory conditions or human rights violations is less certain. Whether companies will comply voluntarily is also unclear. Firms like keeping costs down. They find it difficult to seek new sources of products—thereby incurring higher costs—when their competitors fail to do the same.

This last observation points to a key difference between military power and economic power: military power is concentrated, whereas economic power is disbursed. Armies are hierarchical. Soldiers follow commands from superiors. Battalions are instructed on how to coordinate. Market economies, on the other hand, are decentralized. Companies and households make decisions based on prices, profits, and values. When executives do not believe it is in their firm’s interest to help the state in, say, ousting objectionable leaders or discouraging their foreign adventures, they are unlikely to contribute to their government’s effort to leverage economic power to these ends.

At the same time, executives care about their company’s image, and they are often willing to exert their own economic power against foreign actors to protect their company’s reputation elsewhere. Numerous companies terminated their business in Russia following Putin’s invasion of Ukraine—less, one suspects, out of sympathy for the besieged residents of Mariupol than for fear of how their customers would react to their profiting from continued Russian operations. The Russian case highlights an important point: economic power in the age of social media is rooted in public opinion and in consumers’ purchasing power. A government that is unable to maintain popular momentum for a military campaign will likely be unable to sustain that campaign indefinitely. Public support is, if anything, even more essential to efforts to deploy economic power effectively.

slipping through the net

But the ban on Russian participation in SWIFT also reveals how actors can circumvent dependence on global networks. Economies are flexible; banks and firms regularly seek ways to avoid economic pinch points and find substitutes for scarce inputs. Before SWIFT transmitted its first message, in 1977, banks sent transfer instructions by telegraph and telex systems. This equipment still exists today, as does the Internet. Although these means of communication may be more costly and less secure than SWIFT, they can still be used to carry out the work of verifying details about consumer accounts and transmissions of funds. Iranian banks, for instance, remained able to do business with foreign banks, albeit at a cost, when they were cut off from SWIFT in 2012. Without other punitive measures, Russian banks will likely be able to do the same.

Moreover, the governments of countries cut out of these networks, and other governments simply wary of suffering the same fate, can invest in alternatives. Aware of its dependence on SWIFT and the dollar, China has been promoting the cross-border use of its currency, the renminbi, and developing an alternative to SWIFT and Western bank clearing-houses known as the Cross-Border Interbank Payment System (CIPS). To the extent that it succeeds, China, and potentially other countries, such as Russia, will be able to conduct international transactions in renminbi and transfer funds between domestic and foreign banks using a platform operated by the People’s Bank of China. This practice will eliminate the ability of the United States to use SWIFT to glean information about these countries’ cross-border transactions and to impose costs on a country’s banks and those doing business with them.

The headquarters of the People’s Bank of China, Beijing, May 2022

Jason Lee / Reuters

The People’s Bank of China has been working to develop CIPS into a real alternative to the West’s dollar-based clearing system since 2015. Seven years later, however, China’s system is still far from an adequate substitute. The main U.S. clearing-house for large banking transactions, the Clearing House Interbank Payments System, known as CHIPS, processes 40 times as many transactions by value as does China’s alternative and has nearly ten times as many participants. Despite the Chinese authorities’ efforts to encourage cross-border use of the renminbi, the currency still accounts for barely two percent of global payments, a fraction of the dollar’s 40 percent share. Ironically, these facts are known because CIPS still relies heavily on SWIFT’s messaging system to send instructions regarding funds transfers to and from banks outside China. CIPS’s potential should not be underestimated, however. Eventually, banks will install digital translators enabling them to use CIPS’s Chinese-character-based messaging system, but that will take time. Similarly, the renminbi may one day come to rival the dollar as a vehicle for cross-border payments, although that may take decades.

Still, governments’ attempts to use existing networks and institutions to project economic power will cause rivals to redouble their efforts to develop alternatives. This is not an argument against relying on economic instruments. But it is a reminder that governments wielding their economic power aggressively will see others investing even more heavily in arrangements that render those instruments less powerful in the future.

Don’t Bank on it

Policymakers continue to believe in the potential of economic pressure to sway foreign regimes and actors. Successive U.S. administrations, for instance, have deployed the United States’ economic might in an effort to influence Chinese policy. The Trump administration slapped tariffs on Chinese goods to browbeat China into increasing its purchases of U.S. agricultural products. The Biden administration followed President Donald Trump’s lead, prohibiting sales to China of high-tech equipment that could be used for surveillance purposes. In 2021, President Joe Biden issued an executive order denying 59 Chinese defense and surveillance technology firms access to U.S. investment in an effort to discourage the Chinese government from engaging in foreign intelligence activities abroad and committing human rights violations domestically.

The one thing these initiatives have in common, besides seeking to leverage economic power, is their failure to induce discernible changes in Chinese policy. A study by the economist Chad Bown concluded that Trump’s tariffs and the subsequent trade deal with Beijing led China to purchase exactly zero additional U.S. agricultural exports or any other extra U.S. exports. Denying China access to advanced U.S. technology has not prompted Beijing to back away from its surveillance activities. Prohibiting U.S. investment in defense-linked Chinese firms has not led China to modify its military posture, be it toward Taiwan or more generally.

Counterfactuals are difficult. One can imagine that Beijing would have imported even less from the United States, that its human rights violations would be even more egregious, and that its military posture would be even more aggressive had the United States not used its economic power. But even if that is true, the best that can be said for these policies is that they prevented bad situations from getting worse.

Perhaps it is unrealistic to expect economic instruments to bring about sharp changes in a strategic adversary’s policies within a short period. Gelb, in Power Rules, cautioned that economic power does not produce results expeditiously. “Economic power functions best when you permit it to proceed slowly,” he wrote, “allowing it to act like the tide.” Armies can employ blitzkrieg tactics, but treasury departments must eschew quick victories and stay the course.

The main threat to effective U.S. economic power comes from the United States itself.

Economic power may also be more effective at encouraging behavioral and policy change when it takes the form of positive incentives and rewards for potential allies rather than sanctions and punishments for rivals. The Marshall Plan is the prototypical example of how economic resources can be used to encourage governments and societies to affiliate with a particular economic and geopolitical camp and align their policies accordingly. Trade deals may foster deeper economic relations among the signatories but also encourage closer cooperation on other, non-trade-related matters. China is vigorously pursuing such policies: witness its Belt and Road Initiative, designed to spread its foreign investment around Asia and the world, and its participation in the Regional Comprehensive Economic Partnership, a market-access agreement that includes 15 Asia-Pacific countries but excludes the United States. The United States can and should exert its economic might for similar ends; if not, it may see its own power dwindle.

Thus, the main threat to effective U.S. economic power comes from the United States itself—from the danger that the country will once again turn inward economically and politically, as it did starting in 2017. Foreign trade and investment have always been a source of strength for the U.S. economy, and a country that is not economically strong cannot effectively wield economic power. At the same time, it is important to recognize that there is no fundamental reason why the United States should continue to play the dominant economic role that it did after World War II. Emerging markets will continue to emerge: a number of economic and demographic factors indicate that the United States will account for a shrinking share of global GDP over time. To effectively exercise economic power, therefore, the country will have to coordinate with others—as it has done recently by cooperating with the Netherlands, South Korea, and Taiwan on banning advanced semiconductor sales to Russia.

The future of U.S. economic power will hinge, in large part, on whether there is cooperation between the United States and the single biggest emerging market, China. Chinese banks appear to have acceded to Western sanctions barring business with Russia, presumably for fear of provoking secondary sanctions. This result is an indication that economic power can be effective when it has a very specific focus—in this case, limiting a specific set of transactions, namely those by banks, with a specific country. It is also a reminder that the United States derives much of its economic power from its engagement with the rest of the world. China’s banks—and government—fear secondary sanctions precisely because business with their Western counterparts is so extensive and economically important.

The application of such secondary sanctions—or, more alarming, a direct confrontation over Taiwan, leading to broader U.S. sanctions against China—could cause that interdependence to unravel. China would retaliate with sanctions of its own, redouble its efforts to create self-standing economic and financial institutions, and demand that countries in its orbit operate exclusively through its institutions. The United States and its allies would presumably do likewise. U.S. economic leverage over China would diminish if the world bifurcated into rival camps, decreasing global interdependence.

And that would be the least of Washington’s worries. The unraveling of global supply chains would place the U.S. economy at risk. Were China to liquidate its dollar reserves, possibly in anticipation of the imposition of U.S. sanctions, it could precipitate a global financial crisis of unprecedented proportions. To ward off those disasters, Washington would do well to remember that there is power in numbers and that the road away from interdependence is a dead end.