As the experience of sanctions against Russia has shown, when a major national economy has a high level of integration into the global economy, the implementation of a sanctions regime is not only challenging but also leads to significant blowback. It is precisely this effect that the authors of the Atlantic Council report, 'Sanctioning China in a Taiwan Crisis: Scenarios and Risks,' attempt to assess, and their findings are highly unfavourable.
The authors of the report note that the imposition of sanctions on the Chinese economy may be triggered not only by a military invasion of Taiwan but also by Beijing's hostile behaviour unrelated to military actions, such as a blockade of maritime and air routes, major cyberattacks disrupting telecommunications networks, and so on. According to the Atlantic Council's estimates, a blockade of Taiwan could inflict damage on the global economy in excess of $2 trillion per year and could also cause widespread commodity shortages, mass unemployment, and a financial crisis.
In the event of a serious escalation, the G7 will be forced to impose sanctions against China, targeting 1) its financial sector, 2) individuals and entities associated with the country's political and military leadership, and 3) industries related to its military sector. However, given that China is the world's second-largest economy (surpassing the Russian economy by a factor of 10) and the global leader in trade volume, such sanctions threaten to bring colossal global costs.
China ranks eighth and ninth in the world in terms of the overall volume of external assets and liabilities. As of the end of 2022, China held 95% of its reserves, amounting to $3.3 trillion, in foreign currencies (the remainder in gold). The composition of foreign currency assets is not reliably known, but at least $1.1 trillion was invested in US government bonds. China's banking sector has cross-border assets worth $1.5 trillion, the majority of which are held in the currencies of G7 countries. 77% of China's total trade in goods and services is conducted in currencies other than the yuan, primarily in US dollars and euros. Chinese banks process cross-border payments through correspondent accounts in Western banks. This determines China's dependence on the global financial system, but at these volumes, the inverse dependence also reaches enormous proportions.
Experts at the Atlantic Council consider two potential scenarios for sanctions against the Chinese financial sector. In the first scenario, limited sanctions would be imposed on a small bank or a group of banks associated with China's military or technological industries. This approach has been previously adopted by Washington in 2012 when the US Treasury Department imposed sanctions on the Chinese Bank of Kunlun, which provided financial services to six Iranian banks already under American sanctions. The US later excluded the Chinese Bank of Dandong from the international dollar financing system because it had assisted North Korea’s circumvention of sanctions. Although both banks were cut off from the dollar financing system, they maintained connections with the rest of China's banking sector, allowing them to continue providing financial services to entities under US sanctions. Policymakers would face a similar problem in the event of a Taiwan crisis. Sanctions of this nature are unlikely to have an impact.
The second scenario envisages the United States and its allies imposing comprehensive sanctions, such as denying access to SWIFT for the People's Bank of China, the Ministry of Finance, and the 'big four' Chinese banks, which collectively account for one-third of all banking assets. This would effectively freeze China's foreign currency reserves held in overseas accounts alongside a significant portion of the Chinese banking sector's foreign assets, to the tune of at least $586 billion. In turn, China would freeze the (relatively small) G7 bank assets held in yuan and, due to a sudden shortage of foreign currency, Chinese banks would likely default on G7 bank debt obligations, totalling approximately $126 billion. Trade and investment flows amounting to around $3 trillion would be at risk. In the short term, this would deal a serious blow to a substantial portion of China's exports, lead to a devaluation of the yuan, and impact the currencies of some developing countries.
This second option involves financial sanctions against Chinese government, party, and military officials, as well as associated members of the elite. However, assessing the scale of foreign assets subject to such sanctions is extremely challenging, as these assets are managed by third parties who make investments through offshore entities.
According to Bloomberg, as of 2012, the family of Xi Jinping owned foreign assets worth over $400 million, and the New York Times reportedthat former Chinese Premier Wen Jiabao and his inner circle had foreign assets totalling $2.7 billion. Based on these figures, analysts estimate that the sanctioned assets of the Chinese elite could be worth tens of billions of dollars. If businesspeople associated with the Chinese Communist Party and the armed forces are included in the sanctions list, the volume of assets subject to sanctions could sharply increase. The fortunes of the 200 wealthiest individuals in China are estimated at $1.8 trillion.
The most likely scenario, according to experts at the Atlantic Council, is an asset freeze and travel bans for a select group of Communist Party, government, and military officials directly responsible for the escalation. However, the effectiveness of such restrictions is likely to be low, as most or all of the sanctioned officials will likely remain loyal to Beijing’s official line. A more effective approach may involve the inclusion of a much broader range of party, government, and military officials, as well as the business elite, in the sanctions list, freezing their assets, and restricting the provision of professional and financial services to them, including asset management and business consulting. This approach could be more impactful than in the case of Russia since Chinese officials would have less time to adapt to these restrictions. However, even in this scenario, there is no certainty that the sanctions would compel Chinese elites to exert any influence on Beijing's policies.
The third approach involves exerting pressure on Chinese companies or industries related to the military-industrial complex. While Chinese companies engaged in dual-use technologies are already subject to sanctions and export controls, additional restrictions could target other sectors critical for China's defence industry, including chemicals, metallurgy, electronics, and aviation. These sectors collectively contribute over 10% to China's GDP, generate more than $6.7 trillion in annual revenue, and employ over 45 million people. Notably, G7 countries account for 43% of China's exports in these sectors. In 2018 alone, these industries imported goods worth $686 billion and exported nearly $1.1 trillion. Since 2000, they have received $107 billion in foreign direct investments from the United States, the United Kingdom, and the European Union, while Chinese companies in these sectors have invested over $179 billion overseas.
Conversely, the goods exported by G7 countries to support these sectors of the Chinese economy provide employment to approximately 1.3 million people in the G7 nations. Any sudden disruption of trade in these sectors would cause significant economic disruption. Modest estimates suggest that the volume of trade flows that could be affected by export controls in these sectors would amount to no less than $378 billion. Experts believe that the leaders of G7 countries would only resort to such trade restrictions in the most extreme circumstances.
A more likely scenario appears to involve targeted sanctions against specific companies or subsectors with a high technological dependency on G7 countries. The key characteristic of these restrictions would be their asymmetry, where Chinese companies would suffer more than Western economies. For example, restrictions could be imposed on Chinese aerospace companies such as AVIC and COMAC, which rely on foreign supplies of engines and components. This would jeopardise deals worth around $2.2 billion for parts supplies and would deal a blow to China's ambitions in the civil aviation sector. However, such actions would also have significant consequences for Western countries, as the export of aerospace products to China is valued at $33 billion.
Thus, traditional sanction strategies applied to smaller economies seem ineffective when applied to larger economies. The West should identify areas where China is more dependent on foreign goods, technologies, and finances than vice versa, and maintain communication with its partners in China, warning them in advance about the potential mutual harm that sanctions may cause.
The most stringent sanction scenarios look catastrophic in terms of their consequences. Even limited sanctions packages against Beijing would be difficult to coordinate. As Re:Russia has previously reported, European businesses and public opinion, in comparison to the United States, are more inclined to take a conciliatory stance towards China. At present, they appear divided on the issue of sanctions against the Chinese economy, even in the event of a significant escalation of tensions over Taiwan.