Hope for the Best, Prepare for the Worst: How the European Union Can Address China's Economic Coercion

Europe

Author

Luke Patey

Senior Researcher, Danish Institute for International Studies

Europe and Economic Coercion

As the European Union designs and deploys its anti-coercion instrument to hamper initiatives by other big powers to limit its trade, Luke Patey, Senior Researcher at the Danish Institute for International Studies, walks us through the lessons the Union can take from the way other countries tackled coercion, to render this instrument effective for the future. This article is part of our series of four analyses on EU anti-coercion efforts.

The European Union's anti-coercion instrument is in the works. Its aim is to deter and counter trade weapons harnessed by China, the United States, and other outside powers with the threat of retaliation through tariffs, customs duties, and other measures. The negotiation of the Commission’s proposal within the European Council has exposed divisions between Member States on how the new tool should work. Some have called for decision-making on retaliation to be centralized in Brussels with the aim of maximizing deterrence through the threat of a swift and strong response. Others have advocated that Member States maintain control and limit any response to avoid escalation.

The Council’s version of the EU's anti-coercion instrument is the result of these differences in views. But once the instrument is formally operational, the EU and its Member States will still have difficult choices to make in face of future coercive behavior. Even if Brussels holds onto control and establishes an ambitious schedule in responding to coercion, it will still take time to assess and react. If deterrence fails and diplomacy falls short, by the time the EU prepares its retaliation, severe damage could already be done to European targets. In contrast, if Member States maintain control, the process could become even more convoluted. Those European capitals calling for restraint today might change their views on retaliation and compensation if they themselves become future targets.

The anti-coercion instrument may prove useful, but the EU and its Member States will need to consider complementary measures to soften damage inflicted by outside pressure. To this aim, it is instructive to assess what lessons the EU can learn from how others have handled coercion. China's recent trade pressure on Canada, Australia, and other countries can help the EU understand the challenges that lie ahead and help strengthen its response. Such cases suggest the need to develop shock absorbers, methods of evasion, and countermeasures against a combination of economic and political coercion.

Assessing the damage (or lack thereof)

First, despite Beijing’s accelerated use of economic coercion over the past decade, its own dependencies and the interconnectedness of global markets, have to date limited the impact of its trade weapon. Canada serves as a revealing case study. After Canadian authorities arrested Huawei executive Meng Wanzhou in late 2018, Chinese authorities detained two Canadian nationals and placed trade bans on select Canadian canola seed exporters and other agricultural goods. But after fearing the worst, between 2018 and 2020, Canada's exports to China fell by only CDN$2.5 billion, representing roughly 0.4% of Canada’s total goods exports.

The limited impact of China's economic coercion on Canada and Australia is first and foremost the result of Beijing’s strategic restraint in wanting to avoid strongly harming its own economy.

Then, there is Australia. In 2020, after Canberra’s call for an independent investigation into the Covid-19 outbreak, Beijing put a barrage of trade measures on Australian barley, beef, wine, lobster, copper, and other goods. Tens of billions of dollars of trade were under pressure, but after a full year of facing China’s restrictions, the Australian Treasury only pointed to losses of around AU$1 billion, less than 0.2% of Australia’s total goods exports the previous fiscal year. More recently, some see China’s coercion as providing unexpected benefits in helping Australia diversify both its export and import dependencies on the Chinese market.

The limited impact of China's economic coercion on Canada and Australia is first and foremost the result of Beijing's strategic restraint in wanting to avoid strongly harming its own economy. Chinese officials may be more preoccupied than ever with policing a growing number of redline issues, but Beijing's recent use of economic coercion demonstrates adherence to a "do no self-harm" approach.

For instance, Canada is the world’s largest producer of canola and a major agri exporter. Despite seeking to diversify its food dependencies through the Belt and Road Initiative, China's position as the world’s largest canola importer makes turning its back on Canada quite difficult in the short term. As a result, Canada's overall exports to China already began to recover in 2020 and Beijing dropped its canola seed ban in mid-2022. Neither did China touch Australian exports of iron ore or liquified natural gas to the mainland. These sales are vital for China’s construction industry and energy interests.

Then there is the fungibility of commodities targeted by China. For Canada, over half of the canola seed tonnage loss from Beijing's ban was offset by exports heading elsewhere. Exporters, farmers, and the industry took a financial hit. Other international buyers however - once customers of Beijing's new suppliers - partly lessened the damage of China's coercion by purchasing Canadian canola seeds. For Australia, many of the targeted exports to China have not yet recovered to pre-coercion 2020 levels, but similar to Canada, the loss has been largely counterbalanced thanks to the fungibility of Australian natural resource commodities, such as coal, flowing to other markets across Asia.

The many effects of coercion

Canada and Australia’s experiences should not lead decision-makers in Europe to neglect the potential impact of Chinese economic coercion. Targeted companies and industries do suffer from Beijing’s coercion. They may in turn try to leverage their broader importance in national economies to lobby their home governments to adjust their positions on China.

In 2009, for example, after Denmark's Prime Minister Lars Løkke Rasmussen met with the Dalai Lama, Beijing quietly froze Danish shipments at Chinese ports. A group of 40 Danish export companies then approached the government to express their concern. Denmark later penned a verbal note acknowledging China’s core interests and explicitly stated its opposition to Tibetan independence.

There are also abstract, unseen effects from China’s economic pressure. Coercion can have a demonstrational effect on other governments, industries, and companies, pushing them to pre-emptively adhere to Beijing's foreign policy redlines and limiting their own decision-making independence. Today, the Dalai Lama is rarely a guest of European and other international leaders. Even the small and short-term effects of Chinese trade coercion caused many to dutifully avoid crossing China's redline on Tibet.

Even the small and short-term effects of Chinese trade coercion caused many to dutifully avoid crossing China’s redline on Tibet.

There is moreover an emerging network effect of China's economic coercion. Late last year, after opening a Taiwanese representative office, Lithuania faced a number of measures from Beijing, including its complete removal from China's customs registry. China also instructed multinational corporations to sever their supply chain links with the Baltic state, or else face expulsion from the Chinese market. Some companies, such as German tire-maker Continental, continue to invest in Lithuania, but it is difficult to assess if other European firms decided to avoid new ventures due to China’s coercion, a result which would distort investments in the EU's common market.

Learning to resist

China's economic coercion may also escalate in the near future. Since Beijing's economic policy aims to lower its dependencies on advanced economies, such as those in Europe, it may become more willing to exert such pressure to advance political aims. Political expediency may also simply begin to override economic pragmatism, particularly over issues such as Taiwan, and Beijing may move away from its "do no self-harm approach." China may also increase its use of a broader array of coercive tools, including export controls on processed rare earth elements and other goods. The EU must assess its preparedness for the outcome.

First, the EU should consider the use of short-term shock absorbers. These can come in a variety of forms but are typically financial support to targeted industries. For example, Canada provided credit insurance and increased advance loan programs for affected canola producers and farmers. With the EU's approval, Lithuania opened new access to finance for companies affected by China's trade measures.

Policy, regulation, or even legislation, can encourage companies, particularly in critical industries, to develop specialized mitigation strategies to dampen future risk from coercion.

There are, however, moral hazards in providing such compensation. The EU may not be so ready to aid European businesses that wilfully invest and become deeply dependent on the Chinese market, well aware of the existing political risks. Similarly, EU Member States may not be eager to back one another up if this means suffering an economic loss from China, particularly if control of the anti-coercion instrument lies in EU capitals and there is disagreement on China policy. Policy, regulation, or even legislation, can encourage companies, particularly in critical industries, to develop specialized mitigation strategies to dampen future risk from coercion. The EU should also incentivize diversification strategies among industries heavily reliant on the Chinese market.

Second, the EU can learn from methods of evasion undertaken by targeted industries. Third market circumvention can soften the blow of Beijing's coercion. For example, when Norway faced a Chinese ban on its salmon exports, the sanctioned fish found its way to Vietnam before landing on Chinese tables. China is no monolith of flawless top-down command and control. Although large Chinese state-owned agri importers shunned those Canadian canola exporters banned by Beijing, smaller, privately-owned Chinese importers engaged Canadian sellers. Some Canadian canola seeds were sold to the United Arab Emirates before they were crushed into oil and exported to China. In Australia, beef producers targeted by China sent their cattle to other slaughterhouses still holding export licenses. It is a similar counterbalance and circumvention that challenges the effectiveness of Western sanctions against Russia, Iran, and others.

Third, the EU may be forced to respond to a combination of economic and political coercion. During its six-year dispute with China, Norway was less concerned with the loss of salmon trade as it was with the lack of diplomatic contact it had with its Chinese counterparts on global issues such as climate change and United Nations reform. Canada also faced a combo of economic and political coercion. In response, Ottawa went ahead with a World Trade Organization case against China’s trade measures and launched its international declaration against arbitrary detention, but these actions came well after China’s initial coercion.

Finally, sharing information among partners is essential in understanding how shock absorbers, methods of evasion, combining economic and political countermeasures, and other responses can diminish the impact of Chinese coercion. The EU's recent anti-coercion instrument proposal called for a resilience office to gather information and make an analysis to determine if economic coercion is taking place. The same office could also internationalize its information sharing and learning through the G7 or another international body with North American, Asian, and other international partners.

The EU can hope for economic pragmatists in China to limit the impact of its future coercion, but in designing and deploying its anti-coercion instrument, it also must prepare for politics to take full command in Beijing.

Copyright: Axel Heimken / AFP