US sanctions and Chinese countermeasures related to the situation in Hong Kong threaten to ignite the tinderbox of US-China economic relations. That potential conflagration could soon endanger not only bilateral trade and finance but also cooperation to counter global warming and nuclear proliferation. Yet officials in both countries, along with business leaders, seem complacent about the risks inherent in escalating the US-China sanctions war. Neither side is likely to give in to the other's economic pressure, but both need to temper and contain the scope of their escalatory actions.
As discussed in a recent PIIE Policy Brief, the new Chinese anti-sanctions law bars Chinese nationals from complying with US sanctions. That law, promulgated by the National People's Congress (NPC) in June 2021, may soon be applied to individuals and firms doing business in Hong Kong. The NPC will shortly consider appending it to the Hong Kong Basic Law, handing a powerful tool against those seeking to maintain Hong Kong as a special administrative region for legal and economic matters. Threats and denunciations in the West have done little to deter China's growing dominance over Hong Kong's Legislative Council and legal system, eroding the "one country, two systems" guarantee in the 1984 Sino-British Joint Declaration.
Chinese responses to US sanctions had been relatively low key partly because most US sanctions against China involved violations of US secondary sanctions against North Korea and Iran and were limited to the imposition of fines against the guilty parties. That playbook has changed as Chinese policies in Xinjiang and Hong Kong increasingly have become the primary target of US sanctions. US officials, invoking the Hong Kong Autonomy Act of 2020, the Global Magnitsky Act, and various executive orders, have increased the number of Chinese and Hong Kong individuals and entities subject to trade, finance, and travel sanctions over the past year.
In turn, Chinese officials have begun to upgrade their sanctions arsenal. In September-October 2020, China amplified its existing "Unreliable Entity List" and Export Control Law, akin to those administered by the US Commerce Department and used to restrict trade with Chinese firms. These measures were supplemented in January 2021 with new Chinese sanctions blocking rules, subsequently embodied in the June 2021 anti-sanctions law, to force Chinese nationals not to comply with US and other foreign sanctions. Then soon after the Biden administration issued a business advisory warning on July 16, 2021, about "growing risks" for US companies doing business in Hong Kong, China announced that it plans to incorporate the new anti-sanctions powers into Hong Kong law, which reportedly will be done by the NPC Standing Committee when it meets on August 17–20, 2021.
The prospect for success in changing the other's policies via sanctions is remote. Sanctions rarely "work" (meaning contribute at least modestly to a change in the target's policy) in cases seeking major changes in the target regime's policies. But both the United States and China seem intent on using them with increasing frequency against each other.
Hong Kong: Will US Sanctions Boomerang?
Sanctions often generate unintended and costly consequences. Two troubling developments regarding Hong Kong already have arisen in the wake of the tit-for-tat US and Chinese sanctions. First, US sanctions have abetted an accelerated push by Chinese leaders to remove the veneer of independent administrative and legal practices that have provided Hong Kong its special status since China took back control of the territories from the United Kingdom in July 1997. Second, China adopted a new law barring Chinese nationals (including foreign firms invested in China) from complying with foreign sanctions, which will soon be enforceable in Hong Kong.
The Trump administration removed Hong Kong's special customs status in response to the imposition of the national security law. US officials seemed to have calculated that US trade sanctions would bite and that Beijing would not risk undercutting Hong Kong's status as an international financial center by imposing more control on its legal and political system. They misread the situation: The US action had minimal impact on US merchandise trade with Hong Kong; US firms don't buy much that is produced in Hong Kong—most goods shipped from Hong Kong are re-exports subject to US customs duties applied to their originating countries. Moreover, Hong Kong had long since become a services economy rather than a manufacturing hub, and its value as a financial center depends increasingly on access to Chinese capital markets.
Removing Hong Kong's special status worked at cross purposes to US interests. The US action did little to punish China, and Chinese officials continue unabated in their goal of accelerating Hong Kong's immersion in the Chinese mainstream.
In addition, US sanctions against Chinese "domestic" policies led China to promulgate its own anti-sanctions law. When annexed under the Hong Kong Basic Law, another area of nationwide Chinese policies will become Hong Kong law without action by the Hong Kong Legislative Council, just as occurred with the national security law in 2020. And like the national security law, the anti-sanctions law will likely be enforced and litigated increasingly strictly by Hong Kong authorities and courts consistent with policy directives from Chinese Communist Party officials.
Financial firms that fund and help execute trade and investment in China have so far avoided being hit by the sanctions tussle and are surprisingly complacent about the current business climate. But the risk is growing. International financial firms operating in Hong Kong will be increasingly vulnerable to US penalties as more of their Chinese clients are targeted by US sanctions. And then they will also come under the threat of Chinese countersanctions, unless they ignore foreign sanctions targeting Chinese nationals and take their chances with US sanctions enforcers.
Clash of the Sanctions Titans?
Tit-for-tat sanctions are likely to be the new normal in US-China relations. The imposition of sanctions is built into US trade and export control laws, and Congress is in no mood to lessen the pressure of such actions against China. And now China seems determined to reciprocate in kind with the new legal authorities wielded by officials in both Beijing and Hong Kong. And as the sanctions war escalates, so too does the risk that financial institutions will be caught in the sanctions' web of one or both countries.
Sanctions have made doing business with China more complicated and costly. US sanctions and China's new anti-sanctions policy are likely to force firms operating in China to pick sides: us or them. Some will comply with Chinese laws and forgo the US market; others will leave the Chinese market. High tech firms already are facing this commercial reality and restructuring their supply chains. If financial institutions are forced to exit the US or Chinese market because of sanctions policies, the collateral damage to trade and investment will increase.
One would presume that neither side wants a sharp decoupling of their economies, though rabid political voices in both countries are trying to incite that outcome. Both are worse off in economic terms with the escalation of tit-for-tat sanctions. But neither side is likely to shift its policies in the face of economic coercion by the other; each will likely accept increased economic costs in defense of its strategic interests.
Can the escalating cascade of sanctions be contained or restrained before the measures rupture economic relations critically important to both countries and their trading partners? More is at stake than bilateral and regional commercial relations; the ongoing sanctions war also complicates the task of the two superpowers working together on climate change, nuclear nonproliferation in Asia, and responses to the current and future pandemics. Thus, a counsel of caution is in order; US and Chinese officials should be very careful about how they escalate sanctions against each other.
Before the two powers embark on another costly clash, they should consider other strategic responses as a complement or substitute for sanctions. China is already doing so by aligning more closely with Asian neighbors in the Regional Comprehensive Economic Partnership and its Belt and Road Initiative. The United States could follow that example and support the accession of more democratic nations to its original Trans-Pacific Partnership and should consider—to strengthen relations with strategic allies in the region—a return to the pact in 2022.
1. Under Article 18 of the Hong Kong Basic Law, Chinese national laws only apply to Hong Kong if listed in Annex III. Such laws must relate to "defense and foreign affairs as well as other matters outside the limits of the autonomy of the Region as specified by this Law." Annex III has been updated numerous times since July 1, 1997, most recently in June 2020 to cover the new National Security Law approved by the National People's Congress.
2. To be sure, bilateral tensions flared sharply when US officials pressed for the arrest and extradition of Meng Wanzhou, CFO of Huawei, at the Vancouver, Canada airport on December 1, 2018, for circumventing US sanctions against Iran.
3. US sanctions against Chinese officials and companies doing business in Xinjiang are likely to continue, given the grave nature of the US indictment, which Hendrix and Noland discussed extensively in a recent PIIE Policy Brief. In this blog, I focus on the situation in Hong Kong.
4. Under the United States–Hong Kong Policy Act of 1992, the United States recognized Hong Kong as semi-autonomous from Beijing with respect to its legal and economic system and granted it special status under US customs, trade, and immigration policies.
5. The US action effectively united Hong Kong and Chinese trade under the same umbrella with respect to the administration of US import and export policies (probably in contravention of US obligations to Hong Kong under the World Trade Organization).
6. The Hong Kong Autonomy Act mandated that a specific list of sanctions be imposed over a two-year period against individuals and foreign financial institutions involved in the passage and implementation of the national security law.