Deterring China from Attacking Taiwan: The Role of Economic Statecraft

Deanna Lee

You're listening to Policy Minded, a podcast by RAND. I'm Deanna Lee. Deterring China from attacking Taiwan is one of the most urgent challenges facing U.S. and allied policymakers.

Much of that debate centers on military power. But what about economic measures? If it seemed like China was really preparing to blockade or invade Taiwan, then could applying pressure through sanctions, trade restrictions, or other financial tools make Beijing reconsider?

That's the question at the heart of a recent RAND report. Joining us today are two of the authors of that report, senior economist Howard Shatz and political scientist Naoko Aoki. Howard, thanks for being here.

Howard Shatz

You're welcome. Thanks for having me.

Deanna Lee

And Naoko, welcome.

Naoko Aoki

Thank you for having me.

Deanna Lee

Okay, let's start with the scenarios that you looked at for this study. Can you take us through the hypothetical conflict you were assessing?

Howard Shatz

Sure. We looked at two conflict scenarios, and to design the scenarios, we looked at three levels of incentives. Why would China take military action? These levels were the global system level, basically the world, national level, and the individual level.

So scenario one is an island grab. China decides to embark on military action to take over one of the outlying islands of Taiwan. And to set up that scenario, we had an intensification of international disorder at the system level, greater U.S.-China tension—and at the national level in China—some radicalization of the Chinese Communist Party, increased criticism of China's leader, and greater divisions within society. And at the individual level, Chinese leadership, there was, we had a Chinese leader who still wanted to reduce tensions—global tensions—still wanted to get economic relations on track, but faced internal challenges. So that resulted in an aggressive island grab.

The second scenario is an actual invasion of Taiwan. And again, at the three different levels of incentives, at the system or global level, we said that what might set that up is severe economic disruption. Trade has broken down. China doesn't really see its national development strategies succeeding. At the national level, we would see radical changes within the communist party. Militants taking over, the whole party radicalized more. And at the individual level, it was hard to envision the current leader Xi Jinping embarking on this. There's always a chance he will, but in this scenario, we envisioned a leader unlike Xi Jinping. And these elements come together and result in an attack on Taiwan.

Deanna Lee

Okay, so island grab and invasion are the two scenarios we're talking about here. When people think about deterring something like this from happening, deterring China from moving against Taiwan, they usually focus on military actions. So why do economic measures belong in the conversation as well?

Naoko Aoki

Yes, I think there are a couple of reasons for that. And I would point out that economic measures are probably the first measures that countries are going to think about. A lot of countries have important economic relations with China.

So that is ... probably the measures to using those potential points of leverage ... will be something that the countries will think about first before going into military measures. So I would argue that this is a realistic study in a way.

Deanna Lee

And I want to be clear that we are talking about preemptive sanctions and economic measures because there's a big difference between punishing aggression after the fact and trying to deter it beforehand.

Naoko, you mentioned that this is a big decision for countries. Why is this such a difficult policy choice? Because it is something short of military force, but of course it has a lot of implications, I imagine.

Naoko Aoki

Yeah, there are a couple of reasons I will mention, too. One is because while China will probably retaliate, and that means that your economy—the country that initiated the sanctions—would likely be harmed as well. So that's reason one.

And the other element is, is it legal? If countries are to use economic measures preemptively against China, countries would want to assess any legal problems that may arise from such a step. So, in that sense, having multilateral support behind those actions would be an important factor for these countries.

Howard Shatz

Let me add two things to that, which make preemptive sanctions or preemptive actions so difficult. One is that the countries instituting preemptive actions have to believe that the target of the preemptive actions is going to act in a bad way, right? And intelligence is never certain.

So they want to know that, yes, China is going to take this military action and therefore it's worth doing the preemptive sanctions. The other is that, even if there's some doubt, if we preemptively sanction, we're the first mover. And that gives China or any other adversary (reason) to say, hey, you caused it, we didn't cause it.

You took aggressive action against us, we were only responding to you. So it could lead to unnecessary escalation, and that also makes the decision quite difficult.

Deanna Lee

Absolutely. Let's discuss U.S. leverage specifically. What are the economic options that the U.S. has to deter China from one of the scenarios you looked at?

Howard Shatz

The U.S. has an enormous number of options and the U.S. has the most economic power. Let's start with its economic power, the U.S. is the largest single nation economy in the world. And what is remarkable is that right now we are about 25 percent of the global economy, and with some ups and downs, we have maintained that since 1991.

Our share of the global economy has not shrunk. In contrast, the share of the global economy accounted for by our allies and partners has shrunk. The share held by … the European Union, the share of the United Kingdom, the share of Japan has all gone down. So we remain the dominant economic power.

Even China's share of the global economy, although it rocketed up, has actually declined in the past two years. So we have the largest economy, we have the dominant currency—dollars are used for reserves and for payments—for international payments. Our productivity is the highest of any major economy.

We're a major trading country, but relative to the size of our economy, we actually are quite insulated from the global economy relative to China and our other allies. So we have a lot of advantages to start with.

When we get into what we can do, we have a very well articulated playbook and the kind of broad categories—we can do financial sanctions, stopping other countries from using the dollar, right? And that can be very damaging. We can do export controls; we can stop other countries from being able to buy our goods.

And even third party, even second party, we can do secondary export controls—meaning that we can stop China from buying goods from Europe under certain conditions. We can ban trade, we can ban investment. So, there's really a huge portfolio of things that we can do, not necessarily that we should or will do.

Deanna Lee

And have we seen Washington use this playbook before? I'm thinking, for instance, about recent sanctions on Russia, even though I realize those were implemented both before and after the full-scale invasion of Ukraine. Maybe that's an example? Or there are other historical cases that offer useful lessons for a Taiwan contingency, specifically?

Howard Shatz

There are at least two cases. One is, as you said, the Russia case. And there we moved very aggressively and very deeply. We sanctioned their central bank. We sanctioned their sovereign assets. We sanctioned numerous people. We sanctioned numerous industries.

And early on, just after the full-scale invasion, we instituted very broad export controls over a number of technology items. In addition, we did this with dozens of other countries. So they were deep sanctions, they were multilateral, and some people will say they weren't effective.

It is true the war is continuing, but the sanctions have been very effective in degrading Russia's economy and actually hurting them over the long run. The other comparison might be the comprehensive sanctions on Iran. So, there again, multilateral sanctions—very deep—brought Iran to the negotiating table.

Now, there is one difference. Between those sanctions and sanctions on China. China is a much larger and much more important country than Iran and even Russia. China is deeply connected with the rest of the world. China dominates manufacturing trade, and many countries don't view China as an adversary.

Even if it were to embark on military activity, many countries want to benefit from relations with China. That wasn't necessarily the case with those other major targets.

Deanna Lee

And let's talk about current U.S. economic restrictions on China. How do those figure in here? And I'm also curious about what China's reactions to those restrictions and sanctions have been.

Howard Shatz

Since, at least since 2001, we've done a large number of measures—both cooperative and coercive on China. Lately, they've been much more coercive. Now, the cooperative measures have sometimes achieved some very small goals.

The coercive measures have also achieved some goals, but those coercive measures will also hurt U.S. companies or the U.S. economy—to a small degree or a large degree—and China will usually find workarounds. The area that we found to be most effective are the wave of semiconductor controls that started in 2023, but basically have their roots back to measures we took in 2020, right?

And that's when we instituted these secondary export controls using something called the Foreign Direct Product Rule. And what we found there is we have set back China's development of advanced semiconductors. So in that sense, they've been effective, but compared to what we would want to do in wartime, these are very low levels of sanctions.

The other thing we've done is the various tariffs we put against China have, in fact, reduced direct Chinese trade with the United States. So China used to be our number one source of imported manufactured goods. It is no longer.

Some of that China trade comes through other countries. Some of it, we're just not getting from China anymore at all. So that has also had some effect. But again, nothing compared to what we would wanna do in a wartime situation.

Deanna Lee

The report argues that sanctions alone are unlikely to deter China from an invasion or an island grab. So where do these tools fit in as a broader strategy for preventing conflict?

Howard Shatz

They are part of a broader strategy, and if you do it preemptively, they could do a number of things. The most important thing they would do, if you institute sanctions preemptively, is it would be a very strong signal to China that any military action on its part would be extremely costly.

So, if China is looking at a number of different options, and they see that the U.S. and its allies are very serious about inflicting economic pain, it could lead to changes in Chinese action. Now, suppose that they didn't work, suppose China invaded, did something for some reason.

Those sanctions would now be after the fact. They wouldn't be preemptive anymore, but they could still be used to degrade the ability of China to sustain its combat operations, such as by denying fuel, food. It could hamper the continued fight. It could hamper an occupation of Taiwan.

And in some ways it could make it so that China might win the military operation, but it doesn't get full benefit of that invasion. It is crippled in some way over the long term, and it would have been better not to do that invasion

Deanna Lee

Okay, let's move on to America's allies and what economic actions they might take. You look specifically at Australia, Japan, and the UK. Why these countries, and just give us a quick overview of their abilities to exert economic pressure on China.

Howard Shatz

So we chose those because the UK and Australia have been our closest allies in military operations throughout the 20th century and into the 21st century. They're also our closest allies in terms of cooperating on defense industrial base issues. We've moved shoulder to shoulder with them, and we would want their cooperation.

Japan is a more interesting case. Japan is also a very strong U.S. treaty ally and has close relations with Taiwan. And I think ... what we wanted to do ... Japan had been relatively unexplored. And so we really wanted an expert look at what Japan would do.

Let me talk a little bit about UK and Australia. And I don't wanna talk about Japan because we actually have that expert here. The UK and Australia can contribute to multilateral sanctions. Operating on their own, they are too small to have a large effect on China, and China could also exact retaliation on them.

They would need to be part of a broader coalition. That's how we would expect them to act.

Deanna Lee

And Naoko, as Howard mentioned, you have deep expertise in Japan, so let's stay there for a moment. Can you give us an overview of Japan's relationship with China? Just to have a better understanding of kind of where things would start.

Naoko Aoki

Sure. So Japan has a complicated relationship with China. So on the one hand, Japan has a robust interdependent trade and investment relationship with China that is important for the country's—Japan's—economic growth.

But on the other hand, Japan is deeply worried about Chinese actions, China's rapid military modernization, and country's activities in the region. So the Japanese defense white paper, for example, calls China the greatest strategic challenge for Japan.

So a potential Chinese attack on Taiwan is a top security concern for Japan, and the relationship is basically characterized by economic interdependence and political tensions.

Deanna Lee

And how might Tokyo respond if one of these scenarios that we've been discussing appeared imminent?

Naoko Aoki

Yeah, so we looked specifically at economic measures that Japan might take. So I'll first talk about what types of economic leverage that Japan has. There were several potential points of economic leverage.

The first is Japan's strong competencies in the advanced semiconductor manufacturing sector. So Japan, for example, it's an important source for equipment for extreme ultraviolet lithography coders and developers, which are important for the semiconductor sector. And it's also a major maker of semiconductor materials like silicon wafers.

So this is a potential leverage that Japan can use. Another potential leverage is the fact that Japan is an important market for China, so access to Japanese markets is another area that Japan can leverage.

But when Japan thinks about these things, it is also likely to balance ... potentially using the point of leverage as economic measures against China with various challenges. I'll note a couple. One factor Japan is likely to consider is whether these measures will be effective, because will the economic pain in one sector actually make China change its mind about invading Taiwan? That's one factor.

Another factor would be, as I said earlier, the economic concerns—economic retaliation from China. As I mentioned, Japan has an interdependent relationship—economic relationship—with China, so Japan could be hurt as well if it takes any measures.

The other important thing, and this is something that's not discussed very often, is the Japanese citizens, the presence of Japanese citizens in China. There are more than 100,000 Japanese citizens in China, in the PRC, and about 30,000 Japanese companies there. So the safety and security of these Japanese citizens will be a major concern for the Japanese government.

Deanna Lee

Absolutely. And, earlier, Howard mentioned that the UK and Australia would really need to act in concert with the U.S. What about Japan? Can Japan kind of exert these sanctions and restrictions on its own? Or, how important is it that it's in lockstep with the U.S. as well.

Naoko Aoki

Yes, that's a really important question. Japan can take unilateral measures. And there are some measures that Japan can take that is politically on the easier side for Japan.

And that would be focusing more on the safety and security of the Japanese citizens and protecting basically Japanese assets in the PRC. So, for example, issuing recommendations for Japanese businesses to leave China, or basically convincing Japanese businesses (not to make) new investments, for example. Those can be done, those could be unilateral. They are on the easier side for Japan to undertake, but it's also true that these are probably not likely to make China change its mind about invading Taiwan.

Japan is likely to strongly prefer taking multilateral economic measures against China. This is because this means that it's a stamp of approval from the international community, and that would help gain support from the Japanese public. Again, if this is to happen, and Japan would have to be ready for Chinese retaliation. So, you know, it's important to convince the Japanese public.

Another reason is because multilateral measures have a better chance of affecting the Chinese economy. I mentioned two potential points of leverage for Japan, but Japanese action alone is, I would say, unlikely to change the Chinese decisionmaking. But multilateral measures may have a better chance of doing so.

Deanna Lee

OK, let's kind of sum up what we've already discussed, because we've covered a lot of ground here today so far. What do you think economic tools can realistically do to deter China's aggression? And what can't they do?

Howard Shatz

Each of the countries we looked at has a certain amount of leverage. So, Naoko talked about Japan's leverage. Australia is a major resource exporter to China, and China needs those resources. The UK has research cooperation and a lot of Chinese students at UK universities.

So there are all these points of leverage, and you add that to the enormous U.S. leverage, then it looks like these countries can really cause quite a good amount of damage to China. But if China is intent on invading Taiwan, if Chinese leadership has decided that it is in Chinese national interest to do this, they will have prepared.

They will have stockpiled. They will have anticipated the variety of sanctions the United States will do. So if their decision is made, there's really very little—probably nothing—that preemptive sanctions can do to stop an invasion.

If their decision is made, then the sanctions or the economic measures really need to be tilted at things that would degrade China's ability to succeed after an invasion. Now, if China has multiple courses of action, if China values economic growth, if a military action would turn global opinion against China, hurting China's long-term prospects, then economic measures and sanctions could be a strong signal that China might consider other courses of action.

So there are potential situations where sanctions could deter, but if the decision is made, they really can't.

Naoko Aoki

I would add that there are also ways in which preemptive sanctions could be more effective. And the multilateral part is really important, because that does increase the chances of having the intended impact on the Chinese economy, and it would send a strong signal.

So I think stars have to align for this to work, in a way. So it depends on what the Chinese thinking is, and it also depends on what our actions would look like.

Howard Shatz

Let me add—so Naoko made a really important point about the multilateral coordinated action—we economically modeled 10 different sanction scenarios. And, to give you an example of where multilateral action makes a difference, if the United States and Taiwan alone sanction China, then yes, China gets hurt a little bit, its GDP goes down by about 1 percent a year.

And the United States gets hurt a little bit also, about 0.5 percent a year, right? It would decline. But, if all of the allies that we're talking about and the EU joined in very deep sanctions on China, China's GDP would decline by about 2.6 percent a year.

So much more than just U.S. and Taiwan, and the U.S. economy would decline less. And that's because all of these sanctioning countries would no longer be interacting deeply with China, but the interaction would be increasing among themselves. So Japan, the EU, the U.S., would all be relying more on each other.

And so this point—Naoko's point—about multilateral action is extremely important, as well. It would send a signal to the fence-sitters or to countries in Africa, Latin America, and the Middle East, that there is a united group of countries that will take action against this.

Deanna Lee

Okay, I want to touch on another point that both of you have brought up, and that's about China being prepared for this. How much of the deterrence equation comes down to China understanding what it can withstand economically?

Howard Shatz

China's ability to withstand economic pain is a very important element. And again, it will have prepared. I would expand beyond simply its immediate ability to withstand the economic pain.

I would also, however, look at the social dimension. That's part of withstanding the economic pain, but how much can the population bear? How much is the population willing to bear? And then I would also look at what might these sanctions mean for longer-term development—and for China's place in the world.

This is really what we're seeing with Russia. The very invasive sanctions on Russia—they're not complete, because we're allowing Russia to export its oil and gas—but the very invasive sanctions haven't stopped Russian military operations.

But they have degraded Russia's economy, and Russia's economic prospects going forward are quite poor. And it will be very hard for Russia to recover. It's falling behind the rest of the world across a number of dimensions.

China will need to take into account, is Taiwan so important to us that we want the risk of falling behind, degrading our ability to have long-term positive development? So that's kind of a broader picture of the point you made, which is the ability to withstand economically.

Deanna Lee

Now, I'd like to hear from both of you about what is your main recommendation for policymakers? What would you suggest that they consider doing now before any crisis does materialize to strengthen economic deterrence against China?

Naoko Aoki

I would mention two points. The first part is, of course, working with allies and partners for the United States, because of the importance of doing this multilaterally if it becomes necessary.

The second point would be to involve the private sector. There are a variety of reasons for this, but one I would note is what I talked about earlier about Japanese citizens. But there are other citizens of other countries living in China, for example—businesses, international businesses—and also in Taiwan.

So, involving the private sector in the conversations would be very important to think about the steps that we could be taking.

Howard Shatz

I would add that, regarding allies and partners, we did find that all three of the allies of the United States would probably act only under some pressure from the United States. And that pressure would serve two purposes.

One would be to create a very negative incentive, so that they would do what the United States wants because they face economic risks. But the other is that pressure will also give political leaders top cover with the public.

Even if they wanted to do something, it could be unpopular, and they could then say, well, we don't really want to do this, but the United States is making us do it, so we would do it.

In terms of specific steps by the United States, we can be doing this now, and the U.S. government has been moving towards this ... is doing this. We need greater institutional capacity to really understand how specific economic measures will affect the Chinese economy. And that will enable us to pick out the right targets at the right time.

We should also enhance our inter-agency coordination, create more comprehensive plans. We have war plans. We have what are called OPLANS for the conduct of different wars in different situations. Having EPLANS, economic plans, would be very useful. That would also serve as a signal to China that we're serious about this and prepared.

And the final thing is—and I think this applies to all of the countries, but especially the United States—Congress would need to be informed, because ultimately this could be very economically damaging to the United States. You want Congress on board, and there would have to be planning for all countries, because we're all democracies, we all rely on public support.

There would have to be some planning for how to inform the public and how to keep them on board for what could be economically difficult times.

Deanna Lee

Okay. I'm also wondering if your minds were changed at all after doing this research. Are you more optimistic or more skeptical after gaming out these scenarios that economic measures could help prevent a Taiwan crisis from escalating into a conflict? Naoko, maybe I can guess your answer. You said the stars would have to align, so what do you think?

Naoko Aoki

Yes. I would say that there is potential, again, the stars would have to align, so it could be effective in certain scenarios, conducted in certain ways. So this is not something that would be a cure-all for anything, but I think there is a possibility here.

And if there's a possibility, we should be thinking about it, and we should be trying to think of ways to make this effective, so that there won't be a conflict over Taiwan.

Deanna Lee

Anything to add, Howard?

Howard Shatz

I want to mention about the stars aligning. I agree with Naoko. I think, for us on the research team, this was a very smart use of RAND's abilities, because we have offices overseas. We have a UK office. We have an Australia office. We have a multinational staff. We have economists. We have China experts.

And so, all offices were involved in this. And I think we learned a lot from our China expert, Tim Heath, and he's really the one who helped us understand the circumstances where sanctions and economic measures could be effective and where they couldn't be effective.

And for me, I hadn't really differentiated that before he walked through potential scenarios to reach that definition. And that actually gave me more hope that, in some circumstances, sanctions could be effective.

I had always thought that if China is intent on invading, there's nothing sanctions could do. But we do think now that there are things under some circumstances. And so, the door should not be closed on economic measures for deterrence.

Deanna Lee

Excellent. Sounds like the approach really paid off in terms of lessons learned here, then. Okay, I think that's all the time we have. You can find the research we discussed today at rand.org/policyminded.

Thank you for listening. And Howard, thank you for being here today.

Howard Shatz

You're welcome.

Deanna Lee

And Naoko, thank you. We appreciate your time.

Naoko Aoki

Thank you.

Deanna Lee

Today's episode was recorded and produced by me, Deanna Lee, and edited by Emily Ashenfelter. RAND's director of Digital Communications is Pete Wilmoth. RAND is a nonprofit institution that helps improve policy and decisionmaking through research and analysis.