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Europe’s Misgivings About Sanctions Don’t Bode Well for US Export Controls

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Europe’s Misgivings About Sanctions Don’t Bode Well for US Export Controls

Agathe Demarais’ new book “Backfire: How Sanctions Reshape the World Against U.S. Interests” has important insights for the future of U.S. China policy.

Europe’s Misgivings About Sanctions Don’t Bode Well for US Export Controls
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In October of last year, the United States issued unprecedented controls on exports of semiconductor technology to China in an attempt to blunt the country’s development of military technologies. For these to work, other foreign technology providers will need to impose controls of their own. Key in this regard is a Dutch company called ASML, a world-leading semiconductor equipment manufacturer. According to recent reports, the United States and this small number of key partner countries have closed in on an agreement to coordinate their export controls.

However, it has not been an easy road. The United States encountered resistance in European capitals. The Dutch foreign minister was quoted saying on November 18, 2022 that “the Netherlands will not copy the American measures one-to-one.” It is not the first time that U.S. surety and impatience clashed with Europe’s slow-moving self-determination.

It is a tale as old as sanctions, according to a new book by Agathe Demarais called “Backfire: How Sanctions Reshape the World Against U.S. Interests.” Demarais is now based at the Economist Intelligence Unit and was previously an advisor to the French Treasury working on sanctions. Demarais offers a timely and important contribution of a primarily European perspective to an important debate: Do U.S. sanctions work? Her book is a breezy tour through a series of case studies that examine the sometimes unforeseen forces U.S. sanctions unleashed, their impact on European companies, and the responses they triggered from European officials.

Her assessment on whether U.S. sanctions work is perhaps best summarized as “it depends” or “less and less,” and she leaves her readers with a warning that alienating European partners will undermine their future success. One important factor impacting the effectiveness of sanctions is to what extent they are imposed multilaterally, with the help of or in concert with allies and partners.

To illustrate her point, Demarais regularly returns to the history of sanctions against Iran. Demarais tells of the D’Amato-Kennedy Act, which imposed broad penalties, including secondary sanctions, that would prevent not just U.S. but also foreign firms from conducting certain kinds of trade with Iran. These extraterritorial actions angered European companies as well as their governments, which threatened to bring a case against the United States in the WTO. The U.S. president at the time, Bill Clinton, backed down two years later and issued a promise not to impose these secondary sanctions. It was an important case in which Europe demonstrated that it would not allow its own companies to be submitted to extraterritorial laws of the United States.

In 2010, U.S. President Barack Obama imposed significant sanctions on Iran again. At that point, European governments joined the effort and subsequently worked collectively toward the Iran nuclear deal, which was signed in 2015. This provided an opportunity for a small number of European companies to re-engage the Iranian market. However, three years later, Europeans found themselves abandoned by the United States. In 2018, U.S. President Donald Trump unilaterally left the Iran nuclear deal, and European companies pulled out of Iran due to worries about the threat of secondary sanctions.

U.S. financial sanctions are powerful tools that have the ability to shape the behavior of rivals as well as partners. Yet financial sanctions and export controls are very different things.

As Sarah Bauerle Danzman, an associate professor of International Studies at Indiana University, Bloomington, and Emily Kilcrease, senior fellow and director at the Center for a New American Security argue in a recent article in Foreign Affairs, U.S. confidence in the dollar’s dominance in the financial system should not translate to similar confidence in its dominance in U.S. semiconductor supply chains. The authors refer to this as a “faulty analogy.”

“This supply chain is actually far more difficult to effectively weaponize than the global financial system because its complexity allows for those involved to adapt to shifts over time,” Bauerle Danzman and Kilcrease wrote. They go on to state that such misplaced confidence might lead policymakers “to discount the importance of building multilateral alliances to ensure the effectiveness of export controls.”

However, readers of Demarais’ book will draw a very different conclusion from the comparison of financial sanctions and export controls. She argues that the effectiveness of financial sanctions is already under threat. That would create even more urgency to engage in multilateral approaches.

The chief instrument Demarais cites as reason for the bleak future of financial sanctions is the creation of INSTEX, the Instrument in Support of Trade Exchanges. INSTEX is a European-led initiative to circumvent U.S. sanctions on Iran. Frustrated by the Trump administration’s departure from the Iran deal, European officials looked to find a way to salvage it. Currently, INSTEX is only used for humanitarian trade purposes, to send medical equipment, for instance.

Demarais concedes that INSTEX is not a particularly robust venture; it is a barter system for trade in which no money changes hands. Not many European enterprises want to use it. “American policy makers,” she writes, “have every reason not to be impressed by Instex…Whether Instex works (or not) may not be the most important thing to consider, however.” Instead, she continues, “Instex is the most tangible symbol of European frustrations with U.S. sanctions.”

That should concern U.S. officials. Demarais points to a 2021 Communication by the European Commission, which articulated a need for the European Union to “strengthen the resilience of financial-market infrastructures” in order to protect against the “unlawful extra-territorial application of unilateral sanctions by a third country affecting legitimate EU activities.”

Meanwhile, China has created an alternative payment system called CIPS, the Cross-Border Interbank Payment System, a platform that allows for the settlement of renminbi payments. CIPS is similar to, if distinct from SWIFT, the global system by which most global banking transactions are conducted. As a result, Demarais says, not just U.S. rivals such as China but also partners such as Europe are establishing instruments to work around U.S. sanctions.

These efforts are still at an early stage, Demarais acknowledges. Individually they do not pose a significant challenge to U.S.-dominated infrastructures, but these nascent initiatives should not be ignored. They represent early political momentum that may grow.

The lesson one might draw from “Backfire” is this: The U.S. needs to engage Europe. This will be even more true for U.S. export controls on China than sanctions on Iran. If the history of sanctions tells us anything about the future of export controls then Demarais’ prognosis is exceedingly bleak: “The time of peak U.S. sanctions has passed. American diplomats will be soon deprived of their favorite weapon to cajole, threaten, or punish U.S. enemies.”

Regardless of the proportionality of her predictions, the United States needs to leverage more diplomatic resources than in the past in order to get multilateral participation. Getting friends on board will be key – that will be true for export controls too.

The U.S. government knows that if it ends up going it alone, export restrictions will likely not work as well. After the October 7 controls were announced, one senior U.S. official said: “We recognize that the unilateral controls we’re putting into place will lose effectiveness over time if other countries don’t join us.” The official also noted that such efforts “risk harming U.S. technology leadership if foreign competitors are not subject to similar controls.”

For several months U.S. diplomatic energy has been expended to get ASML and the Dutch government on board. At the end of November, the Dutch trade minister said, “Well, we are having talks with the U.S.… Obviously we are weighing our own interests.” In early December, reports circulated that a deal between the Netherlands and the United States was in the making and last week Bloomberg reported that such an agreement had indeed been reached.

To fortify coordination on export controls, the U.S. and Europe will need to develop a shared understanding of what the challenges emanating from China really are and how to handle them. That will not be easy, as Antonia Hmaidi and Rebecca Arcesati, both analysts at MERICS noted in The Diplomat.

National Security Advisor Jake Sullivan’s doctrine on competition with China, one that aims at keeping the U.S. lead in “foundational technologies” as large as possible has not won over everyone in Europe. This approach moves beyond narrower definitions of dual-use that have typically governed the use of export controls. Sullivan’s strategic assessment is a major break from the past. That means the seeds of success of future restrictive measures will be sown in the current transatlantic debate on China.