Shortly thereafter, Saudi Arabia’s minister of finance approved the kingdom’s 2026 borrowing plan, projecting total financing needs of $57.9 billion. The proceeds are intended to fund a projected fiscal deficit of $44 billion, equivalent to 3.3 percent of Saudi Arabia’s gross domestic product (GDP).

This financing was highly successful, but as detailed in this report, the markets do not price Saudi Arabia as AA credit. In fact, Saudi Arabia trades at a discount to single A-rated sovereign debt, suggesting that the kingdom has work to do to build confidence in the country’s ambitious economic transformation plans, while showing the marketplace that this nation has the ability to generate accretive value generating returns.

Notably, while the Saudi Ministry of Finance constructed the 2026 budget on assumptions of slowing aggregate global demand for crude oil, the revenue outlook embedded in the projections implies a more constructive view on oil prices. As detailed in the table below, oil revenue, captured within “Other Revenue,” is budgeted at 64 percent of total revenue in 2026, unchanged from 2025. This suggests that hydrocarbons remain the dominant fiscal pillar, even as diversification accelerates. 

By contrast, Goldman Sachs, in a December 2025 report titled “Saudi Arabia: FY2026 Budget Targets Significant Consolidation,” takes a more skeptical view of the kingdom’s fiscal outlook, driven largely by oil revenue assumptions. Goldman estimates a budget deficit of 6 percent of GDP, compared with the government’s projection of 3.3 percent, implying that Saudi Arabia may ultimately need to borrow additional capital to finance its growth ambitions.

Saudi Arabia’s widening fiscal deficit, alongside a growing current account deficit, reflects an economy firmly in investment-led growth mode. This is simply a function of a government that is spending more on expenditures than revenues, the definition of an expansionary fiscal policy. In addition, a widening current account deficit is by definition an economy investing more than it has in savings. Taken together, this showcases the government’s commitment to funding growth. Sustaining this trajectory will require continued access to both domestic and external financing markets. During the first week of January, the kingdom demonstrated precisely that access by issuing $11.5 billion of senior unsecured bonds, drawing reported demand in excess of $20 billion from global fixed-income investors, particularly for longer-duration tranches.

The transaction underscored Saudi Arabia’s strong market standing, supported by moderate debt levels, manageable debt-service ratios, and substantial foreign reserve buffers. In addition, Saudi Aramco’s partial public listing has created an additional channel through which the state can access and monetize future oil cash flows, enhancing fiscal flexibility alongside sovereign borrowing. Assuming borrowing remains aligned with economic growth and fiscal discipline, access to capital markets should remain durable.

The diversification of the Saudi economy over the past decade has been significant. Non-oil GDP has risen from approximately 56 percent of total GDP in 2016 to roughly 65 percent in 2026, according to data compiled by the Saudi General Authority for Statistics and International Monetary Fund estimates. Nonetheless, oil revenues remain the primary fiscal driver, and any assessment of Saudi Arabia’s budget outlook is incomplete without considering global energy market dynamics.

In its Global Energy Perspective 2025, McKinsey & Company notes that while fossil fuels are likely to retain a meaningful share of the global energy mix beyond 2050, demand is expected to plateau between 2030 and 2035.

Neal Shear, founder of Morgan Stanley’s commodities platform and former global head of sales and trading, observes that “it is hard to accurately predict peak global demand for energy.”

“However, it is much easier to come to a consensus that the secular trend line for fossil fuel demand is downward over the next decade,” he told me.

Shear further argues that today’s crude oil market is increasingly demand-driven rather than supply-driven, rendering global supply dynamics closer to a zero-sum game. Incremental barrels from countries such as Venezuela may displace production elsewhere, rather than expand overall consumption. Over time, absent commensurate supply discipline, a downward-shifting demand curve implies secular downward pressure on prices.

The year 2026 marks the tenth anniversary of Vision 2030, Saudi Arabia’s ambitious economic transformation strategy. The program’s core objective of diversification away from hydrocarbons into sectors such as petrochemicals, tourism and hospitality, mining, healthcare, manufacturing, retail, construction, and finance has materially reshaped the kingdom’s economic landscape over the last decade.

Looking ahead, policymakers could further strengthen market confidence in two key areas. First, financial markets and more broadly investors would welcome greater fiscal transparency, particularly a clearer breakdown of oil-related revenue assumptions and the treatment of Saudi Aramco dividends within the budget framework. As it stands, the Saudi budget does not delineate this dividend in full, so it is not readily transparent to investors how much of the budget is being driven by oil revenues. Second, as investment scales, there should be a stronger emphasis on capital efficiency and risk-adjusted returns. Transparency around outcomes, including those that underperform, would likely enhance, rather than diminish, investor confidence.

The chart below shows that Saudi sovereign bonds trade at wider spreads than those of AA-rated peers, consistent with the kingdom’s split credit ratings. More notable, however, is that spreads also exceed those of single-A sovereign benchmarks, suggesting that markets continue to apply a degree of caution beyond what headline ratings alone would imply. Part of this reflects technical factors, including index inclusion, but it also points to a broader question of confidence as Saudi Arabia advances its Vision 2030 agenda. As the scale of public investment rises, sustained fiscal transparency, clearer articulation of oil-revenue assumptions, and demonstrable capital efficiency will be critical in translating economic transformation into tighter sovereign risk premiums.

Source: Vaneck, JPM Indices (Saudi Arabia Sovereign Spread JPGCSASS Index, EMBIGD A Spread JPSSGDCA Index, EMBIGD AA Spread JPSSGDAA Index)

Markets do not demand perfection; they value clarity, discipline, and resilience. Saudi Arabia’s long-term strategy is coherent, ambitious, and increasingly credible. If executed with continued transparency and fiscal prudence, it has the potential not only to transform the kingdom but to reshape the broader region. The US debt capital markets, for now, appear to agree.

Khalid Azim is the director of the MENA Futures Lab at the Atlantic Council’s Rafik Hariri Center for the Middle East.

The post Why US markets are betting on Saudi Arabia  appeared first on Atlantic Council.

Estimates of Syria’s post-civil war cost of rebuilding range from $250 billion to $400 billion. This sum is beyond what Syria’s internal resources can generate and will require mobilization of significant outside public and private investment. Syria must articulate a realistic but ambitious national strategy for economic reconstruction and development, and it must align donor and investor projects with that strategy. To help finance reconstruction and development, Syria’s transitional government should expand its partnerships with international financial institutions (IFIs) and multilateral development banks (MDBs), as these institutions can play a key role in mobilizing global capital. The presence of MDBs alone will not be determinative of the success of Syria’s development strategy; other factors such as internal political stability and external economic relations are more important. However, MDB operations in Syria can be a development force multiplier, increasing investment and expanding the technical capacity of both the public and private sectors. MDBs have a greater capacity for investment in high-risk countries, such as Syria as it emerges from civil war. Their presence as public institutions can help mitigate unobservable and unquantifiable risks (such as political risks) for other private-sector participants. Equally important, MDBs provide technical assistance to both the public and private sectors through funding of education, training, technology transfer, and broadening of external partnerships.

Syria currently has memberships with five IFIs and MDBs, including two global and three regional institutions: the World Bank Group, the International Monetary Fund (IMF), the Arab Monetary Fund (AMF), the Arab Fund for Economic and Social Development (AFESD), and the Islamic Development Bank (IDB). The European Investment Bank (EIB), the investment arm of the European Union (EU), was previously active in Syria and has recently indicated its intention to resume operations there in line with EU policy.

Syria is eligible to join three more MDB institutions: the European Bank for Reconstruction and Development (EBRD), the Asian Infrastructure Investment Bank (AIIB), and the New Development Bank (NDB). The transitional government of Syria (TGS) should immediately seek membership in the EBRD and the AIIB. Membership in the NDB is aligned to the expansion of the BRICS (Brazil, Russia, India, China, and South Africa) bloc of nations. Syria is not a member of the BRICS bloc and is unlikely to join in the foreseeable future.

Economic strategy

The TGS is trying to organize the physical reconstruction of the country while rebuilding state institutions that provide essential public services. Syria is emerging from six decades of dictatorship by the Assad family and a horrific fourteen-year civil war (2011–2024) that killed more than six hundred thousand Syrians and displaced about 13 million, more than half of the total population. Syria’s economy shrank by an estimated 85 percent from its pre-civil war levels, and the estimated cost of rebuilding ranges from $250 billion to $400 billion. Syria must build a dynamic, competitive economy to lift Syrians out of poverty. This will require significant investment, beyond what can be generated from internal resources.

The development of Syria’s economic strategy is the responsibility of the TGS and is beyond the scope of this analysis. However, some strategic issues need to be reviewed as we outline the role of MDBs in Syria’s reconstruction and development. Syria’s regional integration, particularly with the Gulf Cooperation Council (GCC) countries and Turkey, is just as important as Syria’s global integration. Syria has considerable economic potential, which differs from other countries in the region. It has an educated population, and its wage levels and exchange rates have not been artificially inflated by oil income (the so-called “Dutch disease”) because Syria is not an oil-exporting nation. Syria has significant potential to develop its agriculture and industrial base. Its ports on the Mediterranean are underdeveloped but well positioned to serve Syria’s development and, potentially, to integrate Syria economically with Iraq and the GCC countries.

Geography

Syria is located at the western terminus of Asia and is a central part of the land bridge between Europe, Asia, and Africa. Syria’s location has made it a target of external actors, notably Israel and Iran, seeking to dominate the country for their own destructive interests.

Most of Syria’s population and previous development are concentrated in the western corridor, north to south from the Turkish border to the Jordanian border through the cities of Aleppo, Hama, Homs, and Damascus. However, the development of Syria’s east-west corridors, from the Mediterranean coast through the cities of Aleppo, Raqqa, Hasaka, and Deir Ez-Zour, and onward to the Iraqi border, is of equal importance and represents an important economic opportunity. Syria’s Mediterranean ports—Latakia, Tartus, and Baniyas—can be further developed to service Syria’s needs, and Iraq’s as well. Syria’s best agricultural lands, and the majority of its water and oil resources, lay along this east-west corridor. Aleppo is the home of Syria’s textile industry and the northern plains stretching east of the city are the heart of its cotton production. The region accounts for a significant share of Syria’s production of agricultural output (wheat, pulses, olives, and livestock). The development of the east-west corridor regions is critical to Syria’s internal political reintegration and would complement regional economic projects such as Turkey’s links to Central Asia via the Caucasus and Iraq’s Development Road project linking Turkey to the Grand Faw Port project on the Arabian Gulf. Syria could be positioned as a western terminus for trade from and with other Asian countries, and Syrian exporters can certainly benefit from those transport links. MDBs can help Syria expand and modernize the transportation, energy, and technology infrastructure needed to take full advantage of its location.

Human capital

Syria has modest oil and gas resources and is currently a net importer of both. The TGS cannot rely upon oil export revenues to finance the country’s reconstruction and economic development. However, that means Syria does not suffer from the “natural resource curse” common in other regional economies that are reliant upon oil and gas exports. Oil and gas export revenues can lead to exchange rate appreciation—which, in turn, impairs the development of export-oriented manufacturing sectors.

Syria’s wealth is in its educated workforce. This is best reflected in its diaspora, which is globally successful in multiple industries across multiple continents and regions (the GCC, Europe, North America, South America, and West Africa). Syrians have long prized educational attainment, and the country has a large pool of skilled and semi-skilled labor that needs meaningful employment. Syria has been a net exporter of human capital for several generations, and this accelerated rapidly during the civil war as the country lost much of its middle class and intelligentsia. MDBs can play a useful role in addressing this by providing financing and technical assistance for the reconstruction and expansion of all levels of Syria’s educational infrastructure.

Building Syria as an economic hub

Foreign Minister Asaad al-Shaybani cited Singapore as an economic example for the new Syria at the Davos Summit in January 2025. This was an interesting choice because Singapore is an open economy that has developed into a regionally and globally significant trade, investment, and manufacturing hub. Syria has a favorable geographic location, spanning from the Mediterranean to Iraq and Jordan, and there are clear synergies Syria can achieve if it develops its transport and infrastructure links with its immediate neighbors. It has an educated population, with wages that are relatively low compared to those in the GCC or its immediate neighbors. The Syrian diaspora is globally successful and eager to invest, as are investors from the GCC. The country has agricultural and industrial potential that can be developed.

Other countries in the region, such as Jordan and Egypt, have similar—though not identical—resource endowments and similar levels of human capital development. However, for a variety of reasons beyond the scope of this analysis, they have not developed into globally competitive manufacturing or technology hubs. Because Syria must be rebuilt almost from the ground up after fourteen years of civil war and the overthrow of the Assad regime, there are fewer entrenched political and economic interests to block the country’s development. The Syrian people have a real opportunity to develop and implement the best available technologies, education, public administration practices, and infrastructure.

To exploit these advantages, Syria needs

• infrastructure investment in its ports, transportation, and energy production;
• reconstruction and expansion of its education system;
• building of public-sector capacity to deliver essential services and ensure transparency and rule of law;
• creation of a regulatory system that ensures competitive markets; and
• building of Syrian firms that can compete in regional and international markets.

MDBs can play an important part in developing Syria by mobilizing investment capital and providing the technical assistance needed by both the public and private sectors.

The potential role of MDBs

MDBs can assist Syria’s reconstruction and economic development through direct investment and provision of technical assistance to enhance local administrative capacity.

Direct investment: Private financial institutions will be reluctant to invest in high-risk countries, such as Syria as it emerges from civil war. MDBs have greater capacity than private financial institutions to mitigate these types of unobservable and unmeasurable risks. MDBs have an in-country presence and an ongoing relationship with host country authorities, providing them with an information advantage when it comes to assessing and mitigating country political and financial risks. MDBs provide public budget support and policy reform advice, as well as supporting government and corporate capacity building. Their presence in a project can provide a political umbrella to deter adverse events because MDBs are in a better position to influence a host government’s potentially adverse decisions. The presence of an MDB helps to reassure private investors and encourage their participation in project financing.

Technical assistance: MDBs engage with local and national governmental authorities and provide key technical assistance that helps to enhance local administrative capacity. For example, the TGS faces an important political and national security challenge in the disarmament, demobilization, and reintegration (DDR) of fighters from the various armed groups that participated in the struggle against the Assad regime. MDBs, such as the World Bank, can play a useful role in advising and funding DDR programs. Another example would be the World Bank’s well-regarded technical assistance program (the Stolen Asset Recovery Initiative (StAR)), which works with partner countries that seek to recover stolen assets. This program could help the TGS recoup the billions stolen by the Assad family and Assad regime officials.

Diversification benefits

Syria will benefit from becoming a member country in more MDB institutions. Membership can insulate Syria from changes in resource availability or changes in political relationships with donor nations. The specific benefits include the following.

• More sources of financing: Syria’s overall borrowing capacity is constrained by its debt-carrying capacity, which is presently quite limited. Nonetheless, it is still useful for the TGS to have access to a greater number of sources for funding and technical assistance.
• Differing institutional expertise: Each MDB has its own areas of expertise that are unique to that institution. The EBRD has successful programs to help finance growth of small and medium enterprises (SMEs), private infrastructure, and municipal finance. The AIIB has executed successful projects in renewable energy, digital and information technology infrastructure, and transportation.

By becoming a member of more MDB institutions, the TGS can draw upon each of these institutional areas of expertise, as appropriate to Syria’s development needs.

Additional potential MDB partner institutions

EBRD

The EBRD was established in 1989 to address the transition needs of the nations of Central and Eastern Europe as they emerged from communist rule. Its headquarters are in London and, following the Arab Spring in 2010, it expanded its area of operations to encompass the countries of Western Asia and North Africa, supporting democratization and economic development in those regions. The EBRD is currently active in Turkey, Jordan, and Lebanon.

Accession to the EBRD as a member nation requires an affirmative vote by two-thirds of governors, representing at least three-quarters of members’ total voting power. The United States is the largest single shareholder, with 9.2 percent of shares, followed by the United Kingdom, France, Germany, and Japan, with 8.9 percent each.

The EBRD’s purpose, as reflected in its founding documents, is to support “multiparty democracy, pluralism and market economics.” EBRD operations focus on former Soviet bloc countries’ transition from a communist state-owned economic model toward market-based economics. That mission remains, even as the EBRD’s area of operations has expanded to include countries in Western Asia and North Africa that, like Syria, have a legacy of state ownership of key sectors of the economy. The EBRD’s mission differs from that of other development banks, such as the World Bank, in that it focuses less exclusively on poverty alleviation and more directly on economic transition and political governance.

Since its inception, the EBRD has invested more than €210 billion in more than 7,500 projects. It undertook 584 projects in 2024, investing €16.6 billion. EBRD investment in green economy projects accounted for 58 percent of the total financing provided in 2024.

The EBRD has a reputation for expertise in several areas directly relevant to Syria. It has programs for financing and advising SMEs, local financial institutions, agribusiness, sustainable energy, and municipal infrastructure. The TGS will need to reach out to ascertain the level of shareholder support for its membership. But Syria’s membership in the EBRD would dovetail with stated US, UK, and EU objectives of stabilizing Syria’s economy and promoting stable governance.

AIIB

The AIIB is the newest MDB, beginning operations from its headquarters in Beijing in 2016. Its mission is the financing of infrastructure on the Asian continent, with an emphasis on projects that are sustainable and technology enabled, and that promote regional connectivity. Sponsored by China (which holds the most shares), the AIIB has grown to 110 members. The United States and Japan have declined to seek membership, but many European nations have joined the institution. Several of Syria’s immediate neighbors (Iraq, Jordan, and Turkey) are already members of the AIIB, and Lebanon is a prospective member. Accession by new members must be approved by a special majority vote of the AIIB Board of Governors, which represents a majority of the institution’s voting power.

The AIIB emphasizes four thematic priorities, including

• green infrastructure;
• connectivity and regional cooperation;
• technology-enabled infrastructure; and
• private capital mobilization.

The AIIB financed 303 projects between 2016–2024, with a cumulative investment of $58.9 billion. The sector breakdown of the projects is summarized in the chart shown here.

The AIIB’s track record on infrastructure finance and its emphasis on regional connectivity are directly applicable to Syria. The AIIB’s priorities emphasize the importance of connectivity as a pathway to economic development. For example, the AIIB is co-financing $250-million expansion of rail links between eastern Turkey and the Caucasus. Regional economic powers in Western Asia (e.g., Turkey, Saudi Arabia, and Qatar) have proposed plans for the development of cross-border infrastructure and integration. Syria’s participation in these plans, through the development of its infrastructure, will in turn advance regional integration efforts. The AIIB can be a useful financing partner in these efforts.

Aligning assistance with development priorities

Since December 2024, there is considerable political and economic excitement about the potential of a stable, rapidly developing Syria. A large measure of this excitement was generated by the United States, which has pressed ahead with easing of sanctions to give Syria a chance to emerge from the catastrophic Assad era. European countries have similarly eased sanctions, and most regional powers—with the notable exceptions of Israel and Iran—have moved quickly to shore up Syria politically and economically. A rush of donors and investors have announced new projects and publicized the signing of investment memoranda. However, there is a risk that these initial projects will conflict with, or potentially undermine, progress on less glamorous but more pressing tasks such as unifying military control, establishing basic national security from internal and external threats (which are often interrelated), rebuilding public administration and essential services, and aiding returning Syrian refugees to start reconstruction.

The TGS must assert clear priorities in reconstruction and development and ensure that assistance and investment align with the country’s development priorities. The TGS can benefit from the various MDB institutions’ differing areas of expertise, aligning each one with specific development goals. For example, despite the easing of sanctions, Syrian banks face immediate challenges in reestablishing correspondent relationships with outside banks because of concerns about anti-money laundering and countering the financing of terrorism (AML/CFT) risks. Until Syrian banks can reestablish those correspondent relationships, it will be difficult for the country to secure the promised investment inflows.

In the immediate term, the IMF, World Bank, and Financial Action Task Force (FATF) via its regional body, the Middle East and North Africa Financial Action Task Force (MENAFATF), are the most logical partners to help address AML/CFT risks in the banking sector. FATF is the standard-setting body, and the IMF and World Bank both provide significant policy support to many countries to assess their compliance with relevant AML/CFT standards. The urgency of addressing AML/CFT risks is compounded by the fact that the TGS is attempting to suppress drug trafficking, much of which is linked to former regime officials. Blocking drug traffickers’ access to both Syrian and global financial institutions is an important step that the TGS can take on national security grounds, and is also crucial for rebuilding local and global confidence in the Syrian financial system.

In the medium term, the TGS can leverage the expertise of MDB institutions like the EBRD, which has significant experience in executing local currency credit facilities, using local banks as partner institutions. The EBRD has used such facilities to build the capacity of local financial institutions and to extend credit to underserved economic sectors, especially SMEs. That experience could be usefully replicated in Syria.

There are numerous other examples of how MDBs can be useful partners in executing Syria’s development priorities. Expanding relationships with these institutions would give the TGS more options for accomplishing those priorities.

Next steps

The TGS should seek membership in both the AIIB and the EBRD but might prioritize moving forward with membership in either of these MDBs, based on its assessment of reconstruction and development needs. The AIIB has an institutional focus on regional connectivity, which complements the heightened investor interest in various projects to reintegrate and reconnect the Syrian economy within the region. The EBRD has a demonstrated track record in local financial sector development, agribusiness, and municipal infrastructure finance, which are clear priorities in Syria’s reconstruction. Accession to the EBRD can be a lengthier process because of the requirement for shareholders representing three-quarters of the institution’s capital to approve, versus the majority approval required by the AIIB shareholders. The TGS should begin diplomatic outreach to the primary shareholders of these MDBs and inform them of its interest in accession to membership. The TGS should concurrently reach out directly to the EBRD and AIIB to notify these institutions of Syria’s desire to begin the process of accession to membership.

Basil Kiwan is a contributor with the Atlantic Council, and a former financial regulation specialist at the Federal Deposit Insurance Corporation. He previously served at the US Treasury Department on a variety of international economic policy issues.

Econographics Jul 17, 2025

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By Kimberly Donovan, Jonathan Panikoff, Lize de Kruijf, Manal Fatima

As Syria emerges from over a decade of conflict, easing sanctions by the United States, the European Union (EU), and other European partners is an important step toward reintegrating Syria into the global economy. Yet, for a country that has been economically isolated for over fourteen years, lifting sanctions is only the beginning.

Economy & Business Financial Sanctions and Economic Coercion

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After partial relief, what’s next for Syria sanctions?

By Alex Zerden

Syria remains a high-risk jurisdiction due to years of conflict, endemic corruption, state institution collapse, narcotrafficking of captagon, insufficient anti-money laundering efforts, and inadequate financing of terrorism controls.

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By Lize de Kruijf and Nazima Tursun

The US withdrawal of foreign aid to Indo-Pacific countries creates space for China to expand its influence in the region.

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Housed within the GeoEconomics Center, the Economic Statecraft Initiative (ESI) publishes leading-edge research and analysis on sanctions and the use of economic power to achieve foreign policy objectives and protect national security interests.

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The post Expanding Syria’s multilateral development bank engagement appeared first on Atlantic Council.

Introduction

This October, the mandate for one of the US government’s most effective tools in its global competition with China is set to expire. The International Development Finance Corporation (DFC) was created under the first Trump administration with the goal of mobilizing private capital to promote economic development in low-income countries (LICs) and lower-middle-income countries (LMICs) while advancing US foreign policy interests.

In the Better Utilization of Investments Leading to Development (BUILD) Act, the bill that first established DFC, China is never mentioned by name. But China’s shadow looms large over references to “debt sustainability” and providing countries with an “alternative to state-directed investments.” When the BUILD Act was written seven years ago, US policymakers were just starting to take note of China’s growing presence in LICs and LMICs. Since then, China has become the top trading partner of 145 countries, making up roughly 70 percent of the world’s population. Between 146 and 150 countries have joined the Belt and Road Initiative (BRI), Xi Jinping’s $1 trillion flagship lending program. China is the world’s largest official creditor, and its lending initiatives have won Beijing significant geopolitical influence.

However, in the last seven years, DFC has turned the United States from a passive observer of China’s meteoric rise as a development lender into a serious contender in an intensifying front of competition with Beijing. DFC is making good on its mandates: advancing development objectives in LICs and LMICs, furthering US foreign policy goals, and winning deals that China wanted. Its lending has exceeded $50 billion to 114 countries, impacting more than 200 million people and businesses worldwide. This includes multiple cases in which DFC stepped in to provide financing that outcompeted Beijing, from the Elefsina Shipyard in Greece to the acquisition of a telecommunications company in the Pacific Islands and the Lobito Corridor railway in Zambia, Angola, and the Democratic Republic of the Congo (DRC).

DFC is one of the United States’ few remaining tools of positive economic statecraft to compete with China in global development—and it must be protected. Congress has an opportunity to fine-tune DFC’s operations and set it up for even greater success before the reauthorization deadline on October 6. In that spirit, this brief explores three case studies in Chinese development lending, what they teach us about why China’s lending programs succeed—and fail—and how Congress can make DFC an even sharper tool.

Case study 1: Jakarta-Bandung railway

China’s approach: Flexible mandates, high risk tolerance

When Beijing is asked to participate in multilateral debt relief initiatives, there is an insistence that one of its two state-owned policy banks, the China Development Bank (CDB), is a commercial lender, and not an official creditor. As a state-owned bank acting purely in its own commercial interests, Beijing argues, CDB is not furthering the PRC’s foreign policy goals, and it should not be subject to the same transparency requirements as other official lenders.

As revealed in an AidData analysis of CDB lending practices, the bank often behaves like a commercial institution adhering to standard commercial lending practices such as lending at floating market interest rates. However, when Beijing deems a project strategically important, CDB will suddenly change its practices, offering unusually concessional lending terms.

CDB came across one such strategically important project in 2014, when the Indonesian government announced a bid to finance a high-speed rail line connecting two of its largest cities, Jakarta and Bandung. Just a few months earlier, during a trip to Indonesia, Xi had announced his intention to build a “21st Century Maritime Silk Road” to enhance connectivity throughout Southeast Asia. This proposed maritime silk road became the “road” in “One Belt, One Road,” the lending program now known as the Belt and Road Initiative. The Indonesian government’s newly announced rail project presented an opportunity to develop a strong early example to showcase Xi’s new initiative in action.
From January 2014 to May 2017, CDB and the Japan International Cooperation Agency (JICA) submitted competing bids to bankroll the Jakarta-Bandung High Speed Rail project. JICA offered to finance 75 percent of the project at a 0.1 percent interest rate, contingent on the Indonesian government providing a sovereign repayment guarantee. CDB’s counteroffer was to finance 100 percent of the project at a 2 percent interest rate, with a lower overall cost and shorter construction timeline, provided the Indonesian government guaranteed repayment.

Indonesian President Joko Widodo surprised observers by rejecting both offers, citing a desire to avoid taking on substantial sovereign debt. JICA responded with a 50 percent reduction in the debt that the government would need to back with a sovereign guarantee. But CDB offered the winning bid: an arrangement that would require Indonesia to take on no debt whatsoever. Instead, the bank would create an off-government balance sheet by lending to a special purpose vehicle, a separate legal entity jointly owned by Chinese and Indonesian state-owned enterprises, created solely for the purpose of financing and building the Jakarta-Bandung High Speed Railway. This would allow CDB and Widodo to work around the Indonesian government’s debt ceiling. The final loan was far more concessional than CDB’s typical offers, and far more concessional than the minimum standards the Organisation for Economic Co-operation and Development uses to define concessionality.

CDB blurs the lines between its commercial, developmental, and geostrategic purposes and, as a result, Beijing gets to have it both ways. CDB protects its balance sheet, evades its responsibility to participate in multilateral debt relief initiatives, and lends at far below-market rates when an opportunity arises to advance the government’s policy objectives.

Lessons for the United States

Flexibility can be a strength. DFC has a dual mandate: support sustainable development in LICs and LMICs and advance US foreign policy interests. This has implications for where DFC operates, and there is currently widespread disagreement among experts on this front.

The conversation around DFC’s reauthorization is bifurcated between two camps. In one corner, development practitioners voice frustration with DFC’s gradual shift toward lending to richer countries. These observers rightly argue that US foreign policy interests have led DFC to stray from its original mandate to prioritize LICs and LMICs. In the other corner, national security analysts advocate harnessing DFC’s demonstrated effectiveness to respond to the short-term foreign policy challenges of the day.

Dealing with China means swimming in murky waters. Beijing blurs the lines between the commercial, the developmental, and the geostrategic, and a heavily siloed US system will not meet the multifaceted and overlapping challenges that the United States must address. While DFC should not neglect its development mandate, it should also have the flexibility to respond to challenges where they occur.

High risk tolerance is critical. Risk tolerance is an oft-cited advantage for Chinese lenders, and an oft-cited disadvantage for DFC. DFC’s cautiousness limits its ability to move quickly and lean into opportunities where the returns are nonmarket geostrategic wins.

Case study 2: DRC Sicomines copper-cobalt deal

China’s approach: Extreme high-volume financing

In 2007, the Export-Import Bank of China and two Chinese state-owned construction firms signed an agreement with the government of the DRC for the nation’s largest resources-for-infrastructure (RFI) deal. RFI deals, in which loans for infrastructure development are repaid with natural resources, are commonplace for China.

Under this deal, the Chinese parties would provide a staggering $9 billion of loans—more than three times the DRC’s annual government budget of $2.7 billion. The deal included $3 billion earmarked for developing and operating the Sicomines copper-cobalt mine, with the Chinese consortium owning 68 percent, and $6 billion earmarked for postwar rebuilding projects following the Second Congo War.

Ultimately, the deal was renegotiated several times. In 2009, the International Monetary Fund (IMF) called for a renegotiation due to concern over the DRC’s capacity to repay the loan. In 2021, the deal faced renewed public scrutiny, and DRC President Félix Tshisekedi launched an audit that found that the agreement presented “an unprecedented harm in the history of the DRC.” China had only spent a fraction of the amount promised for postwar reconstruction projects—reaping $10 billion in profits and giving the DRC only $822 million in return. Last year, this gave the country leverage to renegotiate the deal once more and secure an agreement that increased the infrastructure budget by $4 billion and gave the DRC a greater share of mining revenues.

In this case, Beijing was willing to commit an astounding volume of capital to a highly risky endeavor, but China has lent far greater amounts to critical minerals over the last two decades, nearly $57 billion from 2000 to 2021.

It is difficult to overstate the geopolitical gains that have resulted from high-volume financing deals like this one, which have enabled Beijing to capture over 70 percent of the world’s rare earths extraction and almost 90 percent of processing capacity. Beijing has unparalleled dominance over the essential inputs underpinning the construction of the modern world. To build everything from fighter jets to consumer electronics, MRI machines, and electric vehicles, the rest of the world is now, to some extent, dependent on Beijing’s good graces.

Lessons for the United States

The United States cannot compete with China on a dollar-for-dollar basis, but current resources are insufficient. The United States does not have to close the gap between what it and China can offer globally. US lenders can be strategic, focus on key sectors and countries, and double down on areas in which the United States has a competitive advantage. Narrow the gap it must, though. Small, strategic investments could not have won China supply chain dominance in critical minerals. The current level of resources dedicated to this challenge are not proportionate to the severity of the threat

Invest with foresight. China’s dominance in critical minerals was built over decades of placing strategic bets on resource rich countries with assets that have national security implications. Beijing pledged $9 billion for the Sicomines copper-cobalt deal in 2007, many years before terms like “critical minerals,” “electric vehicles” or “5G” entered the public lexicon. DFC should similarly aim to make strategic investments in the supply chains of the future.

Case study 3: 2025 Sino Metals Zambia dam disaster

China’s approach: Move fast, break things

This February, a dam built by Sino-Metals Leach Zambia, a Chinese state-owned mining firm, burst, spilling toxic mining waste into the Kafue River in Zambia. The damage was catastrophic and unprecedented. The river, now an acid-leached wasteland, had supplied drinking water for roughly 5 million people and supported the livelihood of roughly 20 million farmers, fishermen, and industrial workers.

The dam held waste from nearby mines that were slated to serve a critical role in meeting an ambitious development goal: triple Zambia’s copper output by 2033. As the Zambian government raced forward in pursuit of this objective, the country became increasingly reliant on the only international partner who could meet the speed and scale they required: China.

Over the last several months, Zambian civil society has demanded greater transparency and accountability in the government’s mining deals. Thanks to public pressure to disclose further information, we now have a detailed record of the negligence behind this disaster.

It’s clear now that prioritizing speed led the parties involved to overlook negligence in terms of environmental, social, and governance (ESG) standards. Sino Metals operated within the Zambia-China Economic and Trade Cooperation Zone, Africa’s first special economic zone designed to attract international investment through incentives like tax breaks and streamlined approvals, including environmental approvals. In 2014, a Zambian auditor warned that tailings dams, large embankments used to store mining waste, were being systemically mismanaged in Zambia’s Copperbelt. Nevertheless, Sino Metals decided to rely on a tailings dam to store copper mining waste from its Chambishi Leach Plant. Rather than building a new dam, it was faster for the company to raise the wall of an existing dam built many years earlier.

Once built, the company repeatedly failed to conduct routine inspections, and there is no evidence to suggest that the dam was managed by licensed engineers. Sino Metals’ sister company, NFCA Africa Mining, admitted to disregarding safety and environmental standards in an internal report. Zambian regulators and the Chinese project managers had many chances to prevent the disaster from happening. A 2017 study found that the groundwater near the Sino Mines facility was already contaminated. In 2022, Sino Mines expanded the dam once again.

Lessons for the United States

ESG standards and transparency are important competitive advantages for US-backed deals. The Sino Metals dam disaster was not a one-time occurrence. Beijing routinely scores own goals in the form of flagrant disregard for host countries’ environmental, labor, and anti-corruption standards. The Jakarta-Bandung high speed railway project managers sped through an environmental impact assessment that should have taken twelve to eighteen months in only seven days. The consequence: a fatal accident, flooded roads, ruined homes and farms, improper waste dumping, mass protests, and $1.49 billion in cost overruns.

Particularly in democracies sensitive to public opinion and countries facing civil society backlash against opaque Chinese deals, the United States should lean into this strategic edge.

Moving fast makes a difference. Paradoxically, speed is a commonly cited factor contributing to host countries’ preference for Chinese loans. While the United States should not save time by cutting regulatory corners, US-backed deals cannot afford to be burdened by needlessly lengthy bureaucratic timelines.

Policy recommendations

To promote thoughtful versatility:

• Rethink the guidelines on where DFC operates. The BUILD Act mandates that DFC prioritize the provision of support to countries that meet the World Bank classifications for LICs and LMICs. The resulting arrangement excludes many countries with significant development needs that are classified as upper-middle-income countries (UMICs), often because of socioeconomic disparities or remittances. Examples include Mexico, Brazil, Tuvalu, Thailand, and Malaysia. Rather than relying on the World Bank’s rigid income classifications, DFC should revisit its lending criteria, borrowing from other official lenders’ practices.
• Clarify the key terms of DFC’s dual mandate. The BUILD Act instructs DFC to “pursue highly developmental projects” and assess their “strategic value,” but does not put forward standard criteria to determine what is developmental or strategic. A Center for Strategic and International Studies analysis, which collected insights directly from US government development practitioners, found that different agencies apply varying standards for what qualifies as “highly developmental.” Setting standard definitions for these key terms will begin to bridge the divide between the two camps of development practitioners and national security analysts who have different visions for where DFC should operate.

To strengthen risk tolerance:

• Establish an internal advisory council to provide guidance on projects that have the potential to generate nonmarket returns. The advisory council can weigh the project’s commercial viability against its implications for US strategic interests and judge whether the risk is acceptable to DFC’s balance sheet.
• Transfer the responsibility to approve exceptions to the LIC and LMIC preference from the president of the United States to the DFC’s Board of Directors. Under current law, exceptions to this rule—41.6 percent of investments made in DFC’s first five years—must go up a lengthy approval chain to the highest authority in the United States, who is then expected to parse through highly technical financial terms to evaluate the project’s risk-return profile and repayment terms. Instead, LIC and LMIC preference exceptions should be approved by DFC’s board, a group of development finance and foreign policy experts from across federal agencies. Particularly amid heightened political scrutiny of US government spending, professional oversight may empower DFC to take calculated risks with greater assurance.
• Evaluate investments at the portfolio level, not the individual project level. This creates space for DFC to take on, for example, a high-risk, high-reward mining project, provided the aggregate critical minerals portfolio is generating returns.
• Authorize DFC—permanently. The life cycles of many current DFC projects extend well beyond another seven-year reauthorization period. In contrast, BRI loans have been steady, providing highly concessional, long-term financing that complements LIC and LMIC governments’ long-term economic development plans. Repeated reauthorization cycles disincentivize DFC from pursuing partnerships that require a long-term steady commitment. DFC has built credibility that warrants a longer leash. Despite weathering a global pandemic, significant leadership turnover, and two highly tumultuous presidential transitions, DFC is delivering on its mandates: investing in LICs and LMICs, generating returns, and outcompeting China for key deals.

To boost finance volume:

• Triple DFC’s portfolio cap, from $60 billion to $180 billion. While this may sound like a hefty increase, $180 billion will only make up 12 percent of the $1.5 trillion infrastructure finance gap in LICs and LMICs. A larger portfolio cap will increase the total value of outstanding commitments that DFC can have at any given time and enable DFC to back bigger deals.
• Fix the budget rule accounting for DFC’s equity investments. The BUILD Act granted DFC the authority to make direct equity investments, an arrangement that grants the United States unique influence by giving DFC partial ownership in individual companies and projects. Oftentimes, this means DFC earns a voice in management decisions, enabling DFC to ensure projects align with development and US policy goals. Unfortunately, this authority has been underutilized due to an administrative rule with an outsized impact. Under current federal budget rules, DFC’s equity investments are treated as grants, assuming a total loss on 100 percent of DFC’s equity investments. Instead, DFC’s equity investments should be reflected using net present value scoring, which accounts for the likelihood of financial return over time to determine the true cost to taxpayers.
• Emphasize the importance of collaboration. The United States should pool funding with allies and partners’ development finance institutions to meet the scale and speed needed to match Chinese state-backed capital. DFC already has partnerships with Australia, Japan, and the Inter-American Development Bank; these partnerships should cut the burden of dealmaking in half, not double it. DFC should work with US partners to create standard due diligence requirements, term sheets, and agreements. This will create opportunities for more effective collaboration across institutions and help joint projects move forward faster.

To streamline operations:

• Increase the threshold of investments subject to congressional notification. While the notification process allows for additional oversight and gives Congress the opportunity to raise concerns, this bar is currently set at $10 million, an extremely low threshold that imposes a significant administrative burden for roughly 60 percent of DFC transactions.
• Improve staffing. DFC was built to be a lean and dynamic entity akin to a private corporation, but in practice, it has not been given the personnel and resources it needs to work efficiently. The Office of the Inspector General’s most recent report on DFC found that staffing was insufficient to perform robust site visits. DFC has been steadily growing its workforce and had a total of 675 employees in 2024, but the corporation has not released updated staffing figures since the US government terminated all probationary employees earlier this year. The World Bank has more than thirteen times as many employees managing a portfolio less than twice the size of DFC’s. Furthermore, the salaries of DFC’s investment professionals with prior deal experience are roughly a quarter of their private-sector peers’. Having more staff on board—and compensating them fairly—will help to move transactions through DFC’s project preparation workflows more efficiently.

Conclusion

The most common refrain in commentary on US-China competition in LICs and LMICs is that “don’t take China’s money” is not a policy. It is not tenable to beg host governments not to make deals with China, especially when China is the only option for meeting urgent development needs. For many years, experts have repeated the same recommendation to the US government: show up. Offer a US-led alternative to Chinese capital. DFC represents a major step in the right direction. The last seven years have been proof of concept. Now, Congress must scale it and commit resources that will allow DFC to live up to its full potential.

Staff

Caroline Costello

Assistant Director

Global China Hub

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The World Bank estimates Syria’s economy at around $21 billion, representing an 83 percent decline since 2010, while the United Nations (UN) estimates that the cost of reconstruction will be more than $250 billion. The road ahead is long.

Recent developments are encouraging. Syria has reengaged with the World Bank and International Monetary Fund (IMF) and reconnected with the European banking system. However, fostering stability and reconstruction requires international actors—particularly the United States—to pursue a coherent, positive economic statecraft strategy to anchor recovery in the long term. Without coordinated engagement, targeted investment, and clear policy direction, Syria remains vulnerable to corruption, deepening poverty, and adversarial influence seeking to fill the vacuum left by the collapse of the Assad regime.

Lifting US sanctions on Syria

US President Donald Trump’s recent executive order, “Providing for the Revocation of Syria Sanctions,” marks the first official step in lifting US sanctions on Syria. The order terminated previous executive orders imposing sanctions on the country. In response, the US Department of the Treasury’s Office of Foreign Assets Control (OFAC) lifted 518 designations, including for major Syrian banks and companies critical to infrastructure and rebuilding.

However, the executive branch is limited in what it can do. The Caesar Act, which codifies sanctions into law, requires congressional approval to lift any designations under its framework. Although the Caesar Act sanctions are temporarily waived for 180 days, this exception is set to expire in November 2025. The executive order directed the secretary of state to assess the potential for fully suspending sanctions under the Caesar Act, but the congressional process for lifting these sanctions may be slow and politically complex.

Additionally, the secretary of state recently announced the removal of all Hay’at Tahrir al-Sham (HTS) terrorism designations, after the group was disbanded earlier this year. Nevertheless, HTS remains listed under the United Nations (UN) sanctions. While the United States has drafted a UN resolution to begin the process of lifting UN sanctions, this may prove to be a slow process. Any delisting would require unanimous consensus from the UN Security Council, which is unlikely. While UN sanctions remain in place, financial institutions will continue to struggle with compliance issues when engaging with Syria.

Finally, while the executive order permits relaxing export controls of certain goods, the US Department of Commerce is yet to review or lift export controls, further complicating efforts by the private sector to reenter the Syrian economy.

While these policy changes by the US government are crucial, they are also complex and, on their own, insufficient to enable Syria’s reconstruction and stabilization.

Steps in the right direction

Announcements by the United States, the EU, and other European countries regarding the sanctions relief for Syria have generated significant momentum to reintroduce Syria into the global economy.

For the first time since 2009, the IMF has conducted a mission to Damascus. Their recommendations highlight the urgent need for sound fiscal and monetary policy, institutional strengthening, banking reform, and enhanced anti-money laundering and countering the financing of terrorism (AML/CFT) frameworks. These are foundational steps toward rebuilding confidence in Syria’s economic governance, which the Syrian authorities have expressed commitment to. The World Bank also recently approved a $146 million loan to restore Syria’s electricity infrastructure—a critical step for both economic productivity and civilian welfare.

Meanwhile, the EU’s easing of financial restrictions has enabled Syria to rejoin the SWIFT system, leading to its first electronic transfer in over a decade—signaling cautious reengagement from European financial actors.

With Trump’s executive order, US banks and the private sector are now positioned to reenter Syria too. However, reputational and political risks may temper initial enthusiasm, requiring the US government to lead the way.

Remaining challenges require positive economic statecraft

Even with fewer legal barriers, Syria is considered a complex and risky environment for many private sector actors. The country has been sanctioned in some form since 1979. After years of conflict and institutional erosion, a legacy of opaque regulatory frameworks, weak governance, and perceived instability remains.

Syria’s persistent presence on the Financial Action Task Force grey list underscores concerns about illicit financial activities and the country’s limited regulatory capacity. For the private sector, this listing signals elevated financial and operational risks, including increased regulatory burdens, reputational damage, limited financial access, and economic instability.

Further compounding this risk perception, the recent conflict escalation between Israel and Iran has heightened instability in the region and cast a shadow over Syrian investment opportunities. The United States’ military intervention in the conflict raises concerns about the coherence of US strategy in the Middle East. Meanwhile, escalating tension between Syria and Israel in recent days adds another layer of uncertainty threatening Syria’s prospects for peaceful and stable reconstruction.

While the easing of sanctions was intended to catalyze economic reintegration, the geopolitical landscape in the region may limit the speed and scale of private capital influx, unless it is underpinned by strategic support and risk mitigation. Given Syria’s historical strategic value, adversarial actors are also likely to try to maintain influence and investment there, making sustained constructive engagement by the United States and its allies essential.

A roadmap for US policy

To support Syria’s reconstruction and encourage responsible private sector engagement, the United States should pursue a more structured approach, beginning with the steps listed below.

1. Ensure legal clarity for the private sector. Providing the private sector with structured guidance to navigate the evolving legal landscape of the Caesar Act, designations related to terrorism, and export controls will help US banks and businesses navigate regulatory complexities, ensuring compliance and reducing risks perceptions.
2. Ensure legal and political clarity for the Syrian government. Ongoing communication with the Syrian government regarding the conditions and expectations tied to sanctions relief, as well as benchmarks for continued engagement, will facilitate smoother cooperation and reduce risk of backsliding.
3. Continue diplomatic efforts within the UN. Ongoing diplomacy with the UN Security Council members regarding the lifting of HTS designations is essential to prevent jurisdictional arbitrage, uneven sanctions compliance and enforcement, and increased risk for the financial and private sector.
4. Strengthen financial integrity. Providing technical assistance to enhance Syria’s AML/CFT compliance and to establish formal, regulated channels for investment and financial transfers would prevent the proliferation of informal systems prone to corruption, illicit finance, and state capture, and would reduce risks for financial institutions considering reentry.
5. Leverage US International Development Finance Corporation (DFC) reauthorization to manage risk related to investment in Syria. The United States should use DFC reauthorization to create a strategic framework for investment in Syria, coordinating with institutions like the World Bank’s Multilateral Investment Guarantee Agency to provide insurance mechanisms that protect private investors from political and economic instability, while promoting transparency and policy consistency.
6. Develop a task force with allies to support Syria’s reconstruction. Progress requires strategic alignment between the United States, EU, IMF, World Bank, and key regional actors, including the Gulf states. Considering the upcoming Annual Meetings of the IMF and the World Bank Group, the United States should seize the opportunity to develop a coordinating body to identify opportunities and solutions for Syria’s postwar reconstruction, ensuring reforms are sequenced, accountable, and achievable.
7. Support diaspora and Gulf investment with oversight. Syria’s diaspora and investors based in the Gulf offer strong potential for recovery capital—but only if engagement is channeled through secure, regulated platforms that promote transparency and prevent capture by entrenched interests.

Syria’s recovery and reintegration into the global economy is strategically necessary for regional stability. Past experiences in Sudan and Libya offer cautionary tales about the how removing economic leverage can backfire when there are no clear reform benchmarks or defined positive economic statecraft strategies. If left unstructured and unsupported, Syria’s fragile recovery risks becoming opaque, corrupt, and ultimately reversible.

For the United States, this moment presents a rare opportunity to lead through coordination, clarity, and targeted assistance. Syria’s economic future—and by extension, a measure of stability in the broader Middle East—may well depend on Washington’s willingness to expand its toolkit beyond punitive economic measures and embrace more positive economic statecraft tools.

Kimberly Donovan is the director of the Economic Statecraft Initiative within the Atlantic Council’s GeoEconomics Center. She is a former senior Treasury official and National Security Council director.

Jonathan Panikoff is the director of the Atlantic Council’s Scowcroft Middle East Security Initiative and a former deputy national intelligence officer for the Near East at the US National Intelligence Council.

Lize de Kruijf is a program assistant at the Atlantic Council’s Economic Statecraft Initiative within the GeoEconomics Center. 

Manal Fatima is an assistant director at the Atlantic Council’s Scowcroft Middle East Security Initiative. 

Note: The insights and recommendations presented in this piece emerged from a private roundtable held in June, co-hosted by the Atlantic Council’s Economic Statecraft Initiative and the Scowcroft Middle East Security Initiative. We extend our sincere thanks to all participants for their valuable contributions and for helping shape the ideas reflected here.

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Despite these stakes, the Trump administration has yet to articulate a defined strategy for US engagement. So far, its two most notable moves in the region have been gutting the US Agency for International Development (USAID) and imposing some of the highest tariff rates announced on “liberation day.” These measures risk severely damaging this region’s economies and eroding goodwill.

Compounding this, Defense Secretary Pete Hegseth recently urged Indo-Pacific countries to increase their defense spending to 5 percent of their GDP. Even the region’s largest defense spenders would need to more than double their current budgets to meet that target. This would divert scarce resources away from sectors vital to long-term stability and growth—sectors already strained by the loss of critical US development support.

Security is rightly a priority for the United States in the Indo-Pacific. But in a region with a substantial development and infrastructure gap, scaling back on economic engagement while urging countries to boost defense spending risks alienating key partners. This imbalance creates an opening for China, which is both willing and well-equipped to step in with development financing and infrastructure investment. Without a more balanced strategy that pairs security alliances with meaningful economic and diplomatic engagement, the United States risks ceding long-term strategic influence in the region.

Development cuts are a strategic misstep

USAID had long served as a cornerstone of US influence in the Indo-Pacific. With operations in more than thirty countries in the region and more than one hundred small and large-scale projects across the Pacific Islands, USAID played an integral role in advancing a free and open Indo-Pacific. This was crucial because of the region’s strategic importance and because the Indo-Pacific faces mounting challenges. From accelerating climate change to increasing security threats from China and North Korea, the region is a complex and volatile environment. Compounding this volatility is a significant gap between its infrastructure needs and government investment—one of the largest globally—which continues to obstruct economic progress and regional connectivity. USAID helped tackle infrastructure bottlenecks, advanced climate resilience, promoted governance and public health, and provided critical stabilization in fragile environments.

With US foreign aid on pause pursuant to US President Donald Trump’s executive order “Reevaluating and Realigning United States Foreign Aid,”* those vital development ties have been severed. There are limited alternatives to fill these gaps—leaving a vacuum that China is already stepping into with targeted aid and infrastructure investments that advance its interests while building long-term economic dependencies on Beijing.

China’s development diplomacy

There is a tendency in Washington to overestimate its capacity for coalition building while underestimating that of China. In 2021, then US Secretary of State Antony Blinken said that China lacks what he called the United States’ unique asset—“the alliance, the cooperation among like-minded countries.” Multilateral initiatives such as the Quadrilateral Security Dialogue and the Australia–United Kingdom–United States partnership known as AUKUS, as well as numerous bilateral alliances, have been spotlighted as great successes of US coalition building in the Indo-Pacific. However, China has long understood that influence doesn’t always require formal alliances. Through its Belt and Road Initiative (BRI), it has built a vast web of strategic infrastructure—from the China-Laos Railway to ports in Pakistan and Myanmar—that serve both local development needs and Beijing’s long-term geoeconomic ambitions, such as reducing reliance on strategic chokepoints.

Though often criticized for creating asymmetric dependencies, BRI projects fill real gaps that Western alternatives have neglected. However, economic alignment also often comes with political expectations—most notably, adherence to the “one China” policy. Pakistan, Cambodia, and Myanmar have offered strong diplomatic support for China’s positions on Xinjiang and the South China Sea in return for economic backing. Cambodia, for example, has blocked criticisms of China’s maritime claims from the Association of Southeast Asian Nations.

These asymmetrical dependencies have prompted some pushback. In 2017, Nepal canceled the Budhi Gandaki Hydropower Project with China over transparency issues, and in 2019 Malaysia renegotiated the East Coast Rail Link for better local terms. At the same time, countries across the Indo-Pacific have shown a growing interest in partnering with the United States on economic and infrastructure initiatives where possible. The recent US-Philippines partnership to co-fund a major railway under the Luzon Economic Corridor signals what’s possible when Washington actively engages. A Filipino spokesperson claimed that through this project the Philippines had “sent a strong message that in today’s geopolitical landscape, military and economic support for key allies must go hand in hand.” This signals a crucial reality: As infrastructure and investment gaps persist across the region, many countries may find it difficult to reject Chinese funding outright—particularly if viable alternatives remain limited.

US retreat, Chinese advance

China is moving quickly to fill the gaps created by the United States’ retreat from foreign aid. Within a week of the United States canceling child literacy and nutrition programs in Cambodia, China announced nearly identical initiatives. Prior to its foreign aid retreat, the United States had also funded 30 percent of the demining operations in Cambodia, focused on removing landmines left behind in the Vietnam War. Cambodia’s leading demining authority has since announced that China will provide $4.4 million to support these projects—an effort that was once considered a key link between the United States and Cambodia.

Myanmar is another example. In the aftermath of a major earthquake in March, rescue teams from across the world—including China and Russia—rushed to support the region. The United States was noticeably absent from these efforts, only surfacing days later when it deployed a small USAID emergency team and pledged two million dollars in aid—a small sum compared to China’s promised fourteen-million-dollar aid package. Natural disasters are a frequent and economically devastating reality in the Indo-Pacific, and the United States has historically played a leading role in relief and recovery efforts. Now, however, that space is increasingly being filled by China.

In the Pacific Islands—the world’s most aid-dependent region—China has launched new development partnerships in the absence of US assistance. Beijing announced plans to bolster support for the region’s climate change efforts, committing to one hundred small-scale projects over the next three years. It has also pledged two million dollars in investments focused on clean energy, fisheries, ocean conservation, low-carbon infrastructure, and tourism. Beyond multilateral initiatives, China is also seeking to strengthen bilateral ties through agreements such as its recent deal with the Cook Islands.

China’s efforts extend beyond expanding development aid. Seeking to deepen ties with Southeast Asian countries shaken by Trump’s trade war, Chinese President Xi Jinping launched a diplomatic charm offensive in April, traveling to Vietnam, Cambodia, and Malaysia to promote China as a “stable partner” in light of global economic disruptions. Ultimately, the suspension of US foreign assistance has handed China an opportunity to expand its soft power in the Indo-Pacific at the expense of the United States.

What can the US do?

The Indo-Pacific doesn’t just want military alliances—it wants railways, schools, and hospitals. It wants partners who show up with solutions, not just rhetoric. In that context, the US withdrawal from economic aid sends the wrong message at the worst time.

To maintain strategic influence in the Indo-Pacific, the United States must rebalance its approach. While Trump is intent on reducing foreign aid and has shown no signs of bringing back USAID to its previous size, US policymakers have plenty of options to reengage with Indo-Pacific countries on their development goals and prevent China from gaining more of a strategic foothold in the region.

• Trump should visit the Indo-Pacific. A presidential visit would reinforce bilateral alliances, demonstrate US commitment to the region, and open new avenues for advancing positive economic statecraft in support of US interests.
• Congress should expand the US International Development Finance Corporation’s (DFC’s) mandate, scale, and capabilities. With the rollback of USAID, the DFC—which is up for reauthorization this year—has become the United States’ primary instrument of affirmative economic statecraft. It therefore serves as the most effective counter to China’s BRI, offering a transparent and sustainable alternative to Beijing’s development financing across the Indo-Pacific. Strengthening the DFC will enhance the United States’ ability to compete economically and strategically in the region.
• The US government should prioritize de-risking private sector investment in Indo-Pacific markets. To compete with China’s development financing model, the United States should expand access to political risk insurance through agencies such as the World Bank’s Multilateral Investment Guarantee Agency and the DFC.
• The Trump administration should adopt an economic strategy in the Indo-Pacific that furthers US strategic goals in the region. This strategy should be focused on strengthening supply chain resilience, enabling mutually beneficial economic growth and development with Indo-Pacific partners, and ensuring that the United States maintains strategic influence in the region.

The United States’ withdrawal of foreign aid threatens to undermine its economic, diplomatic, and strategic influence in the Indo-Pacific, creating space for China to expand its foothold. The Trump administration and Congress must act now to reinvest in its economic partnerships in this critical region.

Lize de Kruijf is a program assistant with the Atlantic Council’s Economic Statecraft Initiative.

Nazima Tursun is a former young global professional with the Atlantic Council’s Economic Statecraft Initiative.

Note: Some Atlantic Council work funded by the US government has been suspended or terminated as a result of the Trump administration’s Stop Work Orders issued under the Executive Order “Reevaluating and Realigning US Foreign Aid.”

The post Less investment, less influence: Why the US risks losing ground in the Indo-Pacific appeared first on Atlantic Council.

Reauthorizing the DFC is vital to ensuring the United States is not outcompeted by China in its hemisphere. It is essential for supporting US jobs, creating markets for US exports, advancing energy independence, and linking foreign policy outcomes directly to economic benefits for American workers. Congress must act decisively to secure America’s economic interests and leadership in the Western Hemisphere.

How to update the DFC to further advance US foreign policy priorities in Latin America and the Caribbean

Created in 2018 under the BUILD Act, the DFC merged the Overseas Private Investment Corporation (OPIC) with USAID’s Development Credit Authority. This restructuring introduced a more agile and powerful tool for advancing US development objectives while strategically countering rivals, especially China.

As Congress prepares to revisit the DFC’s authorizing legislation, it should prioritize ensuring that the agency can effectively mobilize private capital for high-impact investments in infrastructure, minerals, energy, technology, and healthcare. These sectors are essential to strengthening the United States domestically—a key criterion set by the current administration for all agencies pursuing foreign policy initiatives. For example, investments in rare earth mineral exploration in the region not only secure preferential access for the US to the resource but can also generate US jobs in areas such as classification, storage, distribution, and processing.

The DFC must also reposition itself with enhanced tools, such as capital financing and technical assistance, so it can lead strategic investments. These investments should prioritize relocating supply chains for critical minerals, semiconductors, pharmaceutical inputs, and digital connectivity throughout Latin America and the Caribbean. Strengthening strategic alliances with like-minded countries and the private sector is essential to expand the DFC’s role in sectors vital to US economic and national security.

Key takeaways:

• Strategic alignment: The US International Development Finance Corporation (DFC) is a crucial agency for advancing US foreign policy objectives, promoting job creation and development, fostering economic partnerships, and supporting strategic allies. It aligns with forward-looking initiatives from the Trump administration, such as América Crece 2.0, which emphasizes private-sector-led growth. But DFC’s first reauthorization provides a unique window for updates to enhance effectiveness and alignment with US foreign policy priorities. Congress has until October to approve a reauthorization bill, but the decreasing availability of funds presents an urgency for approval.
• Geopolitical competition: The DFC can and should act as a strategic counter to the rising global competition for influence across the world, and particularly, in many of the developing nations that have continued to join China’s Belt and Road Initiative. The DFC offers a transparent, market-based alternative to opaque, state-driven financing models that come with political strings attached.
• Economic security: By investing in critical infrastructure and critical rare earth minerals, cybersecurity, energy, and healthcare in Latin America and the Caribbean (LAC), the DFC can enhance US economic security by strengthening alliances with like-minded countries to serve as a counterweight to aggressive Chinese actions that seek to dominate key sectors for the US economy and US supply chains while reinforcing the value of US-led investment.

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Women and civil society are indispensable as first responders in the ongoing war. They must also be central to the planning, distribution, and oversight of funds in reconstruction efforts. As the German and Ukrainian governments recognized, the physical reconstruction of Ukraine needs to be paired with a comprehensive social, human-centered recovery. Women, who represent the majority of the highly educated and skilled workforce in Ukraine, are well-positioned to strengthen anti-corruption measures, modernize the energy sector, and drive Ukraine’s reform agenda. All of these components are essential for an effective recovery. In addition, these efforts can help Ukraine meet the conditions for its accession to the European Union (EU).

The record to date for women’s inclusion in recovery efforts has not been what it needs to be. Policymakers must continue to ensure that Ukrainian women leaders will have the opportunity to meaningfully and fully participate in Ukraine’s recovery. Ukraine can only recover if women and civil society are fully involved in its reconstruction.

Where do women fit in the Ukraine recovery agenda?

Held in Lugano, Switzerland, in July 2022, the first recovery conference resulted in the adoption of the “Lugano Declaration,” which includes guiding principles for Ukraine’s recovery process. At the 2023 conference in London, the EU announced the creation of a new Ukrainian facility that would provide a total of fifty billion euros to Ukraine over four years. From this total amount, thirty-nine billion euros will be allocated to the state budget to support macroeconomic stability. Another eight billion euros will go toward a special investment instrument that will cover risks in priority sectors. This year’s conference in Berlin aimed to attract private-sector investment in Ukraine, including in human capital. The agenda included the explicit goal of investing in women and youth. This was a positive development and should encourage international financial institutions and private donors to continue to invest in women-owned and -led businesses in Ukraine, as well as to train Ukrainian women to take on jobs in Ukraine’s critical sectors.

How to unleash Ukrainian women’s economic potential

Invest, train, and enable Ukrainian women. Women in Ukraine and elsewhere have traditionally had limited access to credit, markets, and training opportunities. They have also struggled to balance responsibilities in the workplace and their primary caregiver responsibilities. These challenges must be overcome if women are to fulfill their economic potential.

The World Economic Forum notes that one solution for improving women’s access to credit is to not necessarily demand collateral, because women often do not own private property. Moreover, many women (as well as men) in Ukraine have lost their homes and properties to the war, so providing property as collateral is not likely to be an option for them. Therefore, adopting alternative ways to determine women’s creditworthiness could encourage more women to apply for business loans.

Ukrainian women, with the support of Western companies and institutions, have already stepped up to launch their own startups. These should be scaled up. Since the start of Russia’s invasion, an increasing number of Ukrainian women have founded tech startups, benefitting from improved access to investors outside Ukraine, as well as programs sponsored by the EU, international organizations, and private companies. For example, VISA launched its “She’s Next” program in Ukraine in 2020, and it has since hosted gatherings where Ukrainian women presented their business proposals and received funding and training at business schools. More Western companies should team up with women-led Ukrainian nonprofits to create opportunities for funding female-led startups and give them access to education and training.

Train Ukrainian women to fill workforce gaps in critical sectors. Now is an important time to train Ukrainian women in two critical sectors that will play a key role in rebuilding Ukraine’s economy: finance and cybersecurity. Ukraine has consistently ranked as one of the most corrupt countries in Europe in Transparency International’s global Corruption Perceptions Index. Although Ukraine has made significant progress in the fight against corruption since 2014, it remains a problem and a concern for the United States and other foreign partners. The cost of complete reconstruction is currently estimated to be around $750 billion, but international donors are concerned about the potential misappropriation of funds put toward reconstruction.

Reform of its financial sector is essential for Ukraine to secure financial aid for reconstruction, as well as to meet the requirements for joining the EU. The urgent need for financial system reform coincides with women playing a much larger role in the financial system, both within the government and private sector. By transferring the knowledge of, for example, the best anti-money laundering (AML) practices to Ukrainian women, the West would create a generation of AML experts in Ukraine who are capable of detecting suspicious money flows and preventing corruption and money laundering within the Ukrainian financial system.

At the same time, equipping Ukrainian women with cybersecurity skills would help them defend Ukrainian banks and the financial system from Russian intrusions. Ukrainian banks were one of the primary targets of the cyberattacks that Russia initiated right before launching its full-scale invasion of Ukraine in February 2022. More recently, at the end of 2023, Monobank, one of the largest Ukrainian banks, reported a massive hacker attack. While the bank has not publicly attributed this attack to any specific threat actor, Russia has been suspected due to its history of backing cybercrime groups attacking Ukraine. The persistent threat of Russian cyberattacks against Ukrainian banks should be countered by training Ukrainian women in cybersecurity and digital forensics.

Ukraine’s partners and allies can learn from and build on existing work to train Ukrainian women in cybersecurity. For example, the United Nations Institute for Training and Research organized a project that trained Ukrainian women evacuees in Poland in cybersecurity and data analytics. The project was held from October 2023 to March 2024 and was funded by the government and people of Japan. Private companies have also launched similar initiatives. For example, Microsoft is working with nonprofit organizations in Poland to train Ukrainian women refugees to enter the workforce in cybersecurity. Such projects need to expand to include more partners and reach more Ukrainian women.

Investing in Ukrainian women is smart economics

Leveraging Ukraine recovery conferences and other global convenings to encourage Western investment in Ukrainian women corresponds with the United States’ existing strategy of providing economic incentives to allies—also known as positive economic statecraft. The EU, United Kingdom, and other Group of Seven (G7) members are already heavily invested in Ukraine’s success. Directing investment toward the female workforce will strengthen an already existing strategy of ensuring Ukraine has the resources to minimize economic dependence on Russia. Investment in Ukrainian women will create a multiplier effect for the economy. It is well-known that women often spend their income on education, healthcare, and nutrition—all of which raise the standard of living. This is a force that moves economies forward but is often sidelined.

Finally, Ukrainian women can fill in global workforce gaps, too. Training Ukrainian women in cybersecurity would help address the global cybersecurity skills crisis. Private companies and policymakers often note that the world does not have enough cybersecurity professionals. Meanwhile, Ukraine has a highly educated population, especially in technical subjects. Cyber-trained Ukrainian women could defend not only Ukrainian banks but also businesses and governments around the world.

As policymakers and private sector actors adopt strategies for Ukraine’s reconstruction, it is crucial that they fully leverage the potential of Ukrainian women and help establish the groundwork for an inclusive and sustainable recovery.

Melanne Verveer is the executive director of the Georgetown Institute for Women, Peace and Security and a former United States ambassador-at-large for global women’s issues at the US Department of State.

Kimberly Donovan is the director of the Economic Statecraft Initiative at the Atlantic Council’s GeoEconomics Center and a former senior US Treasury official.

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This trend reflects both opportunity and necessity. The era of hyperglobalization is over, but the world economy remains more connected than ever, providing nations the opportunity to break linkages of trade, capital, and technology (or threaten to do so) for geopolitical advantage. At the same time, we have entered the most intense period of great power competition since the Cold War ended, with Russia and China expressing a shared desire to upend the US-led international order. Since today’s “great powers” are also nuclear powers, barring catastrophic miscalculation, the logic of mutually assured destruction suggests that direct confrontation is more likely to play out in the theater of economics than on the battlefield.

The implication is that economic statecraft will remain a fixture of foreign policy—filling the policy space between war and words when conflicts emerge. But for economic statecraft to have maximum effect, it should be grounded in a doctrine that animates the United States’ guiding purpose to enhance global prosperity while safeguarding national security. Indeed, while the United States has spent hundreds of years developing and refining its doctrine for military engagement—for example, by identifying “containment” as the strategic anchor at the dawn of the Cold War—the effort to formulate a grand strategy for economic statecraft has only recently begun.

A doctrine of economic statecraft

Laying down a doctrine would serve multiple objectives. If taken seriously, it would limit overreach in the use of restrictive or punitive forms of statecraft. It might also reassure other countries that the world’s leading economic power is not firing economic weapons in an arbitrary or reflexive manner. Most profoundly, it could promote balance in the conduct of statecraft—specifically, between measures that impose economic pain and those that offer the prospect of mutual economic gain—and in doing so, enhance the credibility of economic statecraft and help to bring geopolitical “swing states” into strategic alignment.

Recent events underscore the urgency of this effort. Two years after the start of Russia’s full-scale invasion in Ukraine, more than two-thirds of the world’s population lives in countries that have not joined the sanctions coalition. Some officials from nonaligned countries have voiced concerns about the efficacy of sanctions, arguing that the costs of breaking linkages in the global economy exceed the benefits of changing Russian President Vladimir Putin’s calculus on the battlefield. Others have pushed back with the unfortunate perception that sanctions represent an illegitimate exercise of (mostly the United States’) brute economic force.

These concerns deserve careful attention—first on the merits, but also because the force of sanctions greatly depends on the size of the coalition implementing them. The bigger the sanctions coalition, the higher the direct impact of those sanctions and the lower the opportunity to evade them.

The elements of doctrine: Principles, rules, and a code of conduct

What would be the core elements of a doctrine for economic statecraft? It would begin by laying down guiding principles for restrictive or punitive tools. Illustratively, these principles could include the following:

1. They should be used sparingly, and only when shared global interests of peace and security are under threat.
2. They should seek to avoid unnecessary spillovers to civilian populations of the target country and third countries.
3. They should be calibrated to maximize the chance of coordination with like-minded partners.
4. They should be designed flexibly so that the impact can be ratcheted higher or lower depending on the target’s response.
5. They should be sustainable for the United States and the global economy, recognizing that these measures are typically designed to generate impact over the long term.
6. They must pass a threshold of efficacy; the impact delivered to the target, and the likely influence on the target’s behavior, must be judged as sufficient to justify the economic costs and risks (relative to the next best alternative).
7. Their design and implementation must be infused with a sense of humility. By design, sanctions break the bonds of trade, capital, and technology in the global economy—sometimes instantaneously—making unintended consequences almost inevitable. Humility requires us to change our minds when we’re mistaken in our judgments or assumptions, admit when we’re wrong, and course correct as needed.

A doctrine of economic statecraft should also set out rules of engagement to govern why, when, what, how, and against whom restrictive measures are deployed.

• Why refers to the need for a clearly defined geopolitical objective that sanctions, export controls, or tariffs are designed to serve.
• When refers to the timing of deploying statecraft—the standards for doing so before, during, or after a trigger event. It also considers when and under what conditions these measures should be rolled back.
• What is all about the limits of what the United States will do, and especially what it won’t contemplate—for example, sanctions on food and medicine, or seizing private property without due process.
• How points to the circumstances in which the United States would be willing to deploy sanctions unilaterally if it is unable or unwilling to build a coalition.
• Against whom delineates how the United States thinks about deploying sanctions on private citizens and private companies, as opposed to technocrats, government officials, military personnel, and political leadership.

A third prong of an economic statecraft doctrine would be a code of conduct. Practitioners of statecraft should commit to standards of behavior that uphold the principles and rules outlined above. There should be a pledge of caution to “do no unnecessary harm” to the civilian population of the target country and to those of third countries. In the spirit of humility, practitioners should also commit to follow an evidence-based and unsentimental approach that challenges lazy narratives, strives to imagine the full distribution of possible outcomes, and helps policymakers see their blind spots. Lastly, there should be a pledge of transparency and accountability—to Congress and the broader public—that would involve documenting decisions, sharing the rationale for key judgments, and providing updates on progress or setbacks. 

Operationalizing doctrine: Upgrading the analytical infrastructure

Taking such a doctrine seriously requires an upgrade to the analytical infrastructure of the US government to make it fit for purpose. I would recommend that several actions feature prominently in this effort:

To start, take regular inventory of the tools for economic statecraft that are deployed across various US government agencies and departments: sanctions, export controls, tariffs, investment restrictions, price caps, and so forth. Central banks such as the Federal Reserve maintain an inventory for the range of tools at their disposal—including updates on their operational readiness—and so should government entities with authority to execute economic statecraft.

Second, at regular intervals, assess the historical efficacy of these tools, when used alone or in tandem, unilaterally or multilaterally, before or after a trigger event.

Third, study the historical spillovers from using these tools, with the objective of identifying limitations and tradeoffs when using them.

Fourth, stress test and wargame the tools of economic statecraft against simulated scenarios that imagine a multiplayer, multistage conflict transpiring globally over several years. The test should begin by assessing where the United States’ economic strengths (and those of its allies and partners) intersect with the target’s vulnerabilities, and vice versa. It should evolve into a continuous process that identifies where the United States needs to strengthen or invent new tools, new defense mechanisms, and new forms of coordination to prevail in an extended conflict.  

Fifth, anticipate how and where evasion is likely to occur and build readiness for countermeasures in real time, whether by tightening the screws on the target or by applying outsize penalties on violators to generate a more powerful deterrent to evasion.

Sixth, build surveillance practices that inform the design of economic statecraft. Central banks across the world have developed exercises to spot vulnerabilities in the financial sector, test the financial system’s liquidity and capital buffers against shocks, and locate vectors of contagion. Practitioners of economic statecraft should build an analogous discipline to monitor risks to economic security, for instance by testing the resilience of critical supply chains, assessing the capacity for domestic stockpiles or imports from abroad to boost availability of vital supplies, and building early warning systems with trusted partners to detect emerging chokepoints.  

Creating analytical infrastructure with this kind of ambition will likely require a step change in personnel. One approach would be to recruit a multidisciplinary SWAT team of specialists—centralized either within the Executive Office of the President or a newly established Department of Economic Security—with expertise in macroeconomics, critical supply chains, financial markets, capital flows, trade finance, diplomacy, and the law. The unit will need sufficient scale, scope, and absorption capacity to handle multiple crises at once. It must be accountable to Congress, including through semiannual testimonies. And it needs to develop connective tissue with allies and partners—both existing and potential ones—as well as stakeholders in the private sector and regulatory community, so that it can coordinate and execute quickly in the crucible moments of conflict.  

Regulators will also need to do their part. For example, the Federal Reserve Board could designate a governor with the standing responsibility to evaluate the impact of existing and prospective policies of economic statecraft, drawing on the analytical insights of board staff and those of the Federal Reserve Bank of New York.

The conduct of economic statecraft: Toward a positive vision

Changing the narrative on economic statecraft will ultimately require more than just doctrine and analysis. The most important step policymakers can take in this regard is to strike a deliberate balance in the conduct of economic statecraft. Specifically, the United States should convey a standing preference for using economic instruments when they positively induce and attract countries via the prospect of mutual gain, rather than feed a perception that the United States’ focus and energy is mostly spent on deploying tools that are designed to inflict economic pain. Debt relief, concessional lending, infrastructure finance, supply chain partnerships, and technology alliances are examples of positive inducements, each with the potential to forge an enduring alignment of interests with geopolitical swing states that have expressed skepticism toward the United States’ use of statecraft.

This is especially relevant in the context of the intensifying global competition with China. Relying strictly on the coercive tools of economic statecraft to blunt or weaken China’s geostrategic position is not a winning strategy. China’s defensive buffers are far more formidable than Russia’s, against which the sanctions coalition found numerous areas of asymmetric advantage where the United States and its allies produce or supply something Russia needs and can’t easily replace. So is Beijing’s capacity to go on the economic offensive, whether by exploiting chokepoints in critical supply chains such as clean energy and pharmaceuticals or weaponizing its unrivaled scale in producing manufactured goods.

This is not to suggest there aren’t pressure points that could be targeted in an economic campaign against China before or during a conflict scenario. No country is too big to sanction. But there isn’t an obvious knock-out blow that coercive statecraft could deliver by itself without incurring severe collateral damage in a full-fledged confrontation with China.

There are, however, major geostrategic opportunities for the United States and its allies to attract nonaligned countries into its orbit with positive inducements, and in doing so to gradually isolate China before any conflict unfolds.

We have already seen laudable progress by the United States and Group of Seven (G7) governments in recent years to revitalize their efforts in this regard—most visibly by offering a positive alternative to China’s Belt and Road Initiative lending through the Partnership for Global Investment and Infrastructure (PGI). But additional steps to augment or invent tools that bolster the financial firepower of the United States and its allies would boost their credibility. 

For example, the United States has a sparingly used instrument on the shelf, sovereign loan guarantees (SLGs), that could be put to much greater use—especially for middle-income countries that don’t qualify for support programs offered by the International Monetary Fund and World Bank. The way SLGs work is simple: The US government guarantees to private lenders that a foreign government’s borrowing will be repaid. Unsurprisingly, the guarantee induces private lenders to charge the borrower nearly the same interest rate as the United States enjoys—a benefit that slashes the interest expense of the borrower and is highly cost effective for US taxpayers. By working in concert with the G7 and other partners, the United States could multiply the impact of SLGs and similar guarantees or insurance tools that allow the West to compete with the scale and speed of China’s lending activity, but at higher levels of financial transparency and standards for environmental and labor market impact.

Other ideas worthy of exploration include reimagining the US strategic petroleum reserve as a “strategic resilience fund” that makes direct investments in the supply chains for critical minerals and scarce inputs used to produce clean energy and foundational technologies. A moonshot idea would be the launch of a sovereign wealth fund for the United States to make long-term, strategic investments in high-standard infrastructure projects at the center of the PGI.

As a corollary to imagining new and augmented financing tools at the country level, the G7 and key partners in the Group of Twenty (G20) such as India should keep amplifying calls for multilateral development banks, especially the World Bank, to take on far more risk in terms of how much, where, when, and on what terms it lends—even in the absence of further capital injections. The most innovative idea in this regard comes via former US government official Brad Setser, who suggests that the World Bank issue bonds linked to special drawing rights, a claim on the reserve currencies of the world, to raise funds that can boost lending capacity almost immediately. A less exotic alternative would be to estimate and exhaust the lending headroom available to the World Bank without risking a credit downgrade from rating agencies.

We’ve been here before

Almost a century ago, the UK Foreign Office developed a comprehensive doctrine of economic statecraft as a guide for how its economic powers could be used in the context of its looming conflict with Germany. Having been on the front lines of designing and deploying economic statecraft over the past decade, I’m convinced that we need a modern doctrine to institutionalize how, when, where, and why the United States uses economic tools in the context of today’s great power competition. But for such a doctrine to produce better results than a century ago, the United States and its partners will need to apply the same creativity and urgency toward developing a positive vision for economic statecraft as they have in designing sanctions and other restrictive measures in the recent past. 

Daleep Singh was the chief global economist at PGIM Fixed Income and is a former US deputy national security advisor for international economics. He will soon return to his role as deputy national security adviser for international economics.

This article reflects views expressed by the author in his personal capacity prior to rejoining the US government.

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PES was central to the agenda in principle if not in name at last month’s World Economic Forum in Davos, featuring in both official and unofficial conversations and convenings. New announcements and commitments echo this sentiment and especially illustrate how the private sector, in partnership with governments, can and should play a role in advancing PES. For example, more than twenty Ministers and CEOs came together in a WEF alliance to mobilize financing for the clean energy transition in the Global South. The Network to Mobilize Clean Energy Investment for the Global South will amplify the investment needs of developing nations and advance actionable solutions to increase green energy capital flows globally. Comprising Ministers from Colombia, Egypt, India, Japan, Malaysia, Morocco, Namibia, Nigeria, Norway, Kenya, South Africa, and ten other countries, the Network to Mobilize Clean Energy Investment for the Global South “will provide a collaborative space for its members to accelerate clean energy capital solutions in emerging market contexts—through innovative policies, new business models, de-risking tools and finance mechanisms—and exchange best practices for attracting sustainable flows of clean energy capital.”

Also this month, the US Millennium Challenge Corporation marked the 20th anniversary of its founding, bringing to light its two decades of economic growth and poverty alleviation investments whose model and eligibility requirements—including democratic rights and control of corruption ‘hard hurdles’—have unlocked policy reforms, unleashing the “MCC effect” in numerous countries. To date, MCC has invested over $17 billion in infrastructure and policy reforms in health, education, power, agriculture, and transport in forty-seven countries, benefiting over 300 million individuals worldwide. This year, Cabo Verde was selected for development of a new regional compact “as a result of its strong commitment to democracy, its economic development needs and lingering poverty, and the potential opportunities to strengthen regional economic integration and trade in West Africa with a committed and engaged former MCC partner”; while Tanzania and Philippines can begin developing threshold programs to advance the rule of law in support of compact eligibility after selection by the Board in December 2023.

A third illustration, the European Commission and the Africa Development Bank signing of a Financial Framework Partnership Agreement on January 29 to boost energy, digital, transport infrastructure investments across the continent with co-financing. The agreement falls under the EU’s values-driven Global Gateway initiative which prioritizes advancing rule of law, human rights, and international norms and standards alongside inclusive economic growth, health and education in its cooperating countries: its 2021-2027 package with Africa will support investments worth €150 billion.

Where else might we see PES this year? Here’s a few things worth watching.

While PES has been more complicated to enact in multilateral contexts, this year’s G20 has potential beyond the strength in numbers alone. The members of the G20 represent around 85 percent of the world’s GDP, and more than 75 percent of world trade. Brazil took the reins of the G20 Presidency in November 2023, and has put development front and center on the agenda, opening the door to a robust PES orientation: its three key priorities comprise combating hunger, poverty, and inequality; advancing the three dimensions of sustainable development (economic, social, and environmental); and reforming global governance. Indeed, in the run up to the Leader’s summit in November, the Sherpa’s Development Working Group will convene again in March and May to further public policies to reduce inequality, trilateral development cooperation (grants, technical assistance, lending) and more specifically investments in water and sanitation. At the same time, PES will take center stage as the work of the Finance track gets underway next month when Ministers and central Bankers will convene and deliberate how preferential trade and fiscal incentives might be deployed to address fragmentation and debt challenges of lower middle-income countries.

As it relates to conflict response, we see PES as a frame for continued and specific bilateral and multilateral support to Ukraine’s economic recovery as well as EU expansion—with aid and membership contingent on and related to reforms which capacity building, technical, and financial assistance will be targeted to advance. A €50 billion ‘Facility’ from the EU has just gained unanimous approval, and we could see other moves such as extending Ukraine access to the Single Euro Payments Area (SEPA). The United States Agency for international Development (USAID) Ukraine Mission has forecast awarding this year a new flagship trade and competitiveness project to encourage business enabling reforms, support industries and firms, further job creation, and increase exports.

Similarly, as war rages in Israel and Gaza, fomenting humanitarian crisis, we are likely to see PES incentives. Those could include development grants and economic aid to encourage neighboring countries Egypt and Jordan to increase their intake of refugees and facilitate logistical humanitarian support, as well as to Gaza and the West Bank themselves for economic recovery and reconstruction alongside promotion of rule of law and peacebuilding.

On trade, as fragmentation threatens supply chains, including for critical minerals, new and improved preferential trade and finance mechanisms that reduce dependence on China or bolster regional ties will be on the table. The US African Growth and Opportunity Act is up for reauthorization. First passed in 2000, The African Growth and Opportunity Act (AGOA), which makes preferential terms of trade and investment support dependent upon favorable annual reviews of a country’s economic policies, governance, worker rights, human rights, and other conditions, was last reauthorized in 2020 and is set to expire in 2025. With US Senator Coons releasing a discussion draft of reauthorizing legislation in November 2023, that in part incorporates AGOA with the nascent African Continental Free Trade Agreement, we can expect to see robust, and perhaps unusually bipartisan, discussion this year.

Finally, this year marks the 80th anniversary of the Bretton Woods Conference that launched the World Bank (then IBRD) and International Monetary Fund (IMF) as the nature and direction of global economic governance continues to evolve, creating an important entrée for PES. Over the past decade, developing countries’ options for financing have increased as China and others have increased their global footprint giving way to more strategic competition. At the same time, as their fiscal space tightens and liquidity constrained, the case for using positive economic statecraft tools is clear and all signs point toward seeing more of it than before in 2024. It will be important to monitor impact and learn from effectiveness (or not) of these solutions in real time as well as over time as resulting policy reforms and investments take hold and bear fruit.

Nicole Goldin is a nonresident senior fellow with the Atlantic Council’s GeoEconomics Center.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

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Table of contents

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Introduction

I. Building common ground: Assessing US and European tools of economic statecraft

Capabilities and organizational structures of the US, the EU, and the UK’s sanctions authorities

Equities and vulnerabilities: When transatlantic economic statecraft approaches may not align

Common narrative: Areas of foreign policy and sanctions regime alignment

Building common ground: The need for multilateralism in economic statecraft

II. Positive economic statecraft: Wielding hard outcomes with soft money

What is (and what is not) positive economic statecraft

Why it matters now

How is positive economic statecraft operationalized?

Path forward for positive economic statecraft

III. Networked power: Export control policy across the G7

How networks model power and dependency

Hierarchical networks are easier to leverage

The US, Japan, and the Netherlands jointly have supplier centrality

No evidence that export controls have eroded the US’ central position

Appendix: Data and methodology

IV. New era of financial sanctions: Adapting to de-dollarization

The sanctions obsession

Russia’s anti-dollar strategy

China seeks to internationalize its yuan

Adjusting sanctions policy to the anti-dollar era

Conclusion

Acknowledgements

Introduction

Economic statecraft, or leveraging economic power to achieve foreign policy and national security objectives, dates back to Greco-Roman times. Modern economic statecraft and its associated tools, including financial sanctions and export controls, as well as positive inducements, were born out of World War I and refined by the Allies during World War II to protect their assets held in Nazi-occupied territory and eventually to bolster European economies that were devastated during the war. Since then, governments and multilateral organizations have expanded their authorities and capabilities to leverage economic statecraft tools to protect their nation’s security, advance foreign policy and economic objectives, and stabilize partners and allies’ governments and economies.

Viewed as more than diplomacy, but short of military intervention, economic statecraft has become the West’s tool of first resort to address national security threats and change an adversary’s behavior. Sanctions are used to disrupt terrorist groups, transnational criminal organizations, and illegal traffickers as well as deny regimes access to the international financial system and restrict their ability to move funds. Economic statecraft has gained significant attention over the past year and a half as a result of the Group of Seven (G7) and broader coalition’s economic response to Russia’s invasion of Ukraine. G7 and coalition partners levied significant coordinated sanctions and export controls on Russia to freeze Russian assets, reduce their economic dependency on Russia, and degrade Russia’s ability to import military grade components needed to pursue its war.

The economic statecraft landscape is becoming more complex as transatlantic partners increasingly leverage the tools to counter transnational threats. There is a growing need to understand how these tools are used, by whom, and when as well as their intended and real impacts worldwide. 

This report offers the first step in developing a common operating picture on economic statecraft and how it is used in practice by transatlantic partners. The first half of the report focuses on coercive and positive tools of economic statecraft. The second half is organized around the effects and potential implications of export controls and financial sanctions.

In chapter one, “Building common ground: Assessing US and European tools of economic statecraft,” Kimberly Donovan and Maia Nikoladze examine how the United States, the United Kingdom, and the European Union (EU) are organized to develop sanctions and export controls and identify critical aspects that are needed for successful coordination and implementation of statecraft tools.

In chapter two, “Positive economic statecraft: Wielding hard outcomes with soft money,” Nicole Goldin and Mrugank Bhusari define positive economic statecraft (PES) from the US and EU perspectives and offer a way forward to leverage PES as an approach for achieving foreign policy, national security, and economic objectives.

Sarah Bauerle Danzman and Ambuj Sahu use network analysis techniques to assess the effect of export controls and related tools on the global semiconductor supply chain in chapter three, “Networked power: Export control policy across the G7.”

And, in chapter four, “New era of financing sanctions: Adapting to anti-dollar policies,” Daniel McDowell examines anti-dollar policies and encourages Washington to reconsider when and how it uses financial sanctions to avoid weakening the coercive capabilities that the United States derives from the preeminence of the dollar in the global economy.

Transatlantic partners will continue to use economic statecraft tools to advance foreign policy and economic objectives and counter transnational threats. We must understand these tools, their impact, and potential risks so we may anticipate how they may be applied in the future.

I. Building common ground: Assessing US and European tools of economic statecraft

by Kimberly Donovan and Maia Nikoladze

Within days of invading Ukraine, Russia was locked out of the global financial system in an unprecedented act of coordinated economic statecraft. The European Union (EU), the United Kingdom, and the United States, in collaboration with their Group of Seven (G7) allies, executed major multilateral sanctions against Russia to try and change Vladimir Putin’s behavior and drain Russia’s war chest. As a result of these sanctions, Russian sovereign assets were immobilized and Russian companies and individuals facilitating Russia’s war effort were denied access to the global financial system. These wide-ranging economic measures would not have been possible without Western allies’ alignment on foreign policy objectives, their dominant role in the international financial system, and the preeminence of their currencies in the global economy. However, transatlantic alignment is not a foregone conclusion: Success going forward requires careful consideration of the legal and political constraints that limit policy makers and which could undermine future coordination.

A successful transatlantic approach to economic statecraft depends on three critical pillars: (1) the authorities, capabilities, and organizational structure of the competent authorities within each jurisdiction to levy and enforce economic tools, (2) an understanding and recognition of transatlantic partners’ equities and vulnerabilities associated with implementing economic measures, and, most importantly, (3) a common narrative or shared understanding of transnational threats and alignment in the foreign policy objectives to address them. 

All three pillars will be required to reduce the risk of sanctions evasion. While sanctions evasion persists, officials on both sides of the Atlantic have lauded the development and implementation of multilateral sanctions to counter Russia’s invasion of Ukraine as a successful example of economic statecraft—the use of economic power for achieving foreign policy objectives. 

This chapter provides an overview of the United States, the EU, and the UK’s organizational approaches to economic statecraft, focusing on financial sanctions and export controls. This is a first step in identifying where and when approaches diverge and align so that we may level set expectations and continue building common ground on what may be achievable through the multilateral use of economic statecraft going forward.

Capabilities and organizational structures of the US, the EU, and the UK’s sanctions authorities 

The United States’ approach to economic statecraft

Economic statecraft is the means by which a government can apply economic measures to protect national security and advance foreign policy goals. In the United States, the economic statecraft toolkit includes restrictive measures pursuant to legislation, executive orders, and regulation, that are generally applied to change an actor’s behavior. These mechanisms include, but are not limited to, financial and economic sanctions, export controls, investment screening, trade agreements and embargoes, and regulatory and law enforcement action. The US toolkit also includes positive measures and inducements, such as foreign aid and capacity building to bolster partners’ capabilities, develop their economies, and promote democratic ideals.¹

Through legislative action, the US Congress can create new sanctions authorities or issue exemptions on existing sanctions designations.² As an example, the International Emergency Economic Powers Act (IEEPA) provides the president of the United States the authority to declare a national emergency and direct the Department of the Treasury, in consultation with the Departments of State and Justice, to issue sanctions to block property and freeze assets to disrupt, deter, or degrade the national security threat.“³ The IEEPA, and other US laws, provided the president the authority to issue Executive Order 13660 on March 6, 2014, from which Treasury’s Office of Foreign Assets Control derived powers to designate foreign entities and individuals involved in violating the sovereignty and territorial integrity of Ukraine.⁴ Meanwhile, in addition to its Bank Secrecy Act regulatory responsibilities, Treasury’s Financial Crimes Enforcement Network exercises regulatory powers under the USA Patriot Act to identify money-laundering threats to the US financial system.⁵ The Department of Commerce administers US laws and regulations, such as the Export Administration Regulations on the export of goods and technology, to protect national security interests and advance US foreign policy.⁶ The authority to enforce these actions resides within components of the Departments of the Treasury, Commerce, and Justice, among others.

The US’ approach to financial sanctions 

While the United States has leveraged its economic power to advance foreign policy objectives and protect its national security for decades, the US sanctions regime, specifically economic and financial sanctions as we know them today, were developed out of the US response to the September 11, 2001, terrorist attacks and the creation of the Office of Terrorism and Financial Intelligence within the Treasury. Following the money and disrupting the financing and financial ties of terrorist groups, such as al-Qaeda, the Islamic State of Iraq and al-Sham, and Lebanese Hezbollah, and their facilitators became a primary objective within the US counterterrorism strategy. Targeting these individuals and networks with financial sanctions denied them access to the international financial system and disrupted their ability to raise, move, and use funds, which degraded their ability to carry out attacks and recruit fighters.

Targeted financial designations, as part of broader, whole-of-government strategies, proved to be an effective measure by which to counter terrorism as well as proliferation networks, narcotic traffickers, transnational criminal organizations, cyber criminals, and adversarial regimes that posed a threat to US national security. These tools expanded over the years and became more sophisticated as illicit actors developed ways to circumvent and evade sanctions. New tools were developed and old tools were applied in new ways to use the power of the US financial system and strength of the US dollar and economy to advance US foreign policy and national security objectives.

The United States promotes and implements United Nations (UN) sanctions and issues unilateral sanctions to disrupt illicit actors that pose a threat to its national security and to protect the US financial system from abuse by these actors.⁷ Recognizing the success of sanctions in denying illicit actors access to the financial system, the United States often encourages its partners to join in US sanctions or issue their own restrictive economic measures when foreign policy objectives align. In several instances, the United States helped partner nations create the tools and authorities they needed to issue sanctions of their own. 

Short of military engagement but more than diplomacy, financial sanctions have been most successful in cases where objectives were clearly and narrowly defined. According to the Treasury’s assessment, sanctions succeeded in bringing Iran to the negotiating table on its nuclear program in 2015, dismantling the Cali Cartel, protecting Libyan assets from misappropriation by government officials after Moammar Gadhafi’s fall in 2011, and disrupting Lebanese Hezbollah’s funding streams.⁸ 

The US’ approach to export controls

Export controls became more prominent in the US economic statecraft toolkit following Russia’s invasion of Ukraine in 2022 and the US technology competition with China. While financial sanctions cut off designated entities and individuals from the global financial system, export controls aim to prevent adversaries or competitors from physically acquiring components. The United States and its G7 allies leveraged multilateral export controls to restrict the flow of dual-use technology to Russia and curb Russia’s military production. Further, the United States, the Netherlands, and Japan have levied export controls to prevent sophisticated technology that could be used for military purposes from getting to China.

Export controls became more prominent in the US economic statecraft toolkit following Russia’s invasion of Ukraine in 2022 and the US technology competition with China. While financial sanctions cut off designated entities and individuals from the global financial system, export controls aim to prevent adversaries or competitors from physically acquiring components. The United States and its G7 allies leveraged multilateral export controls to restrict the flow of dual-use technology to Russia and curb Russia’s military production. Further, the United States, the Netherlands, and Japan have levied export controls to prevent sophisticated technology that could be used for military purposes from getting to China.⁹

Apart from being a member of multilateral export control regimes, such as the Wassenaar Arrangement, the Nuclear Suppliers Group, the Australia Group, and the Missile Technology Control Regime, the United States also maintains autonomous export control authorities.¹⁰ The Commerce Department’s Bureau of Industry and Security (BIS) administers US regulations governing the export of dual-use technologies and other commodities. It maintains a list of items that should not be exported without obtaining a license, also known as the Commerce Control List.¹¹ BIS also maintains an Entity List, which includes the names of entities and individuals that are subject to specific license requirements for the export of specified items.¹²

Against the backdrop of escalating technological competition between the United States and China, the Commerce Department has come under scrutiny for its ability to enforce its authority and for being unsuccessful in tightening the export of foundational technologies to the countries of concern.¹³ Some members of Congress have gone as far as to suggest shifting export control authorities to the Department of Defense. Admittedly, BIS’ budget has not increased commensurate with its role in national security.¹⁴ Nevertheless, the Commerce Department has taken action to address some of these concerns. For example, it recently launched the Disruptive Technology Strike Force jointly with the Department of Justice to prevent adversarial states such as Russia and China from getting their hands on advanced US technology.¹⁵

Export control is a powerful tool, capable of degrading an entire nation’s technological progress. The US government should ensure that this tool evolves in conjunction with European and British allies while taking into account their perspectives and concerns. 

The European Union’s approach to economic statecraft

The European approach to economic statecraft is dominated by the EU’s position on a free market and fair competition, but it also acknowledges that the current rules-based order is being challenged by the weaponization of energy and supply chains by countries like Russia and China.¹⁶ While the conversation on US economic statecraft tends to be dominated by sanctions and coercive measures, the EU has historically put more emphasis on open trade as a key element of its foreign policy and has not leveraged financial sanctions to the extent that Washington has for advancing foreign policy objectives. However, over the course of developing sanctions and other economic measures in response to Russia’s invasion of Ukraine, the EU has shown a willingness to leverage its economic power to address transnational threats and also an appreciation of economic statecraft as necessary tool if the EU is to play a greater role as a global strategic actor.

The EU’s doctrine of economic statecraft is based on four pillars: (1) protecting the level playing field between the internal market and third countries, (2) ensuring reciprocity, (3) deploying assertive instruments against coercion and aggression, and (4) developing partnerships. The first pillar is focused on trade defense instruments. The EU, in fact, launched one hundred and sixty anti-dumping and twenty anti-subsidy measures just in 2021.¹⁷ The second pillar of the doctrine establishes that just as the EU gives foreign companies access to its public procurement, third countries should also open their procurement markets to European companies. The third pillar, which is perhaps most similar to US economic statecraft, focuses on assertive measures such as sanctions and strong industrial policy. Meanwhile, the fourth pillar focuses on developing partnerships and increasing development aid to third countries, which is an area the United States also needs to work more on, and thus presents an opportunity for collaboration between Washington and Brussels. 

While the United States can be quick to take action and impose restrictive measures to address national security threats, the nature of the EU and its twenty-seven member states generally requires that it take a more strategic and thoughtful approach to economic statecraft and prioritize developing solid frameworks that account for member state equities before taking action. That said, the EU, rather uncharacteristically, acted quickly in response to Russia’s invasion of Ukraine on February 24, 2022, and executed substantial restrictive economic measures to freeze and block Russian assets within the EU’s jurisdiction. The EU’s actions toward Russia demonstrated its willingness and ability to move fast when there is common view of the threat and foreign policy alignment.

The EU’s approach to financial sanctions

The EU’s process of developing sanctions packages and enforcing them is more complex than that of the United States. In the United States, although the legislative branch passes laws from which the executive branch derives authorities, designation, implementation, and enforcement of sanctions packages is the responsibility of the executive branch. The EU’s process is legislative—member states must unanimously agree on a designation, then the states’ domestic agencies have to implement it. As a result, any policy divergences among the twenty-seven EU member states can lead to delays in sanctions designations and implementation or refraining from sanctions altogether.¹⁸

Similar to the United States, the EU’s financial sanctions primarily developed as a means to counter the financing of terrorism. In December 2001, the EU adopted Common Council Position 2001/931/CFSP outlining criteria for designating those involved in terrorism and adopted Council Regulation (EC) No 2580/2001 to freeze terrorist assets within the EU’s jurisdiction in order to implement UN Security Council Resolution 1373.¹⁹ Since then, EU sanctions programs have expanded and currently count forty different sanctions regimes, including those mandated by the UN as well as the EU’s autonomous lists.²⁰

Officially, several steps are necessary for the EU to impose an “Autonomous Restrictive Measure” independent of the UN. The EU’s Common Foreign and Security Policy procedure demands that the measure be proposed by the high representative for foreign affairs, then examined by member states’ representatives in several working groups, and then adopted unanimously by the European Council.²¹ The unanimity requirement can make the sanctions designation process especially challenging for the council. 

In addition to the EU-level approach, some EU member states, including, but not limited to, France, Poland, and the Czech Republic, are individually taking steps to develop unilateral economic statecraft capabilities to further protect their national interests and financial systems and address areas where they deem the EU process to be insufficient.

While EU sanctions regulations leave little room for interpretation, member states are still responsible for their implementation. This creates discrepancies in sanctions enforcement across the EU member states’ jurisdictions. The European Commission is currently working on making sanctions evasion an EU crime with a harmonized penalty structure and a new mandate for the European Public Prosecutor’s Office.²²

The EU’s approach to export controls 

Similar to the United States, the EU is a member of multilateral export controls regimes, such as the Wassenaar Arrangement. EU member states can volunteer to implement export controls on items agreed upon by the Wassenaar Arrangement. They also have a competency to impose additional controls on items not covered by the arrangement. Unlike the United States, the EU has maintained a country-agnostic approach to export controls and has not created EU-level authorities to impose export controls against specific countries like Russia and China.²³ This is why the EU leveraged its Russia sanctions regime to impose controls on technology exports to Russia in 2022 instead of using export control authorities. 

While the United States continues to leverage export controls as a means to ensure fair competition with China over technology innovations, the EU is concerned about being dominated by Washington’s tech export control policy vis-à-vis China.²⁴ Hence, the EU acknowledges that being part of multilateral regimes such as the Wassenaar Arrangement, where Russia is a member state with veto power, is no longer adequate for dealing with the potential threat of being caught in the cross fire between Washington and Beijing. Brussels needs to develop a doctrine to identify which technologies it is willing to export and where, as well as legal and administrative capacities for export controls implementation.²⁵ To this point, the EU’s most recent Economic Security Strategy states that the member states and the European Commission will deepen their analysis of the resilience of supply chains and emerging technology security threats.²⁶ 

The United Kingdom’s approach to economic statecraft

The UK’s economic statecraft system is similar to that of the United States. A legislative framework, the Sanctions and Anti-Money Laundering Act of 2018 (SAMLA), provides government ministries with authorities to leverage sanctions and protect the UK’s financial system.²⁷ Before Brexit, the UK developed sanctions through the EU’s process and implemented EU sanctions regimes. After Brexit, the UK leveraged its domestic authorities to develop its own sanctions lists and processes for issuing sanctions.

Although its unilateral sanctions process is relatively new, the UK has leveraged its experience in developing and implementing EU sanctions to create a new economic statecraft structure and refine its approach. As part of its 2023 Integrated Review, the UK outlined its goals related to economic statecraft, seeking an approach to deterrence and defense against transnational threats and economic coercion, while managing systemic competition, ensuring economic resilience, and shaping an open global economy and free trade.²⁸ 

The UK’s approach to financial sanctions

SAMLA provides UK government ministries the authority to develop country-specific or thematic, such as counterterrorism or anti-corruption, sanctions regulations and designations, which may include financial, immigration, and trade sanctions. The UK’s financial sanctions authority resides in the Sanctions Unit in the Foreign, Commonwealth and Development Office (FCDO). The Sanctions Unit holds primary responsibility for the use of sanctions as part of British foreign policy and maintains the UK Sanctions List.²⁹ The UK Sanctions List includes unilateral sanctions issued by the UK as well as UN sanctions and the sanctions it implemented when the UK was part of the EU. 

Meanwhile, the Office of Financial Sanctions Implementation (OFSI) within His Majesty’s Treasury is responsible for designing, implementing, and enforcing asset freezes and capital market restrictions using civil enforcement procedures. Individuals and entities subject to these restrictions are included in OFSI’s Consolidated List.³⁰ Further, enforcement of financial sanctions within the UK is managed through investigative and prosecutorial agencies, including the National Crime Agency, the Serious Fraud Office, and the Crown Prosecution Service, among others. 

In designing SAMLA, the UK accounted for lessons learned from its experience developing and implementing EU sanctions and created efficiencies for its own system. For example, SAMLA provides a lower threshold for imposing sanctions than EU law. The UK can issue sanctions, including asset freezes and travel bans, when there are “reasonable grounds to suspect” that an individual is involved in a sanctioned activity.³¹

The UK continues to refine its sanctions authorities to create flexibility and efficiencies in how it leverages and enforces its tools. For example, the UK passed the Economic Crime (Transparency and Enforcement) Act of 2022 (ECA) to provide OFSI the authority to issue civil monetary penalties for sanctions violations, similar to the US approach. The ECA also created the ability for the UK to sanction individuals and entities if they have already been designated by another government, such as the United States, the EU, Australia, or Canada, on a temporary basis and until the relevant ministry can follow its standard process to issue a designation. Further, in the 2023 Integrated Review, the UK announced a new Economic Deterrence Initiative (EDI) to advance the impact of its economic statecraft toolkit by expanding resources and capabilities to implement and enforce UK trade, transport, and financial sanctions. 

The UK’s approach to export controls

The legal framework for the UK’s export control regime is primarily derived from the Export Control Act 2002 and Export Control Order 2008.³² In 2016, the UK established the Export Control Joint Unit under the Department for International Trade, now the Department for Business and Trade (DBT). The DBT, in coordination with the Ministry of Defence and the FCDO, maintains the authority to implement prohibitions on the export of certain goods or technologies and issue export licenses consistent with the Strategic Export Licensing Criteria.³³ His Majesty’s Revenue and Customs is responsible for enforcing the export and trade controls.

The UK recognizes more can be done to improve its export controls toolkit and through the EDI is seeking to update its regime to address sensitive technology and increase collaboration with international partners to ensure multilateral controls are effective.

Equities and vulnerabilities: When transatlantic economic statecraft approaches may not align

Transatlantic partners frequently find ways to work together on economic statecraft initiatives when policies and goals align. However, recent history provides examples when transatlantic approaches to economic statecraft have diverged and created or exposed partners’ economic vulnerabilities, potentially harming their equities.

In some cases, friction has emerged between the EU and the United States over Washington’s use of economic tools that have adversely impacted European businesses. For example, after the Trump administration withdrew from the Iran nuclear deal, formally known as the Joint Comprehensive Plan of Action, in 2018, and the United States imposed secondary sanctions on Iran, European businesses operating in Iran were given a choice of either staying in Iran and sanctions or maintain access to the dollar-dominated financial system.³⁴ Since losing access to the dollar was more harmful than losing access to the Iranian market, European companies complied with US sanctions. However, this created anti-dollar sentiment in Europe and in 2019, the EU agreed to be invoiced by the Russian energy giant Gazprom in euros instead of dollars.³⁵

More recently, in October 2022, the United States invoked the extraterritorial Foreign Direct Product Rule (FDPR) to limit the export of highly advanced semiconductors to China.³⁶ The FDPR requires companies, even those outside the United States, to obtain a license before exporting high-end semiconductors to China if they used US software or hardware in the production process. The FDPR affected European companies that had to comply with US export controls and created tension among the United States and its European allies. The EU became concerned that Washington would increasingly use extraterritorial measures to pressure allies into aligning with its China policy.³⁷

Also in 2022, the United States adopted the Inflation Reduction Act (IRA), which includes elements that are concerning to the EU and the UK, such as local-content requirements prohibited under the World Trade Organization’s rules.³⁸ The EU is vehemently opposed to the IRA’s protectionist elements, such as subsidies that discriminate against foreign companies, and it worries that it will trigger protectionism among other countries, countering the EU’s strategy of trade openness and reciprocity among countries.

Meanwhile, the EU’s Anti-Coercion Instrument (ACI), which will enter into force this fall, could be used against the United States and the UK, in addition to China.³⁹ The ACI enables the European Commission to impose tariffs and restrictions on foreign direct investment and procurement in response to third countries’ coercive measures after diplomatic means have been exhausted.⁴⁰ The commission will be in charge of determining whether a third country’s behavior is coercive. Once member states agree with the determination, the commission, the European Parliament, and member states will prepare a package of countermeasures against the coercing country.⁴¹

The lack of transparency over the criteria for the ACI’s application, along with the EU’s new unilateral approach to economic statecraft, was criticized by scholars in the UK as a potential harm to the rules-based global trading order.⁴² Also, the EU could use the ACI against the United States if Washington continues threatening it with tariffs. For example, in 2021, Washington threatened to impose tariffs against France, Italy, Spain, Austria, and the UK if they refused to withdraw newly introduced digital taxes on US tech giants. The European states eventually agreed to end taxes.⁴³ Although the goal of the ACI is to deter the United States and third countries from making such threats, application of the instrument could quickly turn into a cascade of tit-for-tat measures imposed by Western allies against one another.

Concerns about the EU’s unilateral approach to economic statecraft are valid; however, the EU could argue that no event has shaken the foundations of transatlantic unity as Brexit has. Brexit reduced bilateral trade between the EU and the UK by an estimated 20 percent as of October 2022 and took out the UK, a major influencer, from the EU’s sanctions designation and implementation process.⁴⁴ The UK helped shape the EU’s cyber and chemical weapons sanctions regimes. It also played a major role in developing the EU’s sanctions response to Russia after Russia annexed Crimea in 2014.⁴⁵ After Brexit, the UK created autonomous sanctions authorities while the EU lost a significant contributor to the sanctions designation and implementation process. In the future, as the UK develops its sanctions enforcement framework independently from the EU, UK-EU cooperation on enforcement may become even more challenging.⁴⁶

A common narrative: Areas of foreign policy and sanctions regime alignment

Despite divergences and frictions, Washington, Brussels, and London have been successful in developing and implementing well-coordinated, multilateral economic measures when they have shared a common narrative and their foreign policy objectives were fully aligned. The most recent example is Russia, where both sides of the Atlantic came together to levy unprecedented financial sanctions to deny Russia access to the funds it needs to pursue its war in Ukraine and imposed export controls to curb Russia’s access to the materials and weapon components it needs for waging the war. 

Transatlantic partners were able to take fast, coordinated action against Russia because they had a common narrative and understanding of the transnational threat Russia’s actions posed to the accepted international rules-based order. They also agreed that something had to be done. Partners used existing mechanisms to share information on Putin’s intentions and expanded or created new channels for sharing actionable financial information to develop and implement coordinated economic measures.⁴⁷

Partners used their financial sanctions authorities to target Russian assets within their jurisdictions and made it more difficult for designated individuals and entities to move or transfer funds. Partners also worked together to share best practices and build capacity for implementing sanctions and export controls. Importantly, partners took their time and strategically approached actions that exposed their countries’ vulnerabilities. For example, the oil price cap was rolled out over several months to prevent spikes in oil prices and provide countries time to develop alternative solutions to Russian oil.

Beyond Russia, the United States, the UK, and the EU have a history of collaborating on countering illicit finance and financial crime such as ransomware, human trafficking, and transnational organized crime—areas where their policies happen to be fully aligned. All sides agree that the threats emanating from letting illicit actors abuse the global financial system are substantial and require coordination in sanctions designation and implementation.

Interagency coordination on implementing sanctions against terrorists, cybercriminals, narcotics traffickers, and transnational criminal organizations has built a strong framework of cooperation on sanctions enforcement across the Atlantic. For example, in 2022, the US Treasury designated Russia-based Hydra, the world’s largest darknet market, and Garantex, a ransomware-enabling digital currency exchange. US agencies, including the Treasury, Departments of Justice and Homeland Security, teamed up with German Federal Criminal Police to shut down Hydra servers in Germany and seize their $25 million in Bitcoin. Similarly, the US Treasury coordinated with Estonia’s Financial Intelligence Unit to reveal connections between Garantex and digital wallets used by criminals and designated the exchange for operating in Russia’s financial services sector.⁴⁸ The history of cooperation on sanctions against transnational threat actors has built a strong foundation for transatlantic partners to cooperate on sanctions designations and enforcement in the future.

Building common ground: The need for multilateralism in economic statecraft

Economic statecraft as a means to advance foreign policy and protect national security below the threshold of armed conflict continues to evolve as transnational threats arise. Although transatlantic partners’ economic statecraft tools and procedures are in different stages of development and are built and executed in very different structures, the G7 and allies’ response to Russia’s invasion of Ukraine demonstrated how multilateral economic statecraft can be leveraged against transnational threats when there is a common narrative, partners’ equities and vulnerabilities are accounted for, and foreign policy objectives align. 

The interconnectedness of the global economy and financial system require coordinated multilateral action if economic tools continue to be leveraged for advancing foreign policy objectives. However, this multilateral action cannot be meaningfully developed and implemented without greater transatlantic coordination on the strategic use of these tools and mechanisms to deconflict equities and objectives.

A common narrative and shared understanding of the transnational threat and how transatlantic partners will address it is integral for the successful development and execution of economic statecraft tools. Developing this common ground requires greater information sharing among partners and ensuring appropriate channels exist to enable the consistent and real-time sharing of actionable information with the relevant authorities in each jurisdiction. 

In addition to greater coordination on strategy and information sharing, transatlantic partners must understand and consider their unique and shared vulnerabilities associated with the implementation of economic statecraft tools. Partners must develop the capabilities to assess the potential impact of economic statecraft tools on themselves, allies, the broader international community, and the global economy. Otherwise, they run the risk of overextending these tools, unintentionally damaging their own or partners’ economies and populations, and potentially degrading the strength of the US dollar, the British pound sterling, and the euro.⁴⁹

Further, greater coordination on sanctions and export controls enforcement is needed to ensure these actions are consistently implemented and carry consistent penalties so illicit actors cannot abuse individual jurisdictions to evade or circumvent multilateral sanctions. 

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II. Positive economic statecraft: Wielding hard outcomes with soft money

by Nicole Goldin and Mrugank Bhusari

As discussed across the chapters of this volume, economic statecraft is the use of economic instruments in foreign policy and national security.⁵⁰ Though not new, it has been gaining traction as a framework for analysis and policymaking in international relations discourse and practice since the 1970s. However, as economic statecraft has come of age, it has largely focused on sanctions, controls, and tariffs. While such “sticks” may necessarily take prominence, the global landscape and nature of strategic competition calls for more “carrots.” Punishment tends to inspire resentment, resistance, and a “rally around the flag” effect within the target state, particularly in authoritarian regimes, while rewards are unlikely to produce defensive reactions.⁵¹ Positive economic statecraft (PES) aggregates diverse economic techniques and instruments of statecraft associated with rewards and incentives under one umbrella. This chapter suggests fundamentals of PES from the perspectives of the United States and the European Union (EU) and offers a way forward to amplify such statecraft as an approach to achieving foreign policy, national security, and economic objectives.

What is (and what is not) positive economic statecraft 

PES is the deployment of economic tools by a government to influence the actual or potential behavior of another government by providing or promising it rewards and benefits. In essence, PES aims to alter the cost-benefit calculations of another state’s given policy option by augmenting the benefits of that policy option. Common instruments of PES come from official international assistance or humanitarian aid (grants, capacity building, technical, budget support); development finance (loans, credit or guarantees, public-private partnerships); providing access to currency, trade, preferential tariffs, and subsidies. These tools can be used to impact both the intentions and the capabilities of the target state. Most commonly, one state seeks a behavior or policy change in another, though PES can be deployed multilaterally as well.

This conceptualization of PES emphasizes both means and ends, and there are limiting factors of the approach. Only economic or financial policy instruments (means) are considered, and they must be applied to either provide or promise inducements (ends). 

Similarly, in the context of “statecraft,” only government actors wield PES in an effort to elicit a particular response or behavior from another government. Non-state actors, including individuals, multinational corporations, international organizations, and nongovernmental organizations, are not the direct subject of influence under PES but can be both contributors to or indirect beneficiaries of such statecraft. This conception is broad so that it can capture the myriad of ways a state may attempt to use economic incentives to influence the actual or potential behavior of another state. 

Another limitation on PES is that the reversal or withdrawal of punitive measures does not constitute such statecraft, even when it is framed as the bestowal of a reward because withdrawal of punitive measures is part of the logic of those measures. The imposition of costs is not intended to be permanent. Once an undesired policy option is dropped by the target, the costs imposed in association with the (potential) adoption of the undesired policy are also to be withdrawn. Hence, such reversals do not fit within the parameters of PES. 

Many of these tools have traditionally been analyzed through the lens of soft power, and there is indeed overlap. A key difference between soft power and PES, however, is that under the latter paradigm, such endeavors must be actively undertaken by a government and with the intention of achieving a specific behavior or outcome. Soft power, in contrast, includes actions undertaken by non-government actors. It does not require intentionality in achieving particular policy, behavioral, or attitudinal outcomes. 

Why it matters now 

Responding to polycrisis and mitigating global risks: The full fallout in terms of economic and societal upheaval as a result of the COVID-19 pandemic and conflict is only starting to become clear. Inflation is just starting to cool from record highs that undermined advanced and developing economies alike and historically declining global poverty has been reversed as more than seventy million people were pushed into extreme poverty in 2020.⁵² Russia’s full-scale invasion of Ukraine in 2022 then sent global prices of food, fuel, and fertilizer skyrocketing. Extreme weather events, such as droughts, floods, heat, and dryness, are leaving a deep impact on agriculture, livelihoods, and physical infrastructure. Inequality within and between countries has worsened and existing socioeconomic divides have been exacerbated. Youth and women disproportionately bear the costs of the crisis.⁵³ Governments eased the crises through stimulus and subsidies resulting in the diversion of resources needed to fulfill domestic development goals and to hedge against other global public risks and megatrends, such as migration, digitization, and urbanization. The resources for these concurrent priorities are simply insufficient now and the need to align foreign and domestic interests is pressing. Reflecting a “foreign policy for the middle class,” the United States’ 2022 National Security Strategy articulates “the United States must once again rally partners around rules for creating a level playing field that will enable American workers and businesses—and those of partners and allies around the world—to thrive.”⁵⁴

Emerging economic competitors: The United States and European countries collectively accounted for dominant shares of global gross domestic product, trade, and capital stock in the decades following World War II. They promoted economic recovery and international development worldwide to prevent the spread of communism and channeled aid and concessional loans primarily through the World Bank Group’s International Bank of Reconstruction and Development and later its International Development Association. The resources provided through the World Bank were often the only, if not the easiest, available and accessible at the time, at least until the United States Agency for International Development (USAID) was established in 1961 and a new era and channel for international assistance commenced. Less-developed or transitioning countries were hence eager to partner with the United States and Europe to secure large-scale development or humanitarian assistance and finance, sell debt securities, and access larger markets. There are, however, new donors and more financing options now available to support countries since the turn of the twenty-first century. Brazil, China, India, Indonesia, Mexico, and Russia have become prominent actors in the global economy, with China emerging as the world’s largest official bilateral creditor.⁵⁵ Remittance flows dwarf official development assistance.⁵⁶ The $5 billion in new commitments of the BRICS’ New Development Bank in 2021,⁵⁷ the China-led Asian Infrastructure Investment Bank’s $10 billion,⁵⁸ and the Asian Development Bank’s $22 billion⁵⁹ are individually far smaller than the World Bank’s $100 billion that year;⁶⁰ yet the operations and membership of these newer institutions are expanding rapidly.⁶¹ Sovereign wealth funds, pension funds, and impact investors also provide alternate sources of financing. The United States and the EU are thus no longer automatic partners for achieving economic advancement; they now need to show countries that they remain valuable partners. 

Countering China and malign influence: China has already developed a far-reaching web of geopolitical and geo-economic access and levers of influence by offering economic inducements through its Belt and Road Initiative (BRI). The BRI has offered its partners assistance with financing and construction of dual-use hard infrastructure, such as ports, roads, and railways; soft infrastructure, such as economic institutions; and digital infrastructure on a massive scale: projects that drive employment and economic growth (though not necessarily in an inclusive or sustainable manner as discussed further below).⁶² The United States, the EU, and their allies must provide an alternative at scale to the BRI for developing countries. Competition will complicate China’s ability to use the BRI as a geopolitical instrument, as countries needing large development finance and capital will have alternatives.⁶³ Lacking an explicit blending of strategic interests with international commerce and aid promoting mutual benefits, US and EU efforts to compete in infrastructure development programs so far have failed to generate a strategic impact comparable to the BRI for China. At the same time, China has slowed the pace of new projects to hedge against warnings that several countries may default on its debt.⁶⁴ Countries are also becoming wary of turning over-reliant on China, seeing how it failed in Pakistan and Sri Lanka among other BRI participants, and thus could be more receptive to deeper and positive economic engagement with the United States and the EU. 

PES provides a framework to align these urgent foreign policy goals with the flows of international trade and finance. Moreover, within the context of the current global economy and polycrisis, countries will be eager to partner on large economic projects, providing fertile ground for PES to have a real impact. 

How is positive economic statecraft operationalized?

Comparative institutional architectures: Divergent institutional architectures are apparent in how the United States and the EU go about applying PES in practice. PES tools and instruments in the United States are dispersed among numerous agencies in a web of budgets, authorizing legislation, procurement mechanisms, and governance arrangements. ForeignAssistance.gov, for example, lists US aid spending across more than twenty agencies, though dominated by USAID.⁶⁵ At least fifteen different agencies are included on the US Trade Representative’s (USTR’s) list.⁶⁶ And the still new US International Development Finance Corporation (USDFC) gets its funding from US Department of the Treasury authorization but is also under State Department governance in that the secretary of state is chair of its board. PES-based interagency or “whole-of-government” initiatives are not routine and have a mixed track record (see discussion of Partnerships for Growth, for example, below). 

PES in the EU manifests by the membership as a whole alongside individual member’s bilateral or multilateral efforts (this essay focuses on the EU as an actor). In the EU, each of the principal governing institutions has PES equities and tools in their purview. The European Council and the European Parliament have principal policy and budgetary authority, while the European Commission helps to shape the EU’s overall strategy, monitors policy and legislative implementation, and manages the EU budget, thus also having a key role in supporting international development and delivering aid through a variety of instruments, such as the Neighbourhood, Development, and International Cooperation Instrument and the European Fund for Sustainable Development Plus. While there are divisions of labor within institutions, the authorities are arguably clearer, with less fragmentation than the United States, enabling a more coherent platform for PES. Both the United States and the EU utilize the common set of PES tools described above. Contrary to the United States, however, the EU offers direct budget support in its development aid and makes use of trust funds among its member nations. Both also continue to wield PES activities through their budget allocations to and votes in multilateral fora and multilateral development banks.

Tools and mechanisms: Across institutions and instruments, both the EU and the United States seek to achieve PES goals through two mechanisms: tactical and structural. Tactical linkages operate at a more immediate level, where a reward for the target state is tied to particular desired policy outcomes. For instance, in July 2023, the EU agreed to provide Tunisia with more than €1 billion in trade, investment, and energy cooperation as long as Tunis stepped up efforts to stem migrant departures from the country toward Europe.⁶⁷ With its strict compact eligibility requirements, the US Millennium Challenge Corporation (MCC) can point to specific “MCC Effect” reforms.⁶⁸ For example, in 2006, when the MCC’s first compact for $320 million was on the line in Lesotho, adult married women were considered legal minors, restricting their economic rights and participation—also undermining economic growth.⁶⁹ To ensure more equal reach and benefit, as well as impact, the MCC and the government of Lesotho came to agree, with civil society support, that compact signing would be contingent upon the government guaranteeing gender equality in economic rights. As such, the Legal Capacity of Married Persons Act 9 of 2006 was passed which untied minority status from marital status. The compact was signed in July 2007.

Over the longer term, structural PES aims to better align dominant domestic political interests, capabilities, and actions with those of the PES-wielding country through ongoing rewards for particular activities and actors. The Marshall Plan, which incentivized the removal of trade barriers and prevented the expansion of communism in Europe through the provision of $13 billion in assistance, is perhaps the earliest post-World War II instance of an attempt to reorient political and economic policy abroad.⁷⁰ Often less qualified in nature, structural and tactical mechanisms are complementary and can be applied simultaneously in an integrated PES approach. The EU’s Global Gateway initiative, launched in 2021 and set to run through 2027, brings together EU-wide institutions and members to jointly mobilize up to €300 billion in investments for values-driven, sustainable, and high-quality infrastructure projects.⁷¹ While promoting markets and investment opportunities for the EU, Global Gateway is also based on and seeks to advance EU interests in cooperating countries: rule of law, human rights, and international norms and standards. Since 2000, the United States’ African Growth and Opportunity Act (AGOA) has been led by USTR, with capacity-building support from USAID and other agency engagement.⁷² AGOA was enacted by Congress in 2000 to allow duty-free goods entry from eligible countries in sub-Saharan Africa, driving numerous policy reforms and mutual benefits that have led to reauthorization in 2015. The act authorizes the president to designate countries as eligible to receive the benefits of AGOA if they are determined to have established, or are making continual progress toward establishing, the rule of law and political pluralism; protection of intellectual property; efforts to combat corruption; policies to reduce poverty, increasing availability of healthcare and educational opportunities; protection of human rights and worker rights; and elimination of certain child labor practices in addition to other external policies. Table 2 provides additional examples of how the United States and the EU have deployed a variety of PES instruments across the globe to achieve a wide range of foreign policy goals.

^{Sources 73 74 75 76 77 78 79 80 81 82 83 84 85 86}

Both the EU and the United States generally apply and implement PES in a manner distinct from China’s oft criticized, self-interested, and relatively opaque model of exploitive contracting;⁸⁷ offering grants or concessional finance rather than contracts, engaging and employing local communities, and tending (or at least aspiring) to be more inclusive, sustainable, and people and planet friendly, while increasingly aligned with domestic interests as well.

Path forward for positive economic statecraft

Increase and improve coordination on PES within and across governments

A failure to coordinate frequently plagues governance effectiveness. Improving the application of PES can, for example, strengthen interagency policy coherence; align short- and long-term objectives; and streamline communications, procurement, consultation, co-finance, and other processes within and between agencies as well as with other allies and partners. This includes employing “whole-of-government” approaches that utilize best practices and avoid past mistakes. In the United States, for example, the Obama administration’s Partnership for Growth (PFG) initiative sought to unite tools of economic assistance and development from various agencies to forge new, mature economic cooperation relationships with good-governed states and committed leaders.⁸⁸ While many view PFG to be successful in several respects—advancing transparency, analytical rigor, and cooperating country participation—there were also coordination challenges that undermined effectiveness, such as aligning budgets and implementation mechanisms.⁸⁹ In April 2022, US Sen. Bob Menendez (D-NJ) introduced the Economic Statecraft for the Twenty-First Century Act that expressly seeks to improve coordination.⁹⁰ PES coordination and cooperation can also be amplified with geographic focus. The EU’s immediate neighborhood, for example, is fertile ground for PES to counter Russian influence, while the United States has natural advantages and critical goals in Latin America and the Caribbean.

Advance PES in multilateral fora

PES experience to date has not optimized or relied on multilateral coordination to be effective. European states had an inherent advantage in pursuing such unilateral economic statecraft through the deep trade, finance, and aid networks they developed over centuries of colonization in Asia and Africa—for example, France in Africa. The former colonies of Belgium, France, Germany, Portugal, Spain, and the United Kingdom remain the largest recipients of their official development aid which in turn allows the former imperial powers to maintain influence over governments that rely on the aid for achieving development goals.⁹¹ At the same time, the scale and potential impact of PES could be significantly expanded when the collective reach and resources of multilaterals are brought to bear. Given their influence and leadership in the global multilateral financial institutions and diplomatic systems—the UN, Bretton Woods institutions, the Group of Seven, the Organisation for Economic Co-operation and Development—the EU and the United States are well positioned to promote PES approaches toward shared objectives, such as preserving democracy in and rebuilding Ukraine, reducing food insecurity, mitigating inequality, or adapting to climate change. For example, together, the EU and the United States comprise a significant share—approximately 40 percent—of votes in the World Bank and the International Monetary Fund, as well as in the regional development banks. With reform agenda and “evolution” underway, this is an opportune time to elevate and advance new approaches in the Bretton Woods institutions and beyond.⁹² 

Develop sectoral PES strategies

While PES can be applied in a sector-neutral manner, there may be additional benefit from targeting certain sectors, complementing industrial policy objectives as well economic and national security goals. For example, amid supply chain disruptions caused by the COVID-19 pandemic, critical minerals have emerged in the United States as pivotal to economic and national security.⁹³ Similarly, driven higher by Russia’s war in Ukraine and climate-change-induced droughts and heatwaves, food, fuel, and fertilizer inflation surged and created even more urgency among US and EU leaders and organizations worldwide around food security and the need to promote a resilient agriculture and food sector.⁹⁴

While PES is primarily the realm of the state, private sector partnership and engagement to induce investment, capital mobilization, or blended finance will be important elements of sectoral PES strategies to ensure alignment with, rather than distortion of, market dynamics.

Advance a PES research and learning agenda to build the evidence base

As with many “new” approaches or theories, there may be more questions than answers when it comes to PES. While PES is not necessarily “new,” it is not commonplace in the development and diplomacy discourse and arguably underutilized. Researchers and policy practitioners should collect more case studies, data, and best practice evidence to improve the “business” and “geo-economic” cases for PES. Outstanding questions for research include, for example: 

1. What are the biggest hurdles in implementing PES, and how can those hurdles be overcome?
2. How can subnational or local governance actors apply PES?
3. While they are not direct players in formal statecraft, how should non-state actors—corporations, philanthropies, nongovernmental organizations/international nongovernmental organizations—be engaged in PES?
4. How can PES be used to support the Just Transition?⁹⁵
5. How can PES be used to target and mitigate inequality, especially along gender, generational, or geographic lines?
6. How does PES deployed by the BRICS+ economies—an expanded grouping which now includes Brazil, Russia, India, China, South Africa, Argentina, Egypt, Ethiopia, Iran, Saudi Arabia, and the United Arab Emirates—and other emerging Global South nations compare/differ to that of the United States and the EU (or individual EU member countries)?

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III. Networked power: Export control policy across the G7

by Sarah Bauerle Danzman and Ambuj Sahu

In September 2022, US National Security Advisor Jake Sullivan delivered a speech at the Global Emerging Technologies Summit in which he articulated a new, bold policy framework for maintaining US technological supremacy in the twenty-first century.⁹⁶ One component of this strategy is protecting US technology advantages, largely through a more assertive use of export controls. In particular, Sullivan announced that the United States would move beyond a strategy of using export controls to maintain relative advantages in advanced dual-use technologies over strategic competitors to instead using such tools to “maintain as large of a lead as possible.” In doing so, he pointed to the unprecedented, multilateral semiconductor export controls that the United States, the European Union (EU), and other major partners imposed on Russia after its invasion of Ukraine as an example of how export controls on key technologies can not only work to impede the technological capabilities of competitors, but also as “strategic asset(s) in the U.S. and allied toolkit to impose costs on adversaries, and even over time degrade their battlefield capabilities.”

Less than a month later, the United States announced a sweeping set of export controls designed to cut off China-based entities’ access to advanced semiconductors, technologies necessary to manufacture these high-end microelectronics, and supercomputers to the extent that any of these items rely on US technology.⁹⁷ The rules also prevented US persons from aiding Chinese companies in their pursuit of these kinds of technologies. After several months of negotiations, Japan⁹⁸ and the Netherlands⁹⁹—the other two countries that produce most advanced semiconductor manufacturing equipment (SME) technologies—introduced similar, though perhaps less stringent, controls. 

These export controls are only one component of a multifaceted policy to deny China the ability to develop indigenous advanced semiconductor technology capabilities. The US government has also strengthened oversight and prohibition authority over Chinese investment into US critical technology companies, provided subsidies to re-shore semiconductor fabrication and catalyze further research and development investments in frontier technologies through the CHIPS and Science Act, and placed new regulations on outbound investment to China in activities involving advanced, dual-use technology.¹⁰⁰ And it has sought to convince allies and partners to implement similar measures, whether through the US-EU Trade and Technology Council¹⁰¹ or the Chip 4 alliance between the United States, Taiwan, South Korea, and Japan.¹⁰² Given its status as a relatively minor player in the semiconductor supply chain, the EU has been especially keen to reduce its dependency on foreign suppliers, most notably through the $47 billion European Chips Act,¹⁰³ which seeks to double EU market share in the industry from 10 percent to 20 percent by 2030 (for comparison, US market share is 46 percent, South Korea’s is 19 percent, and China’s is 7 percent).¹⁰⁴

The Biden administration’s willingness to develop these increasingly complex authorities is striking for two reasons. First, it illustrates how rapidly core beliefs have changed over the wisdom of market fundamentalism versus greater government intervention in markets that may generate security externalities. These shifting attitudes have led to a greater willingness to embrace increasingly restrictive forms of economic statecraft. Second, the novelty of these regulations makes it challenging to assess their benefits and costs. Even if commentators agree that China presents a security threat to the United States and its allies, there are substantial concerns about the enforceability of sanctions, whether and when they can effectively slow down the technological development of competitors, their costs to home-country innovation and economic growth, and whether such controls may actually diminish the home country’s technological advantages over time by encouraging targets to more quickly develop their own technologies or shift their consumption to items produced in third countries.¹⁰⁵ This has led to an increasingly fierce debate over whether the United States—individually or working in concert with its partners and allies—can “weaponize” choke-point technology in the semiconductor supply chain¹⁰⁶ and, relatedly, whether the United States, the EU, and other advanced democracies can effectively diversify their semiconductor supply chains out of China.¹⁰⁷ After all, a new semiconductor fabrication plant can cost between $10 billion and $20 billion and take two to five years to build.¹⁰⁸

In this chapter, we use network analysis techniques to provide an initial assessment of the effect of the increasing imposition of export controls and related tools on the global semiconductor supply chain. Key findings from our analysis include: 

• Semiconductor supply chains are hierarchical networks, with a few key producers holding central positions. This is important because the United States and its allies’ export controls are more likely to successfully slow China’s dual-use technological advances when they are imposed on hierarchical networks in which they hold central producer positions. 
• China’s role as the predominant buyer in several segments of the semiconductor production network makes the politics of building and maintaining a strong export control alliance more challenging because consumers have more power when producers rely on one primary buyer rather than multiple, roughly equal consumers. The United States and its allies’ export controls will be more effective in networks where China’s consumer centrality is less pronounced.
• The United States does not occupy an overwhelmingly central role in these supply chains but shares its powerful position with other key countries, including Japan, South Korea, Taiwan, and the Netherlands. These countries all occupy central producer roles in at least one major facet of the global semiconductor production network. This, combined with the fact that in some market segments—notably SMEs for assembling, testing, and packaging (ATP)—China is the overwhelmingly dominant buyer, means that the United States will need to choose technologies to control carefully, and will need to act in concert with other major producers to be effective.
• The network structures of these supply chains have been surprisingly resilient in the face of substantial upheaval over the past five years—a period that includes trade wars, escalating use of list-based sanctions and export controls on semiconductor technologies, a global pandemic, and the fallout of a land war in Europe. 
• Preliminary evidence suggests that the United States’ most recent round of semiconductor export controls have led to a steep decline in China’s position as a buyer in these global markets. 

From this analysis, the following key policy recommendations emerge:

• Export controls on advanced semiconductors and the components needed to fabricate them are likely to effectively limit Chinese access to these technologies with little risk of backfilling by other countries—provided that Japan and the Netherlands impose and enforce similar and complementary controls. 
• However, the United States does not have a powerful centrality position in all critical supply chain networks, and the Chinese government can similarly use its position in other important supply chains, such as some critical minerals, to impose short- to medium-term costs on the United States and its allies in the export control alliance. These tactics will likely be used to try to break the resolve of the control coalition.
• As the United States and its allies consider more assertive use of network positions in the supply chains and technology systems they do control, they will simultaneously need to consider their own vulnerabilities in other critical supply chains. Policy makers will need to balance these risks and continue to pursue strategies to restructure critical networks away from China if they wish to continue the assertive use of export controls with minimal blowback. In the future, policy makers should continue to monitor not the overall value of trade flows between countries, but how these trade systems create, maintain, and revise network structures, as it is the network structures—rather than bilateral economic flows—that confer power and signify vulnerabilities in global supply chains. 

How networks model power and dependency

Most research and commentary on trade focuses either on unilateral or bilateral metrics. That is, they assess how much an individual country imports and exports to the world or how much two countries import and export to and from each other. Such analysis provides a useful first approximation of a country’s trade dependencies and points of potential leverage. 

However, to understand the nature of power and interdependence in complex supply chains, we need to model trade flows as a network. We do this by constructing mathematical relationships of “nodes” and how they connect to each other through network “ties” or “edges.” In our case, countries are our nodes, and they are tied through trade of specific items that comprise the semiconductor supply chain. This approach allows us to understand not just a country’s overall share of the market (either as buyer or seller), or how much it depends on trade from a particular third country, but also the structure of the supply chain as a whole, the role each country plays in stitching together the global supply chain, and what would happen to the system structure if a country was removed: Would the network collapse? Would other countries quickly backfill the role previously performed by the removed country? 

We can uncover how network structure, and countries’ positions in them, impact whether and how export controls influence outcomes by examining three things: 

1. Network structure
2. Country positions within these networks 
3. Whether specific events dislodge countries’ structural positions

Hierarchical networks are easier to leverage

First, we can analyze the shape and performance of each network as a whole by inspecting patterns of trade ties between countries. The “typology” of a network helps explain how resilient it is to disturbances, or, conversely, how easily networks can adapt and change as ties are broken. Resilience and adaptation are functions of how hierarchical the network is. 

The term “resilience” operates slightly differently in network theory than in common parlance. While the word “resilience” might sometimes refer to a person who is adaptable, “resilience” in a network means that the network does not change easily. Resilience for a network is more like the resilience of a building that stays standing during a storm: Resilient networks withstand disturbances and still look the same. And a network’s resilience is a function of how hierarchical the network is.

Hierarchical networks are ones in which most hubs have very few connections, but they all tend to connect to the same small set of actors. For example, the international banking system is highly hierarchical because most countries are connected to few other countries through cross-border financial obligations, but almost all countries are connected to the United States.¹⁰⁹ These networks have become hierarchical because actors in these systems are motivated by “preferential attachment.” That is, part of the value of connecting to the US banking system is that lots of other countries are connected to the US banking system as well. That means that the US system is large and liquid, and the costs of connection are small because there is ample infrastructure to connect to it. The currency network is also a hierarchical system (with the US dollar at its core) as are most social media networks. Indeed, the resiliency of X, formerly known as Twitter, to retain users and resist being overthrown by startup microblogging alternatives, despite widespread frustration with the site, is an illustration of preferential attachment and network resiliency.

In contrast, other networks are much less hierarchical. Here, the average number of connections per node is closer to the maximum number of connections the most highly connected node has formed. These are random, or flat, networks. Flat networks are more able to adapt quickly to perturbations in the system because there are no huge positive externalities associated with connecting to any particular node, and so actors can more easily find substitute nodes to connect to if one node is no longer available to them. Many commodity markets function closer to flat networks because commodities are undifferentiated and interchangeable, so it is less costly to switch to a different supplier.

Our statistical analysis finds that all seven semiconductor networks we examined display hierarchical tendencies—they have a few countries that are highly connected while most countries do not sell semiconductor items to other countries. Across each of these networks, we see that only a small number of countries are highly connected as producers. These producers, then, have substantial power in the network, particularly if they work in coordination. This is because their dominant position within a hierarchical network makes it more possible for them to control access to these semiconductor technologies without fear that subordinate actors within the network could find alternative sources of these technologies. 

The United States, Japan, and the Netherlands jointly have supplier centrality

If hierarchical networks provide opportunities to assert leverage, the question then is for whose benefit? To evaluate which actors can exert control over a particular network, we need to calculate measures that assess the centrality of each actor in the network. Conceptually, centrality helps identify which nodes are most important to the functioning of the entire system. For example, in the case of the global banking network, the United States has high centrality because most countries in the network connect to it. Most other countries have very low centrality because hardly any other actors connect to them. This confers enormous power on the United States—as the central node in the global banking system it can use access to its banks, and US dollars, as leverage. Because the hierarchical structure of the network renders it highly resilient to disturbances, the United States can freeze individuals or more isolated states from the system without worrying that the network could reorganize around other nodes, reducing its importance. Of course, there are limits to how far the United States can use its central position in this way, but the logic of preferential attachment makes it challenging for actors to develop rival systems.

Because centrality measures importance, and because there are many ways to conceptualize what makes an actor important, there are also many ways to measure centrality. In this analysis, we focus on parameters that capture whether a country is a central supplier and/or whether it is a central buyer in the network. A country is a central supplier if it sells many of its semiconductor products to countries that are central buyers of those products. Similarly, a country is a central buyer if it obtains many of the semiconductor products in imports from countries that are central suppliers in the network. Because we are able to model the supply chains of multiple components of the semiconductor supply chain, we can measure countries’ supplier and buyer centrality across each of these supply chain segments.¹¹⁰

Determining countries’ supplier and buyer centrality provides important insight into their structural position in specific semiconductor component networks. This allows us to understand when and how countries have the power to use these network positions to exert influence over others. Countries’ ability to engage tools of economic statecraft such as export controls to coerce or control the behavior or capabilities of others is higher when they are more central, and higher still when the network is hierarchical. In such systems, it is harder for targeted countries to defeat export controls by finding alternative countries with which to trade, and network resiliency means central countries can control access to their technologies without the system easily reorienting away from these central countries.

Conceptually, countries with high supplier centrality are greatly influential as producers of semiconductor items. They control the underlying technology and know-how to produce these goods for export, and others are reliant on them. Countries with high buyer centrality are influential consumers of semiconductor items. They are dependent on others for these goods, but they also may have substantial power to set standards if sellers are dependent on exporting to their markets. When a country has high buyer centrality, it will have the most power in that network if no individual country simultaneously has high supplier centrality. In that case, the country is a dominant buyer that has many options for sellers. Conversely, when a country is a central supplier, it will have the most power in a network when no individual country simultaneously has high buyer centrality. In that case, the country is a dominant seller and has many options for buyers.

Figure 3 plots the network positions of China, Japan, the Netherlands, South Korea, Taiwan, and the United States in the global trade networks for seven semiconductor supply chain items, measured annually from 2017 to 2021.¹¹¹ The x-axis plots countries’ supplier centrality and the y-axis plots their buyer centrality. 

Clear patterns quickly emerge. China stands out as a central buyer for chips and ATP SMEs. This position could confer China a great deal of leverage as a buyer, as their continued consumption of these products is essential to producer profits. In other contexts, governments can use their market power as consumers to influence regulatory standards.¹¹²

But the effectiveness of such tactics also depends on the structural positions of major producers. The logic chip networks are a highly diversified producer market, with no one country dominating. In these networks, we can expect that consumer power has greater potential to be effective. It also means that China’s position in these networks may be particularly threatening to the United States and its allies precisely because its market position generated so much power. In contrast, South Korea’s dominant hub position in memory chips, and its position along with Japan as a broker in the network for SMEs for ATP, dulls China’s ability to exploit its network position because producer concentration shifts more power to dominant supplier countries.

Inspection of network positions across other components of the supply chain further reveals where countries have, either individually or jointly, latent power capabilities. In the networks for integrated circuit (IC)-making SMEs and miscellaneous SMEs, Japan, the Netherlands, and the United States are jointly dominant suppliers, with the United States especially occupying a central position as both a producer and a consumer of miscellaneous SME items. These positions have largely strengthened over time. No one country dominates as a consumer, meaning the United States, Japan, and the Netherlands have the most opportunity to control these supply chains with minimum network adaptation, as long as they act in concert. Japan and the United States similarly enjoy a dominant producer position in photomasks. The process chemicals network is the only supply chain where China operates a brokering position as both a central producer and consumer, but Japan’s dominant producer position means China would likely only be able to successfully leverage this central position if it were able to do so in coordination with Japan.

No evidence that export controls have eroded the United States’ central position

The above exercise provides insight into which parts of the semiconductor supply chains are more conducive to control, and by whom. But that exercise only provides insight into latent power capabilities. In this section, we study the monthly trade data to show the persistence or change in producer and buyer centrality from January 2017 to March 2023. In doing so, we examine whether there are any structural breaks in these time series and map the structural breaks we find to real-world events.

A structural break can be defined as a sudden change in time series data because of an arbitrary interruptive event.¹¹³ After calculating the structural breaks in the time series, we were able to correlate the time stamps with global and domestic developments that affected the global semiconductor supply chain. Table 3 lists all such events.

Overall, we see that producer and buyer centrality is relatively stable across this time, even though it is quite a tumultuous period.¹¹⁴ This period includes a US-China trade war that imposed additional tariffs on all seven semiconductor networks we analyzed, the initial onset of COVID-19 and subsequent relapse of COVID Zero policies in China, entity listings of the Chinese telecommunications firm Huawei and Chinese chipmaker SMIC, and the multilateral export controls on semiconductor chips to Russia following its invasion of Ukraine in 2022. Monthly data are a bit noisy due to cyclical fluctuations in quarterly trade invoicing in many transactions, but relative positions in most networks stay stable, except in SMEs for IC and miscellaneous SMEs. Here the United States, Japan, and the Netherlands maintain rough parity through the period. The relative stability of these scores over time reflects the fact that these networks display high levels of resiliency.

The most interesting shifts in the time series appear in early 2023, after the announcement of the October 7 controls and reports that Japan and the Netherlands would implement their own complementary controls. Because the time series ends in March 2023, we do not have enough data to determine if these structural breaks are statistically significant. However, in the first quarter of 2023, Japan’s producer centrality for ATP and IC SMEs shoots up. The United States registers a significant jump in its producer centrality for logic chips. These changes indicate that the United States and Japan became more central producers after the imposition of controls.

The effect on buyer centrality—that is, the central consumers in the network—is even more interesting. China’s consumer position in logic chips plummets. This is exactly what we would expect would result from the October 7 controls, which created a presumption of denial for logic chips to China.¹¹⁵ However, China’s buyer centrality scores for IC and ATP SMEs increased, meaning it became a more central consumer after the imposition of export controls. The October 7 controls do not involve SMEs for ATP, so we had no prior expectation about how this supply chain would react to the controls. However, advanced IC SMEs are covered by these controls. We will need more months of data to determine the longer-term trend. It may be that this increase in SMEs for IC is only for tooling equipment for trailing-edge chips. Conversely, it could be indicative of some backfilling by other producers before their own controls were implemented along with stockpiling by the Chinese. This is a component supply chain that is important to monitor closely as technological breakthroughs in IC SMEs would be necessary if China were to develop indigenous advanced semiconductor manufacturing capabilities.

Conclusion

The increased use of export controls has raised questions about whether more aggressive attempts to deny China access to dual-use advanced semiconductor technology can effectively stymie its indigenous capabilities or backfire by providing Chinese firms and China’s government with incentives to redouble research and development efforts to achieve technological autonomy. Such assessments are complicated by the novelty of the current US approach and a lack of useful historical examples on which to evaluate the benefits and costs of such controls. 

By modeling the semiconductor supply chain as a multilayered network, we can better understand the structures of these systems and, therefore, their relative resilience versus adaptive capacity. The United States and its allies are more likely to achieve success when they occupy positions of producer centrality within networks characterized by substantial hierarchy. In these contexts, they have ownership over narrowly held technology within networks that are resilient and, therefore, unlikely to provide countries denied access to these technologies with reasonable alternatives to their procurement. In contrast, flatter networks are harder to control because imposing export controls is much more likely to only lead to the network reorienting around alternative producers, pushing US producers and US-controlled technology to obsolescence.

Overall, we find that semiconductor supply chains are hierarchical networks that display surprising resilience despite the tumult of policy and exogenous shocks in recent years. The structure of these networks makes it possible for central producers to impose controls on their technology with little immediate reorientation and backfilling of these networks. However, many of these supply chains are not organized around one central node (as is the global financial system around the US dollar). Instead, the Netherlands, Japan, South Korea, and Taiwan all hold important producer positions in various parts of these supply chains. This means that US efforts to limit leakage of advanced semiconductor technology to China will need to be coordinated with these other central actors to be effective. 

While the United States and a handful of allies are central players in these particular supply chains, other countries, including China, are central in other important supply chains, such as processing of critical minerals that are used in the production of certain kinds of advanced chips and electric vehicle batteries. As the United States and its allies consider more assertive use of network positions in the supply chains and technology systems they do control, they will simultaneously need to consider their own vulnerabilities in other critical supply chains. The Chinese government’s recent announcement that it will require licenses for export of two key critical metals—gallium and germanium—is an illustration of this risk.¹¹⁶So long as the United States can maintain a coalition among key advanced semiconductor producers, it is unlikely that the Chinese will be able to quickly, or easily, restructure these supply networks in their favor. However, it is more likely that the short- to medium-term costs of US policies to limit China’s access to advanced technology will be in Beijing’s retaliatory, reciprocal actions to leverage supply chains in which it has a dominant position.

In the future, policy makers should continue to monitor not the overall value of trade flows between countries, but how these trade systems create, maintain, and revise network structures. Doing so will provide insight into when export controls are more likely to achieve strategic objectives, when they are likely to be counterproductive, and when they must be applied only within a cooperative framework with partners and allies to be able to effectively prevent strategic competitors and military adversaries from gaining access to dual-use technological capabilities.

Appendix: Data and methodology

This paper uses trade data from the United Nations’ Comtrade database to create directed and weighted networks, decomposed across five different segments of the semiconductor supply chain and two categories of finished chips: process chemicals; SMEs used for manufacturing integrated circuits (IC SMEs); assembling, testing, and packaging (ATP SMEs); and miscellaneous SMEs (typically, parts and servicing of SME equipment); photomasks; logic chips; and memory chips.¹¹⁷ For most countries, we use the values of imports and exports they report to the UN. Because of concerns about the veracity of China’s data reporting, we use mirror data for China, meaning that we construct their imports by summing all exports to China that third countries report and their exports by summing all of the imports from China that third countries report. China reports data separately for the mainland, Hong Kong Special Administrative Region (SAR), and Macau SAR; we aggregate the values of these three entities. In the case of Taiwan, the database does not explicitly report data as a distinct country for political reasons. Instead, Taiwan is included in the category “Other Asia, not elsewhere specified.”

We calculate hub and authority scores, which we refer to as supplier centrality and buyer centrality in the chapter, to increase accessibility for non-technical readers. In network terms, the hub score of a node is directly proportional to the authority scores of its outgoing connections. Similarly, the authority score of a country is proportional to the hub scores of its incoming connections. 

Complete annual data is not yet available for 2022. Ending analysis in 2021 allows us to examine the structure of these supply chains prior to Russia’s invasion of Ukraine in February 2022 and the Biden administration’s imposition of increasingly restrictive export controls on chips in October of that year.

For analysis requiring monthly data, we only include the United States, China, Japan, and the Netherlands. Unfortunately, South Korea and Taiwan have not reported monthly data for the entirety of the studied period, so we must exclude them from analysis. This makes our empirical exercise a less accurate reflection of the actual supply chain. However, we focus particularly on the relative positions of the United States, China, Japan, and the Netherlands over time. Our interest in the effect of export controls on centrality means that the focus on these four countries is justified.

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IV. New era of financial sanctions: Adapting to de-dollarization

by Daniel McDowell

According to a popular legend in US history, George Washington refused an offer to become the United States’ first king as the Continental Army was poised to defeat British forces in the American Revolutionary War. Though Washington never assumed the throne as a monarch, his appearance on the US one-dollar bill has made him a powerful symbol of US financial royalty. Indeed, the dollar is often described as the “king” of all currencies, and rightly so. 

Across the full spectrum of international roles that a national currency can play—the reserve currency role, cross-border payments and trade settlement, turnover in foreign exchange markets, and so on—the United States’ currency outcompetes all comers and lacks a true rival.

Dollar preeminence means that the US banking system is at the center of the global economy, giving the US government legal control over the financial plumbing that the world economy depends on to function.

Through the simple issuance of a presidential executive order, or by congressional action, Washington can employ financial sanctions to impose enormous economic costs on targeted foreign entities—including individuals, firms, and state institutions—by freezing their dollar-denominated assets or cutting them out of the banking network through which dollars flow. The costs for individual targets, known as Specially Designated Nationals (SDNs), are immense, greatly curtailing a target’s ability to participate in international trade, investment, debt repayment, and depriving them of access to their wealth.

Since the turn of the century, in response to a long list of international issues—including human rights violations, democratic backsliding, and threats to US national security—the US government has steadily increased the frequency with which it reaches for the tool of financial sanctions. 

Washington’s growing reliance on the tool has provoked US adversaries—as well as some of its friends—to pursue anti-dollar policies in response. Often, these efforts to reduce reliance on the dollar have failed; however, in other instances, policies produced modest levels of de-dollarization. Recent responses by China and Russia in this space, described below, are especially notable. While the dollar’s position as top international currency is unlikely to be upended by these steps, over time such policies could weaken the coercive capabilities that the United States derives from dollar centrality. 

In response, policy makers in Washington should rethink the guidelines around when, and how, financial sanctions are deployed. Those new guidelines should emphasize coordination with allies, reconsider the use of so-called symbolic sanctions, and insist on a higher bar of scrutiny for financial sanctions against issuers of potential rival currencies.

The sanctions obsession

Financial sanctions emerged as a popular new tool of economic statecraft around the turn of the century as policy makers were growing disillusioned with traditional economic sanctions, like trade embargoes, which often harmed civilians while leaving dictators unscathed. In contrast, financial sanctions could impose economic costs on specific targets with great precision. In the same way that smart bombs were changing the dynamics of military combat, “smart” sanctions were revolutionizing economic warfare. 

Policy makers’ emergent enthusiasm for financial sanctions also reflected the fact that traditional commercial sanctions were not usable against terrorist organizations which, in the post-9/11 moment, represented the security threat that posed the greatest concern for many in government.

Finally, the appeal of financial sanctions increased because they are precise yet scalable. At the low end of the spectrum, they can be used to punish a single individual, while at the other extreme, entire financial systems can be isolated through the imposition of blocking sanctions. If US policy makers wish to obtain maximum effect, secondary sanctions, which compel financial institutions from third countries to enforce US sanctions law, allow for the further ramping up of a coercive program. 

The primary way that the United States initiates a new round of financial sanctions is through a presidential executive order directing the Office of Foreign Assets Control (OFAC) at the US Department of the Treasury to add additional SDNs to its “blacklist.” In response, all banks operating in the US market are required to end financial services on behalf of listed individuals and entities. 

Over the last two decades, the United States has used financial sanctions with increasing frequency. In 2000, there were just twenty-two active sanctions-related executive orders; by 2022, this had increased to 109, a nearly fivefold increase.¹¹⁸ In 2000, just four foreign governments were targeted under a Treasury country program.¹¹⁹ Today, that number is greater than twenty—meaning almost one in ten sovereign states is presently under a US financial sanctions program. 

The more the United States has reached for financial sanctions, the more it introduces “political risk” into the international currency system. That is, it has made adversaries in foreign capitals (and, sometimes, friends and allies) more aware of the strategic vulnerability that stems from dependence on the dollar. 

Some governments have responded by implementing anti-dollar policies—measures that are designed to reduce an economy’s reliance on the US currency for investment and cross-border transactions. Russia’s response to years of increasing US sanctions pressure illustrates this point well. 

Russia’s anti-dollar strategy 

For the last year and a half, observers have watched to see how Vladimir Putin’s Russia is adapting to Western economic sanctions imposed following its unprovoked invasion of Ukraine on February 24, 2022. Though the West’s response has included a variety of economic penalties, financial sanctions have played an outsized role. Russia’s biggest commercial banks, its wealthiest oligarchs, its highest-ranking government officials (including Putin himself), and even the Central Bank of the Russian Federation (CBR) have been blacklisted by Treasury as well as the United States’ key allies in Europe and Asia.¹²⁰

While the world’s attention to the Russian economy’s struggle under sanctions is of recent vintage, in Moscow, concern about a weaponized dollar is fast approaching the ten-year mark.

Russia’s experience with US financial sanctions is both long and layered. First targeted in 2014, following its illegal annexation of Crimea, the Kremlin watched as the Obama and Trump administrations continued to pile on Treasury-backed sanctions programs. Penalties were levied in response to a variety of offenses, including Russia’s meddling in the 2016 US presidential election, cyberattacks against US businesses, human rights violations, and ongoing destabilizing actions in eastern Ukraine.¹²¹

Moscow reacted by launching an ambitious anti-dollar policy agenda. The first observable steps came in 2014 when, following the Crimea sanctions, CBR immediately increased its pace of physical gold purchases.¹²² As a store of value, what gold lacks in liquidity it makes up for in security—short of a military invasion, bullion in Russian vaults is safe from Western confiscation. 

Russia’s biggest moves came in 2018, following the harshest round of US financial sanctions to date. That tranche targeted seven oligarchs, seventeen Russian state officials, and twelve major firms, including some in key export sectors.¹²³ Following the Trump administration’s move, CBR again adjusted its foreign exchange reserves, cutting its dollar holdings from roughly 44 percent to 23 percent over the course of 2018. In place of dollars, the monetary authority shifted assets into euros and Chinese yuan. 

While central banks often adjust the currency composition of their reserves over time, such a dramatic move in such a short period is unprecedented.

Russia’s response was not limited to shifts in reserve allocations. Moscow also cut its reliance on the dollar as a trade settlement currency with key trading partners in the years before its invasion of Ukraine in 2022. In 2014, over 90 percent of Russian exports to China and India were paid for in the US currency; by 2021, the dollar’s share had fallen to below 40 percent in each case, as euros and rubles replaced the greenback’s once dominant role. The currency composition of Russian export settlement with the European Union (EU) underwent a similar transformation, with the dollar’s role falling from over 70 percent to around 40 percent over the same period, supplanted by the euro.

Russian de-dollarization has only intensified since the start of the war.¹²⁴ Indeed, the severity of the sanctions levied against Russia has left it little choice. Moreover, because the EU joined the United States in 2022 by blacklisting key Russian state and economic targets, the Kremlin has given up on the notion that the euro could act as a sanctions safe haven. 

Because of the multilateral nature of the most recent wave of sanctions, the dollar, along with the euro, yen, and pound sterling, comprise what Moscow now labels “toxic currencies.”¹²⁵ With few remaining options, Russia is growing more dependent on the Chinese yuan.¹²⁶

In April 2023, the yuan supplanted the dollar to become the most traded currency on the Moscow Exchange.¹²⁷ Russian citizens are increasingly opening savings accounts in the currency. The yuan has also assumed a larger role in Russian cross-border trade settlement, accounting for 16 percent of Russia’s exports and 23 percent of imports at the end of 2022, up from 0.5 and 4 percent, respectively, before the war.¹²⁸ The lion’s share of this is taking place in direct trade with China, where the yuan now accounts for roughly 60 percent of commercial payments between the countries, according to recent remarks from Russian Finance Minister Anton Siluanov.¹²⁹ However, there is growing evidence that Russia is using the yuan as a cross-border payment currency with third countries, including Bangladesh, India, and even Japan.¹³⁰

On one hand, these trends are evidence that Western sanctions are working: Large portions of the Russian economy have been forced out of the dollar and euro systems, complicating Moscow’s ability to participate in the world economy. On the other hand, these moves also signal that Russia is working with partners, China in particular, to develop sanctions workarounds. Moreover, as sanctions force an increasing amount of economic activity in the yuan, this contributes to building economies of scale and experience in alternative financial systems. The development of such alternatives poses risks to sanctions efficacy in the medium term. In time, this could frustrate Western attempts to use the threat of financial sanctions to deter Chinese aggression in the Asia-Pacific. 

China seeks to internationalize its yuan

The notion that the United States’ use of sanctions will provoke a global shift away from the dollar into the yuan reached a fever pitch in the spring of 2023, when Brazil and China inked a deal aimed at increasing the use “local” currencies in transactions between the two BRICS economies.¹³¹ [Brazil and China are part of a grouping that includes Russia, India, and South Africa, together known as the BRICS.] Shortly thereafter, during an official visit to China, Brazilian President Luiz Inácio Lula da Silva provocatively asked, “Why should every country have to be tied to the dollar for trade?… Who decided the dollar would be the [world’s] currency?”¹³²

In truth, China’s interest in internationalizing the yuan long predates the Russo-Ukraine war. Following the 2007–08 Global Financial Crisis, Beijing began to (slowly) implement a series of policies and financial reforms aimed at enhancing its currency’s international use. At that time, Beijing’s efforts were motivated by concerns about economic vulnerabilities stemming from dollar dependence. In recent years, though, geopolitical risks have become the dominant force propelling China’s internationalization efforts forward.

Officials in Beijing have carefully watched and learned from Washington’s growing use of the dollar as a weapon against the United States’ adversaries. For instance, when the Trump administration pulled out of the Iran nuclear deal in 2018 and reinstated sweeping financial sanctions on the country, financial elites in China characterized it as a moment of opportunity for the yuan. With more countries openly complaining about the misuse of dollar dominance—including US allies in Europe—Beijing could capitalize on growing anti-dollar sentiment by floating the yuan as an alternative. 

In 2020, in response to Beijing’s crackdown on pro-democracy protests in Hong Kong, the Trump administration sanctioned then Hong Kong chief executive Carrie Lam and ten other Chinese Communist Party officials in the special administrative region.¹³³ Following this move, officials and elites in China began to see US sanctions as a direct threat to China. Former People’s Bank of China (PBOC) governor Zhou Xiaochuan noted in public remarks that promoting the international use of China’s own currency was the only way that the country could “effectively resist” US sanctions pressure.¹³⁴ Elsewhere, Shuang Ding, a former PBOC economist, summed it up this way: “[Yuan] internationalization was a good-to-have. It’s now becoming a must have.”¹³⁵

Though there is limited appetite in China to greatly increase the yuan’s role as a reserve currency because of the (potentially destabilizing) financial market reforms this would require, developing the yuan’s use as a cross-border payments currency has fast become a priority of the central government. 

Most worrisome for China’s leadership is the prospect that Washington could cut off core export sectors from access to the banks that finance its firms’ involvement in international trade or disrupt its ability to pay for energy and other raw material imports. Beijing is keenly aware of how dollar dependence left vulnerable the commercial relations of Iran, Russia, and Venezuela, and it wishes to avoid a similar fate. 

To do so, China is working to stitch together an alternative financial network, based on its own currency with Chinese banks at the core. Launched in 2015 to little fanfare, the Cross-Border Interbank Payment System (CIPS) is a critical element of China’s play for enhanced financial autonomy and resilience.¹³⁶ Today, more than eighty Chinese banks are “direct participants” in the scheme, serving as the financial hubs to which nearly one thousand four hundred “indirect participant” banks in over one hundred countries are connected through shared accounts. The system is designed to move yuan across borders without touching the dollar or the US financial system, making it difficult for Washington to monitor and disrupt. 

Though CIPS remains far smaller than its dollar-based counterpart (known as CHIPS, the Clearing House Interbank Payments System), the daily volume of yuan cleared on the system has more than doubled since the first quarter of 2020. Foreign interest seems high, too, as nearly five hundred new banks joined as indirect participants during that span.¹³⁷

The critical point is this: For CIPS to be a success, China need not topple the dollar’s global dominance as the world’s preferred cross-border payment currency, it need only extricate itself from the dollar’s grip on its bilateral cross-border payments. 

Here there are signs of progress. The share of China’s trade settled in its own currency has risen from 10 percent in 2017 to nearly 25 percent in 2023.¹³⁸ Assuming the system continues to develop over the next decade, its existence will diminish the deterrent effect that the threat of US financial sanctions has on Chinese behavior. 

Adjusting sanctions policy to the anti-dollar era

Despite click-baiting predictions of its imminent demise, the dollar remains the world economy’s indispensable currency and maintains economic and political advantages over all alternatives. Still, the number of states espousing anti-dollar viewpoints or adopting anti-dollar policies is growing and extends beyond the actions of China and Russia alone. 

For instance, sanctions have played a key role in the revival of gold, that old “barbarous relic,” as a monetary asset.¹³⁹ Central banks, which have been net buyers every year since 2010, bought more yellow metal in 2022 than any year on record.¹⁴⁰ A recent World Gold Council survey found that “geopolitical concerns” and “concerns about sanctions” were important factors driving interest in the commodity.¹⁴¹

Meanwhile, Europe’s trust in the dollar still carries the scars of the Trump administration’s 2018 decision to withdraw from the Iran deal. The move, which reinstated secondary sanctions and forced European banks and businesses to cut ties with Iran, led many policy makers and elites on the continent to advocate for a more internationalized, muscular euro system. Multilateral cooperation on Russia sanctions have functioned as a salve on the Iran wound, yet French President Emmanuel Macron’s April 2023 pledge—while on a visit to China, no less—that Europe should pursue “strategic autonomy” from the United States by reducing dependence on the “extraterritoriality of the US dollar” suggests that all is not forgiven or forgotten.¹⁴²

Financial sanctions remain a potent coercive tool and should retain an important place in Washington’s foreign policy toolkit. However, the significance of these anti-dollar reactions should not be lost on US policy makers. This moment presents US officials with an important opportunity to develop improved guidelines for when, and how, to employ financial sanctions. Such guidelines should be developed with an eye toward protecting the dollar’s status and preserving the tool’s effectiveness for moments when the interests of the United States and its allies are most gravely threatened. 

First, whenever possible, leaders in Washington should work to coordinate the use of financial sanctions with US allies in Europe and Asia. The United States’ partners should feel as if they are critical stakeholders in the dollar system, not vassals to it. Coordinating efforts will reduce the chances that the United States’ allies feel victimized by the dollar and seek to conduct business with US adversaries outside of the dollar system. Just as importantly, multilateral responses also send a strong message to the world that moving activities into secondary currencies like the euro or yen is not a safe haven from sanctions.

Second, the United States should approach the use of so-called symbolic financial sanctions with great caution. If the main objective of a tranche of sanctions is to send a political message to the world or a domestic audience that Washington condemns a foreign government’s policy choices, other measures that send a similar signal but do not politicize the dollar system ought to be utilized first. 

Finally, employing financial sanctions against issuers of potential rival currencies—in particular China and its yuan—should face a higher bar of scrutiny. In such cases, even small, targeted sanctions programs provide information to US adversaries about their vulnerabilities, giving them time to prepare for a future event when a comprehensive financial sanctions program may be called upon as part of a major security crisis, when such measures will be critically important.

Conclusion

The Group of Seven (G7) and broader coalition’s response to Russia’s invasion of Ukraine demonstrates a new dimension of transatlantic economic statecraft coordination. The levers of sanctions, export controls, and asset freezes have been pulled to pursue foreign policy and national security objectives. The economic statecraft landscape is becoming increasingly complex as these tools are used unilaterally and multilaterally by transatlantic partners and the targets of these actions come up with new and sophisticated ways to evade and circumvent them.

While the chapters of this report focus on different aspects of economic statecraft, two common themes present themselves: (1) there is a need for greater coordination among transatlantic partners on the strategic use of economic statecraft tools, and (2) there is a need for greater understanding of partners’ vulnerabilities as they relate to the coercive application of economic power. The authors call on policy makers to balance the risks of economic statecraft as they continue to depend on these tools and develop coordinated, multilateral strategies to address transnational threats. 

This report is the first step in understanding how economic statecraft is used by transatlantic partners and the impact these actions have on the global economy and the US dollar. As transatlantic partners consider how to leverage economic statecraft in the future, more work is needed to better understand the benefits, risks, and vulnerabilities associated with the coercive and positive aspects of these tools.

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About the authors

Kimberly Donovan is the director of the Economic Statecraft Initiative within the Atlantic Council’s GeoEconomics Center. She is an expert in US national security, AML/CFT, sanctions programs, and regulatory actions. Prior to joining the Council, Donovan served in the US federal government for fifteen years in the Department of the Treasury, White House National Security Council, and US Intelligence Community.

Maia Nikoladze is an assistant director at the GeoEconomics Center’s Economic Statecraft Initiative. She manages the center’s flagship sanctions trackers—Global Sanctions Dashboard and Russia Sanctions Database, publishes articles on sanctions and economic statecraft, and analyzes and visualizes data on economic indicators.

Dr. Nicole Goldin is a nonresident senior fellow with the Atlantic Council’s GeoEconomics Center and global head, inclusive economic growth at Abt Associates, a global consulting and research firm. Her strategy, policy and programmatic career at the intersection of economics, development, foreign affairs, finance and social impact has included the World Bank, United Nations, Department of State, USAID, Gerson Lehrman Group and other public and private sector organizations.

Mrugank Bhusari is an assistant director at the Atlantic Council’s GeoEconomics Center. He conducts a broad range of research and convenings focused on multilateral institutions, emerging markets, and the international role of the dollar. He also manages the Center’s Bretton Woods 2.0 Project.

Sarah Bauerle Danzman is a nonresident senior fellow with the GeoEconomics Center’s Economic Statecraft Initiative. She is also an associate professor of international studies at Indiana University Bloomington where she specializes in the political economy of international investment and finance. Her most recent book is Merging Interests: When Domestic Firms Shape FDI Policy.

Ambuj Sahu is a graduate student in the Department of Political Science at Indiana University Bloomington. His research interests include critical technology supply chains, semiconductor geopolitics, and India’s strategic interests in the Indo-Pacific.

Daniel McDowell is a nonresident senior fellow with the Atlantic Council’s GeoEconomics Center and associate professor of political science at the Maxwell School of Citizenship and Public Affairs at Syracuse University. His most recent book is Bucking the Buck: US Financial Sanctions and the International Backlash Against the Dollar.

Acknowledgements

Publication of this timely report on economic statecraft was possible under the guidance and direction of Kimberly Donovan, Director of the Economic Statecraft Initiative within the Atlantic Council’s GeoEconomics Center. The authors would like to thank the Economic Statecraft team, Kimberly Donovan, Maia Nikoladze, and Ryan Murphy for managing this publication. The authors also thank the Atlantic Council and Atlantik-Brücke teams: Josh Lipsky, Julia Friedlander, Walter Frick, Charles Lichfield, Niels Graham, Cate Hansberry, and Andrea Ratiu.

This report is written and published in accordance with the Atlantic Council Policy on Intellectual Independence. The authors are solely responsible for its analysis and recommendations.

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