Three Questions: Smart Sanctions and The Economics of Cyber Deterrence

The concept of deterrence consistently fails to travel well to the cyber realm. One (among the many) reasons is that, although nuclear deterrence is achieved through nuclear means, cyber deterrence is not achieved solely through cyber means. In fact, any cyber activity meant for deterrence is likely going to be covert, while the more public deterrence activities fall into diplomatic, economic, financial, and legal domains. Less than six months after President Obama  signed an executive order to further expand the range of responses available to penalize individuals or companies conducting “malicious cyber-enabled activities”, there are now reports that it may be put to use in a big and unprecedented way. Numerous news outlets have announced the possibility of sanctions against Chinese individuals and organizations associated with economic espionage within the cyber domain. If the sanctions do come to fruition, it may not be for a few more weeks. Until then, below are some of the immediate questions that may help provide greater insight into what may be one of the most significant policy evolutions in the cyber domain.

1. Why now?  

Many question the timing of the potential Chinese sanctions, especially given President Xi Jinping’s upcoming state visit to Washington. It is likely that a combination of events over the summer in both the US and China have instigated this policy shift:

Chinese domestic factors: China’s stock market has been consistently fallingsince June, with the most visible plunge occurring at the end of August, which has had global ramifications. A major slowdown in economic growth has also hit China, which by some estimates could be as low as 4% (counter to the ~10% growth of the last few decades, and lower than even the recent record low of 7.4% in 2014). The latest numbers from today reinforce a slowing economy, with the manufacturing sector recording a three-year low. Simultaneously, President Xi continues to consolidate power, leading a purge of Communist Party officials targeted for corruption and asserting greater control of the military. In short, President Xi is looking increasingly vulnerable, handling economic woes as well as continuing a political power grab, which has led to two influential generals toresign and discontent among some of the highest ranks of leadership.

US domestic factors: The most obvious reason for the timing of potential US sanctions seems to be in response to this summer’s OPM breach, which has been largely attributed to China. This is just the latest in an ongoing list of public and private sector hacks attributed to China, including United Airlines and Anthem. The OPM breach certainly helped elevate the discussions overretaliation, but it’s unlikely that it was the sole factor. Instead, the persistent theft of IP and trade secrets, undermining US competitiveness and creating an uneven playing field, is the dominant rationale provided. Ranging from the defense sector to solar energy to pharmaceuticals to tech, virtually no sectorremains unscathed by Chinese economic espionage. The continuing onslaught of attacks may have finally reached a tipping point.

The White House also has experienced increased pressure to respond in light of this string of high-profile breaches. Along with pressure from foreign policy groups and the public sector, given the administration’s pursuit of greater public-private partnerships, there is likely similar pressure from powerful parts of the private sector – including the financial sector and Silicon Valley – impacting the risk calculus of economic and financial espionage. For instance, last week, Secretary of Defense Ashton Carter visited Silicon Valley, encouraging greater cooperation and announcing a $171 million joint venturewith government, academia and over 160 tech companies. These partnerships have been a high priority for the administration, meaning that the government likely feels pressure to respond when attacks attributed to the Chinese, such as the GitHub attacks this spring, hit America’s tech giants.

2. Why is this different from other sanctions?

Sanctions against Russia and Iran were in response to the aggressive policies of those countries, while those against North Korea were in response to the Sony breach. However, each of these countries lacks the economic interdependence with the US that exists for China.  Mutually assured economic destruction is often used to describe the economic grip the US and China have on each other’s economies. The United States is mainland China’s top trading partner, based on exports plus imports, while China is the United States’ third largest trading partner, following the European Union and Canada. Compare this to the situation in Russia, North Korea, and Iran, the most prominent countries facing US sanctions, none of which have significant trade interdependencies with the US.

Similarly, foreign direct investment (FDI) between China and the US is increasingly significant, with proposals for a bilateral investment treaty (BIT)exchanged this past June, and discussions ongoing in preparation for President Xi’s visit this month. China is also the largest foreign holder of  US Treasury securities, despite its recent unloading of Treasury bonds to help stabilize its currency. Compare this to Russia, North Korea, or Iran, none of which the US economy relied on prior to their respective sanctions. Even in Iran and Russia’s strongest industry – oil and gas– the US has become less reliant and more economically independent, especially given that the US was the world’s largest producer of oil in 2014.

3. Who or what might be targeted?

If sanctions are administered, the US will most likely continue its use of “smart” or targeted sanctions that focus on key individuals and organizations, rather than the entire country. The US sanctions against Russia provide some insight into the approach the administration might take. Russian sanctions are targeted at Putin’s inner circle, including its affiliated companies. These range from defense contractors to the financial sector to the energy sector, and include close allies such as Gennady Timchenko.  Similarly, North Korean sanctionsfollowing the Sony hack focused on three organizations and ten individuals. In the case of China, the state-owned enterprises (SOEs)deemed to reap the most benefits from economic espionage will likely be targeted. In fact, the top twelve Chinese companies are SOEs, meaning they have close ties to the government. More specifically, sanctions could include energy giants CNOOC, Sinopec and PetroChina, some of the large banks, or the global tech giant Huawei because of their large role in the economy and their potential to benefit from IP theft. Interestingly, the largest Chinese companies do not include several of their more famous tech companies, such as Alibaba, Tencent, Baidu and Xiaomi. Most of these enterprises have yet to achieve a significant global footprint, which means they are less likely to top any sanctions list. In considering who among Xi’s network might be targeted, some point to the Shaanxi Gang, Xi’s longtime friends, while others look at those most influential within the economy, such as Premier Li Keqiang.

Given President Xi’s upcoming visit, is the talk of sanctions diplomatic maneuvering, or will it be backed by concrete action? If enacted, the administration’s intent will be revealed through the actual targets of the sanctions.  If the objective is to deter future cyber aggression, then sanctions must be targeted at these influential state-owned companies and inner circle of the regime.  Otherwise, it will be perceived as a purely symbolic act both in the United States and in China and lack the teeth to truly enact change.