Wed. Jun 29th, 2022
By Esfandyar Batmanghalidj

In his 1919 work Economic Consequences of the Peace, John Maynard Keynes warns that “the menace of inflationism … is not merely a product of war, of which peace begins the cure. It is a continuing phenomenon of which the end is not yet in sight.” Keynes was commenting on the negotiations that would lead to the Versailles Treaty. Against a backdrop of hunger and despair, the victors of World War I condemned Germany to further sanctions. The treaty’s proponents believed that to prevent a future war, the German economy, a “vast fabric built upon iron, coal, and transport,” needed to be “destroyed.” But Keynes understood that with Germany in a state of perpetual crisis, the European economy would never recover. Tearing up Germany’s fabric would keep Europe on the path to another great war.

Western governments have responded to President Vladimir Putin’s brutal invasion of Ukraine with an unprecedented sanctions program. President Joe Biden has vowed to sap Russia’s “economic strength and weaken its military for years to come.” Erik Sand and Suzanne Freeman echo Keynes’ warning in this publication, arguing that “there is likely no way to effectively pressure Russia without some increase in the risk of escalation.” Putin may respond to increased economic pressure militarily, but so far he is weighing economic countermeasures. Reports that Russia will ban the export of key commodities for the remainder of the year have rocked global markets given the likely inflationary shock.

Keynes’ polemic, vindicated by World War II and frighteningly relevant today, is driven by two insights. First, wars do not only reshape political orders, but also the organization of economic orders. Second, the consequences of such economic disorganization tend to persist even after wars end, whether because of deliberate acts, such as the economic punishment imposed on Germany or now being meted out to Russia, or because of the entropic tendency of economic systems.

These insights are also present in two recent economic histories. Nicholas Mulder’s The Economic Weapon, published in January 2022, tells the story of the development of sanctions as a tool of modern warfare. Mulder chronicles the political, legal, and institutional innovations that enabled states to begin using blockades, embargoes, and export controls during peacetime to change the behavior of targeted states. Isabella Weber’s How China Escaped Shock Therapy, published in 2021, is a deeply researched account of the intellectual debates that informed China’s economic development, and particularly the decision not to pursue “big bang” economic liberalization, a move that distinguishes China from other socialist countries that undertook economic reforms in the second half of the 20th century.

For both scholars, Keynes is an important touchpoint. Their books help us to understand the “menace of inflationism” from two perspectives. Mulder draws on the speeches, letters, and reports of prominent sanctionists to make clear that the economic deprivation of civilian populations was an intended aim of peacetime sanctions. President Woodrow Wilson, a key proponent, boasted about the power of sanctions to affect ordinary people, describing the measures as “something more tremendous than war” because of their ability to bring “a nation to its senses just as suffocation removes from the individual all inclinations to fight.” In a recent Guardian op-ed, written in the lead-up to Russia’s invasion of Ukraine, Mulder cautions Western leaders about their overdependence on sanctions, citing a letter that Keynes sent to the League of Nations in 1924 in which he warned that sanctions “would always run the risk of not being efficacious and of not being easily distinguished from acts of war.”

Weber’s account of China’s escape from shock therapy is about a different kind of economic war — China’s decades-long fight against inflation. Chinese economists saw price stability as fundamental to economic development and fittingly conceived of their battle against rising prices as a kind of “economic warfare.” The insights that Chinese economists used in their battle had an unlikely source. Weber compellingly traces how the intellectual debates among American and British economists that led to the use of price controls during World War II — debates in which Keynes was a key figure — would later influence economic thinking in China. Weber draws on this debate in her own Guardian op-ed, published in December last year, in which she suggests that the successful use of sectoral price controls during World War II could offer a useful model for policymakers today as the United States and Europe grapple with surging inflation brought about by supply chain disruptions — like those that will be caused by the economic war on Russia. Adam Tooze has placed her ideas within a “a rich vein of recent post-Keynesian writing” marked by an “enthusiasm for the writings of mid-century macroeconomists like Keynes, Kalecki, Lerner et al.”


Nicholas Mulder, The Economic Weapon: The Rise of Sanctions as a Tool of Modern War (Yale University Press, 2022)

Isabella Weber, How China Escaped Shock Therapy: The Market Reform Debate (Routledge, 2021)

In this way, Mulder and Weber’s books — a history of the creation of modern sanctions and an account of the intellectual debates at the heart of Chinese developmentalism — are connected by the intellectual legacy of Keynes and the central insight that economic liberalism creates the conditions for economic warfare. But there is also an important historical event that connects the two projects. It is this unlikely connection that offers us a cautionary tale as the geopolitics of the day increasingly resemble what humanitarian Edmund Morrell termed the “peacewar” condition of the interwar period.

Mulder recounts how Japan’s occupation of Manchuria in 1931 was motivated by a fear of the economic weapon as it had been deployed in World War I. The Japanese military elite believed that “the fate suffered by imperial Germany — a national model since the Meiji restoration — at the hands of the Allied blockade had grave implications for their own country.” The invasion of Manchuria was intended to “create a resource-intensive industrial base” in order to give Japan the means to resist sanctions during a “future continuous war.” But the push for autarky was derailed in 1937 when rising tensions led to skirmishes between Japanese garrisons and Chinese Nationalists. Chiang Kai-Shek and the Nationalist leadership felt that the Japanese encroachment was becoming permanent. Mulder relays that in July of that year H. H. Kung, the Nationalists’ finance minister, told officials in Washington that “China was preparing for what it felt was an inevitable war with Japan.”

One month later, the Second Sino-Japanese War began. Japan declined to formally declare war, citing China’s lack of a unified government. But the absence of a formal declaration was also calculated to reduce the chances of foreign military intervention on China’s behalf. As part of its effort to maintain control of Manchuria, the Japanese government instituted a “pacific blockade” of Chinese ports, preventing trade under the pretense of anti-piracy measures. According to Mulder, this made Japan “the first non-Western power to use organised economic pressure in an undeclared war.” The blockade would remain in place until 1945, “making it one of the longest of the twentieth century.”

Western powers imposed their own sanctions on Japan in response to its invasion of Manchuria with the aim of stemming Japan’s imperial ambitions. Mulder argues convincingly however, citing a contemporary warning from Elizabeth Boody Schumpeter, that while Japan’s experience in Manchuria proved that “conquest was not a sustainable means to autarky … by provoking economic pressure it could cause war to escalate.” Here, the vicious cycle between economic war and conventional war becomes clear. Schumpeter predicted a vicious cycle: “‘Economic pressure, the threat of sanctions, a policy of autarky, and territorial aggression … act upon one another with cumulative force.’”

In some respects, China’s escape from shock therapy was a decades-long attempt to break this cycle. Fearing the effects of a future blockade, Japan invaded Manchuria. When Chinese forces sought to push out the Japanese invaders, they were subjected to a blockade. The consequences of that blockade were profound. Weber argues that hyperinflation was a key factor in the fall of the Nationalist regime. “Inflation began with the outbreak of the Sino-Japanese War in 1937 and by the mid-1940s had evolved into chronic hyperinflation,” she writes. The war led to a decrease in the supply of key commodities and a rapid increase in the money supply as the Nationalists sought to finance their war effort by printing money. Weber also makes passing reference to the role of “Japanese blockages” in exacerbating the “breakdown of the supply and distribution of food grains,” which had reached “a scale unknown in imperial times.” As the government struggled to bring prices under control, peasants confronted increasingly onerous taxes, urban wage earners and state employees resented the loss in their purchasing power, and the army grew restive as food supplies declined. The menace of inflation, driven in part by Japan’s undeclared war and economic sanctions, helped to pave the way for communist forces to cement their hold over China.

Once in power, communist policymakers had to wage their own battle and bring prices under control. Chen Yun, who led the Chinese Communist Party’s Organisation Department during the war against Japan and who would go on to become “a key architect of China’s economic reforms of the late 1970s and early 1980s,” established his reputation in halting the economic crises of the 1940s. The experience of the hyperinflation was formative for Chen, who began to stress “the importance of trade and commodity circulation for economic development.” The blockade — or at least its effects — led Chen to see the both the potential and pitfalls of liberalized trade (the Nationalists had even imposed their own blockades on Communist-controlled regions as China’s civil war reached its final phases). In 1950, Chen would coin a highly influential economic slogan that captured his approach to economic policymaking: “Rising prices are not good, falling prices, too, are not good for production. It is better to be groping for stones to cross the river more steadily.”

For the next 30 years, consensus emerged around a gradual approach to economic reform that included state participation in liberalized markets as a tool of price control. Then, in 1980, an elderly Chen would again invoke the “river” slogan in a pivotal speech at the Central Working Conference. At the time, Eastern European emigree economists and World Bank technical experts were pushing China to pursue rapid price liberalization of the kind that would later become known as “shock therapy.” But Chen prevailed — his speech earned the full endorsement of Deng Xiaoping, who presided over China’s opening to the world from 1978 to 1989. In this way, China’s “escape from shock therapy” owes something to the wartime experiences of Chen, who witnessed both the limits of autarky and the importance of stable prices during a war when inflation itself was being weaponized.

As Western brands flee the country and as Western banks cut ties, Russian officials, who have characterized Western sanctions as an “economic war,” will no doubt be questioning the benefits of participation in a liberal economic order. Chinese officials will be watching closely. Writing in 2020, as President Donald Trump waged his trade war on China and continued to call for a decoupling between the world’s two largest economies, Weber noted that “Chinese researchers and officials increasingly worry about an all-out ‘financial war’” with the United States. Striking a hopeful note, Weber suggested that “after the US election, a window of opportunity might open for a careful renegotiation of the relations at the heart of the world economy.”

For now, no such renegotiation appears to be forthcoming and the global attitude towards economic war continues to be decidedly laissez-faire. Western states that painstakingly rebuilt a liberal economic order after World War II are increasingly dependent on an economic weapon that fundamentally undermines that order. In the near term, sanctions on Russia are creating dysfunction in global markets, driving the prices of energy products, metals, and foodstuffs to new heights. As a result, Russia will not be the only country impacted by the sanctions placed upon it. Vulnerable populations around the world will see their economic welfare eroded as basic foodstuffs and goods become more expensive. In a recent tweet, Weber asked, “How can we have internationally coordinated economic sanctions on a very large scale without equally internationally coordinated measures to stabilize global food, energy and commodity markets?” The answer is that sanctions are implemented on a “shoot first, ask questions later” basis.

Sanctions will change the structure of the global economy itself. Writing in The Economist, Mulder calls the expansive use of sanctions “a tempest that will change the nature of globalisation itself in major ways.” There has been a lot of speculation that the Russia sanctions, which are the first to target a major player in global financial markets, will accelerate efforts among key economies to reduce dependence on the dollar as the reserve currency of choice. But economic liberalism is somewhat agnostic on the question of currency — global markets have relied on the dollar, the pound, and the peso at different stages. More fundamental than the currency used to conduct trade is the willingness of states to engage in liberalized trade in the first place, committing to build common markets and networks that facilitate economic exchanges.

It is likely that the expanded use of sanctions will spur countries to pursue models of economic development that increase friction for the global economy. These moves might be conspicuous, such as when countries pursue policies ranging from protectionism to autarky. But they could also be more subtle. China is an outlier in the global economy because its embrace of markets was circumscribed. Chinese policymakers realized that to win their own economic war — the battle for development — the iron fist needed to guide the invisible hand. Other states may come to that same conclusion, particularly if China fares better than more marketized economies at weathering the coming storm.

As Mulder concludes in his book, the future of liberal internationalism is dimming. The unabated use of the economic weapon is “stitching animosity into the fabric of international affairs and human exchange.” That fabric is built upon iron, coal, and transport. It can blanket us in peace or shroud us in war.

Esfandyar Batmanghelidj is the founder and CEO of the Bourse & Bazaar Foundation. He is also a visiting fellow at the European Council on Foreign Relations.  

Credits | War on the Rocks

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