The EU has declared China a strategic competitor and an economic rival. US policy towards China has shifted from strategic patience to strategic competition (European Commission 2019; Pence 2018; Pence 2019; Pompeo 2019). Economic relations among the world’s three largest economies (China, EU, US) are under strain over a number of issues, including not just trade and investment but also competition policies, national treatment, intellectual property right and so on. Relations between are complex and they are frequently characterised by a mix of cooperation, competition and conflict (Jaeger 2019). Nonetheless, a greater degree of competition and conflict is bound to be a permanent feature of international economic relations. Sino-US relations, for one, will remain under significant strain due to China’s geo-political rise and China’s challenge to US economic and technological supremacy. Moreover, hawkish China policies enjoy bipartisan support in the US Congress, while the US business lobby – traditionally a strong supporter of good relations with China – has become substantially more skeptical towards China in recent years due to concerns over market access, competition policies and national treatment. Sino-European relations will be under less strain given the lesser importance of security issues in bilateral relations. Disagreement pertaining to economic issues will nonetheless strain bilateral relations (e.g. market access, competition). By comparison, US-EU relations will be more amenable to accommodation given generally shared security interests and concerns about China. US-EU relations are experiencing friction due to US trade policies (including Huawei/ 5G), big tech, the climate and, yes, aspects of the security relationship (e.g. cost sharing). The absence of security competition and economic models that are like compared to China will make these issues amenable to solution.
The shift towards strategic competition between the US and China will be weakening the liberal international economic order established in the wake of WWII. High politics (security) will increasingly override low politics (economic welfare) (Krasner 1978). Power, including military power, mattered greatly in shaping international economic and trade relations before WWII. Throughout the 19th century, for example, the major European powers imposed ‘unequal’ trade treaties on lesser, mainly extra-European powers or they sought (and often gained) outright political and economic control over weaker states (including their external trad) in the form of colonialism. The ‘opening of Japan’ and the various ‘concessions’ in China are just the best-known instances of Western powers’ gunboat diplomacy that forced open foreign countries and markets. It was towards the end of the 19th century that the US first sought to manage commercial competition among the major powers in the form of an “open door policy” towards China. The policy aimed to guarantee all the major powers equal access to China’s market. In the 1920s and especially the 1930s, following the breakdown of the international trade system during the Great Depression, the major powers scrambled to secure exclusive access to overseas markets through exclusive commercial treaties, prohibitive external tariffs and/ or outright territorial expansion. The threat of trade closure and intensifying security competition enhanced the role played by economic, political and military power in international trade relations (Copeland 2014). The inter-war period witnessed the emergence of inward-looking, protectionist trading (and currency) blocs as well as a precipitous decline in international trade and prolonged economic stagnation.
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| Japan's Greater Asian Co-Prosperity Sphere |
The post-WWII international economic system, underpinned by the IMF, the World Bank and GATT, is based on a number of principles that constrain the power of the larger states. These include principles such as non-discrimination (esp. most-favored nation clause), reciprocity and enforceable commitments amongst others. The US viewed commercial rivalry as a major driver of the aggressive commercial and foreign policies of Japan and Germany during the inter-war period. (The US did not take a favourable view of Britain’s decision in favour of imperial preferences, either.) The new regime was to provide all countries with market access on equal terms (MFN) and established the principle of reciprocity, thereby circumscribing the ability of the more powerful countries to exploit their stronger political, military and economic position in bilateral negotiations. Moreover, the use of tariffs as a bargaining tool is constrained by tariff binding and/ or is confined to exceptional situations, and even then is subject to rules (e.g. anti-dumping, subsidies, national security, serious injury).
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| British Empire |
Neither GATT nor WTO completely neutralise the larger states’ greater relative power, of course, and the larger states did not always play by the rules (e.g. US-Japan trade dispute). However, by and large, the regime afforded the lesser states with a greater degree of protection, thereby limiting their relatively greater weaknesses and vulnerabilities from exploitation by more powerful states (Krasner 1976). By committing themselves not to exploit weaker states’ vulnerabilities, the more powerful states made it less risky for the smaller states to agree to trade liberalisation (Gowa & Mansfield 2003). Concerns about economic-political vulnerabilities continued to exist, but to a lesser degree. They were mitigated by the fact that most trade liberalisation took place within military alliances rather than between geo-political adversaries during the Cold War (Gowa 1994). Concerns continued to exist between geo-political rivals, which in part explains why the USSR (and its satellites) refused to join the Bretton Woods system, even though Moscow had attended the conference in New Hampshire.
Why are states with larger economies generally more powerful in international trade politics? Strategic trade theory suggests that large economies can use their tariffs vis-à-vis small countries to improve their terms-of-trade. In this case, imposing tariffs is the large country’s dominant strategy. However, economies of similar size face a prisoner’s dilemma in terms of imposing tariffs. Both economies would be better off if they both liberalised their trade, but each will be better if it imposes tariffs in case the other country removes tariffs. Protectionism (defect/ defect) is in game-theoretic language a Nash equilibrium. A rules-based international trade regime – especially under the leadership of a hegemonic power – can help alleviate such concerns about ‘defection’ and make free trade (cooperate/ cooperate) more likely with the help of the principles of non-discrimination and reciprocity. In another strand of international trade economics called strategic trade theory, financially stronger governments can exploit their financial power to dominate oligopolistic (imperfect) markets and appropriate large rents with through subsidies that force the financially weaker party out of the market. Here again, GATT/ WTO rules are helpful by specifying what is allowed and by determining the degree to which trade retaliation may be used. Again this limits the otherwise unfettered power of the financially stronger country (e.g. anti-dumping duties, counter-veiling tariffs). The rules protect the weaker countries from exploitation by the stronger countries. More generally: all other things equal, a large, less open, more developed and more diversified economy is less vulnerable to trade closure and therefore less vulnerable in political-economic terms than a small, open, less diversified and less developed economy (Krasner 1976). Of course, a dependence on critical imports can even make large economies vulnerable, as does a lack of export diversification. While smaller economies benefit disproportionately more from free trade, trade openness makes them also more susceptible to political-economic pressure by larger economies. Once again, the GATT/ WTO regime constrains larger, more powerful countries thanks to non-discrimination and reciprocity.
A weakening of the commitment to a predictable and rules-based international trade regime that constrains the power of the larger economies creates incentives for smaller and mid-sized economies to limit or at least proactively manage their trade- and investment-related political-economic vulnerabilities. For instance, China does not want to find itself in as vulnerable a position vis-à-vis the US as it did in 2017 ever again (e.g. US imports tariffs and export restrictions effectively targeting China; investment restrictions effectively targeting China; legal action against Chinese companies operating in the US). Korea does not want to feel vulnerable vis-à-vis China on account of trade or non-traded-related restrictions imposed by Beijing (e.g. Chinese visitors to Korea; K-pop groups visiting China; Korean companies operating in China). The increasing use of third-party sanctions by the US, for example, has certainly increased the reach of economic sanctions and the risk to states potentially (or actually) seen as hostile by the US. The size of the US market and the importance of US-supplied global economic and financial infrastructure (e.g. dollar) give Washington considerable reach by (ab)using what was once thought of international public goods (Kindleberger 1981). the extent practical, more vulnerable countries will seek to reduce their vulnerability with regard to more powerful, potentially hostile states. Moreover, as national security considerations become more important relative to economic welfare, the security and reliability of supply chains becomes a more important consideration even for larger economies (e.g. China’s dependence on semi-conductor imports; Japanese dependence on rare earth imports). States will seek to more actively manage their trade dependence and limit the ability of potentially hostile states to ‘weaponise interdependence' (Farrell & Newman 2019). This can be done by diversifying import (and export) markets. It can be done by switching suppliers and buyers. It can be done by producing critical goods domestically. Either way, economic efficiency will take a backseat to political considerations and concerns. This effectively politicises international trade (and investment) and its fragments the global multilateral economic regime.
Concerns related to national security and technological leadership will override welfare concerns against the backdrop of increased security competition – at least in the case of Sino-US relations. In a world or in a game where the priority is to come out on top, states will be engaged in a zero-sum rather than non-zero sum games. High politics begins to dominate low politics (Krasner 1978). Naturally, military, political, economic, financial and ideological power has always mattered, including in post-WWII international economic relations. But states were more concerned about making absolute gains, not relative gains. However, absolute gains may be desirable in the context of amicable security relations. In the context of intensifying security competition, relative gains – including maintaining economic and technological leadership – become substantially more important. Therefore, further politicisation and fragmentation is set to occur against the backdrop of intensifying Sino-US strategic competition. A complete breakdown a la 1930s will likely be avoided (Jaeger 2019) given the significant absolute costs this would entail without, arguably, offering any substantial relative gains. Seeking to slow down China's rise by dismantling global supply chains may or may not have worked 20 years ago. The existence of extensive and complex supply chains makes it somewhere between impossible to ineffective to seek to isolate China commercially. But sectors considered strategic in terms of technological leadership and military primacy can be targeted successfully and they will be badly affected. In other words, the ‘political’ in the international political economy will become more important. This may come as more of a surprise to economists than political economists. After all, international political economy has always been about both economic and military power (Viner 1948), including during the Cold War.
Zero-sum game competition in selected areas will lead to the further politicisation and fragmentation of the international economic system. True, the multilateral trade regime has been fragmenting for a while due to the emergence of FTAs. But this was mostly a consequence of the difficulties involved in tackling politically sensitive non-tariff barriers to trade, increasing membership size and so on. The fragmentation was due to a lack of progress in terms of multilateral trade liberalisation. Leaving aside the question if and to what extent regional trade agreements are welfare-enhancing or -reducing due to the relative effects of trade diversion and creation, FTA liberalisation is generally not outright regressive in the sense of putting up new barriers to trade and investment. By contrast, concerns about political-economic vulnerabilities and technological competition are leading states to impose market access restrictions and market access denials in terms of trade and investment. Such measures will be outright regressive from an economic welfare point of view (e.g. China government departments switching to local IT suppliers; CFIUS). In short, politicization and fragmentation will be reflected in market access restrictions, investment restrictions, IPR transfer restrictions, export controls and so. While such measures may foster greater regional integration in some instances (e.g. EU screening and competition policies), it will lead to regressive fragmentation at the global level.
Power considerations will gain greater importance at the expense of pure welfare considerations. Liberal economic theory suggests that international liberalisation leads to a more efficient resource allocation and, typically, to welfare gains in all economies (Ricardo’s comparative advantage). And even though within economies some groups may lose out in relative and absolute terms, they can in principle to compensated thanks to the absolute welfare gains an economy experiences in the wake of liberalisation. The free flow of capital allows capital to go where it is the most productive and generates the highest returns. Foreign direct investment, and especially greenfield investment, also facilitates technological diffusion, a major source of productivity growth and economic development. (Note: The benefits of free trade may be less clear-cut if the environmental costs/ externalities are factored into the equation.) Last but not least, some liberal thinkers have claimed that free trade fosters international peace and stability, even though the empirical situation is a little more complicated (Mansfield 1994). Overall, a liberal international multilateral economic order is undoubtedly conducive to economic welfare. But the major economic powers are bound to attach less weight than in the past to economic welfare considerations relative to the broader political and security implications of their foreign (and domestic) economic policies.
A further regionalization of the global economy is likely given the increasing politicisation of international economic relations. While the blocs would continue to engage in economic exchange with each other, it would be more limited, thereby allowing each to strike an acceptable balance between reaping the benefits of economic openness and the associated political-economic risks in case of closure. It is of course possible that the major economic powers will find a mutually acceptable compromise over how to reform and preserve the liberal multilateral order. It is far certain though that such a reform would suffice to stabilise the regime in the longer term. As long as China is seen as threatening US military supremacy and technological leadership, any regime will be inherently unstable. (Remember: from the US point of view, US trade deficits with Japan in the 1980s were high not due to Japan’s high savings rate/ US’s low savings rate, but “unfair trade practices”.) Unless a reform mitigates Chinese competition, the international economic regime will remain dynamically unstable. This is about which country will emerge as the technological leader, not whether outcomes are due to market forces or state support. This is precisely why the politicization and fragmentation will likely prove an enduring feature of international economic relations, even if the major powers manage to preserve some core elements of it.
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| Source: EuroStat, OECD |
In conclusion, the international economic regime is to suffer from increased politicisation and fragmentation due to (1) the increasing importance of political and military power considerations against the backdrop of increased security competition, (2) rising concerns about relative rather than absolute economic gains. Furthermore, (3) trade and investment restrictions will become a more common feature, but protectionism will on the whole remain selective and targeted (e.g. technology, security) – though admittedly a lot can apparently be construed as relevant to national security (e.g. car imports from allies) and (4) governments will pursue more activist policies in an attempt to win the technological race, including support for national champions, competition policies and so on. In other words, it will be a world where power and security matters more and short-term economic efficiency matters less than in the past.
* A special thanks to the students in my Columbia University capstone workshop on trade wars. Their lively and engaging discussions have inspired this comment: Daniel Marechal, Joon Song Lee, Lukas Feldhaus, Samantha Weiss, See He Kim, Woonjae Kim, Xinyi Sun and Yuxin Huang