New Directions in American Economic Statecraft

Increased risk awareness in a deeply interdependent global economy

The U.S. has entered a new era of economic statecraft and we are witnessing a paradigm shift. There is a broader set of factors that have brought a profound change to the way in which the United States thinks and articulates its international economic objectives. What we are watching in real time is the securitization of international economic relations which comes from a heightened sense of risk in the global economy. So, what are the factors that have increased the awareness about the need to hedge?

There are key drivers such as, of course, the strategic competition of the U.S. and China. This is a situation where two peer competitors, who are deeply integrated economically, are vying for influence. Therefore, economic instruments are a very central part of this competition. Another important aspect is the centrality of the technological revolution and how fast technologies are advancing. Some of these technologies have been referred to as “platform technologies.” Why? Because these are going to affect everything and will be critical for economic competitiveness as well as military modernization and military capabilities. Examples are artificial intelligence, microelectronics, edge computing, and biotechnology.

The pandemic has also increased awareness of risks, especially concerning supply chains, because it exposed some of the risks of depending too much only on certain countries for the supply of important products. And of course, an international environment with growing instability and where conflict is proliferating increases the sense of vulnerability, with Russia's invasion of Ukraine in 2022 and the conflict in the Middle East coming to mind. These factors combined have generated the securitization of international economic relations, which basically means that states are focusing on national security interests to both regulate international economic transactions, but also to try to deepen their technological competitiveness.

We also have to keep in mind that the rise of economic security is happening in the aftermath of the global supply chain revolution. There is a lot of talk about strategic autonomy and self-reliance, but nobody is really aiming for autarky. Because autarky would be the perfect recipe for losing not only economic heft, but also geopolitical influence. On the contrary, addressing national security objectives in the context of a very deeply integrated world economy is the focus of this new drive, giving rise to buzzwords such as weaponized interdependence, where we focus on a specific node in the supply chain as providing a particular leverage or influence for any actor that chooses to take advantage of that leverage.

Reasons behind the changes in the U.S.-China relationship

The current international environment is very different compared to that of 20 years ago. It can be said that China and the United States are thinking of globalization as one fundamental dimension of the strategic rivalry that now defines their relationship. In the beginning of the 21st century, when China joined the WTO as the culmination of a process of economic engagement, the hope was for China to become a more responsible stakeholder as it acquired more influence. But this is certainly not the way that the U.S. sees China today and it looks like the competitive turn is here to stay. The drivers of competition are very strong, both on economic and also on security terms, in particular with a focus on technology.

What brought this profound shift in U.S.-China relations? Among many different reasons, there has been a major shift with China's economic takeoff, in particular with its program to rapidly build its military capabilities in a non-transparent manner. There are also concerns about changes inside China, both in politics and economics. Certainly, since the arrival of Xi Jinping, there has been a greater concentration of power and less room for plural views. In terms of the direction of economic policy, rather than increasingly opening up, China is strengthening its implementation of state capitalism, while entertaining more ambitious objectives of leading in the most advanced technologies. In addition, China’s foreign policy of employing coercion to advance expansive territorial claims is also viewed as concerning by Washington.

When it comes to China's technological ambitions and its push for greater self-reliance in cutting-edge technologies, there will be an effort to subsidize these sectors very heavily, especially with Made in China 2025 and dual-circulation policies. In reality, there are many and various opinions in the U.S. regarding China, its motivations, politics and economics, and these issues are hotly debated in the United States but overall skepticism about China has grown. Frictions in the U.S.-China relationship have been present for a long time over intellectual property theft, and the so-called “China Shock” debate also played powerfully into the 2016 U.S. presidential election. None of the previous concerns have dissipated, but new concerns have arisen in relation to the national security initiatives and China’s push for technological superiority and military strength.

Finally, it is also important to understand that the U.S. has also grown increasingly pessimistic about the ability of the WTO to discipline Chinese state capitalism, in addition saying that national security should not be the subject of judicial review in the WTO. This has profound consequences, not just in terms of U.S.-China relations, but the operation of the multilateral trading system.

Changes in the U.S. approach to economic statecraft

As a consequence of current challenges, there has been a profound change in U.S. economic statecraft that will have wide repercussions. The U.S. has adopted a different approach of what it takes to compete with China on technology. Therefore, new types of export control were implemented. Of course, the United State cannot embark on these new paths on its own and needs to collaborate with like-minded countries. This new era can be dated back to a very important speech that National Security Advisor Mr. Jake Sullivan gave in Washington in September 2022. He talked about the challenges of protecting sensitive technologies in this new security environment, stating that the old approach of maintaining relative advantage vis-a-vis China was no longer sufficient. Instead, for some specific technologies, which he described as force-multiplier technologies, the U.S. would need to slow down Chinese technological development, keeping China's civil-military fusion practices in mind.

Soon after this speech, on October 7 of the same year the U.S. government released new export controls on semiconductors that have changed the rules of the game in many ways. These rules aim to curtail China's access to high performance chips that can be used to train AI or edge computing. The rules and are incredibly complex, but in essence, they prohibit the sale of very advanced chips with technical specifications noted or to provide China with any aid in developing these independently. The idea is to deter China's technological deepening by curtailing access to the chips, to the machinery, and to U.S. talent.

The rules have an extraterritorial element because not only American companies, but any firm in the world that has touched American software or tools must abide by these regulations. Thereby the reach of these rules expanded tremendously. This means that the United States needs to be talking to its partners if it wants to have an effective approach, which has already happened for example through alignments with the Netherlands and Japan.

Industrial policy with a strategic competition rationale

During the years of the Washington Consensus, the U.S. government was actually very negative about industrial policy, which caused frictions in U.S.-Japan relations for a long time. Now, on the other hand, there is this new way of thinking that if the United States wants to continue to deepen its technological progress, it must embark on this new chapter of industrial policy. The Biden administration has set out ambitious goals which are also supported by ambitious legislative packages like the Inflation Reduction Act and the CHIPS and Science Act. Ambitious goals include that the United States would like to be able to produce 20% of the world's most advanced logic chips by 2030 and embark on a green power transformation.

While these goals are motivated by ambition, they also contain a strain of anxiety about the potential of missing out on what could be a very decisive decade. This is not industrial policy of the past where the idea was to keep foreign multinationals at bay and to raise infant industries. On the contrary, it is about attracting cutting edge producers to the country, so collaboration is crucial. Bringing TSMC and Samsung to the United States has been an important step in that direction.

Many other players also have their own industrial policies: not only China, but Japan, Korea, Taiwan, the European Union, etc. all have them. However, there is something distinctive about the industrial policy of the U.S., because it maintains a focus on the strategic competition with China. The U.S. government already started distributing subsidies as part of the CHIPS Act, but there are significant conditions attached. Recipients have to agree to not substantively expand their manufacturing capability in semiconductors in China for a number of years. Similar things are happening with EVs and tax credit eligibility, whose conditions are based on extremely strict conditions. This industrial policy has not only industrial objectives in mind, but also a strategic competition rationale. For U.S.-Japan relations, there is a strategic convergence in thinking about the importance of protecting technology, avoiding overdependence, and concerns about China. The allies have very quickly developed economic security as a pillar of the bilateral and regional agenda. In 2021, the U.S. and the Japanese government launched the core and resilience competitiveness agenda, followed by the establishment of a 2 + 2 for economic security.

Both countries have also focused on the G7 as an important platform to disseminate standards and to think collectively about how to address challenges such as economic coercion or overcapacity. But even though there is convergence at the broad strategic level, the economic security agenda requires both Japan and the United States to work through some important issues and all of this is happening in the context of the upcoming U.S. election.

Critical issues going forward and possible consequences of the U.S. election

The “small yard, high fence” approach of the U.S. is a very focused approach on the restrictions to technology flows. It is important that this remains unchanged, so we need to be careful not to add too many technologies to the restricted category, as doing so would limit open innovation systems and impact companies that are very integrated with China. Regarding export controls, not all countries have the legal structure in place to have country-specific export controls, and would initially only be able to implement country-agnostic controls. This gap will need to be discussed and addressed.

When it comes to the threat of economic coercion, rules-based trade is also very important. Unfortunately for the U.S. and Japan the opportunities for working together are diminishing since both Republican and Democratic administrations have been unwilling to discuss returning to the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) or negotiate new trade agreements, recently demanding policy space before advancing on freedom of data flows. Another issue relates to tensions that may arise from friend-shoring and onshoring.

Obviously, how the U.S. and Japan coordinate their economic security agenda as well as U.S. economic statecraft in general will be greatly influenced by the outcome of the election. While Washington, or the U.S., is polarized, there are areas where there is consistency and bipartisan agreement. The competitive approach to China is here to stay. The same goes for the 301-type tariffs imposed on China during the Trump years. The subsidies for advanced manufacturing in semiconductors and green transformation projects will continue as well.

Nevertheless, the elections will have consequences. The climate change agenda is obviously much more in question if a Trump administration 2.0 were to be elected. Coordination with partners would also likely change and the use of tariffs may be very different.

In general, the U.S. is embarking in a new chapter with a focus on technology competition with China and cooperation with like-minded partners, such as Japan.

Q＆A

Q:
Regarding current international economic relations and increasing geopolitical risks, some people say this development is partly due to the relative decline of the U.S. in international affairs. China’s economy is growing much faster, so they are capable of providing economic assistance to countries which are not on friendly terms with the U.S. and its allies. Also, the U.S. economy and society are now more divided than at any time in recent history, therefore the U.S. president and other political leaders may be preoccupied with internal issues, paying less attention to global affairs, potentially increasing the geopolitical risk in the world. What is your view on this argument?

Mireya SOLIS:
The United States’ influence has been in a process of relative decline compared to how powerful it was at the end of World War II or at the end of the Cold War. Other countries—particularly China—have vastly expanded their economic and military capabilities. And it is true that the divisions within the United States are growing and deepening. This has indeed led to the U.S. becoming more concerned with domestic matters and being less willing to play a more traditional global leadership role. Nevertheless, the United States still has enormous economic and military heft. There is no other country that has been willing to step up and deal with crises all over the globe. Even though there is exhaustion, the United States still plays a very active role globally. When it comes to technology, why these export controls have been so powerful so far is because U.S. companies do occupy a key role in this very important node of the supply chain. When analyzing the intensification of geopolitics, we also need to look at what is happening inside China. The slowdown of the economy, the difficulties in making the transition to a consumption-led model. Xi Jinping has centralized power, but that also creates a situation where mistakes can be made, such as the costly mistakes including the very harsh COVID lockdowns or the decision to announce to the world a partnership with no limits on the eve of the Russian invasion of Ukraine.

Q:
Xi Jinping is very interested in becoming a world leader in many respects. Is he the only Chinese leader with such ambitions or are many political leaders in China really interested in becoming world leaders in terms of various areas?

Mireya SOLIS:
This is a difficult question as information is not easily accessible. The Chinese leadership has aspired for China to be a global leader for a very long time. Economic reforms were precisely aimed at developing the economy to provide better opportunities for the population, but also to increase China's capabilities. But there are certain things that Xi Jinping is doing differently, particularly his prioritization of politics. China is now paying a cost in terms of the economic slowdown and the elevation of security at all levels. The CCP now has greater reach into how enterprises operate in China, making business more complicated and difficult for Western companies. While there was a period when China was pursuing more of a charm strategy to reassure other countries, that approach is gone, by and large, under Xi Jinping.

Q:
Regarding the concept of “small yard, high fence,” will the “small yard” become larger and the “high fence” higher? This would have negative impacts on the free global trading system.

Mireya SOLIS:
I am worried, and I see the potential for this happening. The “force-multiplier technologies” that Mr. Sullivan talked about, or “platform technologies,” are crucially important and are therefore going to affect many economic sectors. But also, when access to a technology is restricted, obviously the private sector and the targeted governments will try to overcome these restrictions by finding loopholes. When the U.S. government updated the export control rules on October 16th, 2023, the number of countries subject to restrictions was expanded from two to 43 and the performance requirement of the chips were changed, expanding the “yard” and the height of the “fence.” This will continue forever, unless a good process for delisting technologies or products once they become mature is found.

Q:
Concerning the U.S. entity list to contain Chinese firms, do you think this will be successful in suppressing activities of designated Chinese firms?

Mireya SOLIS:
China does not yet have the most advanced semiconductor technology. The U.S. rules have slowed down China to some extent and they did make it much harder for China to access the chips and the production equipment. But it is really just a question of time because eventually China is going to develop this technology. I wrote a recent paper on U.S. export control policies and one of the arguments I made is that it is important to have close coordination and work on dissimilar threat perception. If it is about this commercial technology being used for military use, better intelligence coordination with close allies would be important.

Q:
You mentioned your book, Japan's Quiet Leadership. What types of leadership are required for politicians, bureaucrats, the business community and in academia in Japan?

Mireya SOLIS:
Japan is actually far more important in terms of the regional economic architecture and how it supports the U.S. in its goal of providing stability in the region than people give it credit for. Therefore, I used the term “quiet leadership.” Japan went from shying away from taking a political leadership role in the region to being at the center of three mega-trade agreements and embarking on very substantive security diplomacy. This was done by deepening the alliance coordination with the United States, while also having a broader set of partners for coordination.

Japan was able to do this by taking more of a whole-of-government approach to national decision-making compared to the traditional dynamic in Japan, that is strong bureaucratic infighting or a lot of vested interest hindering Japan's trade liberalization ambitions. This is an interesting moment in Japan and in light of the upcoming election for a new party president it will be important to energize the public in terms of how important it is for Japan to address this difficult international environment alongside domestic issues.

Q:
How would you evaluate the Indo-Pacific Economic Framework (IPEF)?

Mireya SOLIS:
IPEF is a good effort and there are some merits in areas such as supply chain resilience but is not as comprehensive as CPTPP and therefore its impact may be minor, due to its highly-diluted ambition. Since this is an executive agreement that does not go to Congress, without any tariff liberalization, it could greatly change after the upcoming elections, and may not even last depending on what happens with the election.