Weaponised Economics and Restoring Economics in the Global Order

Trade as a potential source of peace or conflict

As geopolitical tensions rise and risks to trade and investment increase internationally, the international rules-based economic order is under threat. The debate on whether trade is a source of peace or conflict has been going on for centuries. The French philosopher Montesquieu is often quoted as saying that “peace is a natural effect of trade,” arguing that through trade nations become reciprocally dependent. This argument is applicable to East Asia where trade has been a source of prosperity and security. On the other hand, in The Wealth of Nations Adam Smith argues that “trade has become the most fertile source of discord and animosity.” This can be seen in today’s U.S.-China relationship. High trade shares can lead to vulnerability and sensitivity if that interdependence is weaponized. So, who is right?

Throughout history and in the present day, there are examples of trade as a source of either peace or conflict. It depends on the trade regimes in which respective countries operate. While risks always exist, in the post-war rules-based international economic order, the United States led the enforcement of rules, which in turn helped mitigate risks. However, nowadays, the United States has turned from being an enforcer to a spoiler of this system. Due to the trends toward weaponization of trade and interdependence, there is less confidence in the existing system, as countries have to individually protect their prosperity and security through economic security policies, including trade and investment diversification, onshoring, or friend-shoring.

How can an equilibrium be maintained where prosperity and security work as complements in a virtuous cycle? One example of such a virtuous cycle is, of course, the relationship between Japan and China, where both countries signed up to the established rules and norms.

The fragility of the post-war economic order and recent challenges

The General Agreement on Tariffs and Trade (GATT), which later became the World Trade Organization (WTO), and the other Bretton Woods institutions were negotiated during the Second World War with not just economic liberalism but also security in mind to prevent the economic rivalry and protectionism of the 1930s that fueled insecurity and conflict. In particular, the GATT allowed the separation of trade and economic policy from high politics or national security.

This open global economic order has been underappreciated as a source of security. Even though the existing system is under threat and has been weakened substantially, it is far from dead and still protects countries from coercion. For example, when Australian producers were unable to export goods to China, their largest market at the time, due to trade sanctions, they were able to find other buyers in the open global economy. The WTO still acts to blunt the use of economic weapons.

Security risks are on the rise with more trade sanctions, export controls, and the weaponization of the economy. This trend has caused economic interdependence to be seen as a source of vulnerability instead of a source of prosperity and security. To further complicate things, the WTO dispute settlement system is no longer able to enforce rules through the appellate body. However, a group of countries, including the European Union, Canada, Australia, Japan, and China, set up the Multi-Party Interim Appeal Arbitration Arrangement (MPIA) in 2020 as a plurilateral arrangement outside of the current system that replicates the existing system and is consistent with the rules. Gradually, the membership has been growing, but it is still including fewer than one-third of WTO members that can enforce trade rules with each other.

Another important issue is, of course, that the security exception allowing countries to restrict trade when they are at war, for example, stated in Article 21 of the GATT, has become broadly applied by some. Finding a way to fix the system is crucial.

Rising security concerns and limitations of zero-sum approaches

A major current structural challenge is great power strategic competition. The United States has shifted from focusing on absolute gains to relative gains, prioritizing how much its economy is growing relative to China, which reflects a zero-sum mindset where China’s gains are seen as a loss to the United States. China has reciprocated this stance, locking both countries into a zero-sum competition. Unlike traditional economic competition—where investments in productivity and infrastructure benefit multiple countries—strategic competition can lead to self-inflicted harm. Policies such as trade restrictions and investment barriers, intended to weaken the opponent, often end up causing collateral damage to domestic industries and global markets.

This sort of competition leads to economic coercion—for example, the United States has imposed sanctions on advanced semiconductor manufacturing in China, which also affects other countries. On the other hand, China’s use of economic sanctions for non-economic reasons has increased. The great powers have shown a tendency to ignore the rules when it suits them and forcing countries to choose sides. This is where the idea of de-risking comes in, potentially causing economic and political damage in the long run.

This situation mirrors the Prisoner’s Dilemma, where both the U.S. and China, acting rationally in their own self-interest, prioritize containment over cooperation. While mutual cooperation would yield better economic outcomes, each country fears being placed at a unilateral disadvantage if the other does not cooperate. The result is a worsening strategic rivalry, where each side escalates restrictions and retaliatory measures, deepening instability. This has led to what I and my co-author have dubbed an “epic fail equilibrium,” in which more countries adopt this zero-sum approach, ultimately resulting in negative-sum outcomes where everyone is worse off.

A balance between mitigating national security risks and protecting economic interests is crucial. Some national security risks are existential and countries assign an infinite price to them, meaning that no amount of prosperity is worth catastrophic security outcomes, leading countries to retreat to what is known as a “corner solution” in economics, where one objective is prioritized at the expense of all others. Countries adopting an uncompromising containment strategy risk long-term economic decline. While national security must be safeguarded, policymakers must avoid policies that unnecessarily damage trade, investment, and overall economic stability and choose policies that improve both security outcomes and prosperity. Policies that ensure higher degrees of economic interdependence may in fact be the best solution to both priorities.

This challenge is further complicated by a shrinking range of strategic policy options—the set of viable policy choices available to countries. International cooperation can help expand the policy space available to countries by offering alternatives to unilateral containment strategies.

For instance, ASEAN-centered arrangements that include Japan, Australia, and others provide a multilateral framework that fosters economic ties while reducing dependence on any single major power. Conversely, geopolitical fragmentation and disorder continue to narrow this strategic policy space, forcing nations into defensive economic measures that could limit growth and innovation. Under a robust, multilateral trading system, there is naturally more strategic policy space. However, fragmentation, disorder, and economic coercion lead to a world governed by power and might, instead of one governed by the rule of law.

The pros and cons of diversifying trade

How can policymakers of countries other than China and the U.S. respond to these circumstances? A number of options, such as diversifying trade, are being implemented. This is an obvious response, as diversification is effective in avoiding risks, but the approach has its limits. It is also reasonable to argue that diversifying trade can be seen as the opposite of specialization based on comparative advantage and benefiting from economies of scale. How much diversification is truly necessary to manage real risks, and what is being given up along the way? This question is of great importance since greater specialization, the realization of comparative advantage, and economies of scale will be needed to bring about the green energy transition.

The question of how to manage concentrated markets or high trade shares, which many countries consider a security risk for certain commodities, is closely related. Rare earths and critical minerals are one example. Heavy dependence on China for these materials is seen not only as an economic risk but also as a risk to security interests. In a robust, multilateral rules-based system where countries are restrained by enforceable rules, this was not a major concern. But now, with a certain degree of diminished confidence in that system, these high trade shares are seen as a risk that need to be managed. And yet, in order to achieve a global green transition, high trade shares and specialization will be necessary.

Viewing security in zero-sum terms should be limited to territorial disputes or war. But in areas such as technological competition or the race for technological supremacy, there can surely be positive-sum outcomes. This is where concepts of collective security come in. When several countries join the same security agreement or alliance, it results in a positive-sum outcome. How can the equation be changed so that this kind of thinking expands? Japan and Southeast Asia’s idea of comprehensive security is an example of a broader understanding that transcends the narrow view of military security and includes economic, energy, climate, and human security. These factors are thought of as mutually reinforcing and complementary, not substitutes to be weighed against one another.

It is worth again recognizing the power of economic interdependence. Retreating from high trade shares to some degree may seem rational amid an increasingly unpredictable and uncertain global environment. Where does this lead us? Unlike during the Cold War, when the Soviet Union was largely isolated from global trade, China is deeply integrated into regional and global value chains. While direct U.S.-China trade has declined, production networks now flow through third countries like Vietnam, Mexico, and India. Reducing economic interdependence may seem like a rational response to geopolitical uncertainty, but it will likely make the global economy more fragile. The lesson from Europe’s dependence on Russian gas is often cited as an argument against interdependence, yet key differences exist: European markets adapted. For example, Germany avoided a recession despite cutting Russian energy ties. The complexity of China’s economic ties suggests that unwinding interdependence could create new vulnerabilities rather than eliminating risks.

Ultimately, economic interdependence has historically constrained geopolitical conflicts, making full decoupling a risky strategy. The challenge ahead is finding ways to strengthen multilateral cooperation and restore confidence in the rules-based economic system. Without such efforts, economic policies driven purely by security concerns risk leading the world into deeper instability and economic fragmentation.

The need for a new framework and enhanced middle power cooperation

What aspects of preserving the established system need to be prioritized? The rules of the WTO and the multilateral trading system are out of date. While rule updates are ongoing through plurilateral, regional, and bilateral agreements, reform of the system as a whole is needed. To create new rules for industrial policy, industrial subsidies, the digital economy, and technology, countries need to operate in groups. Multilateral principles must guide plurilateral and regional arrangements. Smaller agreements with like-minded partners or friend-shoring approaches make the world smaller. How can middle powers operate collectively amid uncertainty as the United States becomes inactive in the multilateral trading system? During Donald Trump’s first presidency, many countries signed bilateral deals that were inconsistent with the rules in place, thereby weakening the existing order. If these actions continue to undermine the very order they seek to protect, it could jeopardize the ultimate economic security of these countries.

Many of the bridgeheads of multilateralism that help lock China into a more rules-based market are centered on ASEAN. Thinking about how to mobilize ASEAN-centered arrangements and connect to European arrangements as a response to the new circumstances is probably worthwhile, but what are the forms of that cooperation?

This is an active area for research. Danny Quah speaks of inadvertent cooperation and how middle powers can nudge great powers. Adam Posen has written about principled plurilateralism, with CPTPP and MPIA as examples. Mari Pangestu and Merit Janow introduced the idea of constructive incrementalism, encouraging bottom-up cooperation to compensate for the absence of top-down U.S. leadership. Meanwhile, Peter Drysdale and Ross Garnaut wrote about concerted unilateralism. The success of this sort of cooperation can be seen in APEC, where countries work unilaterally but in concert, so the gains are compounded. The Bogor goals from 1994, which aimed for free and open trade and investment, are a successful case of concerted unilateralism. The Paris Climate Agreement works in a similar manner. While there are no binding treaties or targets, unilateral action is encouraged, leading to greater openness toward non-members and minimizing negative spillovers and economic diversion managing positive spillovers and free-rider issues.

The imperative of the green transition might help organize collective action and provide a framework for countries to work together, acting in their own interest but working towards a common goal. That necessarily requires an open trading system as well as domestic regulation that is harmonized with other countries.

Comment

TAMURA Hideyasu:
Enhanced collaboration among middle powers is definitely necessary. How can we facilitate cooperation in a more tangible way? What could be a realistic and ideal format for agenda-setting? While some experts outside the government say that CPTPP could be a suitable base for middle power collaboration, how we could consolidate views regarding, for example, in the on-going general review.

As for the notion that zero-sum dynamics being potentially relevant to territorial security issues but less so for technology supremacy or technology competition, if that is the case how can the current situation between China and the United States be analyzed? The U.S. has recently introduced a regulation on so-called “connected cars” in this context, which could be construed as a demonstration of further decoupling or de-linking in the area of cutting-edge technologies that are essential for today’s society. How can this be evaluated in the context of security issues and their relevance in the advanced technology sector?

Finally, regarding the WTO, the dispute settlement (DS) reform discussion is still ongoing. While there is some debate on security exceptions, introducing so-called self-judging security exceptions would cause huge challenges to many countries. This also relates to the discussion about how to ensure that the new rules are fit for purpose. There is ongoing discussion about the necessity of industrial policy—some say that the rules should be enforceable, while others support a guideline-based approach. How should we accommodate those kinds of discussions?

Shiro ARMSTRONG:
As for facilitating the middle power coalition, the starting point is to recognize that countries have agency. They are not passive actors in the international system. Exact definitions vary, but middle powers can be defined as countries that are not big enough to change the status quo by themselves but large enough to mobilize collective action. Examples would be Australia and Japan. How can these countries leverage their agency? ASEAN, for example, is what keeps Southeast Asia together. The 10 member nations collectively refuse to choose sides between China and the United States and govern their interactions through multilateral principles based on equal treatment and non-interference, similar to the UN.

Is CPTPP a potential avenue for middle power cooperation? While there are some difficulties due to diverse interests, progress in initiatives aimed at upgrading rules that are out of date and keeping these arrangements open to new members is important. This also leads to the question of China’s potential accession to CPTPP, which would pose a challenge. The addition of the United Kingdom was on a different scale. China would need to dismantle its industrial subsidies and member countries would need to encourage China toward this kind of reform.

That relates to the idea of dispute settlement system reform and self-judging as a developing economy. More economies joining the MPIA while continuing to try to reform the dispute settlement system would be beneficial, because the system needs reform, and saving it is a priority. How can countries expand commitments unilaterally that lead to actions that are essentially in their own interest in the medium- to long-term? This connects back to the idea of concerted unilateralism.

The key question of protectionism versus security in the area of technology is a big issue. This should not be determined by the great powers alone, as countries have different views on security risks. Again, collective action by middle powers through regional multilateral forums is necessary as a defense against great powers.

Q&A

Q:
In the area of highly advanced technology, frontier firms can monopolize the benefits and the market by protecting their intellectual property, such as patents. In that sense, the zero-sum approach can be applied to the technological field. The problem is more serious if we consider the benefits to consumers. What are your thoughts on this zero-sum characterization?

Shiro ARMSTRONG:
Not all technological cooperation or technological supremacy should be seen as zero-sum. Of course, it is applicable to some areas—military technology is seen in zero-sum terms. There are military applications of AI, and almost every technology could be categorized as dual use. The United States has pursued the “small yard, high fence” approach, continuously expanding the yard, so it is not clear where the fence is under Trump 2.0. There is a danger of this approach overwhelming all the positive-sum consumer benefits.

Realistically, we also have to ask whether those sanctions work. China has just released a highly advanced large-language-model AI platform and made it open source. This was done despite quite strict sanctions from the United States, but perhaps there are better ways to approach a vast number of different technologies where China is at the technological frontier. There is room for positive-sum security cooperation.

Q:
Is there a difference between the threat from China and economic coercion from the U.S.? What could a response to these threats look like?

Shiro ARMSTRONG:
Recently, both great powers are ignoring the established rules when it suits them. We have to remember the stake that both countries still have in the established multilateral system. If China were to lose that interest, it would become more unpredictable, resulting in increased uncertainty. Regarding the U.S., it would be destabilizing if the U.S. were to continue its spoiler role of the multilateral trading system without a collective response. To protect economic security interests, countries have to work out how to respond to China, the U.S., or any large country trying to exert economic coercion over a smaller country. This needs to be done collectively through a rules-based multilateral system.