Economic Security in a World of Disruptive Power

The end of the flat world era

The world has shifted from the post-Cold War optimism of Fukuyama's "end of history" and Friedman’s "flat world" to a new era of instability. The previous era featured peace, falling inflation, reduced inequality, dollar stability, and global cultural convergence. However, this era has ended. Europe is no longer at peace, facing military conflict, economic warfare through war on trade and tariffs, and potential financial warfare threatening the stability of dollar dominance and the international monetary system. The Centre for Economic Policy Research has established a dedicated section on their VoxEU platform specifically to track developments in Trump policies and tariffs, with new content appearing almost daily.

Understanding the new trade policy framework

Recent U.S. trade policy, especially under Trump, marks a sharp break from past norms. The administration’s tariff formula—trade deficit divided by imports—has no economic grounding and contradicts textbook trade theory. Markets reacted sharply, and while measures evolved, uncertainty remains.

Europe initially prepared retaliatory measures, but China responded first with retaliation, prompting the U.S. to modify its approach by lowering tariffs on other countries while maintaining its focus on China. Europe ultimately did not enact the full scale of retaliatory measures that had been prepared.

A key concern involves the possibility of even more comprehensive changes. Stephen Miran's 2024 paper "A User's Guide to Restructuring the Global Trading System" provides insight into the intellectual framework that may guide future policy. Unlike traditional views that see dollar dominance as a privilege, Miran argues it burdens U.S. manufacturing through a structurally overvalued dollar. His proposed solution involves imposing tariffs on allies, assuming costs fall on foreign partners, and negotiating a deal to weaker the dollar – a "Mar-a-Lago" version of the Plaza Accord.

Examining the manufacturing decline narrative

The claim that dollar dominance harmed U.S. manufacturing is weak. Most developed countries show similar declines in manufacturing GDP shares, including those without reserve currencies. Even China has lost manufacturing jobs in absolute terms. This evidence contradicts the zero-sum assumption underlying much contemporary trade policy—the notion that there is a constant set of manufacturing jobs in the world and they can just be shifted around. Likewise, U.S. current account deficits persist despite declining foreign inflows, weakening the argument that the U.S. must run deficits to provide global liquidity.

Financial market implications and systemic risk

Despite flawed analytical foundations, the mere discussion of radical interventions in currency markets or converting Treasury bonds into perpetuals may have already damaged confidence in U.S. financial assets. Converting Treasury bonds into perpetuals would constitute some form of default on the U.S. liabilities. Even if never implemented, serious consideration of such measures signals a willingness to contemplate fundamental changes to the international monetary system.

Financial markets are not panicking, but the structural trust underpinning dollar dominance for decades may have been compromised. The challenge lies in the absence of immediate alternatives to dollar-denominated assets, but the euro may gain ground.

Europe's existential security challenge

Europe’s security challenge now overshadows trade concerns. The private Trump-Putin channel showed how Europe could be sidelined. When considering how strongly to retaliate against the U.S., Europe must also consider its own security needs. NATO and U.S. protection have provided the essential security umbrella since World War II, and while there has been a free rider problem with European defense spending, there is also a free rider problem within Europe itself. Threat assessment varies significantly within Europe based on geographic proximity to Russia. Countries like Finland and the Baltic states, which share borders with Russia, feel the threat much more acutely. In contrast, countries further from the Eastern Front face different circumstances.

European economic restructuring imperatives

This new security urgency could accelerate technological upgrades. AI, space tech, and defense innovation are no longer abstract topics.

Europe must also reassess its business model. It prospered under globalization and cheap Russian energy but neglected productivity. The Draghi report notes a widening gap in per capita income with the U.S., driven largely by productivity. Likewise, energy remains a structural weakness. Industrial gas prices are higher in Europe than in the U.S. or China. While renewables will eventually reduce this gap, the transition is slow.

Reports to the European Commission by Mario Draghi and Enrico Letta urged reforms in strategic sectors, EU governance, financial integration, and industrial policy.

The complex China relationship

Europe has benefited from Chinese markets but is now cautious. China’s macro outlook has worsened, but it dominates in sectors like EVs and batteries. Europe imposed tariffs on Chinese EVs, though key countries—Germany, Hungary, Slovenia, Slovakia—despite being home to large car industries. This opposition was due to retaliation fear and since restricting cheap Chinese green tech will hurt Europe’s decarbonization efforts, while the Union remains committed to its net zero path.

Strategic opportunities in crisis

Despite significant challenges, strategic opportunities emerge from the current crisis. Europe is now much more alone, both in terms of security and allies. On one hand, this means more unity for the EU, reduced fragmentation, and reinvigorating the single market. It also means reaching out to new coalitions of the willing.

Building security and resilience is an absolute priority. If NATO can no longer protect the EU and there is an aggressor on the European border actively waging a war, this represents a fundamental change. This has driven the new German chancellor to secured defense funding even before election. He then coordinated with France and Poland to support Ukraine. The new Germany has woken up to the fact that it will need to play a much stronger role within Europe and the world.

Comment

Professor Weder di Mauro’s perspective is particularly timely for understanding current global trade dynamics. The fundamental observation that approximately 74% of global goods trade continues on Word Trade Organization (WTO) most-favoured-nation (MFN) terms provides important context against the overly pessimistic narratives about the multilateral trading system's demise. This objective assessment underscores the importance of measured analysis rather than extreme positions when evaluating trade tensions.

Japan's approach to U.S. tariff measures reflects three strategic pillars requiring careful navigation. First, Japan has positioned itself distinctly by emphasizing its role as America's number one investor, creating millions of high-quality manufacturing jobs. This win-win framing, repeatedly articulated by Japan's Prime Minister, anchors ongoing bilateral consultations that have shown progress through ministerial-level meetings.

Second, Japan has accelerated collaboration with like-minded partners to strengthen the multilateral system. The recent dialogue with EU Commissioner Maroš Šefčovič highlighted the growing intersection of security, economy, and technology, while addressing shared concerns about non-market policies and overcapacity. This alignment extends to supply chain resilience, with progress under the Transparent, Resilient, and Sustainable Supply Chain Initiative incorporating non-economic factors.

Third, Japan's multilateral engagement encompasses both regional partnerships and global institutions. Recent visits to Southeast Asia during the Japanese Golden Week holidays combined with WTO Director-General Ngozi Okonjo-Iweala's Tokyo visit resulting in a joint press release demonstrate this comprehensive approach. The joint statement's dual emphasis on "free, open and predictable trade as a key driver of growth" and "reinforcing the multilateral trading system with the WTO at its core" signals Japan's commitment to institutional preservation while adapting to contemporary challenges. These coordinated efforts with various partners and international institutions represent a concerted push to revitalize and protect the multilateral trading system amid unprecedented pressures.

Q&A

Q:
How do you respond to the view that the multilateral trade system remains largely intact with substantial MFN trade flows and numerous free trade-agreements?

Beatrice WEDER DI MAURO:
That is correct—the U.S. represents only about 15% of world trade. However, the U.S. has been the sponsor of the open trade system for the last 30 years. When the U.S. withdraws from that system and actively negotiates bilaterally with every country on non-MFN terms, this represents a clear departure from established norms. These bilateral turn risks playing countries off against each other, threatening smaller economies, protected by a rules-based system.

Q:
What are the prospects for coalitions between Japan, CPTPP members, and the EU?

Beatrice WEDER DI MAURO:
Japan has been very successful in taking what could have been a dying initiative and making it meaningful. If the EU joins, it becomes a significant bloc. That is definitely a way forward.

Q:
How do you view the different approaches between the EU's readiness to retaliate and Japan's preference for negotiation?

Beatrice WEDER DI MAURO:
It is simply a question of power and size. The EU is big enough to credibly retaliate. If neither the EU nor China responds, the rest of the world gets hit. We should not expect smaller countries to stand up first because it depends on whether you can punch as hard as you have been punched.

Q:
What are your views on potential dollar depreciation, similar to the 1985 Plaza Accord?

Beatrice WEDER DI MAURO:
The dollar has already started depreciating, though not by design. This reflects the disruption and insecurity created and the possibility of U.S. recession. It may also reflect increased caution by other countries in holding dollar assets. A real Mar-a-Lago Plaza scenario would follow renewed tariffs or recession.

Q:
What is your assessment of the bilateral negotiation approach compared to multilateral negotiations, which have also proven difficult in WTO contexts?

Beatrice WEDER DI MAURO:
The focus on bilateral trade deficits makes no economic sense—it would be like requiring balanced trade with your grocery store. The actual problem is uncertainty about what this administration really wants: bringing back manufacturing jobs, increasing tariff revenues, balancing trade with all countries, or simply having ongoing negotiation leverage? Depending on which theory is correct, negotiation strategies should differ. The actual negotiation should be happening with the rest of the world to form coalitions, which is where governments should focus their energy.

Q:
What is your view on the future of international currencies, particularly the renminbi and dollar?

Beatrice WEDER DI MAURO:
We may look back and identify this time as the time when the erosions of dollar dominance accelerated. This is not a prediction of immediate dollar crisis, though I would not exclude a combined dollar and bond market rout in the short run. Long-term, there is every incentive for the rest of the world to diversify and pool resources to insure themselves against a U.S. that may no longer provide liquidity. The reminbi is not ready to be the main currency due to capital controls. However, an increasingly multipolar currency system is more likely.

Q:
What role should policy think tanks play in this transformed international environment?

Beatrice WEDER DI MAURO:
Good think tanks conduct excellent research and provide relevant policy analysis. In these times, it is especially important to emphasize speaking truth to power. The more powerful forces dominate the world, the more important it becomes to have places where intellectual discourse dominates and where we are free to speak and to publish well founded economic analysis.