East Asian Economic Strategies

Getting economic and national security policy right

Shiro ARMSTRONG
Visiting Scholar

The United States and China are locked into a trade war and strategic rivalry that complicates international policy choices for the rest of the world. How do countries like Australia and Japan balance their security interests alongside their economic interests and avoid seeing them as a trade-off? Can countries avoid a binary choice between the United States and China?

Economic policy was never separate from security considerations. The recipe for a secure country—a strong economy that's globally integrated through trade and investment and cooperation—hasn't changed. But economics and security are increasingly entangled in a way that is damaging to both, creating a dangerous trade-off and a negative feedback loop.

Economic engagement between countries strengthens national security by reinforcing and habituating a rules-based order that creates a bigger and broader plurality of shared interests. This is the mutually beneficial win-win trade and investment relationship that is the basis of economics. It's about building national wealth and power but it also broadens the range of strategic policy options available to policy makers. There are market-based solutions, mixed interest games and ways to have risks borne by those other than government or society that can avoid binary, all-or-nothing security decisions.

Economic exchange always involves risks, including national security risks and sometimes the possibility of coercion. If you open the window for fresh air, you have to expect some flies to blow in, warned Deng Xiaoping. Those risks have been managed and minimized under a U.S.-led, multilateral, rules-based system that allowed decades of deepening economic ties, including for China with the rest of the world.

The risks of international exchange are beginning to dominate the calculus for some policymakers as the world becomes more complex and uncertain. There are three main reasons for this: the rise of China, the rise in protectionism in the United States, and new technologies for which international rules don't exist.

The United States underwrote a rules-based order over the past 70 years that helped manage risks from economic engagement and reduced the costs of national security. President Trump's America First protectionist agenda and the U.S.-China trade war are the biggest threats to the multilateral trading system on which the world relies for both prosperity and security.

The difficulty in managing China's rise as the world's largest trader and its second largest economy has been further complicated by President Xi's consolidation of power domestically and a more assertive foreign policy.

New technologies like 5G telecommunications and the growing importance of digital trade raise new economic opportunities and security challenges for which no clear rules exist. Multilateral rules in the WTO may cover trade in goods adequately but are mostly non-existent for a large proportion of international commerce in the 21st century as services, investment, data flows and new forms of technology proliferate. The patchwork of rules from smaller agreements leave major gaps at best and cause economic fragmentation at worst.

If countries don't get the frameworks right to manage strategic policy making in these new circumstances, there will be a return to economic and security policy of the interwar period. That was a period of unilateralism and bilateralism centred on protectionism and raw national power. The multilateral system born at Bretton Woods moved the world to cooperative outcomes with rules that avoided the prisoner's dilemma or lose-lose outcomes.

Economic policy deployed for geopolitical purposes, sometimes called geoeconomics, inevitably produces misguided policies that damage both economic and national security. Economic exchanges are then thought of as tools for zero-sum or negative-sum outcomes instead of creating mutually beneficial outcomes. Ever since President Jefferson's Embargo Act of 1807 that banned trade sent the newly United States into a recession with little impact on European countries threatening their security, governments have misapplied economic weapons. The most brazen recent example is the U.S. tariffs on steel and aluminium, and tariffs threatened on automobiles, in the name of national security that makes the United States poorer and weaker.

New technologies are leading to security worries of ‘weaponised interdependence’. Networks can now be exploited by both state and non-state actors. For example, the U.S. domination of the inter-bank exchange market (SWIFT) means Europe has had to comply with sanctions against Iran. Huawei's close relationship with the Chinese government is threatening to break the world up into two competing spheres for 5G. But arguments that technology is providing asymmetric leverage ignores the fact that technology is also increasing the supply of alternatives. To the extent that nations intervene in international markets to exploit their current advantages likely just mean those advantages don't last that long. The result of sanctions on Iran with the U.S. domination in SWIFT likely accelerates the development of an alternative.

National security relies on command and control and applying resources in contests of attrition. That is not how economies work. A focus on security risks without considering forgone economic benefit or mitigation strategies to deal with those risks lead to all or nothing outcomes. Concern about foreign influence over technology has led some western countries to cut themselves off from new Chinese technologies, such as AI, machine learning and quantum computing. But disengagement can be bad for national security, not only in areas where China is already ahead of the rest of the world. Innovation in the modern economy means working with the best thinkers from wherever they are in the world, giving and taking ideas. There is no other way of staying close to the global technology frontier. Becoming a technological backwater won't only make countries poorer — it would seriously reduce the strategic options available to them.

China's supposed deployment of economic coercion for geopolitical purposes has been checked by multilateral rules in the case of the rare earth metal dispute with Japan. In that case, China wound back the offending policies in order to comply with a WTO ruling. But the economic sanctions deployed against South Korea over the Terminal High Altitude Area Defense (THAAD) system largely lay outside the discipline of multilateral rules. It is far from clear that China's use of these sanctions delivered it geopolitical benefit worth the significant economic and reputational costs.

In the pursuit of national power and security, governments need to be able to operate in a world beyond binary choices: security or economics; and China or the United States. Agreement and commitment to principles and rules that avoid lose-lose outcomes and taking interactions and engagement beyond bilateral interaction to those that necessarily include compromise and a broader plurality of interests helps to expand the policy space and options available.

It is possible to find ways to mitigate and diffuse risks by deepening engagement, not avoiding engagement.

If security concerns and policies dominate economic choices, the policy space is narrowed significantly and leads to binary choices. It is the important job of security agencies to look for and mitigate risks, but not their job to balance those against society-wide benefits.

Different countries are grappling with these challenges in different ways. Japan's National Security Secretariat in the Prime Minister's Office has created an Economic Group and its key ministries have new economic security divisions whose challenge will be to attempt to integrate economic and security policy. The structure of interests and decision making in these are yet to be seen.

Getting the balance in strategic policy right involves recognition that economics and security are linked but that they can enforce a positive or negative feedback loop. The world is in danger of sleepwalking into a negative feedback loop.

Economic engagement enhances national security but inevitably involves some security risk. That risk can be mitigated through international cooperation, multilateral rules and strong domestic laws. More economic engagement and integration into markets increases the costs of harmful behaviour. International rules prohibit the harmful behaviour. One priority is to work towards the creation of those rules where none currently exist.

The experience of the WTO shows that an important feature of such bodies is their ability to adapt to new developments, which is why any rule making apparatus needs to be embedded in a broader framework of ongoing policy cooperation, not just the kind of static, once-and-for-all trade deals of the last century, so that when circumstances change, the rules can too.

The experience of economic and political cooperation in Asia may offer insight into how to navigate a new diplomacy.

The China-Japan economic relationship has prospered under the management of the multilateral framework. In the face of security challenges and historical tensions, they have developed one of the largest trade and investment relationships in history. By contrast, the India-Pakistan economic relationship is close to non-existent as security risks are allowed to dictate economic interests and dealings are confined to narrowly bilateral ones.

Reducing trade or investment to avoid security risks is not the right answer in a world of integrated markets and economies, unless countries want to be poorer, weaker and live in a less certain and stable world.

These are shared challenges and opportunities for countries navigating a more complex world.

Both China and the United States naturally prefer to deal with countries bilaterally, forcing the world into even harder choices. The United States and China left to their own devices will likely decouple their economies and fracture the global economy. It's the response of the rest of the world that will be important.

Small and middle powers will need to get the balance of economics and security right in strategic policy making and work together to avoid a bilateral world of zero-sum outcomes. Acting strategically and beyond bilateralism is the sensible way forward.

Strategic deployment of regional and plurilateral coalitions can help create rules from the bottom up that engage both China and the United States. At a time when the multilateral system is under threat, regional and plurilateral initiatives and agreements need to complement, preserve and strengthen multilateralism, not substitute for it.

Strategic plurilateralism is the best way forward in a multipolar world. Mutually beneficial engagement can make nations stronger, safer and more secure.

December 13, 2019

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