Middle powers, small states and developing countries are increasingly exposed to moves by the US and China to advance their strategic interests by economic means. Nick Crawford* author of the following analysis explains how such nations can reduce their vulnerability to economic statecraft.
The United States and China are increasingly resorting to economic statecraft to influence other countries. Despite their vulnerability to this economic statecraft, governments in the rest of the world have responded hesitantly. Some have reacted with ad hoc, discrete measures to deal with imminent geo-economic threats, but few countries have anything resembling a strategy or theory of geo-economic defence. Governments need to assume responsibility for identifying their countries’ economic vulnerabilities and build up their resilience to economic statecraft.
The risks to the rest of the world from US and Chinese economic statecraft are growing. For the US, it is harder now to win over other governments with persuasive diplomacy alone, whether on China or its other economic and security interests. Other countries worry about the costs of toeing Washington’s hard line on China, and US moral authority is not what it once was. For China, its ability to shape other governments’ policies by persuasion and authority is undercut (except in the eyes of autocrats) by its repressive political system and (even in the eyes of autocrats) by doubts that it is pursuing anything other than its narrow self-interest. And so, looking to exert effective soft power, both the US and China are turning to economic levers for influence.
Vulnerability to Chinese and US economic statecraft exposed
Middle powers, small states and developing countries are dependent on the US and China. Both are central to global supply chains, are enormous markets for exports, and are the biggest sources of foreign investment and lending. And the centrality of the US financial system and dollar to the global economy gives the US extra economic levers to pull on. So the rest are all, to a greater or lesser extent, geo-economically vulnerable to US and Chinese economic statecraft, whether in the form of economic inducements or coercion, or the cultivation of a well-disposed business lobby.
China has exposed other countries’ vulnerability to its economic statecraft. It has successfully used economic inducements to interfere with decision-making in regional bodies including ASEAN, and to encourage states to switch diplomatic recognition from Taiwan. Even in major economies such as Germany, dependence on exports to China has undermined government willingness to criticise Beijing. Coercion has been an effective tool for Beijing too. In 2010, for example, it banned exports of rare earths to Japan – vital for its hi-tech manufacturing industry – in relation to the dispute over the Senkaku/Diaouyu islands. More recently, Beijing imposed restrictions on imports of beef and barley from Australia in response to Canberra’s call for an inquiry into the origins of the COVID-19 pandemic. Beijing has also imposed tourism boycotts of Japan, South Korea and Taiwan at times in the past ten years.
The US has recently focused its economic statecraft on China – attempting to prevent it from dominating strategic sectors of the global economy and to force it to change its economic policies. However, it is resorting to economic levers to influence other countries too. The US has even used its economic statecraft to interfere in Europe, imposing sanctions in 2017 on companies (of any nationality) involved in the Nord Stream II gas pipeline between Russia and Germany to which the US is politically opposed, sparking outrage in Germany and the European Union. The appetite in Washington for economic statecraft is broad: it was Congress that introduced the Nord Stream II sanctions; the White House was opposed.
Need to renew geo-economic defences
Governments have responded to the threat and experience of US and Chinese economic statecraft – but mostly in ad hoc ways. The experience of Beijing’s rare-earth export ban has seen Japan try to establish alternative lines of supply. In Europe, the fear of Chinese takeovers of strategically important businesses has prompted the EU to strengthen foreign investment screening rules. And the impact on European businesses of US secondary sanctions on Iran led France, Germany and the United Kingdom to create a new (yet ultimately unsuccessful) payments vehicle to circumvent the use of SWIFT. Some countries have accepted their predicament and simply picked sides. But the costs of going ‘all in’ with one power or the other are high. Most governments do not want to make this choice.
Concern about the impact of others’ economic statecraft is nothing new. In the first half of the 20th century, the economic aggression that accompanied the First and Second World Wars led Albert Hirschman to spell out the basics of geo-economic defence. There were, he said, three common-sense responses to the threat of economic aggression: control of shipping routes, preventive accumulation of stockpiles, and redirecting trade towards countries unlikely to disrupt it. In addition, he called for international rules to regulate trade. In the post-war period, the General Agreement on Trade and Tariffs (GATT) did offer countries some protection from the economic aggression of the past. But as China and the US have exploited the ambiguities of GATT’s national-security exceptions, the protections that it offers have been eroded. Not since OPEC’s 1973 embargo on oil sales, which led to the formation of the International Energy Agency (IEA), have Western governments had to worry so seriously about economic coercion.
Although neither the threat of economic statecraft nor the basics of how to address it are new, current governments are ill-acquainted with the challenge. There is little by way of contemporary theory or strategy of geo-economic defence.
First steps towards a geo-economic strategy
To move beyond ad hoc responses, the first step is to assign responsibility within government, just as Japan has done in establishing an economic division within its National Security Secretariat. Located at the centre of government, the unit has the authority to coordinate work across government, which is essential when considering the range of ministries – from foreign affairs and defence, to economy, trade, industry, science, technology, energy and agriculture – that have a role to play in geo-economic defence.
The owner of this policy portfolio then needs to answer two main questions. The first is how to reduce vulnerability to economic statecraft – whether in the form of coercion, inducements or building strategic economic ties – or, in other words, how to build ‘geo-economic resilience’. A lack of economic diversity, both across sectors and among trading partners, has long been understood as an economic vulnerability but not so much as a security vulnerability. But if countries are overly dependent upon the US or China for critical sectors of the economy, it creates an easy opportunity for them to exercise political influence. Therefore, building geo-economic resilience is primarily a matter of increasing diversity of economic partners and fostering an ability to substitute between them, and putting in place strategies and legal powers to check and control the leverage foreign powers build up over economies. Following the example of the IEA in the 1970s, geo-economic resilience may also require that governments build up stockpiles of critical inputs to their economies.
Those responsible for geo-economic defence need, therefore, to work with industry to identify vulnerabilities. Governments should ask how prepared businesses are for disruptions to trade and investment relations, and how they can reduce their vulnerabilities. In addition, government and industry need to identify emergent products and services – such as gene-editing, quantum computing, pharmaceuticals and fin-tech – and ensure they do not become reliant on single foreign suppliers in future, deliberately building diversity or sovereign capability from the start.
The second question for governments of middle powers and smaller states is how to discourage the use of economic statecraft against them, or in other words, how to increase the costs to its purveyors. On the one hand, the credible prospect of retaliation even by small states will have a deterrent effect where they are essential to supply chains. On the other hand, the pursuit of legal remedies could increase both the reputational and financial costs of economic statecraft.
Striking a balance
The threat of Chinese and US economic statecraft creates added impetus for middle powers, small states and developing countries to cooperate. Such nations all face geo-economic vulnerabilities individually, but there is scope both to foster geo-economic resilience collectively (for example by building regional substitutes for foreign suppliers on which they are wholly dependent, and agreeing to build strategic reserves of key goods) and to craft collective responses in the face of Chinese or US economic coercion. Both well-established economic groupings such as the European Union and newer ones such as the Comprehensive and Progressive Agreement for Trans-Pacific Partnership and the Africa Continental Free Trade Agreement could find an additional sense of purpose in the pursuit of geo-economic defence.
In developing a defensive geo-economic strategy, governments face the challenge of reconciling the pursuit of security objectives while seeking to reap the benefits of international trade and upholding the rules of the global economy. After all, in trying to defend the economy from external threats, the means of doing so should not themselves weaken it. But a strategy that is based on diversity and competition among economic partners and that deters foreign countries from disrupting trade, investment and finance could yet yield economic gains.
*Nick Crawford is a Research Associate on the Geo-economics, Geopolitics and Strategy programme at the IISS. His research focuses on great-power competition in developing countries, including coercive economic diplomacy. His recent work has focused on China’s economic and political activities in Africa and Eastern Europe.