Trade Off

A new economic order is nascent: call it securitized globalization. After years of brewing discontent, the confluence of the pandemic, Russia’s war on Ukraine, and the intensifying China-US rivalry has shifted economic paradigms among key international actors. The promise of the old, neoliberal variant of globalization that the free flow of goods, capital, and people would produce win-win relations and political convergence has lost its credibility in many parts of the world. Notwithstanding evidence that economic integration has led to huge aggregate prosperity gains across the globe, it is widely perceived to have caused economic dislocation in industrial economies, generated highly unequal gains, and created asymmetric interdependencies that have increasingly become weaponized.^[1] In response, national security considerations are now shaping the economic policies of key players. This paradigm shift is highly consequential. The looming specter of “policy-led geoeconomic fragmentation”^[2] could reduce some of the gaping vulnerabilities and thus remove opportunities to weaponize interdependence.^[3] But the costs of fragmentation into two blocs along geopolitical lines could also be vast.

The combination of growing discontent with neoliberal globalization and increasing economic coercion paved the way for the emergence of securitized globalization.^[4] During the 2016 US presidential election campaign, both Donald Trump and Bernie Sanders attacked neoliberal globalization for causing a loss of manufacturing jobs and stagnating wages. Similar arguments featured prominently in the Brexit referendum campaign in the UK. When in office, US President Trump followed through on his rhetoric, launching a trade war against China and others and subverting the WTO to allegedly reshore jobs. US President Joseph Biden, too, has promoted reconfiguring globalization to serve working families in the US, coining it “foreign policy for the middle class.” The Covid-19 pandemic and accompanying supply chain disruptions only heightened concerns about the costs of global interconnectedness.

In parallel, countries have increasingly exploited asymmetric interdependencies. China has long used its market power to coerce other countries or punish those that defied Beijing’s will.^[5] And Russia’s weaponization of Europe’s energy dependency catapulted economic security to the top of the agenda in Europe and the US. Moscow’s attempted blackmail exposed the dangers of surrendering control of critical chokepoints in the global economy to rivals. 2022 was thus a turning point in how the transatlantic partners viewed globalization. But many autocratic regimes had realized these dangers earlier. To them, the US sanctions against Iran in the early 2010s, the threat to exclude Russian banks from SWIFT following its attack on Ukraine in 2014, and the Trump Administration’s throttling of Huawei demonstrated the perils of depending on the US-controlled financial system.^[6]

Countries from both sides of the geopolitical divide thus fear that their dependencies invite exploitation. As a result, economic security policies designed to defend against or preempt coercion abound. They include measures to strengthen strategic industries and protect critical infrastructure. Economic security policy also means diversifying trade relations to reduce exposure to rivals (“de-risking”), shifting supply chains and investment to countries that are geopolitically aligned (“friendshoring”), sanctioning adversaries, and preventing the leakage of technology that could yield military advantages.^[8] The number of discriminatory interventions has surged in recent years (Figure 6.1). A recent report shows that national security concerns are often used as explicit justifications for such interventions.^[9]

China was an early adopter of a “geopolitically oriented political economy,”^[10] aiming to reduce its own dependencies while weaving webs of dependency for others. Under Xi Jinping, Beijing had never subscribed to the premise that economics and security could be disentangled, instead pursuing a “comprehensive national security” vision to sanction-proof China.^[11] The Belt and Road Initiative, launched in 2013, aims to shift Chinese trade flows away from the US.^[12] Attaining self-reliance in key technologies is what motivated the “Made in China 2025” strategy, issued in 2015. The “dual circulation” strategy, launched in 2020, seeks to reduce China’s export dependence.

And Beijing has recently gone into “overdrive” ^[13] on economic security, with a new, comprehensive export control law, an anti–foreign sanctions law, and outbound investment screening measures.

The US, too, has been actively pursuing economic security policies, abandoning once-sacred neoliberal principles. There is a bipartisan consensus in Washington that the US has become dangerously dependent on China, following a “multidecade campaign of economic aggression” by Beijing, as a recent Congress Select Committee report put it.^[14] These concerns have been exacerbated by the realizations that semiconductors are key ingredients in modern weapon systems. In response, the Biden Administration has launched several initiatives, including the CHIPS and Science Act and the Inflation Reduction Act, to relocate supply chains, limit Chinese investment in the US, and control exports of foundational technologies.

Meanwhile, Japan has been actively promoting supply chain diversification ever since China threatened to block Tokyo’s access to rare earth minerals amid a maritime dispute in 2010. The BRICS, too, are promoting local currencies and building parallel institutions, such as China’s Cross-Border Interbank Payment System, in a quest to “de-dollarize” the international financial architecture.^[19] As the world’s most sanctioned country, Russia has long been concerned about its economic security and created its own financial messaging system.^[20] India has also sought to further its economic security through the “Make in India” campaign and other initiatives.

These dramatic policy shifts are beginning to translate into macroeconomic reality. For a long time, global economic integration seemed to advance inexorably. Not even the global financial crisis could structurally affect the steady growth of cross-border trade, even if capital flows slowed and aggregate global flows leveled off at a lower share of global GDP (Figure 6.2). Trade between the US and China still hit an all-time absolute high of 531 billion US dollars in 2022.^[21]

The macro-view, however, obfuscates crucial meso-level changes. Geopolitics is starting to fragment the world economy.^[22] This trend is most visible in foreign direct investment (FDI), where geopolitical proximity increasingly matters more than geographical proximity. That is, companies invest more in countries that their host country votes with at the UN than in countries that are located near them (Figure 6.3). Indeed, FDI diversification away from China is well underway. China’s share of global greenfield FDI dropped from 11 percent in 2018 to below 5 percent in 2021,^[23] and in the first three quarters of 2023 alone, investment outflows exceeded 100 billion US dollars.^[24] Business surveys corroborate the waning corporate interest in investing in China.^[25] There are also early signs of fragmenting trade flows and supply chains. Between 2017 and 2022, China’s share of all US imports dropped by 5 percent,^[26] and its share of strategic products dropped by 14 percent.^[27]

Two caveats are warranted, however. First, US friendshoring efforts are more tenuous than they appear. As US trade flows have shifted from China to countries such as Vietnam or Mexico, imports to these countries from China have increased almost synchronously, suggesting that indirect links remain. Trade flows tend to be more difficult to reroute than FDI, as it requires finding new suppliers. Hence, it may simply take longer for the “great reallocation” in supply chains to unfold.^[28] Second, Europe is bucking the trend. The EU is failing to diversify its trade relations, with its collective trade deficit with China ballooning from 155 billion euros to 396 billion euros between 2018 and 2022, driven by surging imports.^[29] German companies also continue to invest heavily in China, defying Berlin’s ambition to reduce its exposure.^[30] German FDI in China remained at a near-record high in the first half of 2023, and its share of overall investment even increased.^[31]

Decision-makers need to reconcile legitimate security concerns with minimizing the ramifications of disintegration. The danger of economic coercion by geopolitical rivals is real, but so are the potentially immense costs of fragmentation. The IMF estimates that in the worst-case scenario, fragmentation could reduce global GDP by up to 7 percent over the long term, with low-income countries disproportionately affected.^[33] Geographically concentrated supply chains could also become more vulnerable, as supply shocks are likely to increase due to the climate crisis.^[34] Moreover, economic security policies could spiral into sweeping trade wars, which would likely bury the multilateral trade order and fuel geopolitical tensions.^[35] And loosening ties will also remove mutual dependencies, which have historically often tempered tensions among rivals.^[36]

It is therefore imperative that decision-makers avoid adopting an ever-more-expansive conception of security relevance. Economic security policies need to be selective, not sprawling.^[37] However, it can be exceedingly difficult to distinguish high-risk dual-use goods from primarily single-use goods and identify dangerous chokepoints in complex supply chains.^[38] And most countries are institutionally ill-equipped to do so. Japan, for example, has a minister for economic security, but in most other G7 countries, competencies are scattered across ministries, with limited coordination.^[39]

Economic security alone, however, is not a sufficient vision for global economic governance. Liberal democracies also need to work toward a new, inclusive order that promotes global prosperity and pursues “interdependence without overdependence.”^[40] De-risking from China should go hand in hand with redirecting investment toward Africa and other low-income countries.^[41] President Biden’s declared ambition to reform the international financial architecture must only be the beginning.^[42]