The Return of Geoeconomics

Michael Lind

FOR DECADES, the study of international security has been divorced from the study of international trade and investment, along with domestic economic development. In political science departments on university campuses, self-described realists debate defense and diplomacy with idealists of various kinds. In the economics department next door, there is no debate; the academic economists almost unanimously agree that free trade and investment benefit all sides. They instead postulate an ideal world where national borders would be insignificant and there would be free flows of goods, services, money and labor.

Even before Donald Trump became the first president in living memory to explicitly promote U.S. economic nationalism, the wall that divided the national-security realists and the free-market economists was crumbling—mainly because of the rise of China, which has benefited from a version of statist economics while challenging U.S. military hegemony in Asia. Slowly but inevitably, debates about national security and the global economy are merging into a single dispute about relative national power. This marks a revival of what Edward Luttwak has called “geo-economics.”

THE CENTRAL concept in realism is “the security dilemma.” In an anarchic world without a world government, each state is responsible for its own defense. The problem is that militaries can be used for offense as well as defense. If one country arms itself, another country can never be certain that those arms will not be used for aggression. So the second country arms itself as well, alarming the first. In this way, mutual suspicions lead to spiraling arms races.

The security dilemma applies to economics as well. In the industrial era, the basis of military power is manufacturing. This still holds true, notwithstanding the current hype surrounding the so-called “knowledge economy.” A country cannot defeat its enemies with cat video apps (though it might divert them).

Many of the same factories that produce capital goods or civilian consumer goods can be converted to produce weapons. It is thus not enough for rival powers to monitor each other’s standing armies, navies, fleets and stocks of weaponry; they must also monitor the overall industrial capacity of their actual or potential rivals. Industrial capacity, in turn, has to be defined broadly to include the entire economy of the rival state—not only its factories, but also its infrastructure, energy and telecommunications systems, resources, workforce and financial system. In the mass mobilization wars of the industrial age, like the two world wars, whole economies have gone to war with each other. Even in the less-intense Cold War economies were partly mobilized.

There can be no simple dividing line between civilian and military production. The space race between the United States and the Soviet Union—prompted by the latter’s launching of the Sputnik satellite—always had military implications.

Any country which hopes to be an independent great power must be able to obtain and maintain its own state-of-the-art manufacturing sector, if only for fear of falling behind in the economic arms race inspired by the security dilemma. As Alexander Hamilton, the first U.S. Treasury Secretary, wrote in his Report on Manufactures, the United States must be “independent on foreign nations for military and other essential supplies.” Overall, Hamilton, who viewed with scorn the Jeffersonian vision of America as an agrarian paradise, sought to protect America’s nascent industry from the depredations of the more developed European nation-states.

Second only to the concept of the security dilemma in the philosophy of economic nationalism is the idea of increasing returns to scale. In the jejune version of Econ 101, which is all that most policymakers and pundits know of economics, all markets are naturally competitive and divided among many small producers. There are constant or diminishing returns to scale—that is to say, a bigger producer is not necessarily more efficient than a small one.

This assumption was valid in the pre-industrial era, when a single blacksmithing firm employing a thousand blacksmiths working side by side under one roof could not turn out horseshoes any better or more rapidly than a thousand self-employed blacksmiths. But modern mechanized manufacturing industries are characterized by increasing returns to scale. An automobile factory with assembly lines can churn out automobiles more efficiently and cheaply than a team of artisans assembling one automobile at a time by from scratch.

In increasing-returns industries, including the manufacturing industries that are the basis of modern military power, Econ 101 does not apply. Markets are imperfect. Efficiency is produced by scale, not competition. Because bigger firms and establishments are more efficient, unchecked competition tends to drive out small firms, leading to oligopoly and perhaps to monopoly. We are accustomed to thinking of monopolies emerging as the result of cheating and unfair practices. But in the imperfect markets of increasing-returns industries, an efficient rule-abiding firm can wipe out its rivals and achieve monopoly status simply because it is slightly superior to its competitors—all without breaking any rules. (The same is true in industries with network effects like communications, but those are less relevant to our topic.)

What is true of firms is also true of the nations in which the firms are based. In theory, a single country or trade bloc can monopolize all of the manufacturing in a particular industry. China could make all of the world’s iPhones, Europe’s Airbus could make all jetliners, Japan could make all automobiles and South Korea could make all ships. Once achieved, these national or bloc monopolies in particular industrial sectors characterized by increasing returns could be long-lasting. Their very success ensures high barriers to entry, protecting incumbents from would-be competitors. Indonesia would have a hard time breaking into a global jetliner market monopolized by Airbus.

Conventional academic economists might see nothing wrong with such a world. Traditional trade theory is based on the idea that countries should specialize along the lines of absolute advantage (Adam Smith) or comparative advantage (David Ricardo).

BUT GUIDED by the logic of the military-economic security dilemma, prudent national strategists will ignore the academic free traders and their libertarian allies. From the point of view of national security, industrial interdependence is not a courageous step toward the utopian ideal of a borderless global market and a golden age of perpetual peace. Far from that, it is a dangerous risk that must be minimized. In particular, national strategists must ensure that the supply chains in the country’s defense industrial base are not located in the territory of potential military rivals or in coercible third countries. They must protect the militarily-relevant industries they have and, if necessary, obtain new ones. This is the essence of the approach that the economist Robert D. Atkinson and I have described as “national developmentalism.”

As we have seen, the very scale and success of existing manufacturing sectors pose barriers to entry into a sector on the part of not only new firms, but also of entire nations. This being the case, late-developed countries which seek to acquire industries that are already flourishing elsewhere can do so only by means of market-defying policies.

In the early industrial era, Britain had a near-monopoly over global manufacturing. Acting to promote British interests, economists like Smith and Ricardo tried to persuade other countries not to compete with British manufacturing, but to specialize in supplying raw materials to British factories and cheap food to British factory workers. For example, in The Wealth of Nations (1776), Adam Smith wrote:

Were the Americans, either by combination or any other sort of violence, to stop the importation of European manufactures, and, by thus giving a monopoly to such of their own countrymen as could manufacture the like good, divert any considerable part of their capital into this employment, they would retard instead of accelerating the further increase in the value of their annual produce, and would obstruct instead of promoting the progress of their country towards real wealth and greatness.

If American leaders had followed the advice of Adam Smith, the United States in the twenty-first century would still be an agrarian country, shipping cotton, corn and wheat abroad while importing all factory-made goods on unfavorable terms from industrial nations in Europe and Asia.

Hamilton rejected Smith’s advice, noting that the American states “cannot exchange with Europe on equal terms; and the want of reciprocity would render them the victim of a system which should induce them to confine their views to Agriculture and refrain from Manufactures.” As the nineteenth-century German-American economist Friedrich List later pointed out, free trade between an advanced and a backward country would lock in the advantages of the former: “The result of a general free trade would not be a universal republic [of commerce] but, on the contrary, a universal subjection of the less advanced nations to the predominant manufacturing, commercial, and naval power….” Recognizing free trade ideology as the self-serving British propaganda that it was, the nineteenth-century United States and Imperial Germany both protected their own infant industries from British competition. By the 1900s, both had surpassed Britain as industrial powers.

The truth is that every country that has successfully caught up with earlier industrialized nations has protected its infant industries by one method or another. Consider Asia. Following World War II, as part of their programs to catch up with the West in industrial capacity, Japan and the “Little Tigers”—South Korea and Taiwan—used nontariff means such as regulations, currency manipulation and other tactics to protect their domestic firms from imports while subsidizing their own exports. More recently, China has followed in these footsteps by “cheating” in order to build up its manufacturing. Beijing has promoted a variety of policies—including luring Western firms with cheap labor, protecting its internal markets, stealing foreign intellectual property and subsidizing its exports by means of currency manipulation—to bolster its economic prowess. Only now has Washington begun to respond to this systematic exploitation of American industry.

Such developments raise an obvious question—if considerations of national security and industrial self-sufficiency are so important, then why has free trade ever existed at all? The answer is that free trade is something of a historical aberration; it has been extremely uncommon in the two and a half centuries since the industrial era began. The world economy between the early modern era and the 1940s was carved up among protectionist European empires and protectionist nation-states like the United States. There was a brief period of trade liberalization in the mid-nineteenth century, promoted by Britain and France, but that was rejected by late-developing nations like the United States and Germany.

As economic realism would predict, free trade is promoted very rarely, and only then by great powers which do not fear military or industrial competition. Put otherwise, countries are apt to promote free trade, not in the abstract, but in proportion to the amount that it is likely to benefit them directly. Exhibit A is Great Britain: after having employed protectionist measures for centuries to build up and expand its manufacturing lead, Britain opportunistically became an evangelist for free trade in the mid-nineteenth century, hoping to open up fresh foreign markets for its exports. A century later, after 1945, the United States also switched from infant-industry protectionism and preached free trade with the zeal of a convert. How convenient.

What international relations theorists like to call a strategy of “liberal hegemony” is not an alternative to realism and economic nationalism; rather, it is a version of both. A country that is a military and economic hegemon, with overwhelming military power and unmatched industrial supremacy, can afford to be relaxed about the military-economic security dilemma—at least for a time.

Until the war-devastated economies of Europe and Asia could begin to recover over a decade later, the United States enjoyed a near-monopoly in global markets for manufactured goods—a situation that it saw as the natural state of affairs. During the Cold War, U.S. policymakers indulged Japanese and German mercantilism, sacrificing the interests of American producers to the goal of keeping Japan and West Germany in the U.S.-led anti-Soviet alliance. They did so on the complacent assumption that the United States would remain by far the dominant industrial economy.

THE LOGIC of the military-economic security dilemma suggests that a grand strategy of liberal hegemony should be abandoned by a declining hegemon that is losing relative shares of military and industrial capacity to rising powers. The former hegemon need not revert to the infant-industry protectionism of its own earlier catch-up phase. Rather, it should seek to open foreign markets for its exports while preserving its domestic industries from unfair competition by insisting on strict reciprocity in trade. And it should minimize its economic dealings with current and potential military rivals altogether, for fear that its consumers and capitalists will build up the power of enemies.

Neither Britain nor the United States following their heydays have acted on this common-sense logic. Britain should have abandoned its policy of unilateral free trade in the 1870s and 1880s in response to the rise of protectionist America and Germany. Instead, it did not adopt neo-protectionism until the 1930s. By then, a crepuscular glow had set on the British empire—its elites realizing all too late that their might was disappearing.

Likewise, the United States dallied when it should have abandoned liberal hegemony for a more transactional Nixonian economic nationalism in the 1970s and 1980s, once American manufacturing began to be battered by revived German and East Asian imports, even before the industrial rise of China. Instead, for the last half-century, the United States, like Britain a century earlier, has done the reverse. Mesmerized by a putative liberal world order, Washington has extended its military frontier, taking on more and more imperial commitments, while allowing mercantilist Asian and European trading partners to wipe out much of American manufacturing. Likewise, U.S.-based multinationals have transferred over much of their production capacity to China, Mexico and other countries, where cheaper labor or government subsidies exist in abundance.

In my view, the persistence of free trade policies in Britain and the United States, even after they became harmful, is perhaps best explained in terms of domestic political factors. The most important among these is the political influence of finance.

Nations that rise to dominance via manufacturing enjoy vast profits, which are ploughed back into finance in the same country. Initially, a country’s financial sector tends to grow on the back of manufacturing and other industries. Consider how the Rockefellers moved from manufacturing into banking, or how Texas oil profits seeded Houston and Dallas banks.

The problem is that a politically dominant financial sector may be willing to sacrifice the interest of domestic manufacturers in the service of other goals, like opening trading partners to financial investment. More than a century ago, in the debate over British policy, the City of London successfully defeated the British economic nationalists whose fears about German military and economic power and the decline of British industry were brutally confirmed in the world wars.

In the contemporary United States, Wall Street, through its allies in the U.S. Treasury Department, has been the strongest supporter of liberal globalization. Wall Street has been joined in its war against Detroit and Pittsburgh by multinationals like Apple, which moved assembly of its iPhones from the United States to China, and importers like Walmart, whose success was based on selling low-cost Chinese goods in the U.S. market.

DONALD TRUMP’S trade strategy, whether toward Europe, Mexico, Canada or China, has been blundering and inconsistent in many ways. Nevertheless, it can be viewed as a version of one of the two options for the United States that can be pursued by Trump’s successors. One is a new economic nationalism, preferably more sophisticated and far-sighted than Trump’s. It would abandon the anachronistic liberal hegemony strategy of the Cold War and post-Cold War eras for a more transactional approach in trade. It would treat domestic manufacturing as the basis of national military power.

The other option is an attempted restoration of liberal hegemony, possibly on a smaller scale—for example, by trying to create a “triad” bloc of the United States, Europe and America’s East Asian allies that excludes China. The Obama administration tried something like this second strategy of consolidating the industrial countries other than China into an American-led bloc with its promotion of European-American trade via the Transatlantic Trade and Investment Partnership and U.S.-Asian trade via the Trans-Pacific Partnership.

In the long run, the restoration of liberal globalism on a smaller scale minus China is unlikely to succeed. For one thing, America’s European and Asian allies cannot agree whether China is a threat or a commercial opportunity. For another, India, should it rise to great power status, is no more likely than China to give up self-interested economic nationalism and convert to quaint nineteenth-century British free-trade ideology of the obscurantist kind recycled in mathematical form in American economics departments.

Thanks to the logic of the security dilemma, in a multipolar world of rival great powers in which the major centers of military-industrial power are North America, Europe, East Asia and South Asia, in the decades ahead international liberalization as a general economic strategy is unlikely to find powerful champions. To be sure, there may be a high degree of economic integration among allied countries, as well as free trade in particular industries of lesser strategic significance. But the major powers will not allow market forces to compel them to lose not only narrowly-defined military industries, but also a much larger set of strategic industries with both military and civilian applications.

Power politics is back. The dream of a global free market is dead.

Michael Lind is a Professor of Practice at the Lyndon B. Johnson School of Public Affairs and co-author, with Robert D. Atkinson, of Big is Beautiful: Debunking the Myth of Small Business.

Image: Reuters

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