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[Research Reports] Economy and Security in the Era of Sino-American Rivalry

Yoshinobu Yamamoto (Visiting Professor, National Graduate Institute for Policy Studies)
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The Research Group on ‘Economic-Security Linkages’ # 1
“Research Reports” are compiled by participants in research groups set up at the Japan Institute of International Affairs, and are designed to disseminate, in a timely fashion, the content of presentations made at research group meetings or analyses of current affairs. The “Research Reports” represent their authors’ views. In addition to these “Research Reports”, individual research groups will publish “Research Bulletins” covering the full range of the group’s research themes.

Strategic Adversaries in an Interdependent World: The Relationship between the Economy and Security in "Version 3"

Today's relationship between the economy and security can be considered to be in its Version.3, if its evolution since the end of World War II is considered in a broad and schematic manner. In Version 1, the West, led by the United States, tried to prevent/control the transfer of military technology and strategic materials to the Soviet Union (and the Eastern bloc) and to contain the Soviet military and economic power. This was done for the national security and foreign policy reasons of the West in the context of US-Soviet (East-West) relations. In Version 2, during the Cold War, high economic growth was achieved in the Western bloc (including developing countries) under a liberal international economic order, which led to remarkably enhanced economic interdependence. However, several issues emerged regarding the relationship between economics and security in this context, such as targeting of vulnerabilities stemming from asymmetric interdependence by the counterpart nation, thus leading to certain economic security situation (instability of national economy).

This Version 2 coexisted with Version 1 during the Cold War period. However, after the end of the Cold War, goods, money, people, and information flew across borders to encompass the entire world ("globalization"). Globalization has brought countries with various regimes together into one interdependent system and led to the emergence of newly industrializing countries. With the rise of China, the international system has changed into what may be termed a bipolar system. with thick economic interdependence between the poles. In particular, since the Trump administration came into power, the situation can be characterized as the existence of a strategic competitor (China) in a deeply interdependent (or interpenetrated) system. If this can be called Version 3, it combines the characteristics of Versions 1 and 2, and further demonstrates the complicated relationship between security and the economy that incorporates changes in the international system: technological development, enhanced information flows, and increased movement of people across national borders.

Diverse and Complex Mechanisms: Continuity and Change in the Nexus Between Economics and Security

Let us consider these characteristics—coexistence of strategic rivalry and interdependence—by starting from several patterns under Version 2 (interdependence without strategic rivalry). The first, as we have seen above, is that when vulnerabilities increase due to asymmetric interdependence, they are used for political and security purposes. During the oil crisis of the 1970s, petroleum was used politically, and countries that were heavily dependent on Arab oil were forced to bear high costs (and to change their foreign policy orientation toward the Middle East). In general, this represented a pattern that asymmetric interdependence, particularly involving strategic materials, could be exploited for political (and sometimes security) purposes by the supplying party. Policy measures were taken to avoid and overcome the vulnerabilities by securing alternative suppliers, developing alternative sources, and stockpiling.

This kind of relationship between the economy and security—targeting of vulnerability— continues to be evident in Version 3. Since around the 2010s, for example, China has increasingly adopted coercive measures to achieve its political and security objectives by leveraging its asymmetric economic relations with other countries. When South Korea tried to introduce THAAD, China reduced the number of tourists to South Korea and moved to restrict Lotte's business activities in China. The latter was intended to achieve political (or security) objectives by controlling the activities of a foreign firm already in the country through inward investment, rather than simply taking measures at the border. Further, in today's world, a phenomenon that can be called "weaponized networks"— pressuring target states (such as China and Iran) by making full use of financial (US dollar) networks has become the hallmark of US policy in addition to the traditional policy of pressuring a target state by means of tariffs and quantitative restrictions. This is called the "weaponization of networks" (or weaponized interdependence).

Secondly, the industrial foundations of national security have sometimes been shaken under the principle of free trade (comparative advantage). For example, countries could be surpassed in, or become dependent on other countries for, militarily essential products such as semiconductors. This is a problem of dual-use products/technologies. To cope with this situation, nations consider taking steps to increase their manufacturing capabilities and/or to restrict trade.

In the case of the United States, this issue is related to Section 232 of the Trade Expansion Act (1962). With the advent of Version 3, application of this provision to steel and aluminum (and cars) has been pursued or considered by the Trump administration even against US allies. This is a typical case of restricting trade in order to protect industries related to national security (but it is often a mixture of economic protectionism and security concerns). For security reasons, the United States not only forbids supplying parts to Huawei Technology ("export ban"), but also prohibits government procurement from Huawei ("import ban"). This exclusion from the US market, and in particular the latter policy, amounts to excluding foreign (non-Chinese) products built with Huawei components from US government procurement. This policy aims to contain China via networks at the corporate level.

Third, the relaxation of capital controls in the 1970s accelerated the growth of inward investment and strengthened cross-border investment ties. This sometimes caused security problems such as the acquisition of national security-related industries by foreign capital. As a consequence, regulations on inward investment were introduced (e.g., the Exon-Florio provision enacted toward the end of the 1980s was a reaction to Fujitsu's acquisition of Fairchild Semiconductor) and have since been strengthened. The authority of the Committee on Foreign Investment in the United States ("CFIUS"; established in 1975), which assesses the national security implications of inward investment, has also been bolstered.

Today, under Version 3, investment from China to the United States has been increasingly regulated for security reasons. The National Defense Authorization Act enacted in 2018 incorporated the Foreign Investment Risk Review and Modernization Act (FIRRMA). As a result, investments in critical technology, critical infrastructure, personal information, etc., are subject to CFIUS review. In August 2020, President Trump ordered ByteDance to sell TikTok's US operations for security reasons (on the basis of International Emergency Economic Powers Act). The US says it will consider taking similar measures against other Chinese companies, meaning that, in addition to simply blocking penetration by restricting inward investment and technology outflow through M&A, foreign companies already active in the United States can be expelled for security reasons (exclusion and removal) . In Version 3, the movement of not only money (investment) but also of people has drawn attention for reasons of national security. Humans carry out various activities across borders. Individuals are, of course, expelled or punished for criminal acts such as industrial (and security) espionage. In addition, entry into the US will now be suspended for graduate students and researchers from China who have connections with the PLA or are judged to be involved in China's "military-civil fusion strategy".

Interdependence and globalization have been promoted under the rules of the GATT/WTO (China's economic growth was accelerated after its accession to the WTO in 2001). However, security issues have remained outside of GATT/WTO rules. In the US, while Article 301 of the Trade Act of 1974 governs unfair trade practices, it was not supposed to be invoked in areas covered by WTO rules. However, the WTO is often bypassed when imposing sanctions against unfair trade practices of illiberal nature (such as national intervention in economy) in Version 3, where countries with different regimes are included in a system of interdependence. The Trump administration has imposed sanctions on China because of such unfair practices. US Trade Representative Robert Lighthizer argued that China's unfair practices and other actions constituted an "existential threat" to US companies and the American economy.

US policy toward China under the Trump administration aims at preventing China from growing stronger through various means including controlled trade, and at changing the behavior of China on discrete occasions such as the introduction of the Hong Kong National Security Law through imposition of tariffs and financial sanctions. The US introduces tariffs and quantitative restrictions on imports from China, and puts restrictions on investment, to protect its own economy and security. It also seeks to regulate and sometimes ban the activities of high-tech and information-related companies within the US. Furthermore, it has begun to exclude or expel Chinese graduate students and researchers. Such policies are multifaceted and complex, demonstrating how the US is dealing with its strategic opponent in a multidimensional, tightly interpenetrating system of goods, people, money, and information between the US and China.

From "Constructive Engagement" to "Cold War" or "Competitive Coexistence"

These US policies seem to respond to such Chinese policies and strategies as "Made in China 2025" (to develop high-tech industries through state subsidies, an unfair trade practice in the eyes of the United States), the "National Intelligence Law" (enabling the government to control corporate information), and the "military-civil fusion strategy". Nevertheless, there is no sign that China will change this policy system, which it sees as involving matter of national sovereignty. More broadly, these events stem, on the one hand, from China's shift from taoguang yanghui to a more proactive and aggressive strategy under the Xi Jinping administration, and on the other hand, from the Trump administration's abandonment of the engagement policies of previous administrations, its characterization of China as a strategic adversary and a revisionist country, and its strategic shift towards hard-line policy. This signifies the end of a long era of Sino-American "constructive engagement". Trump's policies include many measures to sever (decouple) economic ties with China. If the two countries become economically disconnected as well as transform into strategic security adversaries and ideological rivals (in terms of human rights, democracy and economic systems), US-China relations would come to resemble the US-Soviet rivalry (the "Cold War"). However, disconnecting economic relations is very costly and its feasibility is uncertain. Economic decoupling, then, could be limited to certain areas such as military-related technologies (partial decoupling or partial engagement), with the United States pushing China back and reinforcing its competitive policies in the security and ideological dimensions, while at the same time both would try to create some measures (confidence-building measures) to keep competition from spinning out of control and build cooperative frameworks in the areas of arms control, terrorism and climate change. This is what is called "competitive coexistence". In this sense, the United States is currently engaged in a tug-of-war between "Cold War" and "competitive coexistence". The relationship between the economy and security will also be defined in this context.