The Strategy of
Geoeconomics
This video
will be about the strategy of geoeconomics, which covers how states use, or
should use, their economic power in pursuit of geopolitical goals. This video
aims to introduce the concept, outline the elements of geoeconomic strategy, and
finally come up with two strategic blueprints that states can use to achieve their
goals.
Geoeconomics: Introduction
First, we
have to be clear about what geoeconomics is not.
- Geoeconomics
is not about states pursuing economic instead of geopolitical ends.
- Geoeconomics
is not about foreign policy being driven by economic concerns.
- And
geoeconomics is not about states using their economy to fuel a military
machine.
One way of
thinking about geoeconomics is to think of it as “4th Generation Geopolitics”.
This refers to “4th Generation (Dimension) Warfare”, which proposes
that in modern war, the decisive contest may not actually be on the physical
battlefield. Instead, targeting the meta-dimensions of modern warfare:
communications, logistics, legal and especially political, may well prevent the
enemy from even coming to the battle in the first place. Russia’s actions in
Crimea are an example, where speed, ambiguity, propaganda and legal procedure all
combined to deny the West a viable reason for intervention, leaving Russia in
sole possession of the field by default.
In the same
way, the economic meta-dimension within geopolitics can also be targeted. States
that achieve economic dominance are in a good position to achieve geopolitical
goals, as rivals either compromise or are compromised due to their economic
dependency.
The rise of
geoeconomics is due to several factors. Firstly, the high costs of modern war
have diminished the power of diplomatic and military threats. Secondly, while
states still prioritize their own security, citizens also expect them to ensure
their economic well-being, and will replace governments based on the state of
the economy.
Lastly,
today’s globalized economy has created a new dimension of strategic
competition. Power is no longer limited to controlling geopolitical territories
and chokepoints, but also on ownership of key industrial sectors, markets and
supply chains. Mastering this new arena is, essentially, the point of
geoeconomics.
Geoeconomics and Economics
So we have
seen how geoeconomics offers potential solutions to geopolitical questions. But
why geo-economics instead of plain old economics?
After all, economists
can argue that if states run the economy based on purely economic rather than
geopolitical principles, they will grow faster, which in turn gives them
greater options and leverage against geopolitical enemies. Running the economy
with an eye towards geopolitical goals will only be counterproductive as state
meddling interferes with growth.
The geoeconomic
response comes in a critique of Ricardo’s Principle of Comparative Advantage, a
key model mathematically demonstrating the benefits of free trade. Suppose two
countries and two initial goods: Britain is better at making cloth,
Portugal is better at making wine. If both countries try to produce both goods by
themselves, they get a small amount of each.
Ricardo demonstrated
that if each country focuses on its advantage: Portugal on wine and Britain on
cloth, they will make a larger amount of their chosen product. Trade with each
other, and they will both end up with more goods compared with going it alone.
This relationship holds even if Portugal is better than Britain at producing
both wine and cloth. So here, we see how economic principles encourage
specialization and trade, which in turn leads to both countries having more
resources.
In response,
geoeconomists point out two things: firstly, the relationship must be analyzed
in terms of its long-term impact, not just short-term economic gains. So let’s specify
that this example of Comparative Advantage analyses long-term gains, which
leads to the second point, which is that this model assumes that the economic
effect of specializing in wine and specializing in cloth are the same.
But they are
not. Cloth is a standard ‘gateway industry’: it encourages urbanization, social
development, industrial growth and mechanization; it also stimulates derivative
industries like dyes, design and machine tools. These characteristics exist to
a much lesser degree, if at all, when it comes to wine.
So in our
model, cloth-focused Britain is set for industrial takeoff. It will stimulate
the rapid and massive growth of simple manufacturing firms, educating
entrepreneurs on the intricacies of mechanization and industrial management.
These firms will drive the development of an internal market, earning profits
that can be used to invest in increasingly complex and innovative production,
which in turn stimulates entrepreneurs and internal markets even more in a
positive feedback loop. In such a way, Britain easily become richer and more
developed than a Portugal that has dumped its cloth industry.
OK, the
economist says, but Portugal still remains better-off in this scenario. By
specializing and trading, it will still get more than it would producing
everything by itself, and furthermore, through trading with developed Britain,
Portugal gets goods that it can’t even produce at all. The result is still more
resources to potentially spend on geopolitics.
But this
argument ignores the geoeconomic and geopolitical consequences of lopsided
economic development. In war, wealthy Britain will naturally prevail over poor
Portugal; but even in peace, Britain’s wealth will give it significant
geoeconomic advantages over Portugal.
Britain can
use its money to buy up Portugal’s resources and firms, gaining a say in how
Portugal’s economy is run. This British economic dominance means that Portugal
actually needs Britain’s cooperation to fund its activities. Needless to say,
this means in a geopolitical dispute between Portugal and Britain, Britain wins
by default.
So we can
see how blindly following economic principles has resulted in negative
geopolitical benefit for Portugal. It has gained more resources, but they have
been rendered irrelevant since geoeconomic dependence has already led to
Britain’s geopolitical victory. Under a geoeconomic strategy Portugal would
have insisted on keeping its own cloth industry, sacrificing short-term economic
benefit for long-term geoeconomic and geopolitical gains. To update
Clemenceau’s quote, “the economy has become too important to be left to
economists”.
Geoeconomic Strategy: Aims
As
repeatedly stressed, the point of geoeconomics is to support broader
geopolitical strategy. In practice, this support comes in the form of ‘hard’ or
‘soft’ economic power.
‘Hard’
economic power coerces and deters by threatening economic destruction:
embargoes, withdrawal of investment, currency and stock manipulation and the
like. ‘Soft power’ is about shaping rivals’ behavior and goals through
enticements, structures and links: for example, the US will only allow states
to use the IMF or US dollar if they conform to certain behavioral standards,
while states conform to Chinese geopolitical desires in order to obtain loans.
‘Hard’ and
‘soft’ economic power are of course not mutually exclusive and in most cases
are two sides of the same coin. What is relevant for our purposes is that both
methods require a strong and influential economy. Clearly, embargoes and
enticements do not work if the economy is too small or too irrelevant to have a
meaningful effect on a rival.
Geoeconomic
strategy therefore aims for two things in general: firstly, the creation of a
large economy; and secondly, the creation of a relevant economy, either in the
sense of controlling critical industrial links or being in the relevant
markets. How this is done will be the subject of the remaining part of this
video.
Geoeconomic Strategy: Elements
The core
element in military strategy is force or firepower: everything is about
creating, deploying and supporting units so that the right arrangement of
firepower is in place to achieve the strategic goal.
In a similar
vein, the core element in geoeconomic strategy is capital: everything is about
creating, deploying and supporting firms so that the right arrangement of
capital is in place to achieve the strategic goal. Capital is needed to invest
in production and grow the economy, and capital is what firms need to expand
and maintain their positions within markets.
Capital is
generated by firms in industrial sectors. As implied in the analysis of
Comparative Advantage, not all industrial sectors are created equal, and firms
in capital-rich sectors, mostly services, will generate outsize profit and
capital compared to others. These rich economic territories are of course
needed to fund geoeconomic strategy, but the nature of geoeconomics means that
it is more interested in industries that also have geopolitical impact. These strategic
industries, perhaps less cash-rich but certainly more influential, include:
- One:
scarce yet critical industrial resources like oil, machine tools or microchips;
- Two:
services that underwrite the modern economy like communications and finance;
- Three:
high-tech, high-innovation industries that create and monopolize entirely new
markets.
Additionally,
apart from industrial sectors, states also need to consider the value chain
dimension of geoeconomics. When we look at the value chain ‘smile curve’, we
find that the bottom of the ‘smile’, consisting of simple, labor-intensive work
like assembly – is powerless and capital-poor.
By contrast, the capital- or knowledge-intensive ‘tips’: R&D, design,
management, marketing – are not only capital-rich, they are inherently powerful
positions that impose their aims and values on subordinates and customers.
Needless to say, geoeconomic strategy aims to occupy these positions.
Last is the
concept of markets, which generally still correspond to political borders.
There are capital-rich markets, of course, but generally strategic targets here
tend to be selected for purely geopolitical reasons, either because they bring
great political benefits or because they can neutralize the opposition of a
broader political bloc.
Geoeconomic Strategy: Means
Now that we
know what the elements of geoeconomic strategy are, we can think about how
states can manipulate them to achieve strategic goals. States can use the means
at their disposal either in an offensive fashion – deploying capital to seize
control of strategic economic territory – or in a defensive fashion –
preventing others from doing the same.
Here, we
group these means into three categories: regulatory, financial, and
directional, representing increasing state intervention in the economy.
Regulatory
Regulatory
means set out the “rules of the game” within an economy, consisting of laws,
standards and bureaucratic procedure. Barring additional intervention, firms
playing within the rules are free to deploy and direct capital in the most
efficient way possible. States can of course still tweak the rules to loosely
guide firms towards offensive geoeconomic goals, such as by raising minimum
standards to stimulate the innovation needed to capture sectors or rise up the
value chain.
More
commonly, however, regulatory means are used defensively to prevent firms from
sacrificing geoeconomic imperatives in search of maximum profit. Minimum
standards keep out firms who try to undercut innovative firms based on cost,
while Committees on Foreign Investment review acquisitions to ensure that
economic secrets are not sold out to geoeconomic rivals.
Financial
Financial
means redistribute or inject capital into certain national champions, usually
in situations where the free market is unable or unprepared to. They are used
offensively to fund unprofitable investments that serve geopolitical purposes,
and defensively to allow firms to maintain sectoral or market positions in
response to a rival’s offensive.
There are
two types of financial means: the first one is direct capital injection, where
the state directly funds a national champion through subsidies, loans and tech
transfers. The other is the protected market, where the state erects tariffs to
keep external competition out and allows the formation of cartels to do the
same against internal competition. The result is that the monopolistic national
champion can jack up prices, thus redistributing capital from the public to the
champion without too much overt intervention.
Directional
Directional
means straight-up direct national champions to compete for strategic sectors,
positions and markets regardless of short-term profit. The less-common
defensive variant orders firms to hold on to legacy businesses for geopolitical
benefit. The state can also direct firms to abandon investments and deals for
purely geopolitical reasons, as China is infamous for doing.
*
All in all,
states can select from a broad array of tools in order to influence capital and
firms towards desired sectors, value chain positions, and markets in line with
their geoeconomic and geopolitical goals. Free market economies may be more
associated with regulatory means and command economies with directional ones,
but in reality most economies utilize all three means to some degree: the US,
for example, finances Boeing’s exports through the Export-Import Bank while
European states financed and directed Airbus to seize the strategic high-tech
sector of airplane production.
That said,
the geoeconomic strategies of liberal and less-liberal economies are distinctly
different and this will be examined below.
Geoeconomic Strategy: The Liberal
Blueprint
We can think
of geoeconomic strategy as divided into three separate phases: firstly, the
capital phase where firms receive capital to compete in the global market;
secondly, the directional phase where firms decide which sectors or markets to
aim for; and thirdly, the maintenance phase where firms attempt to maintain
their hard-won position in the market or sector.
A liberal
geoeconomic strategy is a ‘short-term defensive, long-term offensive’ strategy.
In it, the capital and directional phases are overseen by market forces.
Through the profit mechanism, markets will naturally direct capital towards the
most capital-rich sectors and markets, and distribute capital according to firm
quality with the most capable getting the most capital. Firms are therefore
incentivized to be constantly targeting capital-rich sectors, the capital-rich
value chain positions within those sectors, and capital-rich markets.
Over the
long-term, this creates a hyper-competitive economy that will naturally
dominate economic sectors and markets, generating significant geoeconomic and
geopolitical benefits for the state. The state’s support during these phases
should mainly consist of getting out of the way, with intervention limited to
smoothing out market failures, providing public goods and infrastructure, and
spearheading research in areas where the market has not yet caught up to.
Note that
the liberal geoeconomic strategy is not the state abdicating all control to the
market, and it is in the maintenance phase that the state’s role becomes
paramount. This is because the liberal strategy is based on free and fair
markets: no firm, no matter how hyper-competitive, can compete for long against
free or cheating.
The state
must therefore use the regulatory means at its disposal to set up, enforce and
update a set of rules that would maximize the effect of its liberal strategy:
internally, it should promote things like competitiveness, free movement of
capital and labor and so on, perhaps using standards to encourage innovation
and upgrading within the economy.
Externally –
which is far more important – the state should also insist that the only way
others can compete on an equal basis is by conforming to the state’s own rules
and geopolitical outlook. Ideally, the choice is for rivals to concede
geopolitical victory to the state in return for participating in the state’s
economic dynamism, or to refuse and lose in the long-run anyway as the state
outcompetes and dominates the rival’s economy. As such, the state should neither
hesitate in creating a protected market that keeps out unreformed rivals, nor
should it shy away from financially supporting a firm that is disadvantaged
against an external rival.
This
blueprint can be seen as a purist and more aggressive version of the proposed
Trans-Pacific and Trans-Atlantic free trade partnerships, which sought to
create a free-trade bloc that forced geopolitical rivals to either adopt
Western economic and geopolitical norms or be unable to benefit from the
Western market.
The liberal
strategy is fairly straightforward, but it is not without drawbacks. The key
one is that in a liberal strategy, the state has limited control over
direction. In practice states retain many tools to incentivize market forces in
the desired geoeconomic direction, but in general they have little control over
where specific capital goes.
This, of
course, becomes a problem when it comes to capital-poor but strategic sectors
and markets, where lack of market interest creates vacuums which a less market-conscious
rival can exploit. The geoeconomic successes that Chinese companies have
enjoyed in the transport and communications infrastructure sectors, as well as
in developing markets from the South Pacific to Africa to Latin America, are a
product of Western disinterest as much as Chinese strategy.
Related to
this is the broader issue that liberal geoeconomics tends to devolve into pure
economics, where the state, driven by dogma and entrenched interests, gets out
of the market regardless of its impact on geoeconomic goals. A liberal strategy
requires constant management to prevent market forces from overpowering
geoeconomic logic. Current worries may include excessive financialization,
where firms cut production or underinvest for the sake of stock prices; and
perhaps Western underinvestment in the public goods, especially education and
infrastructure, that are necessary to a competitive and high-value-chain
economy.
In short, a
liberal strategy is not an excuse for governments to forget about the economy.
Free markets are a means, not the end, and they should be curbed when they
start interfering with geoeconomic or geopolitical goals. The trick is to find
that sweet spot, where economically-dominant firms take the offensive thanks to
helpful market forces, and are defended from unhelpful ones through government
intervention.
Geoeconomic Strategy: The
Developmentalist Blueprint
Contrasted
with the liberal blueprint is the developmentalist blueprint, so-called because
of its origins in German and East Asian developmental economics. Here, the
state directs capital towards favored ‘national champions’, directs them
towards certain targets, and supports them so that they can maintain their
positions in the long-run. In short, it is a ‘short-term offensive, long-term
defensive’ strategy.
The
developmentalist strategy is especially relevant where the free market is
unwilling or unable to achieve geoeconomic goals. We have seen how markets can
ignore geopolitically-significant but capital-poor territory. In poor,
underdeveloped countries, markets may not even be able to concentrate enough
capital to achieve meaningful economic growth. State intervention is therefore the
alternative.
Financial
means are liberally used to infuse select champions with capital. Externally-
and internally-protected markets allow champions to extract as much capital as
possible from the public. Direct state support will be financed by taxation or
by a negative-real-interest-rate regime that converts the public’s savings into
usable capital. In both cases, the state suppresses domestic consumption and
transfers the money saved into investment.
In return
for the support, champions must follow the state’s direction and target
specific industries. Competent bureaucracies will tailor targets to ensure that
the limited capital is focused on capital-rich or geoeconomically-significant
sectors, and are within the technological capabilities of the champions. And
since champions cannot rely on the suppressed domestic market to buy their
goods, they have to export overseas for their profits, which in the East Asian
case meant exporting to the US.
Given the
many cost advantages they are working under, champions should easily undercut
the firms in their chosen market and quickly become a relevant force in their
sector. The profits they earn will either be used to invest in themselves and
advance up the value chain, or be repaid to the state who will use the money to
fuel another national champion.
With
appropriate state financing and direction, most champions can easily dominate
the lower segments of a value chain based on cost advantage. But these
positions are not capital-rich nor powerful, and a champion here will always be
vulnerable to political or market developments that can make it obsolete in an
instant. To maintain the state’s foothold in this sector, therefore, a firm
must continue to receive constant support as it attempts to advance up the
value chain.
Some level
of innovation is required for a champion to advance up the value chain.
Long-term this requires the state to pour additional capital into building the
required knowledge and educational structures; in the meantime, it can have
champions compete with each other for subsidies or loans, weeding out the unfit
in the process. Alternatively, the state can cheat and support its champions
through enforced tech transfers and industrial espionage, allowing them to keep
abreast of the latest developments.
Repeat this
cycle enough times, and eventually the champion will reach a scale and
value-chain position where it can actually begin making a genuine profit and
start contributing to state coffers. Long before that, however, it would have
already become a ‘growth pole’, stimulating internal development and bringing
the economy closer to the level where it can start fueling itself.
The meteoric
rise of Japan, South Korea and now China is proof of the power of this
blueprint. But there are also glaring drawbacks:
Firstly,
state intervention on this scale and timeline creates significant market
distortions. Cronyism and inefficiencies are to be expected, but to scrounge up
the capital to fuel champions, states either take on massive debt or manipulate
currencies and capital flows to get the real interest rates they want. And few
states have been able to forever defy the laws of economic gravity: from the
Japanese asset bubble of the late 80s to the Asian Financial Crisis of 1997 to
China’s current debt overhang.
The second
drawback – which is less of a drawback and more of a tough prerequisite – is
that the developmentalist strategy requires international tolerance. A key step
in this strategy is to have states gain capital by exporting to overseas
markets under pretty unfair conditions, undercutting other firms in the
process. There is no reason why the export destination should tolerate this.
Indeed, the liberal strategy’s emphasis on ‘free and fair markets’ was to
prevent this sort of one-sided deal in the first place.
During the
Cold War, the US tolerated Japanese and South Korean practices because their
increased strength was a geopolitical gain. This is not the case for China and
accordingly US tolerance is wearing thin. It’s not clear whether the
developmentalist strategy will be as successful in a less unconditionally-open
trade environment.
In short,
the developmentalist strategy has the state put the economy into
capital-generating gear. Domestic consumption is suppressed, capital earned
from overseas exports is brought in, and the money is invested into select
national champions, whose task is to exploit their many advantages to seize the
desired geoeconomic territory. Its historical effectiveness is undeniable, but
it may be a product of circumstance. Additionally, the state can only defy
economic logic for so long before coming back to reality in the form of an
economic crisis.
Conclusion
Over the
course of this video, we have seen how geoeconomics is relevant to modern
geopolitics. By dominating key industrial sectors, value chain positions and
markets, geoeconomic powers can suppress hostile activities of dependent
countries and thus win geopolitical conflicts by default. Domination requires
abundant and strategic use of capital, leading to two general strategic
blueprints: a liberal one where the free market directs capital, and a
developmentalist one where the state provides direction. Most countries
recognize the need for both dynamism and direction and will combine elements of
both in their strategy.
In an age of
muted political conflict, geoeconomic competition is becoming more relevant in
the quest for global power and influence. It is important to remember, however,
that geoeconomics is not a substitute for geopolitics. In the last counting,
states still value security and political control over economic comfort, and
geoeconomics provides the means, not the end, of achieving that.
Thanks for
watching the video, and please like and subscribe! If you have any comments or
questions, I’ll be happy to respond to them in the comments section.
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