In search of trust and security in global trade
Published 15 November 2022
Trust, the invisible glue that has held the global trade system together for more than seven decades, is in significant decline. In the face of rising geopolitical tensions, predatory trade practices, and supply chain vulnerability, countries are now becoming more proactive in pursuing economic security over efficiency and mutual benefit.
The pursuit of economic security is rapidly becoming a defining feature of our current economic age. This represents a marked shift from the hyper-globalization which has characterized the past four to five decades. During those years, the prevailing approach to economic and trade relationships was straightforward: how can economic efficiencies be maximized? That approach is now being transformed by the need to respond to a very different question: how can economic and trade relationships be made more secure?
China’s rising economic, technological, and military might, along with the deeper entrenchment of its authoritarian system of governance, have led many in the West to view China as a geostrategic rival, if not an outright threat. This shift towards greater economic security is not solely due to China, however. The pandemic reminded us that trade can bring not only economic benefit, but also risk and vulnerability, especially across extended global supply chains.
These developments have been exacerbated by a precipitous and mutually reinforcing decline in trust. Trust has been the invisible glue that has held the global trade system together for more than seven decades after the Second World War. The system was founded with a strong collaborative spirit that engendered trust and a sense that we were all joined together in a common cooperative endeavor. This spirit proved remarkably resilient over the decades but has now been significantly eroded in the face of rising geopolitical tensions and predatory trade practices that the rules-based trade system seems incapable of remedying.
In response to rising risk and declining trust, countries are now becoming considerably more proactive in pursuing trade and economic policies designed to strengthen economic security, rather than simply pursuing efficiencies and mutual benefit. Japan is the first country to appoint a Minister for Economic Security. It certainly will not be the last.
We have arrived at an important milestone. For many countries, economic security has now become synonymous with national security. But do we understand what this really means for the global trade system?
Elements of economic security
Although the precise manner in which it is pursued will vary from jurisdiction to jurisdiction, the typical elements of an economic security strategy include intensified investment screening, tighter export controls, outright prohibitions on trade in some cases, and enhanced cooperation with “trusted” partners.
Examples abound. The US has significantly tightened-up its screening procedures under the Committee for Foreign Investment in the US (CFIUS) for the first time since its inception in 1975. Various legislative proposals gaining traction on Capitol Hill would institute screening for certain outbound investment as well. Japan has tightened rules on foreign entities investing in companies that affect national security and has allocated nearly a quarter of a billion dollars for so-called “China exit” subsidies to entice Japanese companies in China to return to Japan or relocate from China to elsewhere in Asia.
The European Union moved with unusual speed and cohesion in imposing tough export restrictions on trade with Russia in the aftermath of its invasion of Ukraine and instituted a partial ban on Russian oil imports. China prohibits government agencies from using foreign computer hardware or software. Various trade and economic initiatives – including the Indo-Pacific Economic Framework (IPEF), the US-EU Trade and Technology Council, the US-Japan Competitiveness and Resilience Partnership, and the Shanghai Cooperation Organization – foster cooperation among like-minded and trusted partners.
Squaring with the rules-based trade system
The General Agreement on Tariffs and Trade (GATT) in 1947 established non-discrimination, national treatment, and the Most Favored Nation (MFN) status as cornerstone principles of the global trade system. Since the objective of economic security strategies is to cherry-pick trading partners, these strategies could contravene these foundational principles.
There is a loophole, however. Most trade agreements, from the GATT onward, contain national security exemptions. In most cases, they are vague and entirely self-judging. When countries deem it to be in their national security interests, they have wide latitude to block trade and investment, establish local content requirements, or otherwise skirt commitments to treat foreign products and producers in the same manner as domestic.
For the better part of the last half-century, countries rarely availed themselves of this flexibility. Part of the reason for restraint has been the belief that once the genie is out of the bottle, things could rapidly unravel. As soon as one country starts to block trade and investment in response to self-judged security needs, other countries could be expected to do the same.
The era of restraint seems to be over. Economic security is national security, and countries have little compunction about imposing barriers or restrictions to achieve their often arbitrary and sometimes dubious security objectives.
Is economic security a blank check?
The advent of economic security as a defining feature of trade policy raises a thorny dilemma for the global trade system. Do countries have carte blanche to block trade and investment as they see fit on the basis of subjective and sometimes dubious assessments of security?
Given that trade is a voluntary activity undertaken on the basis of mutual benefit, a reasonable argument could be made that the answer is yes – countries have wide, perhaps unlimited, latitude to block trade in response to security considerations. But others could also reasonably argue that such an approach would lead to so many carve-outs and opt-outs that the remaining fabric of the global system would be in tatters, if not entirely disintegrated.
It is worth noting that our existing rules-based trade system was founded on a recognition that countries would need to surrender a certain degree of autonomy in order to “join the club” and that this would entail trade-offs. The expectation was that the overall benefits of a global system would outweigh the drawbacks of trade-offs.
If countries no longer believe that is true, the pursuit of economic security through trade restrictions will continue unabated. On the other hand, if countries conclude that the benefits of a global trade system outweigh the compromises required, then a degree of greater restraint will likely creep back into the pursuit of economic security. We won’t be returning to the 1990s idealized vision of globalization, but the quest for economic security will be tempered by a desire to ensure the underlying integrity of the rules-based global trade system is not decimated.
A more fragmented world
The deeply integrated global economy is now being buffeted by the most severed geopolitical tensions we’ve seen in three-quarters of a century. Trade is being weaponized, and the proliferation of dual use technologies means that economic security has – understandably and undeniably – become synonymous with national security.
How should this new terrain be navigated? In an ideal world, we would seek a nuanced balance between the periodic need to restrict trade in response to legitimate security interests, and the desire to maintain, to the maximum extent possible, the benefits of an open and truly global trade system.
Given the level of distrust and dysfunction in the trade system today, there is little evidence to suggest that such a delicate balance is achievable. Expect instead to see the scales tilt toward greater economic security at the expense of a globalized trade system.
Countries will gravitate toward trade relationships with trusted partners and away from countries that elicit discomfort, suspicion, or fear. There has been much talk recently about “friend-shoring” but that is simply a catchy way of saying “we want to trade with countries we trust and minimize trade with those we don’t”.
Interventionist policies will be put into place to push trade in the desired direction rather than a hands-off approach which allows trade patterns to be shaped by economic efficiencies. Policy makers and corporate executives alike would be well-advised to begin now to adjust to this new world.
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