The Triumph of Security over Economics

Last week was economics week in Washington. Both the International Monetary Fund (IMF) and the World Bank held their spring meetings, so the town was filled with finance ministers, other dignitaries, and economists (who do not generally fall into the dignitary category). As part of the many meetings, there were fearless projections of future economic developments, many of them ignoring the economists’ professional axiom—provide a number or a time frame, never both.

The prevailing mood seemed to be gloomy with a heavy dose of uncertainty. The Federal Reserve Board’s latest prediction for U.S. economic growth was 0.4 percent this year and 1.2 percent next year. The EU economy is forecast to grow less than 1 percent this year. China’s forecast, however, was more optimistic with the government targeting around 5 percent.

The gloom was tempered a bit later in the week by data suggesting that inflation was slowing down, at least in the United States, although that is both good news and bad news—the price increases are moderating, but that means the economy is cooling, which increases the likelihood of recession.

I’m not smart enough to make my own prediction. As Yogi Berra said, “Predictions are hard, particularly about the future.” (Right up there with, “Nobody goes there anymore; it’s too crowded.”) What struck me as interesting about this debate is some of the arguments being made to explain the gloom.

The obvious explanation is inflation but driving that are political events, including uneven recovery from Covid-19; the deteriorating U.S.-China relationship; and the Russian invasion of Ukraine, which has created both a food crisis in the Middle East and parts of Africa and major uncertainties in global energy markets, as Russia attempts to weaponize its energy exports and Western nations scramble to avoid dependence.

The uncertainty these developments create has led to the resurrection of an old word: balkanization. In deference to the Balkan nations, which are probably tired of being the poster child for disorder, I will use fragmentation instead, but both denote the breakdown of the global economy into smaller pieces often at odds with each other. Some would argue instead that the global economy is not fragmenting but rather rearranging itself in new ways. I think that’s semantics, but if it makes people feel better, okay.

The point is that companies and governments are in the midst of massive risk reassessments, both political and economic. Governments seek security; companies seek resilience. Both involve diversifying sources of critical items and reducing dependencies, and both involve economic and political costs. For governments that means a turn toward industrial policy and the subsidies that go along with it in order to create desired domestic capabilities. It also means restrictions on the outflow of technology and possibly investment in order to maintain leadership and deny our adversaries capabilities. For companies it means restructuring supply chains, often relocating them in ways that will be time-consuming and expensive.

Both public and private restructuring create fragmentation because they prioritize the individual country or company at the expense of the common good. For example, the U.S. emphasis on reshoring has led to protectionist content requirements that alienate our friends and reduce economic efficiencies created by globalization. Our injection of security issues into economic policymaking has the same result. The same is true for companies. Injecting resilience, a noneconomic variable, into supply chain management leads to results that are more expensive and suboptimal.

One partial solution—“friend-shoring”—causes problems in turn because it requires governments to decide who is a friend, with repercussions for those that don’t make the cut. Unfortunately, friendship is not binary; it exists on a spectrum. So, we are negotiating critical minerals deals with Japan and the European Union, both clearly friends. Now, however, Indonesia wants in. If we agree, we lower the bar on friendship and commit to a more complicated negotiation. If we decline, we damage an important regional relationship, potentially deny ourselves access to minerals we need, and create further fragmentation.

Lost in translation are rules and the importance of adhering to them. We have a post-World War II framework for how countries should deal with each other, including, on the economic front, most-favored nation and national treatment principles. China has long broken those rules, and Russia has done so in a particularly spectacular way. The United States, sadly, is following that pattern, and we can see other countries following those examples.

Most of these actions are taken in the name of national security, demonstrating that mutual trust has broken down, even among ostensible friends. The Biden administration is trying to restore trust among our friends and allies after the Trump years, but its actions don’t match its rhetoric in the economic sphere, where the United States acts in its own short-term interest at the expense of the rules and the global commons just like everybody else. We have been better than that and should get back to being better than that, but we have a long way to go.

William Reinsch holds the Scholl Chair in International Business at the Center for Strategic and International Studies in Washington, D.C.