“API Geoeconomic Briefing” is a weekly analysis of significant geopolitical and geoeconomic developments in the post-pandemic world. The briefing is written by experts at Asia Pacific Initiative (API) and includes an assessment of burgeoning trends in international politics and economics and the possible impact on Japan’s national interests and strategic response. (Editor-in-chief: Dr. HOSOYA Yuichi, Senior Consulting Fellow, API & Professor, Faculty of Law, Keio University)

This article was posted to the Japan Times on July 28, 2020:

https://www.japantimes.co.jp/opinion/2020/07/28/commentary/japan-commentary/coping-chinas-economic-threat/

API Geoeconomic Briefing

July 28, 2020

Coping with China’s economic threat

OYA Shin, Senior Consulting Fellow, Asia Pacific Initiative (API)

 

 

 

 

In recent years, China has been escalating moves to achieve its geopolitical goals by taking advantage of its economic power.

There are so many cases of economic coercion by China. Salmon imports from Norway were suspended after Chinese human rights activist Liu Xiaobo was awarded the Nobel Peace Prize, and rare earth metal exports to Japan were restricted following a collision between a Chinese fishing boat and Japan Coast Guard cutters near the Senkaku Islands.

Beijing also restricted banana imports from the Philippines after a standoff between Chinese and Philippine naval forces in the South China Sea near Scarborough Shoal, discouraged Chinese tourists from visiting South Korea after Seoul decided to deploy the Terminal High Altitude Area Defense (THAAD) anti-missile system and restricted imports of beef and barley from Australia — as well as warning Chinese tourists against travel to the country — after Australia called for an independent international investigation into the origins of the novel coronavirus pandemic.

With the world’s largest population and second-largest economy, as well as the Communist Party of China asserting control over the activities of people and companies in the country, it is relatively easy for China to resort to economic coercion.

Economic coercion is one form of geo-economics, which refers to the use of economic measures to achieve geopolitical goals. It is more effective if a country’s economic dependence on the coercive country is large and if the size of a country’s economy is small compared to that of the coercive nation.

The percentage of China-bound shipments among total exports is 13 percent for the Philippines, 20 percent for Japan, more than 25 percent for South Korea and more than 30 percent for Australia.

 

Countering economic coercion

What should we do to avoid yielding to China’s economic coercion? There are three issues to consider.

First, it is necessary to strengthen international rules, including those of the World Trade Organization. Article 21 of the General Agreement on Tariffs and Trade (GATT), the rules that are the foundation of the WTO, allows a government to ignore its free trade obligations for the protection of its essential security interests. Countries such as the United States have claimed that measures taken by WTO members for the purpose of national security are final and cannot be reviewed by a WTO dispute settlement panel.

Fortunately, the dispute settlement panel ruled in April 2019, in a case between Russia and Ukraine, that the WTO has the right to review whether national government claims are justified and that the national security exceptions do not grant WTO member countries unlimited discretion.

Still, WTO rules should be strengthened further, including those on national security exceptions, in order to effectively mitigate China’s trade-related economic coercion.

Moreover, there is the issue of the current WTO rules on subsidies (which narrow the definition of subsidies to only those provided by so-called public bodies — entities with governmental authority) not being adequately effective to prevent China’s predatory trade practices involving subsidies.

However, with the WTO having more than 160 member countries, it is difficult to revise its rules. And going through its dispute settlement procedures takes time.

Japan challenged China’s restrictions on rare earth exports, and a dispute settlement panel and the Appellate Body, the higher court, both ruled against China. The ruling was finalized in August 2014, but China’s strict export quotas were imposed in 2010.

Furthermore, since December last year, the current Appellate Body has seen its normal seven members shrink to fewer than three — the minimum number required to serve on a case — as the appointment of new members to replace those completing their terms has been blocked. Considering such a situation, the review and strengthening of international rules is urgently needed — but even that is unlikely to be enough.

It is necessary, secondly, to reduce economic dependence on China. In the wake of the COVID-19 pandemic, concerns have grown over supply chain reliance on China.

The focus of supply chain issues lies in how much politics can control and regulate the trade-off between efficiency and resilience, beyond what private companies think is the optimal balance point.

Various measures can be taken to strengthen resilience, such as securing certain inventory levels or having countries involved in making agreements not to restrict exports even at times of crisis. But regarding the current situation where dependence on China, the manufacturing superpower, is extremely high, it would be effective to reduce reliance on the country by diversifying investment and reshoring production, taking into consideration items that need to be prioritized.

However, a policy to reduce dependence on China would mean a decline in efficiency that leads to increasing costs for countries investing in and trading with China. There are limits to how much dependence can be reduced, and it is not possible to rely solely on this policy.

To increase resistance against Beijing’s economic coercion, it is also important to reduce excessive reliance on the Chinese market as a sales destination. But that would also mean some of the economic benefits gained from China’s gigantic market would be lost. Since a complete decoupling from China would be unrealistic, such action would be insufficient.

The third option is for like-minded countries to cooperate to mitigate adverse effects of economic coercion, and at the same time take measures to deter China from coercing easily.

Since China targets countries individually to apply economic coercion, there could be a situation in which any country except for the U.S. could be pressured by China with its larger economy.

If like-minded countries with common values work collectively, they could together create an economy larger than that of China. But how can such cooperation be achieved?

 

Cooperation and deterrence

There are various ways like-minded countries can cooperate with each other to fight economic coercion, but I would like to propose establishing the Freedom Alliance Fund as a means to realize solid and functional cooperation.

Participants would be like-minded countries sharing the same values, with each country paying premiums in proportion to the depth of its economic relationship with China. When China threatens a member country economically, that member country will receive compensation, up to a maximum of the estimated financial damage, from the fund.

The fund will be open to participation by any country that shares common values. For example, we expect participation by Asian and European nations which support, or coordinate with, the Free and Open Indo-Pacific vision.

China’s coercive measures take advantage of economic ties, including trade, investment and tourism, and the Freedom Alliance Fund would be aimed at mitigating adverse effects of China’s economic coercion, but it would be inappropriate if the fund ended up working to reduce China-related risks, and deepened economic ties with the country.

Each country could collect necessary premiums from domestic companies according to the degree of their economic involvement with China, so as to avoid moral hazards among businesses. This also means nations wouldn’t need to shoulder the financial burden of such a measure from the national coffers.

The Freedom Alliance Fund would address China’s economic coercion in two stages. The first stage would be for member countries to discuss and designate a case of economic coercion after a request by a country claiming to have been coerced.

Then the case would be made public, in order to provide legitimacy and inspire courage, and show support and solidarity to the coerced country — which otherwise would be put in a severely disadvantaged and isolated position due to its weaker economic power compared with that of China.

The move would, at the same time, pressure China to stop its coercion through reputational effect.

The second stage would be to calculate the damage caused by China’s coercive measure over a given period of time and, setting that amount as the maximum, provide the coerced country with funds.

Although it is likely to be the private sector, such as dairy farmers, barley farmers and companies in the tourism industry, who are likely to suffer damage, funds from the Freedom Alliance Fund would be given to the national government since it has a relative advantage in collecting information on the actual damage inflicted and the administrative capacity to provide assistance.

As mentioned above, a case of economic coercion would be designated based on a request from a coerced country, but the Freedom Alliance Fund’s secretariat could also constantly monitor the situation for economic coercion by China and share that information among member countries, and also with the rest of the world if necessary, to alert them and pressure China.

When needed, the Freedom Alliance Fund could conduct discussions and negotiations with China itself.

Working under those two stages would be the most effective way for the Freedom Alliance Fund to function, but it might take time to establish a framework for the second stage involving the provision of funds.

In that case, countries should consider first setting up a Freedom Alliance Initiative. Considering the current global situation, such a move is urgently needed.

 

A free and fair international order

There are a few different scenarios under which geo-economic action can be taken against China.

The first scenario would be exercising proactive actions, such as freezing the assets of authorities involved in a breach of Hong Kong’s “one country, two systems” framework.

The second would be exercising geo-economic counteractions, such as taking measures against China’s actions toward a certain nation.

The third scenario would be exercising mitigation actions, such as like-minded countries cooperating to denounce China and reduce damage when it economically coerces another nation.

The Freedom Alliance Fund corresponds to the third scenario, being a means to share the pain among member countries, rather than to counterattack China. But if they can show strong solidarity and a clear message through this framework, it will have the effect — to a certain degree — of deterring China’s economic coercion.

As China becomes increasingly active in exercising economic coercion, there is a pressing need for like-minded countries to work closer together and the Freedom Alliance Fund could be an effective framework to achieve this goal.

Geo-economic actions are favorable to military bloodshed for achieving a nation’s goal, but since they are easier to implement, they involve the risk of overuse.

The Freedom Alliance Fund would be a countermeasure against excessive use of geo-economic actions and would, at the same time, give its member countries the opportunity to review the appropriateness of exercising their own actions.

I believe that a rule-based, free and fair international order that is free of economic coercion will offer a better world for both the fund’s member countries and China.

 

Disclaimer:API The views expressed in this API Geoeconomic Briefing do not necessarily reflect those of the API, the API Institute of Geoeconomic Studies or any other organizations to which the author belongs.