“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, Research Director, API & Professor, Faculty of Law, Keio University)
This article was posted to the Japan Times on January 26, 2021:
API Geoeconomic Briefing
January 26, 2021
It’s time to reduce the world’s trade dependence on China
Senior Consulting Fellow, Asia Pacific Initiative (API)
The COVID-19 pandemic has made many aware of the vulnerability of supply chains, giving an upper hand to China, which manufactures crucial medical and other products for Japan and much of the world.
With Beijing taking advantage of the vulnerability, or the dependence on China in trade, resorting to economic coercion, Japan needs to strengthen its economic security as part of its strategy to ensure national security.
The spread of the novel coronavirus has affected Japan’s auto production sector, dependent on parts imported from China, and led to a serious shortage of face masks, also supplied largely by that country.
The United States, hit by a surge in infections, also suffered from shortages of face masks, medical gloves and gowns, leading to growing calls for the need to increase domestic production of medical supplies rather than relying on imports.
After Australia pushed for an independent inquiry into the origins of the coronavirus, China suspended beef imports from major Australian suppliers and imposed an 80.5% tariff on barley imports from Australia, as well as restricting imports of other products such as wine and coal.
While just-in-time production, or lean manufacturing, achieves high efficiency, it also proves to be a vulnerable system. Its vulnerability surfaced following the 2011 Great East Japan Earthquake and the severe flooding in Thailand the same year.
Being aware of such risks, 57.7% of Japanese companies surveyed by the Japan Bank for International Cooperation in 2016 said they were diversifying supply chains. Interviews with the companies included a response that said they were working to keep sufficient inventory to reduce risks.
Such diversifying of supply chains and increasing inventory can be effective to solve the vulnerability issue, but if companies lose efficiency as a result, it would be a disadvantage in competing with other firms in the market.
Companies need to seek the best balance between efficiency and tenacity as enterprises, while adopting various measures such as the sharing of parts and managing supply chains using digital technology.
The problem of supply chain vulnerability should be dealt with not only by companies but also by governments.
Shortages of personal protective equipment including masks and medical gowns were mainly attributable to a fiftyfold surge in demand compared with normal times due to the spread of COVID-19 infections, but they were also caused by many countries taking measures to restrict exports of such products.
There were also cases of governments restricting exports to implement economic coercion for political reasons, like the measures taken by China against Australia.
Albert O. Hirschman, in his book “National Power and the Structure of Foreign Trade” published in 1945, describes how trade is used as economic coercion.
Hirschman points out that foreign trade has two main effects upon a country — the supply effect and the influence effect.
He says that foreign trade expands the economy and increases the welfare of the country. This is the supply effect. But he also says that foreign trade leads to relationships of dependence, which can be utilized for achieving political purposes. This is the influence effect.
The two effects are not mutually exclusive.
While two trading partners become interdependent, offering a foundation for an influence effect on both sides, Hirschman notes that the dependence is asymmetrical.
He cited the example of German-Bulgarian trade in 1938 which represented 52% and 59% of Bulgarian imports and exports respectively, but only 1.5% and 1.1% of German imports and exports, indicating a relationship in which Germany is in a position to unilaterally implement the influence effect.
Where China is positioned
Hirschman’s book is an analysis of how Nazi Germany expanded its trade and political influence over East Europe and Southeast Europe in the 1930s, not about China. But the analytical framework used in the book can be applied to Beijing’s economic coercion in the present day, as China, which has become the world’s top trader, imposes a strong influence effect on other countries.
China is well aware of its power. President Xi Jinping, in a speech at a meeting of the Chinese Communist Party’s Central Financial and Economic Affairs Commission on April 10, said, “We must tighten international production chains’ dependence on China, forming a powerful countermeasure and deterrent capability against foreign countries which would artificially cut off supply.”
It is widely known that China has repeatedly been taking actions that go beyond “countermeasures,” rather pre-emptive attacks in a form of economic coercion, against moves including Australia’s investigation into the origins of COVID-19, Japan’s control of the Senkaku Islands, Norway’s awarding of the Nobel Peace Prize to Chinese dissident Liu Xiaobo and South Korea’s deployment of the U.S. Terminal High Altitude Aerial Defense (THAAD) missile defense system.
Eighteenth-century economist Adam Smith, in his book “The Wealth of Nations,” wrote, “defense … is of much more importance than opulence,” recognizing the logic of security beyond free trade.
However, he noted that if a country gives up its exclusive trade with its colonies, it will become richer and its defense capabilities will increase under free trade. From Hirschman’s viewpoint, Smith’s recognition of the influence effect created by dependence was insufficient.
Then, how should we deal with the current situation?
In order to benefit from foreign trade and also reduce the influence effect at the same time, Hirschman proposed transferring trade restriction authority from countries to international organizations.
Indeed, the global community later transferred that authority to international institutions by signing the General Agreement on Tariffs and Trade and establishing the World Trade Organization.
But international rules are neither perfect nor comprehensive. China took advantage of this loophole and claimed that its actions against Australia were an “anti-dumping” measure and related to “environmental quality” problems and quarantine issues. The nation never admits that the moves represent economic coercion.
When China suspended exports of rare earth metals to Japan in 2010 following the arrest of a Chinese trawler captain near the Senkaku Islands, the nation said it was cutting the supply for environmental concerns.
Countering economic coercion
Considering such a situation, it is necessary to strengthen cooperation among allies in addition to boosting multilateral functions under the WTO.
I have previously proposed the establishment of the Freedom Alliance Fund as a means for like-minded countries to fight economic coercion in two stages, with the first stage involving a process by which member countries cooperate in designating China’s economic coercion and publicly denouncing the nation.
I believe that this framework will be effective as a deterrent and that like-minded countries seriously discussing the framework itself will have a deterrent effect to some extent.
It takes courage to raise a voice in protest against coercion, even more so if you are not the one being coerced. But if coercion proves successful, it will certainly be repeated.
Therefore, cooperating with Australia today means protecting Japan tomorrow. Protesting against internationally unacceptable economic coercion means being sincere toward China as well.
In 1979, 34 years after publishing “National Power and the Structure of Foreign Trade,” Hirschman wrote a note titled “Beyond Asymmetry” to present his critical perspective on the book.
In the note, he says that while a relationship of dependence created by trade is asymmetrical and stronger nations are better placed, the preponderance may be countered by an asymmetry of opposing desires, such as when weaker nations desire their freedom of domination more than the stronger nations desire to dominate them.
Like-minded countries working together to show their determination to fight coercion is an important step towards deterring coercive actions.
There are other things which can be done to overcome vulnerability.
If a country is overly dependent on another nation for supply of essential commodities, diversifying supplying countries and strengthening domestic production capacity would be effective.
Discussions have started regarding the need to strengthen supply chains among Japan, Australia and India, as well as between Japan and the Association of Southeast Asian Nations (ASEAN), and it is significant to expand this move by cooperating with other countries such as the United States.
To encourage companies to set up production bases in ASEAN member nations and India, it is necessary to improve the investment environment there, including infrastructure development, and this is where Japan can contribute.
It is also important to boost the strategic reserve of essential commodities in the same way as stockpiling petroleum and other energy sources.
Moreover, Article 20 of the General Agreement on Tariffs and Trade (GATT) states that WTO members may adopt trade-restricting measures if they are necessary to protect human life or health, and this may lead to difficulties in obtaining essential commodities in times of emergency.
Revising international rules to limit these export restrictions or like-minded countries agreeing to refrain from using such exceptional measures would raise the stability of procuring essential commodities in times of emergency.
It is reassuring that such moves are already taking place, such as an initiative proposed by the Ottawa Group, a group of 13 WTO partners including Japan, to avoid export restrictions on essential medical goods.
Lastly, it is necessary to be careful to avoid the strengthening of supply chains leading to disguised protectionism. A policy of reshoring all the factories weakens a nation’s strength.
“Economic security is national security” — this phrase, often used in the U.S., is right in terms of what Hirschman calls the influence effect.
On the other hand, economic growth raises a country’s strength and supports an increase in its defense spending, making the nation more secure. In that sense, economy is also national security from the viewpoint of what Hirschman refers to as the supply effect.
Japan needs to strengthen its economic security, but protectionism under the name of economic security — seen in some parts of the U.S. — damages national security by weakening the economy.
It is important to avoid such a pitfall and strengthen and enrich the nation by utilizing the supply effect of trade while controlling the influence effect from trading partners through appropriate economic security policies.
Now we must learn anew from Hirschman’s contributions.
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.