EconoMonitor

Policies of Scale: Efficient Global Policy

Linchpin Politics: The Economic-Foreign Policy Nexus

We talk a lot about how geopolitics affect economic performance, and vice-versa. But we miss the importance of the overlap between the two policy sets. With American economic and foreign policy barely containing crises, it is time to consider the two, together, in the same conversation.

We talk a lot about how geopolitics affect economic performance, and vice-versa. Conflict puts physical distance between labor and capital (and often destroys some of both), driving down productivity and driving unemployment and costs up. It drives investment out of some places and into others, and interrupts supply chains. Investors and businesses spend some of their time looking at geopolitics in the process of determining how and where to conduct business.

In the same vein, economic considerations constitute major factors in political decisions that affect foreign relations. Exporters and importers have to take into great consideration how their political actions will affect their ability to buy or sell the products they produce or consume.

There is significant overlap between the economic policies of a country and the foreign relations decisions it makes. In some cases the overlap is so unavoidable that it is explicit; trade agreements between two or more nations, for example. In others, however, it is harder to detect. An example of this type of overlaps is how American domestic financial regulatory decisions affected its influence in United Nations bodies working on altogether different issues (this will be discussed more in a separate post).

This kind of overlap represents the economic-foreign policy nexus. C. Fred Bergsten, among other impressive bona fides the former head of the Peterson Institute, understands the economic-foreign policy nexus better than most. He illustrated the importance of the nexus well in an interview with Daniel Drezner in Foreign Policy:

“When Henry Kissinger was national security advisor under Nixon, he asked me to take a job as one of his economic deputies. He said, “Fred, I want to make a deal with you. You do everything in my name and never bother me.” I was 27 years old. It worked for a couple of years, but then some really hot issues started to require his personal involvement, and he just wouldn’t do it. After a few months of that, I went in and told him I was quitting. He was shocked and asked why. “Henry, arms control, U.S.-Soviet relations — all those things can wait until you clear your inbox,” I said. “But the world of economics and finance does not wait until you clear your inbox. And therefore I can’t do my job right.”

Bergsten’s point is still critical today: Since economics is the first priority of effectively every country (after all, the Cold War ended with a USSR collapse largely because Moscow could no longer afford its communist model), a country’s treatment of matters of economy goes far in shaping global attitudes towards it on a variety of issues outside the economic sphere, meaning a country’s ability to achieve foreign policy or national security goals is tied to its economic performance and reputation. This is the most critical link in the economic-foreign policy nexus.

In 2011, as the BRICS countries seemed to be weathering the Great Recession better than developed economies, these developing countries began publicly questioning the wisdom of continuing to use the US dollar as the de facto global reserve currency. They argued that because America’s irresponsible regulators and financial sector was the center of global finance and the epicenter of the global recession, the world should no longer emulate American economics or operate according to Western-created international economic system. The dollar could not be trusted.

This weakening of the American economic position resonated so far around the world that it made its way back to a 2011 Congressional hearing in which General Martin Dempsey, speaking at his nomination for Chairman of the Joint Chiefs of Staff Senate hearing, famously announced that the greatest threat to US national security was its fiscal position.

Even with Dempsey’s warning, the potential repercussions of a loss of America’s economic leadership position on America’s foreign policy strength seems to have gone largely underappreciated. Most Americans, for example, do not appreciate just how valuable the status quo global economic system is to them personally and their country writ-large. Losing the “Exorbitant Privilege,” as Barry Eichengreen titles one of his book, of the US dollar as the de facto global currency would verge on disastrous for the US economy. The dollar is used in approximately 85% of all foreign exchange transactions world wide, according to Eichengreen’s book, and accounted for over 60% of global reserves in the third quarter of 2014 according to the IMF. This means the US is the recipient of extremely favorable seignorage. The US derives essentially free borrowing and free goods from foreign governments and private companies who buy and transact in the dollar because of the monetized demand for what is essentially a high profit margin product (greenbacks). It also means that US borrowers, public and private, enjoy artificially low interest rates because of high global demand for one domestic currency.

Beyond the dollar, the US-developed and led global economic system that has facilitated a lot of global economic growth was put at risk by America’s poor economic performance. This system facilitated the “rise of the rest” developing economies and generated, largely on the strength of the growing American economy, world gross domestic product in 2011 that was about 51 times larger than it was in 1960. Yet by 2011 America’s economic performance and policies had become liabilities that were sapping strength not only from its international position, but also the legitimacy of the international system responsible for dramatically improving life around the globe since World War II. It was no coincidence that some rising economic powers and historically influential countries amplified their calls for diversifying permanent leadership in the United Nations Security Council around the same time.

Thankfully, however, as seemingly better performing alternative models began showing signs of thinning economic strength while America weathered the storm, world leaders came to appreciate the potential for disaster if they changed global economic institutions to minimize American and European influence while also weaning themselves off their dollar-denominated reserves without an established alternative.

Subsequently, America benefited from a sizeable flight to safety as countries and investors clamored to scoop up dollars. Yet the decision to continue with the status quo was not for any proactive US strategy or even a cogent domestic economic strategy, but rather for a lack of better options. This may be a bit overly pessimistic, but the US proved to be the best of the bad, and that’s why America is still the leader of a surviving international economic system that still bears its fingerprints.

The international economic system matters for reasons beyond facilitating global prosperity and its serving as a means for America to foster a world system that facilitates personal, political, and economic freedom. It also serves as a venue for America to demonstrate its influence and reach beyond economics. Since economics is any government’s top priority in situations where their security is not existentially threatened, US foreign policy outcomes tend to be more favorable when the international economic system is held in status. America wins when the world adheres to and upholds the system, so strategizing policy to encourage adherence to the economic system is vital to good outcomes in other areas like security.

Hong Kong presented an opportunity to advance adherence to the system in Asia. The massive protests last year against China’s subtle but effective pressure on the Hong Kong government to increasingly limit democratic governance triggered uncertainty in the international economy over the future of Hong Kong’s ability to be a free market gateway to a region largely dominated by less than free economies. In the world of foreign policy, the discussion focused squarely on the impact China’s actions would have on the future of political rights in Asia. Both of these are valid concerns with major long-term implications. It was therefore a shame that economic and foreign relations considerations elsewhere in the world held countries back from more demonstrably standing up for the people of Hong Kong.

The world had two opportunities: one to defend democratic Hong Kong against autocratic China, and a second to defend the free-market system of Hong Kong against the centralized economic system of China. Not only does Hong Kong present the better model of governance, but it represents the better economic example as well. Further, protecting Hong Kong now is an important investment in seeking long-term governance and economic reform in China and greater Chinese adherence to the international economic system.

Having protected neither good governance nor the international economic system, the door was left open for China to increase its influence and grip over Asia and impose its ways on the international system. On Monday, March 17th, German, France and Italy announced that they intend to join Britain in joining the Chinese-led Asian investment bank that the Obama Administration has said would be a rival to the World Bank and other global institutions. With multiple requests from the Administration to not join, the European leaders’ decision represents a rebuke against the system they helped America build 70 years ago. The appeal of China’s export and investment markets is simply too strong for the fledgling European economies to ignore considering China’s economic growth remains strong by global comparisons.

At issue is not so much the establishment of another development bank, but the way in which China systematically circumvented the established international economic system and willingly undermined it. Rather than approaching the G7, as the Obama Administration had counseled, it set a deadline (end of March) to join the new bank and then went one-by-one to pick of G7 members (it is likely on Japan and the US will not join). China has long resented the American and European dominance of the World Bank and the IMF, and its new development bank is the result of a “power struggle” that has “moved beyond the world of 1945” as one senior European official put it.

This power struggle goes beyond regional or even economic power. In its crosshairs are the global institutions that define and distribute global influence, and it should be of no surprise to anyone that the main targets for China are the economic ones because these are the source of the most influence. The way in which the bank is being planned, it appears likely that China will be at the center of its operations and decisions. It remains unclear what power its European members will have, other than the ability to bless and finance infrastructure projects that are likely to be dominated by Chinese companies. The main motivation for the Europeans to join, it seems, is to avoid angering China’s government.

Whether the correct response that would uphold the established international economic system in this case is following through on promises to give developing countries greater influence in international institutions as Secretary Jack Lew has suggested may well be determined by how committed these developing countries are to upholding the system. This question is certainly what is holding up the United State Congress from approving such a transfer of power.

It appears at the moment that America’s weak reputation in international institutions, economic and geopolitical, is making it easier for its competitors to peel away America’s allies. It is hard to imagine an international system created in the image of China can produce the kind of economic growth created by the current system while also producing the kinds of political and individual freedoms that make it the better system. The nexus between economic and foreign policy is where this will be determined.

 

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