After a period of rapid growth, recent trends in world trade reveal a phase of stagnation. Rising geopolitical tensions have been accompanied by trade restrictions in the name of national and economic security. This column argues that analysis of economic security measures should consider multiple dimensions, including the effect on global supply chains, efficiency, costs, foreign direct investment, trade in services, and international competition.
Recent trends in world trade reveal that the rapid growth at the beginning of this century appears to have ended, ushering in a phase of stagnation. While the factors that caused this paradigm shift should be cautiously identified, it is undeniable that soaring wages in China, which has been supplying vast amounts of low-wage labour to the global economy since the adoption of reform and open policy in the 1980s, and changes in China’s fundamental policies concerning market economy and international order, have had a significant impact.
The conflict between the US and China has intensified. Not only has the Biden administration maintained the majority of US tariffs against China imposed abruptly during the Trump administration, but export controls targeting advanced technology have been strengthened. Chief Economist of the International Monetary Fund (IMF), Gita Gopinath described the current situation as ‘Cold War II’ (Gopinath 2023). It might be correct to say that we have stepped into an era that can be called the Second Cold War, transitioning away from the era of deepening globalisation that followed the end of the US-Soviet Cold War.
Indeed, trade between the US and China declined in 2023, and foreign direct investment (FDI) into China experienced a sharp decrease. The global value chains, which rely on the intricate international division of labour incorporating imported intermediate goods into exports, have shifted to a phase of stagnation or reversal due to the apparent vulnerability to disruption revealed in recent years. The US-China rivalry has escalated beyond the past economic disputes that characterised the Japan-US trade friction into national conflicts involving security concerns including dual-use technology. This is increasing the division of the global economy into the following two rival blocs: market economies with well-developed institutions based on the rule of law, and economies in which the state commonly intervenes and has wide and deep involvement in economic and social activities.
In this column, I would like to discuss the challenges related to conducting economic analyses in such circumstances.
Economic analysis of economic security
There does not appear to be a well-established definition of economic security, but it can be understood as either securing the economic welfare of the nation (economic aspects of a nation that need protection) or as utilising economic measures to ensure national security. Protecting national security is more relevant to recent discussions involving economic coercion. There are various economic measures employed in this context, but trade restrictions are pivotal. When large countries impose import or export restrictions, the terms-of-trade effect amplifies the impacts on trade.
The main topics of economic analysis concerning economic security all involve clarifying the extent and nature of the impacts of security-oriented measures on the economy. A typical example is the analysis of the impact of supply restrictions or import regulations on the production in other countries connected through global supply chains. According to the Ministry of Economy, Trade and Industry (METI) White Paper on International Economy and Trade 2024, it is important to measure not only how dependent the overall trade of a country is on other specific countries, but also to determine on a granular level of item classification and specific input-output relationships the degree of such dependence.
In addition to directly regulated trade, it is necessary to consider the wider effects of reduced efficiency and increased costs resulting from rerouting and substitution. The increased security requirements narrow the range of choices available to firms for profit maximisation and optimisation. Furthermore, measures adopted to reduce risks, such as stockpiling, also incur costs. The benefit of importing a wide variety of goods from around the world at low prices is also diminished, representing a significant burden on consumers, which should also not be overlooked as a significant sacrifice.
As long as we expect that the global conflict can be managed as a cold war rather than leading to kinetic combat like in Ukraine, the scope of regulation should be kept as narrow as possible (as with the ‘small yard, high fence’ concept). It is important for the international division of labour and international trade to continue in relation to a wide range of goods that are not considered advanced strategic technologies in order to mitigate the burden of economic security concerns.
However, the impact of the global division due to this cold war extends beyond trade. One phenomenon characterising the globalisation that has occurred since the end of the last century is the rapid increase in FDI. Recently, FDI is beginning to show a significant decline, and particularly toward China, and since many multinational firms from developed countries (including Japan) conduct much of their production of goods outside of their home country, the impact on FDI is a crucial topic alongside trade.
Regarding trade, it is important to consider not only goods recorded by traditional customs data, but also the impact on trade in services, including intellectual property. While the global trade in goods has entered a period of stagnation, the importance of services in the global economy is increasing as trade in services continues to grow. If the distributions of goods, funds, technology, and information, and even labour are affected, there are concerns that a long-term productivity decline could have persistent negative impacts beyond any decline in short-term production.
International competition for foreign investment based on government subsidies to attract production is increasing in intensity, and advanced semiconductors are a prime example of this competition. A wide range of domestic industrial policies are indirectly related to economic security, so it is necessary to exercise caution to prevent discussions on economic security from expanding too far afield. Regarding domestic support measures, it is necessary to deepen consideration of the economic effects of increased domestic production, of the security risks related to procurement from like-minded allied nations, and the necessity and effectiveness of industrial policy interventions themselves.
Research activities at RIETI
At the Research Institute of Economy, Trade, and Industry (RIETI), research related to economic security has been conducted, particularly focusing on the global supply chains which characterised the globalisation that has occurred since the end of the last century. Professor Yasuyuki Todo of Waseda University, the Programme Director for the International Trade and Investment Programme at RIETI, and his colleagues have pointed out the possibility of experiencing a decline in domestic production that greatly exceeds the amount of imported intermediate inputs in the event of a disruption in Japan, using data from Japan’s input-output tables and other sources. In practice, changes in prices and technology will lead to the substitution of goods from other sources, so it would be beneficial to undertake and accumulate estimates based on alternate scenarios going forward.
Furthermore, while the input-output tables compile detailed data on the transactions between industries, it should be noted that the tables are ultimately aggregated industry figures, representing averages of heterogeneous companies in the same industry. In light of this, there is a need for the use of microdata concerning transaction networks at the firm level. Additionally, the analysis of the influence of security-related export controls on trade flows is closely related to economic security. Senior Fellows Hongyong Zhang and Willem Thorbecke have been focusing on this research area at RIETI.
As economic security has been composed of a broad range of topics that are typically unsuited to economic analysis, RIETI, which primarily focuses on economic analysis, is also engaged in legal research related to trade rules under the leadership of Faculty Fellow Tsuyoshi Kawase (Professor, Sophia University) and his colleagues. With the increasing number of trade restriction measures taken under the justification of economic security and the need to rebuild the now dysfunctional dispute settlement mechanism in the WTO, it is necessary to hold detailed discussions to maintain a rules-based international order.
Research collaboration with think tanks in like-minded countries
Aiming for globally recognised, high-level research, RIETI has been conducting research exchanges with think tanks around the world. Recently, there has been a noticeable trend toward topics related to economic security in such research exchanges with RIETI. Almost all of the international symposiums and workshops held by RIETI recently can be related to economic security. It is important for RIETI to further deepen research collaboration with think tanks from ‘like-minded countries’ that face a similar security environment in mature market economies underpinned by the rule of law, as there are many common topics that must be analysed and issues that need to be addressed.
Visualisation of relevant research findings
Because of the recent situation, RIETI is prioritising research on economic security as a critical issue for Japan’s economy and industries. However, since comprehensive research is inevitably very time-consuming, RIETI has established a ‘Special Feature on Economic Security’ on our website. The site highlights and visualises the relevant research findings that RIETI accumulates. We hope that this information will be of help to those who are interested in economic security in their search for relevant information.
The Berlin Wall stood for 30 years from construction to collapse. The subsequent progress in globalisation also lasted for approximately 30 years. Similarly, many factors indicate that the current new Cold War between the US and China could last for a long period. On the other hand, the security situation is ever-changing, and we must be prepared for the unexpected. RIETI intends to promote research on economic security in a way that is agile enough to contribute to policy through close exchanges of views with policymakers, while simultaneously ensuring that the research can withstand future academic scrutiny.
Source : VOXeu
