Economics of power

by Martin Parkinson

The only serious threat to the real interests of the United States can come from a failure to adjust sensibly to the newer world order.

Paul Kennedy, The Rise and Fall of Great Powers (Vintage, 1987)

 

THE TRANSITION OF power among nation-states creates great complexity and challenges for governments – for the incumbent powers, for the rising ones, and for those that are spectators to the transition. The world is currently in the midst of a marked shift in economic weight from the countries of the trans-Atlantic toward those of Asia. Emerging market economies, which have been supplying around three-quarters of annual world growth in recent years, already comprise half of world gross domestic product and are likely to be approaching 60 per cent by 2030. Much of this growth is driven by Asia, especially China.

This phenomenon raises challenging questions for the United States about its role in Asia and more widely, and how it should respond to the efforts of emerging economies, especially China, to play a more assertive role in world affairs. Chief among these questions include: whether the US can adopt the same posture in the region as it has in the past; what responsibilities it can, and should, expect China to take on; and what role the rest of the region should be expected to play over the decades ahead.

 

WHETHER AND HOW to deploy power is always a conundrum, and never more so than in a fluid and changing environment. The pursuit of influence through economic diplomacy will be particularly important for the evolving role of new and incumbent powers.

The transition of economic weight from the trans-Atlantic toward Asia is playing out in real time, and challenging the institutions and rules that have governed global economic activity over the last seventy years. These emerging economies have become more vocal about the failure of existing institutions and governance arrangements to satisfy their objectives, leading to pressure to ‘rewrite’ the rules and for the creation of new institutions. While it is important to acknowledge that the global rules are always being re-made, typically this is evolutionary – re-tuning in response to economic developments. In contrast, this challenge goes to the heart of who writes the rules, not just the rules themselves.

Notwithstanding this pressure, economic weight does not automatically bestow global strategic power or influence. Accordingly, the key issue is not whether the US is in relative economic decline or whether we are seeing the end of the American Century; the US will remain central to efforts to galvanise institutions and other nations to address global challenges and to deliver global public goods. But the diffusion of power, both among nation-states and from nations to non-state actors, means that the US will need to operate differently than in the past if it is to achieve success. In particular, it will need to be ever more strategic in identifying its core national interests and to be more agile in its response to events. As Joseph Nye noted in Is the American Century Over? (Polity, 2015), in this emerging world ad hoc reactions to events will not be enough – success means the US needs a ‘smart power strategy’.

The rising importance of non-state actors reflects a number of factors, but in large part has been enabled by developments in information technology. The information revolution has brought significant benefits – greater community engagement via social media, for example – but it has also enabled the easier creation of communities of (inimical) interest, while media-savvy entities such as Islamic State have been able to extend their reach beyond historic constraints. Both these positive and negative developments strain government’s capacities to respond carefully to unfolding events.

If a strong international order is a worthwhile objective, a change   to global economic governance arrangements is not only necessary, but inevitable. Failure to recognise this risks eroding influence and capacity to achieve national objectives. However, at this stage there is no clarity about how such an evolved order might look or how the transition to it can be best managed. This throws up multiple questions without answers: will it be more or less liberal than in the past; will it have a greater range of ‘acceptable’ modes of behaviour; how should economic diplomacy be conducted in such an environment; and what capabilities do our institutions and policy makers (including diplomats) need to be successful in such an environment?

The long-term forces that shape the destiny of nation states are fundamentally economic: the response to globalisation; the strength and effectiveness of domestic institutions and the quality of the rule of law; demographics and the development of human capital; the extent to which culture fosters innovation and entrepreneurship; and so on. Failing to recognise the economic underpinning, and failing to pursue policies that foster dynamism, help manage shocks and deliver citizens what they desire and value, risks the capacity to project power and sustain influence. Yet economic success is only a necessary, not sufficient, condition for the sustained deployment of power and the achievement of influence. Without economic success, countries will not have a track record of high employment and rising living standards, of sustained and stable growth, to which others may aspire to emulate. Without economic success, a country will also lack resources to be sustainably deployed to influence others – whether they be military assets, aid programs, cultural and social outreach, or even the effective distribution and use of missions and diplomats.

How countries choose to deploy their economic resources is key, as the relation between economic success and power projection is neither mechanistic nor linear. Clearly, sustained economic success can provide resources that can be used to deploy strong military or other forward-projected forms of power. But equally, countries can erode their capacity to achieve economic success for a long period of time, diverting resources from productive activities to military assets, personnel and equipment. The former Soviet Union was a clear case of a nation able to project military power for a long period in the absence of good economic performance, but at the cost of immiserating its people and sowing the seeds of its own collapse.

Economic success also influences the capacity to project soft power: countries without rising living standards are unlikely to be able to enrich the world with the key cultural industries, values and foreign policies that constitute soft power. However, economic success does not guarantee soft power success if the underlying social model lacks other desirable characteristics. The US has a long track record of developing and projecting soft power well – the Soviet Union did not and, to date, modern China also appears relatively unsuccessful.

Whether countries choose to deploy power is dependent on a range of other issues. US isolationism during the interwar period in the twentieth century could be seen as a failure of power conversion though, to me, this appears to have been a perfectly legitimate and deliberate policy choice rather than a sign of inability (that is, an unwillingness rather than an inability). While China has been gaining economic strength for some time, it had shown little evidence until the last few years that it was interested in deploying its strength to influence others.

Interdependence, as a result of globalisation of trade, capital and labour markets, brings with it great benefits for the global economy but also creates new complexities for countries in the pursuit of their national interests. In particular, rising interdependence, combined with the increasing economic weight of China and other countries with emerging economic power, requires Western nations, and particularly the US, to develop a more dynamic view of relative economic and strategic power, and how best to shape and deploy economic power to achieve national-interest objectives.

Yet very few countries think about policy interconnectedness in a strategic fashion. Indeed, very few countries could be said to do ‘ joined-up’ government well at all, as there is a recurring lack of co-ordination between the strategic, military, economic and cultural institutions within nation-states. While it may be hard to achieve this outcome, especially in democracies, history suggests those that do can have a disproportionate influence at key points in time.


THE US HAS a long and enviable record of bringing together economic, strategic and soft power in the face of key challenges. It has been, perhaps, less successful in more ‘normal’ periods – that is, where change is more gradual – in part, perhaps, because the stakes do not seem to be as high. Perhaps the pre-eminent example of joined-up policy, and the pursuit of economic diplomacy as part of a clear strategic agenda, can be found in the Marshall Plan.

Equally, US leadership in creating the institutions that underpinned the postwar liberal economic order – the creation of the International Monetary Fund, World Bank, General Agreement on Tariffs and Trade, and the World Trade Organisation – helped underpin postwar growth, trade and investment, lifted hundreds of millions worldwide from poverty and delivered rising living standards to billions more. More recently, US leadership in the establishment of the G20, with strong Canadian support, after the Asian financial crisis was recognition that the world had changed and that solving global problems required the involvement of a broader group of countries. The foresight embodied in that decision turned out to be particularly important when collaborative responses were needed to the global financial crisis.

But the question is not about the United States’ track record. Rather, it is whether diplomacy in its current form will be as successful going forward, particularly in Asia. The fact that Asia’s importance has risen, and will continue to do so over the decades ahead, owes much to the US’s underwriting of the liberal economic order. It is that regime of open markets, trade and investment flows, rules and effective institutions that contributed to the environment in which regional economies have been able to grow and develop – from Japan to the Asian Tigers of South Korea, Taiwan, Hong Kong and Singapore, and now China, India, Indonesia and others.

Moreover, it has been US military primacy that has underpinned Asia’s fragile strategic balance. Without both of these contributions, Asia’s recent history and future promise would look much different. This should be acknowledged more often than it is.

But what is striking about postwar Asia is the absence until the 1980s of virtually any regional institutions to support economic growth and strategic stability.

By the late 1980s this was changing, with countries’ acceptance of the concept of an Asia region resulting in the institutionalisation of the reform processes and openness to trade and investment flows that had been fostered by the US and had come to characterise Asia’s postwar economic development. Geopolitical change – the end of the Cold War – was a key factor, leading to ASEAN’s expansion to cover all of South-East Asia, and the broader embrace of regionalism.

The 1989 Asia-Pacific Economic Co-operation initiative – led by Japan, Korea and Australia and designed to embed ‘open regionalism’ – initially struggled to engage the US. After active lobbying of President Clinton by Australian Prime Minister Paul Keating, who recognised that APEC couldn’t succeed without the US – then Asia’s largest trading partner – US engagement resulted in the first leaders’ meeting in Seattle in 1993.

The initial US ambivalence reflected disparate views within Washington as to the appropriate objective for APEC. ‘Community builders’ saw it as fostering greater understanding and encouraging collaborative responses to issues in the region, helping countries become ‘normalised’ to the idea of working together. As such, they took the view that the APEC project required patience and a long-term perspective. Others feared it was a vehicle to exclude the US from security and foreign policy discussions in the region and hence should be opposed, while a third group saw it predominantly as a vehicle to promote economic reform and trade liberalisation.

While ultimately the ‘community builders’ prevailed, the tension between the manner of Asian multilateralism, with its focus on processes to deliver ‘behind the border’ structural change, and the United States’ more immediate focus on reciprocity, has been an ongoing source of friction within APEC.

Even after embracing APEC, the US has often looked to use economic forums to advance broader multilateral interests. For example, the expansion of APEC membership to include Russia, while probably desirable in the long run, added challenging complexity to a nascent institution and likely diminished its effectiveness for some period. The US also diluted the economic focus by broadening the agenda to include non-economic issues such as terrorism in the wake of 9/11. Each of these decisions seemed driven by US interests and short-term imperatives, not the long-term integration of the region. More recently, the same issues are presenting themselves in the G20 leaders’ meetings.

 

BUT IT WAS the handling of the Asian financial crisis of 1997–98 that fundamentally changed Asia’s perception of itself and the nature of US–Asian economic relations.

The US, through the IMF, was perceived as both misreading the nature and causes of the crisis and then orchestrating a response that advanced its own political and economic interests. The IMF’s overloading of the reform agenda, arguably at the behest of the US, was seen throughout the region as ruthless exploitation of the crisis to push countries in directions they may otherwise not have pursued. While the region has conveniently chosen to overlook the culpability of the countries at the centre of the crisis, this perception of the role of the US is now deeply rooted in public and official consciousness.

This experience also directly resulted in the long-term trend of Asia looking for new mechanisms for mutual support in order to reduce reliance on the IMF. This has not only damaged IMF credibility and effectiveness in the region, and arguably beyond, it directly triggered the proposal for an Asian Monetary Fund, which was ultimately killed off by vehement US and Australian opposition; the establishment of the Chang Mai Initiative, which created a network of bilateral financing facilities and foreign currency swap arrangements; and, most damaging to growth prospects, a widespread prioritisation on building foreign exchange reserves as a (costly) form of insurance against refinancing risk.

Moreover, the region, at the time of the Asian crisis, contrasted US behaviour with that of China, concluding that China’s decision to maintain the value of its currency at the height of the crisis and in the face of depreciation and devaluation elsewhere in the region was a mark of leadership, notwithstanding that this was clearly in China’s own narrow self-interest.

The recurring tension between the short-term outcome orientation of the US versus the focus on the building blocks of future co-operation was seen again in the context of the Manila Framework Group, which emerged as a mechanism during the Asian crisis to build confidence in macroeconomic co-ordination and operated successfully for several years, until US reluctance to continue participation triggered its demise. It is an unfortunate reflection on regional inadequacies of the time that member countries couldn’t countenance continuation of the MFG without US involvement. Again, the apparent US rationale was that the pay-offs, as defined by (unspecified) concrete outcomes, were not obvious. In this regard, it echoed the initial disinterest in APEC and the ongoing frustration with its performance.

Such attitudes are, of course, never universally shared within any government, and senior Bush Administration officials privately described the decision to kill off the MFG as ‘one the US would eventually rue’.

These three examples suggest the US has not always understood Asian attraction to open regionalism via a suite of institutions, or how the region thinks about economic co-operation and co-ordination. An affinity for non-interference and relationship building deeply underpins Asian economic diplomacy. America’s default position of bilateral, rules-based reciprocity has worked well with many countries and in some regions for decades, but has a more limited track record of success in Asia. This is something that the US should keep in mind as it responds to China stepping up its role in Asia – the default for Great Powers tends to be bilateral dealings as they are more likely to prevail (which again highlights the enlightened nature of US statecraft in the aftermath of World War II).

Yet the US has also shown great flexibility in other areas, such as championing the creation of the G20 to help strengthen crisis management efforts and the global financial architecture in the wake of the Asian crisis. The 2011 pivot to Asia is a reflection of how core US interests are at stake with the transition of economic weight to the region, and to China in particular. The pivot has embodied traditional elements of both economic diplomacy and military power in the pursuit of strategic objectives.

As part of this, the Trans-Pacific Partnership was an initially well-considered initiative and, if successful, will deliver a strong benchmark for others to emulate. As such, it would be a visible sign of US leadership in the provision of global public goods. Yet, if true liberalisation is the aim it seems short-sighted to keep the world’s largest emerging economy out of a core trading group, one in which it is the major trading partner of most, if not all, members. Moreover, it stands in sharp contrast to the approach taken by Asia toward involving the US in APEC. While the TPP is theoretically open to any country in the region, ANU Professor Michael Wesley asserts that in reality the costs would be heavy for many developing countries, suggesting its existence has spurred China’s ‘One Belt, One Road’ trade, investment and infrastructure initiative.

And whereas the US has prioritised the TPP, and its partner Transatlantic Trade and Investment Partnership, China has put multilateralism at the core of its approach to trade policy, an approach that appeals to much of the developing world and to the other emerging economies.

Looking back, it is hard to avoid the conclusion that, overall, US economic diplomacy has become increasingly more tactical rather than strategic. Far from the clarity of purpose and commitment that underpinned US leadership in the formation of global institutions and their initial direction, US strategic intent has been increasingly difficult to discern. This can be seen repeatedly, from the failure to deliver on US-championed IMF quota reform to the response to the proposal to establish the Asian Infrastructure Investment Bank (AIIB), or the willingness to undermine US credibility with the pursuit of short-term domestic political agendas across multiple forums.

 

TO SOME EXTENT, this echoes criticism of US diplomacy more broadly – in particular, that the collapse of the Soviet Union took away the organising framework for thinking about how to achieve US national interests and allowed the pursuit of short-term, single issues without any strategic connection. The apparent focus of the US on short-term expediency at the expense of long-term goals all raise questions about what has been, and what may become, the organising framework for US economic diplomacy in the Asian region. This question becomes more important as it becomes harder for the US to unilaterally determine the rules of the game – the costs of short-termism are rising.

This raises two intriguing questions. First, does China risk becoming a new organising principle for US policy if it pursues a determined strategy to displace the US as the pre-eminent power in the Indo-Pacific? Second, will the structural slowing of China’s economic growth rates change perceptions about the speed of US relative decline? If so, it would be a clear case of economic outcomes with strategic consequences.

Far be it, though, for an Australian to criticise US diplomacy – Australia’s own history of economic diplomacy is, at best, a mixed bag. As a small open economy, Australia has benefited from the US-led liberal international order. It was Australia’s ‘mates’ who wrote the rules and Australians have benefited from that – but, increasingly, it will not be the West holding the pen, so we also ask ourselves how should we respond?

Australia faces a reality different to many other countries. As the Secretary of Australia’s Department of Foreign Affairs and Trade, Peter Varghese, has noted, Australia belongs to no natural global, regional or cultural grouping, and ‘cannot bully or buy its way in the world’. This has made us firm advocates of multilateralism alongside our bilateral relationships – indeed, both are ‘anchored in our national interests’. But Australia has also long recognised that its economic weight and influence in global forums are a direct consequence of what happens at home – that is, policy success begets both greater economic weight and global influence. But unlike the US, Australia lacks what economists call ‘market power’ – it is effectively a ‘price taker’ rather than a ‘price setter’ when it comes to global rules and institutions. Accordingly, Australia has a long history of trying to use its limited influence to strengthen existing global institutions, to a degree that some might say is annoying.

Like the US, however, Australia has not always been as strategic as possible in pursuit of national interests – witness the strident opposition to the Asian Monetary Fund proposal, which damaged Australia’s credentials within the region for several years, and the opportunity missed to shape the AIIB with an initial rebuff of China, notwithstanding China’s genuine efforts to respond to Australia’s concerns.

This being said, successive Australian governments have recognised the centrality of a successful and effective G20 to the pursuit of national interests. Were the G20 to fail, politicians and policy makers recognise that Australia may not have a seat at its successor. It is this realisation that underpins the extensive efforts Australia makes in this forum, especially during its 2014 presidency.

 

WHILE THE COLLAPSE of the Soviet Union left the US as the dominant global power economically and militarily, that dominance has come to an end, replaced by continuing US pre-eminence accompanied by the rise of other countries, each individually weaker on each dimension of power, yet able to stymie or challenge, although not displace, the US on different issues at different times.

As a result, we now live in a world where no country indisputably leads, and this makes for a more fluid environment where regionalism and plural narratives are more likely to be the order of the day, as Amitav Acharya explores in great detail in The End of American World Order (Polity, 2014). This is a change in circumstances in terms of the breadth of issues and the number of countries able to constrain American capacity for unilateral action, or required to be ‘on-board’ for effective multilateral responses to issues.

Arguably, the issues confronting the world – transnational threats like weak global growth, terrorism, pandemics and climate change – and the diffusion of power from nations to non-state actors, make multilateralism critical at a time when it appears in crisis. What is unclear is whether this crisis is, as Peter Varghese has asked, transitory or permanent.

While economic power has been multipolar since well before the global financial crisis, with the emergence of the European Union and the strength of Japan in the 1980s, the rise of other countries, especially those that don’t automatically share Western liberal values, creates greater complexity than that offered by either Japanese or European economic success, or indeed that when faced by one single rival in the Soviet Union. And while the transition of power among large individual nations is tricky, history can offer something of a guide. What is unknown is how best to manage the likely more difficult diffusion of power among multiple states and away from governments to non-state actors.

 

IT IS CLEAR that China has neither the capacity nor inclination to step forward, at this stage, as a consistent supplier of global public goods. However, while it is generally content to support the existing global institutions and rules, it clearly wants a greater role in being able to help shape governance arrangements, including through the creation of new institutions.

In the mid-2000s, then US Deputy Secretary of State Robert Zoellick couched the emerging situation as one where success would see China become a ‘responsible stakeholder’. While this concept garnered support in many circles, for emerging players it invoked the reaction of: responsible in the eyes of whom?

If it meant Chinese conformity to Western modes of behaviour and a passive agreement to rules and institutions created without its input, China was never likely to accept its role being defined in this way. And this was the case even as China recognised the importance of those rules and institutions for its own impressive economic development.

Indeed, how we respond to China’s rise will itself help shape China’s behaviour. Therefore, a more realistic objective should be to, in Joseph Nye’s words, ‘shape the environment for China’s decisions’ – and indeed, for the decisions by emerging economies more generally.

Chinese economic diplomacy has been remarkably deft in recent years, geared to its long-term objectives and clear in its support for open markets (especially in other countries) and strong multilateral institutions, even if its broader strategic impact has been undercut by fears of increasing militarisation and regional assertiveness. Some of this is clearly strategic positioning and in China’s own interests as the world’s largest trading nation. Some is clearly designed to reflect well on China’s model of growth in order to amplify its attraction to others. But some of it is also because China recognises it has been a beneficiary of the US-created global economic order and that the robustness and credibility of this regime is important to its own long-term prosperity.

Equally, China is building a track record of effectively using various multilateral forums. In 2014 it successfully hosted APEC, working closely with Australia to ensure the APEC and G20 agendas were mutually reinforcing. On a number of occasions during Australia’s G20 host year, China was a critical and highly effective supporter for ambitious action.

China’s hosting of the G20 in 2016 will be a significant opportunity on a number of grounds. It will clearly invest in the G20 as a mechanism to build trust and better co-ordinate growth initiatives in the face of continuing weak global outcomes. It is also highly unlikely China will overload the agenda. Rather, it is likely to focus on delivering existing commitments and a small number of high-impact key initiatives – given its own history, I anticipate a focus on development, outward-oriented growth and inclusive institutions.

Considered strategically, China’s hosting also provides a significant opportunity for the US to work closely with it on issues of mutual importance – the question is whether the US is willing or able to take advantage of this opportunity. This questioning of US willingness and ability may sound harsh, but it reflects an increasingly held view in parts of the region that, in recent times, despite the TPP, the US has not displayed leadership on key economic issues other than bilateral ones – this is seen as reflecting an unwillingness to lead on some issues and ineffective attempts on other occasions because of an unwillingness to accept that the world has changed.

In particular, the often singular focus of the US on global imbalances and exchange-rate manipulation is widely seen as a reflection of domestic political imperatives. In part, this seems to reflect a concern that it cannot be expected to be the sole driver of global growth – but the reality is that it hasn’t been for quite some time. Moreover, a continuing tendency to criticise Chinese exchange-rate policies will challenge the abilities of the two superpowers to co-operate to ensure that minimal global dislocation results from China’s impending capital account liberalisation. This requires a huge transition in approach from both countries.

 

THE CRITICAL POINT from all this is to acknowledge that most of the emerging and developing world does not share the West’s ‘world view’, and that changing economic weight makes it harder to ride roughshod over their objections to the West’s objectives or means of achieving them. Carrying on business-as-usual in a world where others are able to effectively block what is desired is a recipe for frustration and disillusionment for all involved, and risks further eroding support for multilateral responses to transnational issues, not to mention guaranteeing no actual progress on addressing issues of real importance. The world has changed and will continue to change as power moves between nation states, changing the relative balance, and diffuses across more countries and non-state actors.

These changes are important, but they are not existential for the US – dominance is being replaced by pre-eminence and the US will remain critical to the world’s capacity to act on global problems. The key challenge for the US will be how to frame its strategic objectives and economic diplomacy strategy for the long-term, and against a different backdrop to that of the last quarter-century. Importantly, the US has time to make these changes and to prepare itself for a more challenging environment in which to conduct its economic diplomacy.

For all countries, a few key messages are common.

First, while non-state actors are increasing in importance and will complicate the pursuit of objectives in ways never previously seen, only nation states can negotiate and then deliver economic frameworks. However, how these outcomes are negotiated internationally, and then implemented domestically, needs to change to reflect the changed realities of the twenty-first century.

Second, policy success begins at home – delivering growth and economic outcomes that citizens value. Domestic success is the foundation for successful economic diplomacy. Good domestic outcomes both increase relative economic weight and create models that others may aspire to emulate.

Third, it will be increasingly important to reflect on the skills and capabilities required by foreign ministries, treasuries and other economic institutions if they are to produce the economic diplomats who can succeed in this new environment. Efforts will also be needed to ensure greater co-ordination among institutions in national capitals.

Fourth, the world needs more combined US–Chinese leadership in shaping global economic institutions and addressing transnational issues. China cannot avoid this responsibility, but it will fall on the US to facilitate and ultimately accommodate this. US economic diplomacy in Asia since the 1990s has been characterised by periods of strong and effective leadership interspersed with periods of ambivalence and short-sightedness. When the US was the world’s indispensable power, such an approach carried limited costs for sustained US influence. That world, though, is rapidly receding.

For the world, the role of the US in galvanising institutions and groups of countries to address transnational challenges will remain crucial. How best to use US power to accomplish joint objectives, in circumstances where absence of support from other key countries will assure failure, is something that will be determined over time. As such, clarity of strategic objective and a flexible and adaptable style of leadership will be central. What it will require is an agility in approach that can both embrace unilateralism on some issues while recognising the importance of multi-polarity and collective action on others. Again, to some extent this is not new – rather, it is that the balance of options is moving away from unilateral action and, hence, constraining the US’s degrees of freedom to act, and raising the value of agility.

It will be an uncomfortable journey for all of us.

 

This is an edited version of the Warren Hogan Memorial Lecture, delivered at the University of Technology, Sydney, on 2 December 2015, which itself is drawn from a longer paper ‘US Economic Diplomacy: A View from Afar’, delivered at a public lecture at Princeton University on 28 September 2015 and available as Princeton University Griswold Center of Policy Studies Working Paper 246. The ideas reflected here have been long in gestation and have been developed through many conversations with individuals too numerous to mention. I would like to express my appreciation, though, to three people who have particularly influenced my thinking about international and strategic issues over the years: Allan Gyngell, Heather Smith and Peter Varghese, none of whom can be held responsible for these views.

From Griffith REVIEW Edition 51: Fixing the System © Copyright Griffith University & the author.