Tag Archive for: Economics

It’s been done before: pay for more defence spending with debt

Australia, Britain and European countries should loosen budget rules to allow borrowing to fund higher defence spending, a new study by the Kiel Institute suggests.

Currently, budget debt rules are forcing governments to finance increases in defence spending with savings elsewhere or with taxes. But the study, examining military build-ups across 22 countries over the past 150 years, shows that defence spending increases have almost never been funded by spending cuts and that tax increases generally come later.

The larger the military build-up, the more governments rely on deficit and debt financing. These findings are consistent with economic theory, which suggests a mix of deficit and tax financing, with deficit financing playing a dominant role in large, short-term build-ups.

Australia has been under pressure to increase defence spending ever since 2010–11, when cuts reduced the defence share of GDP to just 1.6 percent, the lowest since 1938.

Earlier Kiel Institute research shows defence spending across the G7 advanced nations has been at a record low. The Trump administration has pushed allies to raise defence spending above 3 percent of GDP and has challenged their assumption that the US military would always be there as a backstop to their national security.

Last week, Germany’s incoming chancellor, Friedrich Merz of the Christian Democratic Union, won agreement from the Social Democrats and the Greens to exempt defence spending from the country’s strict limit on debt, enabling a defence build-up.

The European Union has also proposed bending its fiscal rules to allow member states to lift defence spending by up to 1.5 percent of GDP over a four-year period.

In contrast, Britain’s Keir Starmer is sticking to rules demanding a return to a balanced budget by 2029. The Labour prime minister said reaching a defence target of 3 percent of GDP would have to be funded by tax increases and spending cuts, starting with a cut to foreign aid from 0.5 percent of GDP to 0.3 percent.

In Australia, the fiscal strategy of the Labor government of Prime Minister Anthony Albanese requires that spending growth be limited until government debt is ‘on a downward trajectory’ and that most of any improvement in tax revenue should be used to lower debt.

The rule is not ironclad and allows for exceptions. But in practice, the increased defence outlays recommended in the Defence Strategic Review have been funded largely by cuts to existing defence programs until 2027–28, when Treasury predicts gross debt will start falling.

The Kiel Institute says Britain showed the folly of putting budget rules ahead of national security in the 1930s.

Despite massive external threats, it maintained a balanced budget and reduced its debt to GDP ratio until the late 1930s. It thus places concerns of debt sustainability and currency stability above the growing concerns of war.

Britain’s Treasury regularly rejected requests for increased defence spending during the 1930s and, the Kiel Institute argues, contributed to the British policy of appeasement. Britain’s defence spending was below 3 percent of GDP until 1937. In contrast, German military outlays had been more than 10 percent of GDP since 1935. While the British budget was balanced, Germany ran large deficits, funding its military with debt.

The defence spending increase being envisaged across the advanced world is much smaller than would be needed to prepare for war. During World War II, combatants devoted between 40 and 70 percent of their resources to the war effort. In Australia, spending rose to 40 percent of GDP in the early 1940s.

The Kiel Institute research, which excluded both world wars, identified 113 examples of military build-ups where spending rose rapidly over at least two years.

On average, military build-up raised defence spending by about 1.5 percent of GDP and occurred over a five-year period.

The central finding was that health and education spending grew at similar rates during periods of military build-up and when defence spending was level or declining. Total non-military spending rose more rapidly (about 0.75 percent of GDP a year) during periods of military build-up than when military outlays were level or falling.

During military build-ups, budget deficits grew by an annual average of almost 0.5 percent of GDP but declined on average in normal times. This shows the dependence on debt. Tax revenues rose by about 0.75 percent of GDP a year during military build-ups, compared with about 0.5 percent in normal times.

The paper said governments should rely on borrowing to fund increased defence, at least in the short term.

To manage the resulting debt burden in the medium term, governments could raise taxes, reduce tax avoidance and exemptions, and temporarily freeze the growth of consumptive government spending, such as social transfers and subsidies.

When dealing with China, Australia must prioritise security over economics

China’s economic importance cannot be allowed to supersede all other Australian interests.

For the past couple of decades, trade has dominated Australia’s relations with China. This cannot continue. Australia needs to prioritise its security interests when dealing with Beijing, and it shouldn’t overestimate or overstate its vulnerability to China’s coercive trade practices.

Prioritising security is particularly important as we confront escalating global competition and China’s increasingly assertive behaviour. China’s live-fire exercises in the Tasman Sea have once again brought attention to the growing threat of aggressive Chinese military actions in the Indo-Pacific.

The exercises were conducted in international waters and violated no international law. But the behaviour broke norms and was less than ideal: usually, such exercises are preceded by adequate early warning to affected countries. In this case, neither Australia nor New Zealand was informed, and early reports suggest that passenger aircraft that were already enroute were forced to reroute because of the exercises. This is unacceptable international behaviour, and the Australian government should not be shy in saying so.

Australia has been more than accommodating of China. In response to press questions on live-fire exercises, Prime Minister Anthony Albanese said China ‘could have given notice but Australia has a presence from time to time in the South China Sea’. This framing was unwise, to say the least. Albanese no doubt wishes to avoid escalation, but it is unnecessary to provide such false equivalence, which Beijing could exploit. The comment offers China a free pass.

Economic issues are important for political leaders, especially in democracies, where everyday issues take precedence even over discussions about national security. This is probably why Albanese highlighted the government’s success in boosting trade and addressing disputes with Beijing—even though many of these disputes were of China’s doing, rather than Australia’s.

But Australian leaders should also recognise that China is not simply doing us a favour by trading with us. It benefits from the goods and services that Australia offers and the revenue from what it sells. This is a mutually beneficial relationship, and disruptions will affect China too.

While China may be able to source its mineral and other resources from other parts of the world, Australia can similarly find other markets for its resources, as it has in response to previous Chinese trade obstruction. China buys from Australia for a variety of reasons, including price, quality and the predictability of supply. These are not values it can get from anywhere. In many countries, resources are in conflict zones that are difficult to access.

Any trade disruption would likely hurt Australia more than it would hurt China, but it would still damage China’s economy. There is a reason why previous trade punishments have targeted a few niche products, such as wine. China has not targeted critical items, such as mineral resources, precisely because it knows that its own economy would face difficulties if it did so. As China’s economy slows, the cost of transitioning away from Australian goods and services rises.

China has repeatedly used trade sanctions against smaller economies—such as Norway, Canada, Sweden and Mongolia—for perceived slights and other political reasons. But it has never really benefited from doing so, instead gaining a reputation as a bad and unreliable actor. Its trade threats in the past few years have been more bark than bite, with most targeted countries, including Australia, standing their ground and China eventually backing off.

While Australia should not pursue trade confrontation, it may be similarly unwise to emphasise or exaggerate its vulnerability, as this will only invite pressure. Rather, Australia should initiate talks with its European and Indo-Pacific partners, as well as the US, to present a united front against such threats.

China can make threats and apply sanctions only against countries with smaller economies, and only because it thinks they will have to face such sanctions alone. Even if sanctions are ineffective—as indeed they have been—we cannot let China assume that it can get away with such behaviour without consequences. A united response to China’s trade bullying is needed to deter and, if deterrence fails, punish China for such aggressive actions.

Political leaders in democracies no doubt have a hard time balancing economic and security requirements in foreign policy. But they should avoid over-emphasising trade and economic factors—Beijing will assume these are pressure points when leaders talk as if they are. Australia must instead emphasise that it will not bend to such tactics.

ASPI USA roundtable: Trying to understand US economic statecraft

Governments are outraged, industry leaders are keeping a low profile, and economists and analysts are confused as they work to understand how the Trump administration’s approach can make the United States simultaneously safer, stronger and more prosperous.

In its first month, the Trump administration has shaken up the world trading system as it uses tariffs to try to promote US investment, productivity, industrial and technological advantage; defend US economic and national security; and help US workers.

An ASPI USA discussion with Claire Chu, Aaron Glasserman, Kimberly Donovan, Phil Rogers and William Alan Reinsch this month focused on what this approach means for US-China relations. This is the first in ASPI USA’s series of Chatham House roundtables to consider the Trump administration’s approach to geoeconomics.

The administration has imposed a 10 percent general tariff on Chinese imports, adding to economic measures established under the previous Trump and Biden administrations.

It has threatened to impose 25 percent tariffs on aluminium and steel not made in North America, reciprocal tariffs on all countries, 25 percent tariffs on automobile imports, and tariffs of at least 25 percent on pharmaceuticals and semiconductors. The US will also place 25 percent tariffs on imports from Mexico and Canada, unless these countries can further appease Trump. This is all before considering retaliatory tariffs levied on the US.

If a country adds a tariff to protect an industry, it does so by making foreign goods more expensive and domestic goods relatively more attractive. If the protected local companies then enjoy a larger market, they may expand their workforces.

But tariffs could also lead to job losses in non-protected industries. When companies pay more for imported inputs, they may pass on the higher cost to consumers. They may shrink their workforces, too. Costs would rise for US imports with no domestic alternative, affecting businesses downstream. For example, placing a tariff on coffee would increase prices for cafes. This might then affect bakeries that supply the cafes, as some consumers decide not to buy coffee.

The administration wants businesses to invest in domestic manufacturing, but this will take time. Tariffs and export controls, together with incentives, have led to reduced US investment into China, with some returning to the US. However, Donald Trump has questioned the value of mechanisms incentivising business to relocate. He suggested he might abolish the CHIPS and Science Act, a law that provides funds and incentives for semiconductor research and production in the US. He has also paused disbursement of grants under the Inflation Reduction Act, which seeks to do the same with renewable energy.

Broad tariffs increase production costs, which in turn inflate consumer prices. They also undermine US export competitiveness by increasing production costs and strengthening the dollar, leading to inflation and fewer jobs in the short to medium term.

The US must also consider how applying tariffs on allies and partners will affect its reputation. Imposing tariffs on any country the US perceives as having an unfair trade deficit, including when this is for a single sector within a broader trade surplus (for example, aluminium from Australia), signals a shift toward purely transactional economic relationships.

An apparent US disregard for decades of strategic and security cooperation will erode trust in US leadership, particularly among allies. This will reduce its ability to rally international partners for broader strategic objectives.

The proposed tariffs might also affect the US’s ability to counter China in the Indo-Pacific, particularly regarding Taiwan. Tariffs on Taiwanese goods, targeting its world-leading semiconductor industry, could impact Taipei’s calculus about whether its alignment with the US is in its best interest.

US tariffs could also affect Taiwanese public opinion, influencing voters to reconsider the viability of self-determination and strategic alignment with the US. This would be a gift to China as it works to lure Taiwan to unite with it.

The loss of Taiwan would undermine US national security; isolate key US allies and trade partners; make the 80 percent of global trade that passes by Taiwan and the South China Sea vulnerable to Chinese manipulation; and reduce US commercial access to 60 percent of global GDP.

Further, the Trump administration’s use of economic measures to elicit political outcomes—such as against Mexico to get action on the southern border or Columbia on illegal migrants—undermines its ability to call China out when it does the same.

Campaigning for election, Trump and his supporters boiled his trade proposals down to creating jobs and lowering prices, which would make the country safer, stronger and more prosperous. If the above principles of economics stand, then we must ask why the administration is using tariffs in contradictory ways.

At the roundtable, some experts pointed to Trump’s long-held view that allies and adversaries had taken advantage of the US for decades on trade and security. Others noted that with the national debt at more than US$36 trillion and still climbing, Republicans were willing to back Trump’s deal-making skills to lift revenue and get more favourable trade and political outcomes. While Elon Musk’s effect on trade policy was unclear, maybe the tariff on China being set at 10 percent instead of the foreshadowed 60 percent was because of his investment in the country.

At this stage, it is hard to see a strategy behind the tactics being employed.

The strategic importance of the Whyalla steelworks

Australia has been losing so many sovereign manufacturing capabilities over the past two decades that it is hard to know where to draw the line. The Whyalla steel mill may mark the spot.

The Australian and South Australian governments certainly seem to think so. Prime Minister Anthony Albanese on Thursday said the two governments would spend an immediate $484 million, mainly to keep the works going during the period of administration that the South Australian government initiated on Wednesday.

And they allocated $1.9 billion for upgrading the plant when it is under a new owner. It has been owned by GFG Alliance, chaired by British businessman Sanjeev Gupta.

The machinery of the Whyalla steel works is antique, having started production in 1965, and it supplies, in a good year, only about 15 percent of Australia’s steel needs.

However, it is the only domestic source of long steel products, such as structural steel and rail. The steel billet it sends to Newcastle for rolling is the only domestic source of reinforcement bar for the construction industry.

Bluescope’s Port Kembla steelworks, by contrast, is focussed on coil, which is turned into flat products such as roofing.

Whyalla’s steel is relatively free from impurities, meaning it has strategic importance for military manufacturing, including for the Benalla munitions plant. Electric arc furnaces cannot match the quality of blast furnace steel. In addition to Whyalla, Sanjeev Gupta’s GFG Alliance controls arc-furnace steel operations at Laverton in Melbourne and Rooty Hill in Sydney.

The structural steel and reinforcement bar coming from Whyalla could all be imported—indeed last year a record 3.1 million tonnes of steel product was imported as distributors sought to manage their insecurity over Whyalla’s steel supplies. There is no alternative global producer of Whyalla’s rails, which are made to unique Australian standards.

There was no federal government intervention last year when chemical company Qenos shut down the last two petrochemical plants in Australia capable of making polyethylene, the essential ingredient for most plastic products. The plants are to be demolished to make way for industrial property development.

Australia’s only stainless steel plant was shut in 1996, the only tinplate plant in 2006 and the last aluminium rolling mills in 2014.

The motor industry, which was the most advanced integrated machinery manufacturing operation in the country, was shut down between 2015 and 2017.

Market forces have been allowed to bring the destruction of domestic manufacturing capability, with the standout exception being the Morrison government’s 2022 decision to extend subsidies to ensure the survival of the last two oil refineries, Viva in Geelong and Ampol’s refinery at Lytton in Brisbane. This followed the closure of Exxon’s Melbourne refinery and BP’s Kwinana refinery the previous year.

There was a strategic argument that Australia needed to preserve a domestic capability to make diesel fuel, even though the remaining refineries are only a fraction the size and efficiency of the plants in Singapore, South Korea and China that supply most of Australia’s needs more cheaply.

The government’s Future Made in Australia strategy for reviving Australian manufacturing has two streams: one devoted to sectors that will contribute to lowering carbon emissions, and an ‘economic security and resilience’ stream aimed at supporting sectors vulnerable to supply disruptions and that require support to unlock sufficient private investment.

The second stream looks tailor-made for Whyalla. While the federal government is presenting its rescue as a green-steel initiative, what is most urgently required is a reline of its existing coal-fired blast furnace. The technology for hydrogen-fuelled blast furnaces, which could make green steel, is not yet proven and would not be viable for Whyalla.

While government rescue finance is welcome, the plant needs a corporate saviour.  Buying the Whyalla works is probably not what Bluescope Steel has in mind for strategic diversification, although a national purchase would have political appeal. South Korea’s Posco was interested in Whyalla when the plant’s former owner got into financial difficulties eight years ago. The government may be able to use the strength of its relationship with Japan to entice an operator such as Nippon Steel into the fray.

What is disturbing is that the decision to provide support is reactive and ad hoc, as was the case with the decision to save the last two oil refineries. There is no strategy spelling out what manufacturing capabilities Australia possesses that must be preserved in the interests of sovereignty.

The Swiss resources group Glencore said late last year it would shut its Mount Isa copper mine but that its copper smelter in the town and its Townsville copper refinery would keep going with third party supplies. Should those operations become marginal, would an ability to produce refined copper be deemed strategic?

Diesel, steel and cement are arguably the most basic industrial inputs to national security, for which a domestic production capacity should be retained.

There is an interesting story about cement. In the early days of the Covid-19 pandemic, many Chinese businesses faced mandatory shutdowns and China’s exports plunged. Australian quarries providing the stones to turn cement into concrete soon found they could not get the cutting tools they relied upon, raising concerns about their continued ability to operate. There were other manufacturers in Germany, but there was also a rush on their supplies.  Chinese cutting products returned, but the episode showed that even concrete is vulnerable to trade disruption.

Whatever the arguments for retaining a domestic ability to make steel, dreams of self-sufficiency or autarky are not realistic.

Manmohan Singh leaves a large strategic legacy

Former Indian prime minister Manmohan Singh, who has died aged 92, made an impressive contribution to contemporary India. As finance minister, he was the architect of the country’s economic liberalisation. As prime minister, he championed a deal with the United States on India’s nuclear energy program.

Both represented fundamental shifts in India’s direction with long-lasting effects. His apparently apolitical, academic background made him appear as a mild, risk-averse leader, but both the liberalisation and the India-US nuclear deal took India into unchartered and potentially risky waters.

Singh was born in a village in what is now Pakistan’s Punjab province. His family moved to India after the partitioning of what had been British India. Educated in Pakistan and India and later at Cambridge and Oxford—from where he received his doctorate in economics—he worked as an academic and in various policymaking institutions, including as governor of the Reserve Bank of India and deputy chairman of the Planning Commission. In 1991, P V Narasimha Rao, prime minister of a newly elected Congress-led coalition government, made him minister of finance.

This led to Singh’s first and the most important contribution, his pivotal role in the opening of the Indian economy and the liberalisation process from 1991 to 1996. The drastic economic and foreign-exchange situation that the country faced—India had barely enough US dollars to pay for a couple of weeks of imports—demanded equally drastic solutions. His economic reforms changed India’s development trajectory, moving India’s economy up from the what had been derided as the Hindu growth rate to more than 7 percent a year.

Shifting the focus from the public to private sector, it was a radical change of direction. India’s new economic dynamism and its status as a rising power resulted from Singh’s policies. Also for the first time, India began to look for international economic collaboration, initiating the Look East policy to build closer linkages with dynamic Southeast Asian economies.

In 2004, a Congress-led coalition unexpectedly won power. Equally unexpectedly, the unassuming non-politician Singh was nominated as prime minister. This set the stage for his second transformative achievement, the India-US civil nuclear deal, which changed the course of India’s relationship with the global nuclear non-proliferation architecture. India had refused to sign the nuclear Non-Proliferation Treaty (NPT) and in 1998 had conducted nuclear tests and declared itself a nuclear power. But this required some acceptance from the US, the reigning unipolar power.

Building on initiatives by the previous government of Atal Bihari Vajpayee, Singh reached agreement with the US to normalise India’s civil nuclear activities. More importantly, this transformed relations with Washington. It removed India’s pariah status in the global nuclear order even if it did not remove India’s non-nuclear weapon status under the NPT. India went on to be recognised for its exceptionally clean record in nuclear non-proliferation. The civil nuclear agreement, signed in 2008, was critical in opening nuclear commerce opportunities with the rest of the world.

As prime minister, Singh recognised the need for a closer and warmer relationship with the US, for both economic and strategic reasons. He found a willing partner in US president George W Bush, who was keen to see India at the centre of Asian security order. The US and India each had an eye on China as they built this relationship.

India’s changed relationship with Australia was also a consequence. Singh, along with then prime minister Kevin Rudd, elevated the Australia-India relationship to a strategic partnership in 2009, setting the scene for strengthened relations. Though, to be fair, the modern day comprehensive partnership, including regeneration of the Quad, did not take hold until later under Prime Minister Narendra Modi, who, unlike Singh, visited Australia.

The Bush administration took the leadership in getting various exemptions required within the US domestic legal structure as well as the global ones at the Nuclear Suppliers Group, the member countries of which seek to support nuclear non-proliferation. Neither was easy.

Singh also faced challenges, leading a disparate coalition government in the Indian parliament that included communist parties that unrelentingly opposed the deal. His own party was less than supportive, not understanding why the government had to be risked for a deal for closer ties with the US. But Singh was equally determined, reportedly threatening to step down as prime minister if his party didn’t support him; this forced the Congress party leadership to back him. The communists withdrew their support to the coalition, but the coalition, and the nuclear deal, survived.

He remained prime minister until 2014.

Singh had his share of disappointments too. The vaunted economic liberalisation hasn’t entirely dismantled the central economic and market role of the Indian government, with bureaucratic obstructionism and red tape still a serious problem. Equally, he was unable to prevent his own party from undermining his nuclear deal with a destructive nuclear liability law that negated much of the benefits of nuclear commerce that the deal promised.

But probably his biggest failure was in failing to respond forcefully to the Mumbai terror attack, when Pakistani terrorists held the city to ransom for two days. His failure led to an image of Indian impotence that no doubt led to greater support for the much more assertively nationalist turn in Indian politics.

Singh was known as the accidental prime minister, a characterisation that he appeared to like. This was both his strength and his limitation. But, as he himself asserted at his last press conference as prime minister, history will no doubt prove kinder to his record and achievements.

Manmohan Singh, born on 26 September 1932, died in Delhi on 26 December 2024.

Protectionism is not the way to protect workers

In both the United Kingdom and the United States, political parties on the left and the right are competing to show voters that they are on the side of working people. The question is whether prevailing approaches to protecting workers—which focus on a combination of industrial policy and restrictions on trade, investment and immigration—are actually in workers’ interest.

Protecting workers has become practically synonymous with protectionism. In recent years, voters in many countries, concerned about their economic well-being, have turned against free trade, immigration and inward foreign direct investment, and have rejected the leaders and parties who long promoted such policies.

Europe is a case in point. After the 2007-2008 global financial crisis plunged even middle-class households into economic insecurity, voters began to look beyond mainstream political parties in search of greater support and protection and were often attracted by those blaming immigration for their struggles. The COVID-19 pandemic, and the cost-of-living crisis that followed, reinforced this trend. Recent elections in Austria, Germany, Italy, and the Netherlands saw surging support for anti-immigration parties.

In the US, new political parties did not emerge, but a new kind of leader did. Donald Trump won the US presidency in 2016 partly by blaming free trade (particularly with China) for decimating jobs and investment in America’s Rust Belt. While criticising free markets and capitalism used to be the preserve of the left, even The American Conservative now runs articles pillorying trade, immigration, and the free movement of capital for the ravages of deindustrialisation.

One answer to such ‘carnage’ is tariffs, which Trump eagerly introduced while in office. But Joe Biden—who defeated Trump in the 2020 election—maintained and even built upon those tariffs. Earlier this year, Biden imposed a 100 percent tariff on Chinese-made electric cars—a very high rate, though it affects a very small percentage of US imports from China. Trump promises that, if re-elected, he will implement 60-100 percent tariffs on all Chinese imports.

The protectionist message is clearly one that workers want to hear. But tariffs are unlikely to work. For starters, they lead to retaliation and distrust among trading partners, as we saw in 2018, when Trump imposed tariffs on steel and aluminium from Canada, Europe, and Mexico. They thus reduce a country’s access to overseas markets, while driving up prices. Because they disrupt supply chains providing vital components for domestic manufacturing, they might also lead to employment losses.

Those losses would not be offset by the ‘reshored’ jobs the protectionists promise, as previously offshored (low-wage) jobs are increasingly filled by machines, not workers. This is already happening in China, where ‘smart manufacturing’ is carried out in ‘dark factories’ run entirely by robots. Protecting manufacturing jobs is thus no more a solution to China’s high youth unemployment rates than reshoring such jobs is a realistic means of revitalising the Rust Belt.

But, as US President Franklin D. Roosevelt’s administration showed in the 1930s, there is a better way to protect workers: domestic labour legislation that supports unionisation. Beyond ensuring a decent standard of living for workers, such legislation in the US and the UK gave greater political voice to working people, enabling them to rise through the labour movement into politics.

That changed when traditional labour parties came to be dominated by urban liberal professionals, rather than representatives of the working class. For example, the proportion of working-class members of Parliament representing the UK’s Labour Party plummeted from nearly 30 percent in 1987 to only 10 percent in 2010.

Fortunately, policymakers in the UK and the US increasingly seem to recognise the role of domestic labour legislation in protecting workers. In the UK, the new Labour government has put forward an Employment Rights Bill, which would extend workers’ rights in areas like sick pay, flexible schedules and protection against unfair dismissal. The bill paves the way for reviving trade unions, removing restrictions on workers’ right to strike, addressing the gender pay gap and strengthening protections against sexual harassment in the workplace. Predictably, employer reactions have been mixed, and the government will now engage in extensive consultations as it works to turn the bill into legislation.

In the US, the Biden administration sought to include incentives for supporting unionisation in the Build Back Better Act, which aimed to create ‘millions of good-paying jobs’. But industry lobbyists pressed the US Congress to eliminate the bill’s proposed incentives for manufacturers to base their assembly plants in the US and to use unionised labour. Ultimately, the act’s passage came down to one vote—that of Democratic Senator Joe Manchin, who insisted that the support for unionised labour be removed.

Trade policy can also be used to protect labour—if we look beyond tariffs. The US-Mexico-Canada Agreement, which the Trump administration negotiated as a successor to NAFTA in 2018, has the strongest and farthest-reaching labour provisions of any US free trade agreement. Beyond placing labour obligations at the core of the agreement, and making them fully enforceable, the USMCA provides that countries can help workers adapt through domestic programs, such as the US Trade Adjustment Assistance programs that have been helping workers transition away from jobs lost to import competition since 1962. The USMCA proves that worker protections are compatible with international competitiveness.

Political support for protectionist trade policies is easy to explain. A growing share of working people in industrialised democracies feel—and, in fact, are—less represented and less protected than previous generations, and both Chinese factories and immigrant workers are easy targets. So, when politicians acknowledge these voters’ frustration and promise to improve their lives with tariffs and immigration controls, they are easily convinced. Ultimately, however, this approach will do little for workers—or for the political leaders who embrace it.

National security and economic prosperity are two sides of the same coin

The recent release of the US national defence strategy identifying China as the ‘pacing challenge’ and most consequential strategic competitor for decades to come further reinforces the need for thinking that clearly articulates Australia’s strategic positioning. The decoupling in key technology sectors currently occurring between the US and China, however, will require Australia to re-evaluate the costs associated with meeting national security needs through market economics.

The scarcity and importance of rare-earth elements have made them desirable because they are used in vital parts of consumer goods like electric vehicles and military equipment such as the F-35 fighter jet. China is the global rare-earths superpower, a role it has used to its own advantage in the past and will likely continue to. In 2010, for example, it stopped exports to Japan over territorial disputes. The general consensus in Australia, the US and other like-minded countries is that for strategic reasons building rare-earth processing capacity outside China must be prioritised.

But diversifying rare-earth supply chains is about more than mining; it requires a complete alternative value chain that extends from processing to manufacturing. Historically, the costs associated with mining and processing rare earths, combined with China’s lax environmental policies, were the basis for their consolidation in China. Growing the rare earths supply chain in Australia will therefore require substantial financial incentives and policy mechanisms to make it economically attractive.

There’s also a pressing need to prioritise semiconductor production because of supply shortages. Semiconductors are also integral to F-35s and electric vehicles, as well as smart phones and other devices. Over the past couple of decades, the Taiwan Semiconductor Manufacturing Company has become the nanoscale semiconductor export superpower. The large amount of capital required to set up and operate a semiconductor fabrication makes it financially unattractive for many corporations.

Taiwan’s proximity to China and the continued threat of an aggressive Chinese takeover of the island, have prompted US President Joe Biden’s administration to invest large sums of money to regrow the American semiconductor industry and increase the number of US suppliers. Ramping up the US’s industrial-scale manufacturing capacity, though, will take many years and a lot of capital. Whether it can be done in a competitive manner with the incentives under the new CHIPS Act is an open question.

It’s not just semiconductors and rare-earth elements that are under the microscope. The list runs from munitions to medical supplies and includes anything that may affect the functioning of a nation and its critical systems. The ongoing calls to rectify shortcomings in secure supplies of these items and the drive to prioritise newer sectors, though, are cast against the years of relative stability during which globalisation created unprecedented wealth in Australia—albeit on an unequal basis.

The dominance of a pro-market, globalised mindset led to the undermining of the vital notion that market economics and national security are intertwined. Events like the war in Ukraine and its impact on Europe’s energy needs have shown once again that markets can be significantly affected by geopolitics and that an assessment of potential national security risks should always be part of the calculations made by both governments and businesses.

This is not to say that Australia needs to go back to the uncompetitive price controls and government interventions that started to be unwound in the 1960s. The Covid-19 pandemic, however, exacerbated existing tensions and demonstrated that a completely hands-off approach by government in sectors such as the energy market can create havoc when they’re affected by global events. The government has shown its ability to mobilise emergency spending in some circumstances, but in others, such as ensuring sufficient supplies of Covid-19 vaccines, hasn’t been able to resolve shortages in the short term because of limited domestic manufacturing capacity.

Capacity constraints are particularly pertinent for Australia’s defence organisation, and highlight the problem with simply calling for the defence budget to be increased to match the times. It’s one thing to increase the budget to boost the number of desired capabilities or platforms, but it’s not possible to offer quick returns if the handful of options for production are already at capacity. It’s hard to respond effectively to strategic circumstances that are deteriorating now if there’s little else to do but wait for years before the expected capabilities can enter service.

The government may also choose to increase how much it’s willing to pay for a specific product to jump ahead of others in the queue. But even for simple things like surgical masks such actions can create tensions between allies and partners, an outcome that can have its own ramifications in the context of Australia’s approach to national security.

Looking into the near future, Australia will need to contend with multiple macro risks that are surrounded by deep uncertainty, such as dealing with the effects of climate change, the potential for nuclear war in Europe and a possible major-power conflict in the Indo-Pacific. These risks are intertwined, creating a compounding effect that limits the government’s ability to deal with any one of them discretely.

After decades of operating in a world with globalised supply chains for a range of vital products, the government is faced with having to navigate the challenges associated with distributed production because of the potential national security risks that come with relying on supply chains with single points of failure. It’s a difficult knot to untangle and the costs will likely be significant, but the risks to both national security and future economic prosperity are too high not to attempt to do so.

The new era of decoupling, deglobalisation and economic war

The Covid-19 pandemic marks the end of the great era of globalisation. Now the troubled times of decoupling arrive.

We are at a Matthew Arnold moment:

Wandering between two worlds, one dead,
The other powerless to be born,
With nowhere yet to rest my head,
Like these, on earth I wait forlorn.

China’s President Xi Jinping and US President Joe Biden give fresh shoves to the decoupling that will define this new world. Decoupling of trade and tech shapes the contours of strategic competition.

Biden last month lunged at Beijing’s throat by banning the sale of semiconductors and chip-making technology to China.

‘A superpower declared war on a great power and nobody noticed,’ was Edward Luce’s comment in the Financial Times. Biden had launched a ‘full-blown economic war on China—all but committing the US to stopping its rise—and for the most part, Americans did not react’.

America’s reaction was relatively low key because elements of the world being born are already the established reality. Given the reality, US policy responses follow.

The ‘dramatic escalation of the technology war,’ Carl Bildt writes, is bound to have equally dramatic economic and political consequences: ‘The new chips war eliminates any remaining doubt that we are witnessing a broader Sino-American decoupling. That development will have far-reaching implications—only some of them foreseeable—for the rest of the global economy.’

Computer chips are to this century what oil was to the 20th century. Thus, the economic war/technology war discussion summons a dark echo: the US imposed a total oil embargo on Japan in 1940 because of its invasion of French Indochina; Japan’s response was delivered at Pearl Harbor. Tokyo’s dire choice on 7 December 1941 was to risk national suicide rather than suffer loss of face.

Economic war has a violent and unpredictable twin.

China’s thinking on Taiwan—and any unification timetable—has a semiconductor dimension that’s now red hot, perhaps a new red line.

The chips ban and the new national security strategy show the transformation of US policy toward China, Brad Glosserman writes:

Previously, the US, along with allies and partners, focused on preventing China from acquiring technology that would improve its military capabilities. The ambition is now much grander: The goal is to constrain the development of China’s high-tech economy, to thwart its rise as a challenger to US (and Western) technological supremacy. It is a risky strategy and may instead accelerate developments it seeks to thwart.

The Washington debate on the semiconductor ban goes in two directions. One school laments that the US is abandoning the huge China market while forcing China to redouble its tech ambitions. The other view is that the US has finally got serious about outcompeting China.

Either perspective, however, shares the US understanding that globalisation has crested and begun to recede. ‘Free trade’ is dismissed as a naive faith and ‘neoliberalism’ becomes a swear word.

The Washington consensus is that China has spent decades looting tech know-how. Unable to unite on almost anything else, the US political class speaks with one voice as it turns to Beijing to proclaim: ‘Enough!’

In the New York Times, Thomas Friedman points to ‘Chexit’ (the idea that China will exit the multilateral order) ending China’s four decades of steady economic integration with the West: ‘[W]e will miss that era now that it’s gone, because our world will be less prosperous, less integrated and less geopolitically stable. But gone it is.’

US exports to China this year have been ‘strangled’, prompting commentary that decoupling ‘may go too fast or too far’.

China’s conclusions about decoupling come wrapped in its own ideological language.

In a two-hour address, Xi told the 20th congress of the Chinese Communist Party they were ‘confronted with drastic changes in the international landscape, especially external attempts to blackmail, contain, blockade and exert maximum pressure on China’.

The US was never named in Xi’s speech, but was constantly attacked:

[T[he hegemonic, high-handed and bullying acts of using strength to intimidate the weak, taking from others by force and subterfuge, and playing zero-sum games are exerting grave harm. The deficit in peace, development, security and governance is growing. All of this is posing unprecedented challenges for human society. The world has once again reached a crossroads in history.

The dramatic and sinister image from the congress was the former leader Hu Jintao being led away from his seat next to Xi.

One of Australia’s journalist sages, Rowan Callick, wrote that Xi’s steely, dismissive demeanour as his confused predecessor was ejected was that of a mafia boss (appropriate since Xi has ‘listed The Godfather among his favourite films’).

Callick searched Xi’s written report for the key words: ‘The word for “security” is used 91 times in the work report, and “economy” 60 times. “Battle” gets 46 mentions. “Political reform”, once given a special section, has gone altogether.’

In a chat last week, Callick told me that Xi’s key message to the comrades is that ‘the world has turned sour’. And the most striking image he offered was that Xi has ‘doubled down and doubled speed’.

The danger also doubles. Xi’s coronation means he’s the unrestrained leader of the most powerful dictatorship in history.

China’s belligerent dictator faces off against a US determined to achieve supremacy in the technology that will drive this century. What could go wrong?

Decoupling and deglobalisation mean geography is back. So is protectionism. One sign of the world that’s fading is the damage inflicted on the World Trade Organization and the crisis in its dispute settlement system.

The US and the EU join to support Ukraine in the war with Russia; the West unites to fight a proxy war. Yet in this perilous moment, the US and Europe argue themselves towards a new trade war because of the subsidies America is giving its electric car industry. Biden geostrategy can push against ‘Bidenomics’ and the effort to overhaul America’s economy.

What we’re losing in the world that’s passing is painfully clear. As for the world struggling to be born, over to Matthew Arnold:

Years hence, perhaps, may dawn an age,
More fortunate, alas! than we,
Which without hardness will be sage,
And gay without frivolity.
Sons of the world, oh, speed those years;
But, while we wait, allow our tears!

Is the world’s financial firefighter ready?

The world needs to prepare for a cascade of financial crises across emerging and developing economies. The writing is already on the wall, with Bangladesh, Ghana, Pakistan and Sri Lanka currently queuing at the International Monetary Fund’s door. Wealthier countries must now equip the IMF—the world’s financial firefighter-in-chief—to prevent and manage the spread of crises. They could start by ensuring that the fund has the resources to stop lower-income economies adopting beggar-thy-neighbour policies that destroy other countries’ livelihoods and threaten political and economic stability.

As the US dollar strengthens and global growth slows, many poor-country governments that are already seriously overstretched by Covid-19, and by the food and energy crises sparked by Russia’s war in Ukraine, must now contend with depreciating currencies and rising borrowing costs. And support from China is declining as the country’s new political priorities, zero-Covid policies, distressed property market, demographic pressures and structural reforms cause its economy to grow at its slowest rate in four decades.

Adding fuel to the fire, foreign investors are withdrawing funds from emerging markets at a record pace. As a result, many of these countries are burning through the foreign-exchange reserves that they had carefully built up after previous crises.

Major economies should now be taking several practical steps. During the 2008–09 global financial crisis, for example, G20 leaders agreed to create a ‘trillion-dollar IMF’ that would have the means to slow and contain the spread of the crisis. This involved letting the IMF borrow from a group of willing countries, as well as increasing the fund’s capital to SDR 477 billion (US$621 billion).

The IMF has additional lines of defence. In January 2021, its New Arrangements to Borrow scheme, under which 38 countries have agreed to lend to the fund should the need arise, was doubled in size and extended until 2025. The IMF also has bilateral borrowing agreements, the extension of which is currently being negotiated.

In August 2021, countries agreed to a general allocation of US$650 billion in special drawing rights, the largest in the fund’s history. The allocation was intended to boost the global economy’s resilience and stability and to assist vulnerable economies that were struggling to cope with the Covid-19 crisis. But, because SDRs are distributed according to countries’ IMF quotas, which depend heavily on their GDP, the measure’s impact has been limited.

In previous financial crises, the IMF has played a key role in helping to sustain a minimum level of confidence, thereby reducing the costs of containing and managing the crises. Given volatile markets, fleeing investors and financially overstretched governments, there is a strong case for again bolstering the IMF’s firepower.

For starters, the G20 countries should commit to doubling the IMF’s core capital. That means a twofold increase in each country’s contribution (which is proportionate to the size of its economy). Such negotiations have been tricky in the past, because fast-growing economies will insist on gaining greater quota shares (influence) at the IMF, as Japan, Saudi Arabia and China have done over the years. The far-reaching 2010 reforms involved substantial changes, and although geopolitical tensions have risen further since then, those changes have paved the way for a further increase now.

The need for the IMF to play a central role in managing a global crisis is one of the few areas on which G20 countries might agree. They should do this soon, because ratifying and implementing any new set of quotas will take time—five years, in the case of the 2010 agreement.

A second, more immediate step would be for the IMF to enhance its borrowing arrangements with richer countries through the New Arrangements to Borrow scheme and bilateral agreements. Middle Eastern energy producers, for example, are set to receive up to US$1.3 trillion in additional oil revenues over the next four years, and stand to gain quiet leverage by agreeing to increase their lending to the IMF.

A third possibility is either to sell off some of the IMF’s gold holdings or for countries to agree to another general SDR allocation. But, again, the bulk of an SDR issuance goes to the largest economies (which have mostly chosen not to redistribute them to countries in need). And there are limits to countries’ willingness to exchange their hard-currency reserves for SDRs.

A far less discussed (and more controversial) option would be for wealthier countries that don’t borrow from the IMF to reduce the amount the fund pays them for providing it with credit. In 2020, the IMF spent SDR 546 million remunerating members’ reserve tranche positions, and a further SDR 90 million on interest expenses. This is now set to increase, as both the IMF’s credit outstanding and the SDR interest rate rise.

Lastly, the IMF, like its sister institution the World Bank, could tap the capital markets—something it has never previously done. The World Bank’s International Bank for Reconstruction and Development provides loans to low- to middle-income countries by borrowing four to five times its equity capital in the market. Even the International Development Association, the World Bank’s concessional financing vehicle for the poorest countries, relies on capital markets to maximise its financing, although on a much smaller scale.

Both the International Bank for Reconstruction and Development and the International Development Association have AAA credit ratings, enabling them to minimise their cost of capital. Their experience, as well as that of other multilateral borrowers, suggests that the IMF could issue AAA-rated debt and leverage its equity, as well as its record of never reporting a credit loss in its 78-year history.

Powerful countries in the IMF, especially the G20, must now seriously consider what’s at stake. Like the forest fires ripping through the northern hemisphere this summer, financial crises spread quickly. Managing them effectively will require adequately equipping the IMF ahead of time with well-positioned reserves and firebreaks.

The decline and fall of Davos man

‘Davos man’ has had a grim 14 years. The late Harvard University political scientist Samuel Huntington popularised the term in 2004 to describe a new overclass of evangelists for globalisation. Davos man, he claimed, wanted to see national borders disappear and the logic of politics superseded by that of the market.

But since the 2008 global financial crisis, politics has increasingly trumped economics, a trend that reached its apotheosis in 2016 with Donald Trump’s election in the US and the Brexit referendum in the UK. Both events represented a backlash against Davos man’s vision of a frictionless world governed (not run) as efficiently as possible by ‘multi-stakeholder processes’.

At this year’s annual gathering in Davos, attendees had to confront an even bigger challenge than national politics: the return of geopolitics. The World Economic Forum’s theme was ‘history at a turning point’, in recognition of the fact that we have reached the end of the ‘end of history’. Although the WEF’s ethos is to promote cooperation in the pursuit of ‘one world’, the new agenda is necessarily focused on conflict and division.

Russian President Vladimir Putin’s war of aggression on Ukraine obviously loomed large at this year’s meeting. To open the event, Ukrainian President Volodymyr Zelensky—appearing virtually in his now familiar military fatigues—spoke of a world split along the fault lines of fundamental values. And Russia House, the facility where Russian delegations hosted parties and networking events in years past, was transformed by Ukrainian activists and donors into Russian War Crimes House, with an exhibition calling attention to Russian atrocities in Ukraine.

After browsing this year’s program, it soon became clear that not a single aspect of globalisation has been spared from the fallout of new geopolitical conflicts—between Russia and the West, China and the West, China and its neighbours and so forth. Instead of panels discussing free-trade agreements, there were multiple sessions on economic warfare. Political and business leaders grappled with the fact that we now live in a world where central-bank reserves can be confiscated, commercial banks can be summarily disconnected from the SWIFT international payments system, and private assets can potentially be seized to pay for a country’s reconstruction.

The sessions on climate change, meanwhile, looked beyond the Paris climate agreement’s decarbonisation targets to focus on the links between the war in Ukraine, the current global energy crisis, food shortages and inflation. For example, German Vice Chancellor Robert Habeck held a panel with India’s petroleum and gas minister and the CEO of an oil company to discuss whether Europe and India can end their use of Russian oil and gas without setting back their economic goals.

A panel on migration dealt not with the question of skills training—as would have been the case in previous years—but rather with the weaponisation of refugees. As a Ukrainian MP warned, Putin is aiming to ‘turn migration into a “hybrid war 2.0”, in the hope that driving millions of Ukrainians from their homes could lead to the collapse of Europe’.

At a panel on the future of technology, a senior Japanese policymaker discussed how geopolitics is transforming the relationship between the market and the state. In the old days, innovations like the internet were initially developed by the state and then picked up by private companies. But today, artificial intelligence, quantum computing, drones and other technologies are being developed by the private sector and then weaponised by the state. Export controls and restrictions on technology transfers thus have become essential elements of national security.

But the most anxious of all sessions were those focusing on the fear of a new cold war, which would spell the end of the globalised world. Many leaders from outside Europe and North America sympathised with Ukraine but refused to see the war as a global conflict about values. They worried that Putin’s aggression, and the countermeasures taken against Russia, would accelerate the fragmentation of an already divided world through rising energy prices, mass starvation and the politicisation of markets.

They did not buy into the notion, heavily promoted by the Biden administration, that we are in a battle between democracy and autocracy. That framing, they feared, would lead to a world even more deeply divided along ideological lines. Representatives from the Middle East, Africa and Asia repeatedly expressed fears of having to choose between China and America, describing that prospect as an ‘existential threat’.

This year’s Davos gathering was totally unrecognisable from the conference I started attending 15 years ago. It is now clear that while Davos man was not interested in geopolitics, geopolitics has become very interested in him. The weaponisation of interdependence has reshaped every aspect of his life. The geopolitical takeover of globalisation is almost complete and its primacy will almost certainly outlast the war in Ukraine.