Putting Biden’s “New Economic Statecraft” in Context

On Aug. 9, President Joe Biden declared (via executive order) a national emergency associated with the development of artificial intelligence, semiconductor, and quantum computing technology critical for “military, intelligence, surveillance, or cyber-enabled capabilities” in “countries of concern” (read: China). The order itself mandates that U.S. firms disclose investments in China related to these markets (notifiable transactions) while seeking to restrict others entirely (prohibited transactions).

This represents just the latest salvo in what we have previously described as “new economic statecraft” in which governments use economic levers far beyond the use of sanctions to shape international relations in their favor.

The Biden administration’s turn toward the use of economic levers as part of a return to an era of strategic competition consists of a host of measures beyond the most recent executive order. These include domestic industrial policy measures, border restrictions on trade and investment, and efforts to build coalitions of the (un?)willing to restrict the export of chips and other high-tech equipment to China. At the same time, Chinese investment in U.S. technology companies is to be limited by an expanded set of protections via the Committee on Foreign Investment in the United States (CFIUS)—for fear of technology transfer across the Pacific.

The recent precipitants of these measures include the coronavirus pandemic that affected supply chains; the trade conflict between Washington and Beijing; and increasing concerns that dual-use technologies developed in the United States—particularly in industries such as artificial intelligence, quantum computing, synthetic biology, and the cyber domain—will continue to find their way to China, with subsequent consequences for military competition between the two sides.

In simplest terms, think about Washington’s position as attempting to balance two imperatives. The first is market efficiency—the driving force of globalization in which goods and services were provided by firms in countries where they had a comparative advantage and, thus, prices were lower. The second is security. There are some goods and services so important that a government cannot rely on foreign firms and governments having control over their provision. And there are some goods so important to a country’s geopolitical standing that one might seek to limit its trade. Military hardware often falls into this category, but so did personal protective equipment during the coronavirus pandemic. More recently, semiconductors have been placed into this category with efforts to bolster U.S. manufacturing. And while economists might say that efficiency dictates markets, we suggest that the latter concern surrounding security imperatives is going to reshape the global market—whether efficient or not.

Thus, understanding the process by which some industries are defined as strategic is critical for both academic analysts and government officials. Protecting everything in the name of national security with autarkic policies is a path to economic failure; ignoring geopolitical realities in an increasingly hostile global environment is the path to political failure.

Old Wine in New Bottles

Of course, economic statecraft efforts focused on the technology industry have been tried before. The creation of Sematech in 1987 as a government-industry consortium to help the United States catch up with Japan is the most prominent example of industrial policy that was also tied to trade, namely the 1986 Semiconductor Trade Agreement with Japan. This trade agreement aimed to stop the dumping of chips in the United States and to increase the U.S. market share in Japan. There is a dispute about the impact of these policies despite the recovery and improving condition of the U.S. semiconductor industry since the early 1990s—a debate that has been revived in light of the 2022 CHIPS and Science Act. In any case, it is clear that this policy effort was not smooth sailing. Analysts have pointed to management conflicts over how competitors would cooperate, a $1 million entry fee that kept out smaller firms, claims of a lack of serious innovation, and a decrease in private investment in response to Sematech’s investment. Most telling is that, by 1996, Japanese firms had been invited to and joined the consortium.

In terms of general U.S. policies, regulatory provisions on trade go back to U.S. law in 1962 (Section 232) and 1974 (Section 301), allowing the government to block trade for national security reasons. And with respect to investment, CFIUS—an interagency committee that reviews the national security implications of foreign investments—has been in operation since 1985. CFIUS has now been “enhanced” with the passage of the Foreign Investment Risk Review Modernization Act of 2018. Today, however, there is greater coherence in both U.S. and Chinese policy to systematically manage economic relations through economic statecraft, particularly in the face of growing tensions.

Most recently, the CHIPS Act provided $280 billion in funding with the goal of reducing U.S. reliance on overseas supply chains (though it remains to be seen how this money will be spent). The act also aims to boost the nation’s science and technology research base and address China’s anti-competitive trade practices amid broader concerns surrounding intellectual property theft. The direct link between industrial policy and investment regulation is explicit in the CHIPS Act. Specifically, it prohibits recipients from “expanding semiconductor manufacturing in China and other countries defined by U.S. law as posing a national security threat to the United States.” In addition, companies doing business in China over the next 10 years will not be able to produce chips that are smaller than 28 nanometers (with size becoming, rightly or wrongly, a proxy for “advanced” technology).

The National Defense Authorization Act for Fiscal Year 2024 (NDAA) also includes these levers of economic statecraft. For example, five years after the date of enactment, the NDAA prohibits federal agencies from procuring, obtaining, or renewing contracts for any electronic parts, products, or services that include “covered semiconductor products or services” that are “designed, produced, or provided” by Chinese firms, including Semiconductor Manufacturing International Corp, Changxin Memory Technologies, and Yangtze Memory Technologies Corp. The act also contains more than $200 million for investments related to aircraft technology, electronic warfare, and 5G technology development and almost $100 million for the Defense Advanced Research Projects Agency’s quantum computing and artificial intelligence programs—contributing to basic science and technology, the expansion of the defense industrial base, and human capital development programs.

Various other U.S. legislative efforts—including the 2022 Inflation Reduction Act via its focus on green technology—also include within them various aspects of industrial policy.

Privileging Security

Of course, hardening supply chains to disruptions driven by security competition and privileging security concerns represents a worthwhile goal—but it comes with attendant consequences.

Past efforts to promote industry in strategic sectors have often foundered on the shoals of self-serving lobbying by firms. As the Economist notes, a key question facing policymakers is which economic activities have “strategic consequences” for the state—with the attendant risk of all economic activities being designated as important for international security. Firms have long had an interest in portraying their industry as being “strategic” so as to secure protection, subsidies, and other types of state intervention to restrict competition. In the 1950s, for example, the textile industry claimed that woolen blankets were essential to protect against nuclear radiation and that lace was critical for the military to make epaulets. In the aftermath of the 2008 financial crisis, too, government responses went beyond at-the-border and traditional behind-the-border protectionist measures to what was aptly labeled “murky protectionism” in support of their respective financial services industries.

Indeed, what much of the existing analysis of the Biden administration’s policies misses is that there are downstream consequences to pursuing economic statecraft in this manner—justified or not.

There are intrinsic costs associated with wholesale “decoupling” of supply chains between the United States and China as well as the more discrete “de-risking” of strategic industries—whether via “re-shoring” or “friend-shoring” of strategic industries and attempting to control the access of Chinese firms to U.S. and Western markets.

First, as the Sematech effort demonstrates, the costs of re-shoring are high—with downstream consequences across the value chain and, eventually, consumers. Relatedly, even where industrial policy might succeed in terms of bolstering an industry that might otherwise have struggled to survive, it is difficult for governments to pull the plug on support. Indeed, how much support is enough? And when does the government exit? From the perspective of industries and firms receiving protection, the answers to these questions are (a) as much support as possible and (b) never.

Second, there is an inevitable race to the bottom with the application of industrial policy as countries retaliate against one another for their various forms of protection. Indeed, efforts to arrest technology and data transfer to China via export control and import bans—for example, Huawei and ZTE—have met with reciprocal measures impacting U.S. firms. Executives at Idaho-headquartered Micron represent the latest casualties in this race following China’s decision to ban Micron memory storage chips for use in systems that handle “critical information.” As a result, Micron’s competitors—South Korea’s SK hynix and Samsung—stand to gain significant market share in China, despite calls from the United States to not fill this gap. And while we have spent the better part of five years pointing out that countries around the world have used various levers of economic statecraft to bolster their domestic industries viewed as strategically important (and usually associated with technology markets), the facade of trade liberalization and the surreptitious use of human capital development programs along with government procurement papered over some of the impetus to embark upon this race to the bottom.

Finally, and related to the above, allies and partners have their own response to economic statecraft—some of which might be less aligned with U.S. priorities than might be hoped. Indeed, Beijing’s knowledge that memory chips from SK hynix and Samsung (both headquartered in South Korea—a U.S. ally) could replace Micron’s contribution to the Chinese market simplified its decision to ban the U.S. firm.

The Path Forward

Both the U.S. government and the broader commentariat need to grapple with these questions—recognizing that governments’ attempts to exercise new, and increasingly robust, economic statecraft are here to stay.

It is naive to believe that all of these efforts by China and others will result in failure as some neoliberal economists would have us believe. But at the same time, in terms of what new economic statecraft might look like for the United States, and what “de-risking” actually looks like in practice, is something policymakers must understand if the United States is to play in this new sandbox.

Indeed, the United States is arguably uniquely ill suited to engage in economic statecraft. Compared to “strong” states, characterized by China, Japan, South Korea, and Singapore, among others, the U.S. government has been prone to domestic lobbying, and decision-making authority is fragmented among a large number of agencies—indeed, the U.S. Department of Commerce and the White House’s Office of Science and Technology Policy are hardly the equivalent of the Japanese Ministry of Economy, Trade, and Industry. There has also been a strong reluctance on the part of U.S. firms across the technology sector to support U.S. government prerogatives—as they want and need access to the Chinese market on both the supply and demand sides of production.

The impacts of the most recent executive order on the U.S. market and geopolitics will take time to play out. In the meantime, analysts, scholars, and policymakers need to consider the various levers that the United States has at its disposal and outline where the tools of new economic statecraft need to begin and end—to engage with stakeholders, both internally inside the U.S. market and externally among partners and allies, and to identify and create an institutional framework that might sustain an integrated approach to economic statecraft. This will likely involve a significant shift in the activities of multiple U.S. departments and agencies and a renegotiation of the international architecture that has sustained global trade over the past 70 years.

This blog post was originally published on Lawfare. It has been reprinted with permission. 

Photo credit: The White House.