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Free Trade: A National Security Threat?

How National Security Concerns Are Shaping Modern Trade

The 1990s marked a period of optimism, liberalisation and globalisation. In the aftermath of the Cold War, the West emerged seemingly triumphant, ushering in a new world order guided by democratisation, capitalism and free trade. The decade marked several landmark achievements in the liberalisation of international commerce with the establishment of WTO in 1995 following the Marrakesh Agreement, the European single market in 1993, and various free trade agreements such as the North American Free Trade Agreement (NAFTA). Political leaders championed the cause of globalisation and free trade, arguing it would not only enrich nations economically but also pave the way for a more interconnected and democratic world. During a speech on March 8, 2000, President Clinton declared, “Globalization is not something we can hold off or turn off. It is the economic equivalent of a force of nature, like wind or water.”  

Fast forward to the present and the contemporary narrative on free trade and globalisation unveils a notable shift. For instance, recent research suggests that between 2002 and 2018, support for free trade in Japan, the United States, and various European countries declined substantially. The shift has predominantly been propelled by a rising hostility towards free trade and globalisation among the working-class and low-skill workers, groups which have been forced to bear the brunt of the cost of globalisation. World leaders have noted that the tide is turning and has, in recent years, begun signaLling a departure from the unbridled globalism of the past to a new era of protectionism and decoupling. While protectionism is a tale as old as trade, recent legislation suggests a shift from viewing trade solely as an economic consideration to regarding it as a matter of national security, making it an important instrument in a time characterised by ever-increasing geopolitical tensions. 

Tariff rate across all products, 1988 to 2017.

The Wary West

This shift in the perception of trade is not limited to one corner of the world or a single geopolitical block; rather, it is a commonality among new trade legislation and industrial policy. Despite its history of championing free trade, the United States has embraced the new era of protectionism and decoupling in many ways. Under the Trump presidency, the “America First” economic policy imposed various tariffs. For instance, in March 2018, citing national security grounds, the U.S imposed 25% tariffs on steel and 10% on aluminium coming from key allies such as the EU, the UK, South Korea, and Japan resulting in retaliatory measures. Whilst the Biden administration has since agreed with the EU to pause, not abolish, the tariffs, the administration is still pursuing an aggressive industrial policy in other areas. Following the Inflation Reduction Act and the CHIPS and Science Act, the U.S. has provided more than $450 billion in subsidies for green energy, electric cars, and semiconductors, often with the conditional requirement that production is domestic. 

President Joe Biden speaks during a campaign event in 2020 on manufacturing and buying American-made products in Warren, Michigan. (AP Photo/Patrick Semansky)
A notable exemption is Taiwanese firms, which can take advantage of the CHIPS and Science Act incentives. Recent tensions between Taiwan and China have emphasised not only the geopolitical importance of Taiwan as an ally to the U.S. but also its significance as a trade partner. U.S intelligence estimates show that losing Taiwan’s chip production could potentially erase up to $1 trillion per year from the global economy for the first few years, which experts fear could have severe repercussions for U.S national security, as semiconductors are a key driver for advanced weapon capabilities. On the topic of investments, President Biden signed an executive order in August 2023 to extend instruments for inbound and outbound investment screenings to protect sensitive technologies that are critical to military innovation, such as semiconductors, microelectronics, and quantum information technologies. Ahead of the 2024 U.S. presidential election, the frontrunner candidates for both the Democrats and the Republicans have continued to signal for an “America First” agenda and continued decoupling, with President Biden promoting his “Buy American” slogan and 2024 presidential candidate Trump vowing to implement a new 10 percent tariff on all foreign goods imported into the United States if elected.

In the European Union, the idea of EU Strategic Autonomy (EU-SA) or 'open strategic autonomy' has recently gained traction following Russia’s war against Ukraine and a desire to reduce dependence on the United States. First introduced in 2013 mainly as an approach to security and defence matters, the EU-SA has since been widened to all EU policy areas in light of Brexit, the Trump Presidency and China’s growing assertiveness. Today, the strategy calls for greater energy independence and emphasises mitigating economic dependence on foreign supply chains, critical raw materials, semiconductors, and digital technology. For many European lawmakers, Russia’s war against Ukraine accentuated the need for strategic autonomy, particularly due to the weaponisation of natural gas exports. By withholding energy shipments to Europe through its pipelines, Russia created political and economic pressure on countries dependent on its gas. Recognising the potential ramifications of such a vulnerability, the EU, along with other countries, has enacted policies to reduce the sourcing of critical products such as energy from “countries of concern.” 

Since 2019, the von der Leyen Commission has introduced several new defensive trade tools, such as outbound investment screening on sensitive technology, filtering foreign direct investments into the EU and an anti-coercion instrument. In a speech to the Mercator Institute for China Studies in March 2023, President von der Leyen emphasised the need for “de-risking” EU trade and diplomatic relations with China. Later in October of the same year, the Commission adopted a recommendation on critical technology areas for the EU's economic security, to restrict potential leakage of critical technologies to countries such as China. On the national level, many EU countries have adopted or tightened preexisting investment screening mechanisms across the board, with many citing national security concerns.

Pro-Trade China?

Employees of Foxconn Technology Group, the world's largest contract manufacturer of electronics, working at a production line of the company in Zhengzhou, China. (Photo: VCG)
With China's deteriorating relationship with the West, significant debt, and unfavourable demographics, many economists have predicted an era of slower growth for the country. Consequently, China has launched several landmark initiatives, prompting a recalibration of its trade and national security agenda. In 2015, the Chinese government launched “Made in China 2025”, a state-led industrial policy to pursue technological leadership in global high-tech manufacturing through the use of government subsidies, mobilising state-owned enterprises, and intellectual property acquisition. Chief among these innovations are the now familiar “sensitive” technologies such as next-generation information technology and telecommunications, as well as advanced robotics and artificial intelligence. The U.S. along with other industrialised democracies have raised concerns regarding the policy’s national security implications, arguing it relies on discriminatory treatment of foreign investment, forced technology transfers, intellectual property theft, and cyber espionage. 

Internationally, China has expanded its economic reach through President Xi’s flagship project, the Belt and Road Initiative (BRI) which has opened foreign markets to Chinese goods and companies. Within the BRI, is also the Digital Silk Road (DSR) which aims to create technology infrastructure to support economic development and power projection. Whilst critics argue its state-led industrial policy is increasingly pursuing national security and geopolitical goals at the expense of free and rule-based trade, China ironically continues to stress the importance of avoiding politicising economic and trade issues. As recently as the 2024 World Economic Forum, Chinese Premier Li Qiang emphasised the Chinese economy was open for business and highlighted its potential for foreign investment, declaring the world needed to put down barriers to competition and trade to tackle global challenges.

Make in India

Amongst the deterioration of free rule-based international trade, India has seemingly emerged as a benefactor all while pursuing its own protectionist trade policies. A recent report showed how U.S. and European firms are shifting investment away from China to other developing markets, with India receiving the lion’s share of the redirected foreign capital. Many companies cited concerns over China's business environment, economic recovery and politics as the reasons for this shift. Total green-field investments announced by U.S and European firms increased by circa $65 billion or 400% between 2021 and 2022, while investment into China decreased to less than $20 billion during 2022 from peaking at $120 billion in 2018. As the United States has for the last two decades bet on India to become a key partner in its geopolitical rivalry against China, the recent economic shift should perhaps not come as a surprise. Indeed, India has many reasons to celebrate: favourable demographics in an otherwise ageing Asia, a recent discovery of lithium reserves (a key ingredient for the green transition), and the fastest pace of economic growth the country has seen in the last 13 years. Yet some argue India’s potential is limited by its longstanding and continued tradition of protectionism.

Similarly to the rest of the world, the 1990s and 2000s marked an era of liberalisation as average tariffs were slashed from over 80% in 1990 to 13% in 2008. Then, in 2014, Prime Minister Modi was elected and launched a familiar slogan “Make in India”. Similarly to other major economies, India has recently begun subsidising the production of semiconductors and introduced several new investment schemes to promote domestic manufacturing. For instance, in August 2023, a new measure was announced which would require Indian companies to get a licence before they could import personal computers or tablets as a part of a plan to accelerate the “Make in India” initiative. Following the Indian-China border crisis in 2020 and the subsequent rise in tension, The Modi government has shifted from initially seeking to deepen economic ties with China to disentangling India from China and reducing its vulnerability in critical sectors. Indian officials have, for example, placed restrictions on Chinese investment, Chinese access to Indian public procurement contracts, and Chinese companies’ or organisations’ activities in critical economic, technology, telecommunications, civil society, and education sectors. Many of these protectionist trade policies are therefore a consequence of pursuing national security objectives rather than economic ones. However, tensions with China have not solely resulted in protectionist policies, but have also compelled India to seek allies and economic partners in the West, Indo-Pacific, and Middle East.

A Brief History Lesson
Caption: Number of harmful and liberalizing trade measures implemented, 2009 to 2023.

For policymakers, the immediate political effects of these policies are seemingly obvious. Reshoring production should help create more domestic jobs and increase competitiveness, all while reducing foreign influence by decreasing FDI, exports of sensitive goods and dependence on fragile global supply chains. History, however, tells a different story. There is certainly some credence to industrialising and developing infant industries behind tariff barriers, with the United States, France and Germany being notable examples. After the Second World War, similar policies had some success in developing Japan and South Korea, but with mixed results elsewhere. In the 1970s the U.S. dominated the computer chip market. To compete, the Japanese government invested heavily in semiconductor research and introduced policies to protect domestic industry. Research by economists Richard Balwin and Paul Krugman suggests that without the policies, Japanese firms would not have succeeded in the export market.

Nonetheless, the effort to protect the Japanese home market produced more costs than benefits for Japan. Research on Chinese shipyard subsidies by Myrto Kalouptsidi at Harvard found that the policies helped reduce costs by as much as 20% between 2006 and 2012, with Japan being the loser as the subsidies helped contribute to a major reallocation of shipbuilding to China. Economist Bruce Blonigen at the University of Oregon examined industrial policies aimed at boosting domestic steel production between 1975 and 2000 across 21 countries. His findings suggest that the policies had an economically harmful net effect on the export competitiveness of downstream sectors, with the most harmful policies being export subsidies and government ownership. The historical evidence is thus inconclusive at best, with a zero-sum game outlook on trade seemingly being the only way to rationalise such policies. 

What’s Different Today?

The protectionist policies pursued today are fundamentally different in three notable ways. Firstly, policies are motivated not only by an infant industry argument but also rationalised by framing issues as a matter of national security. Policies target “sensitive” sectors which tend to have potential military applications. Export controls have been understandably imposed ex-post after acts of war, but perhaps more worryingly, they are also being applied proactively against potential adversaries. For instance, Japan, the Netherlands and the United States agreed to restrict exports of advanced node semiconductors in response to Chinese President Xi Jinping’s “military-civil fusion” policy. In President Biden’s executive order on inbound and outbound investment screening, the only country labelled as a country of concern was China. Secondly, the policies are not limited to developing economies; it is the world's most developed countries leading the race in subsidising and decoupling. As mentioned, China, the United States, the EU and India are all pursuing similar policies and framing the issue with an analogous national security narrative, likely spurring the continuing spiral. 

The 15 Countries With The Highest Number Of Protectionist Trade Intervention Policy Measures Implemented Since November 2008

Harmful Interventions
November 2008 -
Liberalising Interventions
November 2008 -
United States of America
United Kingdom
Data from The Global Trade Alert, at the University of St.Gallen.

Lastly, the policies are pursued in a far more interconnected world where global supply chains require international cooperation. However, trust in global supply chains has seemingly dwindled in recent years as the system's fragility and the world’s interdependence have become more apparent. The breakdown of global supply chains during the COVID-19 pandemic was deemed a leading cause of the rise in inflation and economic downturn. The 2021 blockade of the Suez Canal exposed further vulnerabilities and emphasised the world economy’s reliance on functioning a well-oiled seafaring industry. Yet, the recent Houthi rebel missile attacks in the Red Sea threaten to cause another crisis potentially continuing to diminish trust in global supply chains and further intertwining trade issues with national security. 

Hope and Despair

While the current rhetoric and newly introduced policy suggest a global downturn in international trade is underway, the data tells a more contradictory and hopeful story. At a recent Policy Research Talk, World Bank Research Manager Daria Taglioni pointed out the three apparent paradoxes in global trade policy trends. Firstly, despite the U.S. and China being engaged in a trade war and the EU’s wish to “de-risk” trade relations, China has become an even more integral part of global trade networks. Secondly, despite recent shocks in global supply chains, both due to the COVID-19 pandemic and new trade policy, the global value chains (GVCs) are accounting for an increasing share of global trade flows. In 2022, GVCs accounted for 52% of global trade, an increase from 48% in 2015 and even eclipsing values before the 2007-2008 global financial crisis. Lastly, despite increasing protectionist measures, firms continue to deal with customers and suppliers around the world rather than turning solely towards their region. Looking at international trade as a percentage of the world's GDP, its share did not drop significantly during the pandemic and made a swift recovery towards the pre-pandemic levels, reaching an all-time high in 2022 where trade constituted 62,8% of world GDP.

Caption: Trade as a share of GDP, 1970 to 2022.

There is, however, still cause for concern, as protectionist policies have outpaced trade-liberalisation policies in recent years, and researchers remain highly uncertain about the future. International organisations have attempted to estimate the cost of decoupling trade and dividing the world into economic blocks. A working paper from the IMF suggests that technological fragmentation, as seen with semiconductors for instance, can lead to a loss of 5% of GDP for many of the world’s economies. A recent paper by economists at the WTO estimated the opportunity costs of decoupling the world into two geopolitical economic blocks could be as high as 12% of GDP in some regions. These high costs stem from the fact that complex supply chains have been carefully developed over decades and cannot be easily replaced, particularly in industries which rely on specialised inputs and global trade networks. In the modern global economy, industries thrive through specialisation and economies of scale, which naturally require coordination and open rule-based trade. 

For countries that are not as strongly politically and economically aligned in the “West vs East” paradigm, the current fragmentation of global trade provides both opportunity and risk. One such region is Latin America, which has enjoyed significant investments from China whilst maintaining strong trade relations with the EU and the United States. Accordingly, economists argue that the region would be well-equipped to deal with mild scenarios of global trade fragmentation.  Latin America can potentially benefit if companies choose to relocate operations to the region, if the risks for trade disruptions are perceived as lower or to find alternative sources of key commodities, such as raw materials. However, in more extreme scenarios, where global trade is divided into competing blocks, not aligning with either block may result in the region losing access to important markets. This has already proven difficult in the development of 5G technology in the region, as countries are attempting to walk a fine line between complying with U.S. pressure to ban Huawei bids whilst maintaining strong relations with China, which has become the region's largest trading partner. This situation is not unique to Latin America; countries and regions worldwide that are not closely economically and politically aligned with a particular block are carefully navigating trade relations with multiple competing parties, all while avoiding being labelled a threat to national security by any of them. 

There is cause for hope and concern. Trade is as important as ever, yet the direction of current policy trends and political rhetoric could potentially have disastrous consequences. As the line between trade issues and national security continues to blur amidst rising geopolitical tensions and an increasing number of countries adopting protectionist measures, it is crucial to start questioning what the long-term goals actually are. Economically, the policies evidently do not make much sense. Politically, the effects are seemingly desirable, both domestically as nationalism is on the rise and internationally to show assertiveness against geopolitical adversaries. It would be naive to suggest uncompromising free trade is the be-all and end-all with the existence of prevalent national security concerns and increasing geopolitical uncertainty. However, these policies mark a clear departure from an era of free trade and globalisation and are part of a larger move towards a multipolar and fragmented world in a time where humanity faces increasingly complex and existential challenges which require global cooperation. In the past, we have seen how trade can build bridges between countries. Today, we are seeing how trade is used as a tool to burn them.


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