Table of ContentsChapter 16


Key U.S. Security Policy Issues

Promoting Power Through Prosperity
Avoiding the Creation of Closed Economic Blocks
Promoting High Technology Industries
Managing Dependance on Foreign Firms and Sources for Key Goods
Maintaining an Adequate Defense Industrial Base
Using Economic Sanctions Effictively

The benefits of opening borders economically, however large in the aggregate, are widely dispersed, whereas the costs are concentrated. Thus, those who suffer the pain of adjustment have a larger incentive to bring political pressure to bear than those who enjoy the benefits. In short, the "low politics" of domestic interest groups vying for protection may well predominate over the "high politics" of the national interest--even when the latter has security implications.

In the aftermath of World War II, the United States economy had not yet experienced globalization, and U.S. preeminence in almost all major industrial sectors generated a confidence that is much less evident today. In this setting, the U.S. could tolerate a considerable degree of protectionist and nonreciprocal behavior on the part of allies in Europe and Asia, while keeping its own incipient domestic pressures for special treatment under control in the name of Cold War solidarity. Economic tensions among the major industrial powers, when they did arise, could be tucked away under the common security blanket.

Today, the globalization of the U.S. economy is more evident, the adjustment costs are greater, the U.S. no longer enjoys across-the-board industrial dominance, and the common bond of the Cold War is a thing of the past. A widespread hypothesis holds that the U.S. will now be less willing (or able) to take the longer term vision of the common good and bear a disproportionate share of the costs of maintaining a harmonious international economic system.

Perhaps the single most important test of whether special-interest "low politics" will supplant "high politics" in trade policy will be on the issue of enhancing market access for exports from the former Warsaw Pact countries. The U.S. has a major national interest in seeing that trade and investment supplement and eventually replace aid in underpinning market-based reform in Russia, Central and Eastern Europe, and the rest of the former Soviet Union. Yet so far, even modest initiatives to ease protectionist barriers (particularly anti-dumping barriers) against products from these countries have aroused strong opposition from the threatened industries.

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Pomoting Power Through Prosperity

There is a national security rationale to take steps that will strengthen the competitiveness of firms and workers in the United States. Higher productivity (or enhanced "competitiveness," as some prefer to call it) not only creates prosperity at home, but also augments a country's power in the international system by furnishing resources and capabilities to meet external challenges. Both international stature ("soft power") and concrete military capabilities ("hard power") typically accrue to a country with greater industrial and technological prowess.

On the macroeconomic front, the most fundamental step to strengthen the U.S. economic position would be to alter the underlying balance between savings and consumption in the United States. This would enable the U.S. to invest a greater proportion of its wealth in plant and equipment, R&D, and human capital. As long as the U.S. consumes more than it produces, it will continue to run a trade deficit and accumulate obligations to foreigners against U.S. assets. As long as it does not save enough to reequilibrate this balance, it will have to rely on foreign funds to renovate its industrial base--or, worse, simply slow the rate of renovation. A nation that is turning over the assets of the current generation to foreigners, or mortgaging the assets of future generations to current consumption, is likely at some point in the future to find its freedom of action and ability to influence events in the international arena constrained.

While the U.S. is still out of macroeconomic balance, the trends of recent years are promising. The largest single contributor to national dissaving, the federal budget deficit, is on a trajectory that will take it from 4.7 percent of GDP in 1991 to 2.1 percent of GDP in 1998, if fiscal discipline can be maintained. At the same time, investment rates for plant and equipment, and for R&D, have been rising. New initiatives to expand investment in human capital (especially in the area of vocational and work-related training) have been launched. If the trend towards human capital investment is reversed, the evidence suggests that the U.S. firms may substitute capital for labor, that is, the U.S. may develop a more highly automated economy with a more low-skilled workforce. This would exacerbate the difficulties of maintaining domestic support for constructive engagement in the international system and heighten the pressures for short-sighted protectionism.

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Avoiding the Creation of Closed Economic Blocs

Avoiding the creation of closed economic blocs may require a surprising level of subtlety in framing U.S. policy. If the threat sprang from the construction of overt walls of protectionism such as high tariffs, as happened in the 1930s, national leaders might find it easier to call forth concerted action to prevent it. But the policies that are pushing regional free-trade zones in the direction of exclusive blocs are much more arcane--"rules of origin" specifying the amount of domestic content required for a product to qualify as an internal product, obstructive anti-dumping regimes, preferential subsidies to particular regions, government rewards for engaging in local R&D, and similar policies. In short, the devil is in the details, far below the horizon of most economists, let alone national security strategists.

The most straightforward way to counter the drift toward exclusive blocs is through persistent efforts to keep the liberalization of trade, investment, and technology flows on a multilateral track. The most powerful multilateral impetus will come from implementation of the Uruguay Round. The Uruguay Round is the largest global trade agreement in history, reducing industrial tariffs by more than one-third, imposing meaningful limits on subsidized agricultural exports, and--for the first time--reducing trade barriers in services and intellectual property, where the U.S. has a solid comparative advantage. It promises to add approximately one trillion dollars to world output, of which almost $200 billion will accrue to the United States.

There is some concern that the World Trade Organization (WTO), established under the Uruguay Round GATT Agreement to settle disputes arising from the new trade regime, may undermine U.S. sovereignty. WTO rulings are not binding on any domestic legislature or agency, so in this sense, U.S. sovereignty and the force of U.S. trade laws remain intact. However, in the case of an adverse ruling with which the U.S. refused to comply, the nation that lodged the complaint could retaliate via trade restraints against U.S. products.

A second method to counter the creation of exclusive regional economic arrangements is to ensure an easy and transparent method of accession into blocs. A key case in point will be the creation of accession procedures for NAFTA. For example, will NAFTA ultimately extend not only to other nations in the hemisphere, but to countries in Asia (Singapore, Korea) and elsewhere (the Visegrad countries of Central and Eastern Europe) as well, as some have suggested? Equally important will be the question of whether accession agreements and other market access arrangements eliminate quotas on sensitive industries, prohibitive anti-dumping regulations, import surge mechanisms, and other protectionist devices.

Finally, there might well be an effort to harmonize, on a global basis, those elements of regional economic agreements that are most distortionary, such as rules of origin and anti-dumping procedures.

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Promoting High Technology Industries

As indicated earlier, a theoretical case can be made for government intervention to support national participants in key high tech industries where simply allowing markets to work may be dangerous from a national security as well as from an economic point of view.

Objections to strategic trade intervention arise first of all from practical considerations of implementation. There is the problem, as in all industrial policy debates, of devising criteria for picking winners and losers that work better than the market. In addition, there is the issue of pork-barrel and special-interest politics contaminating the selection process. As a result, despite an appealingly rigorous justification for public sector support for high tech industries with large economies of scale and dynamic learning-curve advantages, the prospects for creating an effective national policy in this area may be less than favorable.

But perhaps the biggest obstacle to using strategic trade precepts as a guide to U.S. policy is the beggar-thy-neighbor dynamic inherent in the theory itself. A nation that uses market intervention to capture vital markets for its own high-tech industries can expect other nations to follow suit. Cycles of public intervention, matching moves, escalation, and retaliation would be endemic. Thus, a policy shift toward government intervention in strategic trade industries by the U.S. would be certain to generate new tensions among the major powers.

But what of the fear that the United States is being systematically left behind in high tech industries? This was a cause for widespread concern in the mid-1980s, as the positive U.S. trade balance in high-tech sectors was dropping precipitously, from $25 billion in 1982 to $16 billion in 1986--a 35 percent decline in four years. By the early 1990s, however, the U.S. trade balance in high tech had regained all these losses and was setting new highs. There is now no overarching evidence that the U.S. is being left behind to such an extent as to require strategic trade intervention on a scale that would pose a risk to the stability of the international system.

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Managing Dependence on Foreign Firms and Sources for Key Goods

Globalization results in greater dependence on foreign suppliers. This raises the question of identifying the most appropriate methods to deal with growing reliance on non-U.S. suppliers of critical goods, services, and technologies.

Unfortunately, doing nothing is not a sufficient response. The evidence that dependence on non-national suppliers for critical goods, services, and technologies can pose a threat to national security is clear. That threat may take the form of denial, delay of delivery, blackmail, or the placing of conditions on access or use. The U.S. has itself been a prime practitioner of the manipulation of dependence in the past. Today, others may be in a position to exercise similar influence over the U.S., and that influence is likely to increase as the globalization of international economic activity continues.

However, for a threat of denial, delay, blackmail, or the placement of limitations on access or use to be credible, a necessary condition is the concentration of external suppliers. Whether for oil, semiconductors, or flat panel displays, the fundamental issue that determines the dependence of the U.S. on any particular foreign source is the availability of alternative sources and the ease of substitution. This allows national security strategists to distinguish cases that are legitimately worrisome from those that are not, and helps target industries of concern for national security. But the public policy tools for allaying such concerns--stockpiling, providing trade protection, awarding public subsidies for domestic production--all have important drawbacks.

To deal with dependence in standardized products whose characteristics do not change over time, stockpiles can offer an important cushion to mitigate the onset of a crisis. For example, petroleum is one imported commodity that is both critical and sufficiently concentrated externally that supply interruptions are plausible; thus, the U.S. maintains a Strategic Petroleum Reserve. The disadvantages of this approach include its high cost and the tendency to maintain stockpiles after the rationale for them has disappeared, as in the case of U.S. stockpiles of magnesium, chromium, and other minerals in the post-Cold War world.

Stockpiling of foreign-supplied products whose characteristics change over time is less feasible. An alternative is providing formal or informal trade protection to local producers. This may, however, lock domestic purchasers into using inputs that are higher in price or technologically inferior to what is available from foreign sources. In the case of machine tools, for example, "Buy American" requirements on defense contractors have forced the U.S. aerospace industry to use equipment that was more costly and had less precise tolerances than foreign-made products. In the case of semiconductors, price support mechanisms designed to help the U.S. semiconductor industry saddled U.S. avionics and computer companies with input costs much higher than those of their non-U.S. counterparts.

Public subsidies to create or strengthen local producers is another approach to dealing with dependency on concentrated foreign suppliers. From a strictly economic point of view, such subsidies are more appropriate than trade protection. Nevertheless, they raise nettling questions about how Washington should choose specific technologies to support, where to draw the line between precommercial development and commercial production, and how to reconcile such programs with commitments to bring government assistance under a common multilateral discipline. The new U.S. program to support domestic flat panel display producers, rather than forcing U.S. producers to rely on a handful of exporters abroad, may prove an interesting experiment.

An increasingly important question in the dependency debate is what to do about foreign acquisitions of U.S. companies in critical technology sectors. Once again, the crucial test is whether the international industry is sufficiently concentrated, and not, as is commonly supposed, whether the company to be acquired is the sole remaining domestic supplier (or one of a very small number). Once again, the logic is straightforward: no international concentration, no credible threat, and no reason to be concerned about the acquisition.

Difficulties arise when the international industry in which the U.S. company to be acquired is a rather tight oligopoly. Here, the national security strategist may have to face a choice of whether to block the acquisition and then perhaps to prop up an inferior domestic supplier, or to allow the acquisition to proceed, with ownership passing to the hands of foreigners who will then hold quasi-monopolistic control over access. In such circumstances, the emerging consensus is that, for civilian companies, the preferable path may be to permit the acquisition to take place while imposing requirements on the new subsidiary to maintain production and R&D within the United States. For defense contractors, on the other hand, the calculus is different, as described in the next section.

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Maintaining an Adequate Defense Industrial Base

Meeting the challenge of maintaining an adequate defense industrial base in an era of declining defense budgets is a vast subject. Three central issues arise: minimizing the loss of core capabilities; maximizing the ability to reconstitute when needed; and providing for the consolidation of defense contractors worldwide.

The adverse structural characteristics of defense contracting suggest that many firms may withdraw even more rapidly and more completely from the defense business in the coming decade than would be predicted by declining defense budgets alone. These adverse structural characteristics include large economies of scale and a high ratio of fixed to variable costs, which magnify the impact of shrinking production runs; a monopsonistic buyer whose purchasing procedures generate great risk and uncertainty for suppliers; a uniquely constrictive regulatory environment; and a tendency to yield relatively low profits. The consequent pressures for withdrawal from defense contracting will, if left unaddressed, exaggerate the loss of core capabilities and magnify the difficulties of reconstitution.

The most straightforward path to maintaining a relatively vibrant defense industrial base is to reduce the incentives for firms to exit, despite lower overall DoD expenditures, by reducing the cumbersomeness of defense contracting and facilitating the integration of civilian and defense operations within individual firms. The first step in this direction would be to eliminate barriers to incorporating civilian technology into defense products by minimizing military standards and specifications (MILSPECS) and by turning over more maintenance and repair contracts to the private sector. A second step might be to expand opportunities for multi-year procurement. A third option is to institute specific reforms to shrink unusually burdensome defense contracting procedures in cost-accounting and auditing, enhance recoupment of R&D expenditures, grant contractors greater proprietary data and technical rights on publicly-funded research projects, and improve the progress payment system.

However, all of these measures may fall short of the goal of preserving sufficient core capabilities for reconstitution in an emergency. Some specialized kinds of know-how, facilities, and assets will have to be identified and supported directly.

Another issue is how to deal with the consolidation of defense-oriented suppliers into quasi-monopolistic industries. On the domestic side, the year 2000 is likely to find the U.S. with a single submarine-building facility, a single carrier-building facility, a single tank producer, and perhaps two builders of military aircraft. Under these circumstances, the challenge will be to ensure prices and rates of innovation comparable to those achieved under the more competitive conditions of the past. With regard to quasi-monopolistic foreign suppliers of defense products, the preceding section offers some guidelines. For some commodity-like products, stockpiling might be the least expensive method to guard against the risk of a cut-off. For non-commodity products, trade protection or subsidies to domestic suppliers are options, although the disadvantages of both approaches must be borne in mind.

A special case of the problem of dependence on quasi-monopolistic suppliers will arise in the course of cross-border mergers and acquisitions in which foreign corporations seek to acquire U.S. firms whose operations include defense contracting. An immediate consideration in any potential foreign acquisition of a defense contractor, of course, is the ability to safeguard confidential material. A second consideration is familiar from the previous section: how concentrated is the international industry of which the company targeted for acquisition is part? If the industry is not concentrated globally, the acquisition can be approved--assuming the safeguarding of confidential material is assured--without fear of denial or blackmail. But if the industry is concentrated globally, what is the appropriate policy response?

Some observers argue that the imposition of requirements for R&D and production to remain in the United States is sufficient to protect U.S. interests. However, while such requirements might ensure that the U.S. will not be denied access to the acquired firm's products, they cannot guarantee U.S. government control over disposition of the defense products in question, especially as the acquired firm's know-how is dispersed throughout the foreign owner's international operations. The foreign owner might, for example, be free to make sales that conflicted with U.S. government directives or policies--to Iran, for instance. The only way to assure that the quasi-monopoly power of the acquired firm remained under U.S. jurisdiction would be for Washington to deny permission for the proposed foreign acquisition and, if necessary, to find a U.S purchaser for the target firm or support it directly.

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Using Economic Sanctions Effectively

The dispersion of control over goods, services, and technology among suppliers around the globe means that Washington's ability to coerce other states to abandon disruptive patterns of behavior is becoming more complex to organize and more difficult to achieve. Even in past decades, economic sanctions have had a mixed record of success. Since 1973, economic sanctions have achieved their specific goals in only about a quarter of the cases in which they have been deployed. When success is defined more broadly, in terms of exacting a significant economic cost or restraining undesirable behavior in general, their record improves somewhat.

Economic sanctions work best against small, economically dependent states. They are most likely to be effective if they are comprehensive, with multilateral support and strict enforcement. Further, sanctions are likely to be more effective against states that are sufficiently democratic for their business communities to have some internal influence. They are generally less effective against authoritarian regimes and dictatorships, particularly highly personalized ones. In the case of South Africa in the 1980s, and Guatemala in 1993, domestic business groups transmitted the pain of sanctions into inner political circles. A difficulty with the cases of Iraq, Serbia, and potentially North Korea, in contrast, is that there are few such channels for translating economic hardship into policy changes. On the contrary, for many rogue regimes, economic sanctions may produce what has been called the "neutron bomb" effect--namely, destroying the soft targets in a nation's civilian economy while leaving the hard structures of the regime intact (or worse, enriching the leadership against whom the sanctions are directed).

Most sanctions regimes follow the path of gradual escalation--sanctions are threatened, tentatively or partially applied, expanded or strengthened as required--punctuated by demands for compliance at each stage. The advantages of this approach are, first, that it can facilitate the formation and maintenance of multilateral coalitions, which can only proceed at the pace of their most reluctant members. Second, slow application of sanctions may provide an opportunity to see if diplomacy can produce better results than pressure. Third, the quick imposition of hard-hitting sanctions may provoke a spasmodic reaction on the part of the target state rather than a more rational act of submission--for example, an attack by North Korea on the South in response to sanctions, rather than a capitulation on nuclear reprocessing. A considerable disadvantage of this approach, however, is that the process typically takes place over such a long period of time that the target regime can adjust and black markets can be organized, while the costs to front line states wear down these states' appetites for maintaining the sanctions.

Frequently, the only effective alternative to sanctions is military force, an instrument that the market democracies are even more reluctant to wield. The national security strategist's dilemma, therefore, often consists of choosing between a flawed approach to sanctions or simply doing nothing. Thus, the use of sanctions to express displeasure and perhaps inflict pain is likely to continue even in absence of any realistic expectation that they will decisively alter another state's behavior.

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