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[Research Reports] On Economy-Security Linkages

Keisuke Iida (Professor, Graduate School of Public Policy, The University of Tokyo)
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The Research Group on Economy-Security Linkages #3
“Research Reports” are compiled by participants in research groups set up at the Japan Institute of International Affairs, and are designed to disseminate, in a timely fashion, the content of presentations made at research group meetings or analyses of current affairs. The “Research Reports” represent their authors’ views. In addition to these “Research Reports”, individual research groups will publish “Research Bulletins” covering the full range of the group’s research themes.

1. Introduction

In April 2020, the Japan Institute of International Affairs established a study group on economy-security linkages. In recent years, there has been an increasing incidence of events in which the economy and security are closely interlinked. The purpose of this study group is to analyze the current situation in detail and draw guidelines for Japan's economic diplomacy. Before describing the increasing links between the economy and security, let us consider the background against which this phenomenon is taking place.

First of all, the security environment has changed. North Korea conducted several nuclear tests from 2006 to 2017. China has been strengthening its military power and trying to change the status quo in the East China Sea and the South China Sea. Russia annexed Crimea in 2014, showing an expansionist tendency.

Second, China is challenging the technological hegemony of the United States. The "Made in China 2025" program explicitly stated a goal of becoming a technological superpower. China has already surpassed the United States in the number of international patent applications and is closing in on the United States in R&D spending.

2. Classification

There are two types of linkages between the economy and security:
(A) when the economy affects military power; and
(B) when the economy affects bargaining power.

Type A includes export controls, investment screening, arms transfers, indigenous arms production, and burden sharing of the cost of stationing US forces in Japan (HNS). Type B not only includes economic sanctions, economic coercion, energy security, engagement policies, supply chain diversification, and human security, but also "Free and Open Indo-Pacific," infrastructure security, World Trade Organization (WTO) disputes, and space policy.

3. Recent Trends

First, I will explain policies belonging to Type A that are directly related to military power.

Export control

During the Cold War, the Coordinating Committee for Export Control (COCOM) system was established as part of the containment strategy against the communist bloc. This system prevented the communist-bloc-bound flows of not only weapons but also various materials and technologies that could be used for military purposes. After the end of the Cold War, COCOM was dissolved because it had lost its raison d'etre, but the Wassenaar Arrangement was agreed to as its successor. In addition, the Nuclear Suppliers Group, the Zanger Committee, the Australia Group, and the Missile Technology Control Regime are among the frameworks on the basis of which Japan is implementing its own export controls. These regimes leave considerable discretion to each country regarding dual-use technology.

Through the National Defense Authorization Act for Fiscal Year 2019, the United States strengthened its export control. The law incorporates the Export Control Reform Act (ECRA) that significantly expands the coverage of US export control.

Japan needs to tighten its own export controls. Until now, Japan has taken a more lenient stance on export control than the United States, but on July 1, 2019, Japan announced that it would seek individual licenses for three chemical products destined for South Korea. South Korea, reacting against this decision, has filed a complaint with the WTO, and the two countries are now in the process of dispute settlement.

Investment screening

In the United States, the Committee on Foreign Investment in the United States (CFIUS) has long examined inward investment from the viewpoint of national security. In 1986, CFIUS blocked Fujitsu's attempt to purchase Fairchild. After this incident, Congress gave the president authority to deny inward FDI on a security basis in 1988. In the 2010s, the sense of crisis heightened as China's direct investment in the United States increased, and the Foreign Investment Risk Review Modernization Act (FIRRMA) was enacted. As a result, investment screening has become much stricter.

In the European Union, investment screening is conducted by each Member State. However, foreign companies might try to boost their presence in Europe through countries with weak surveillance. The EU's FDI Screening Regulation, which came into effect in April 2019, requires Member States to review investments from outside the EU in areas related to artificial intelligence (AI), semiconductors, and national defense. It is up to the Member States to decide whether to restrict investment, but they are obliged to inform the European Commission and other Member States.

In Japan, the Foreign Exchange and Foreign Trade Law was revised in November 2019 based on the consideration that strengthening security monitoring of inward FDI is desirable. This revised law lowered the notification threshold for stock and voting rights from 10% to 1% and came into effect in May 2020.

Arms transfers

Arms transfers are on the rise worldwide, and Japan is also seeing an increase in imports of foreign military sales (FMS) from the United States. Commitments are increasingly sought at the summit level. In November 2018, the leaders of the two countries agreed that Japan would purchase state-of-the-art F-35 stealth fighters, and in December of the same year, the Japanese cabinet decided to purchase 105 fighters.

Japan, which had restricted arms exports under the 1967 Three Principles on Arms Exports, paved the way for the resumption of arms exports through the Three Principles on Transfer of Defense Equipment and Technology.

Domestic production of weapons

Japan has also made efforts to domestically produce defense equipment. However, wholesale domestic production is not easy, so defense equipment is often jointly developed with foreign countries. In the past, Japan and the United States experienced frictions over the development of the next-generation fighter (FSX), forcing Japan to be cautious about producing 100% of defense equipment domestically. Japan is now focusing on the domestic production of the X-2 stealth fighter, which was developed as an experimental stealth fighter by the former Technical Research and Development Institute (now the Acquisition, Technology & Logistics Agency).

Host Nation Support (HNS)

Japan has shouldered more than 70% of the costs of stationing US forces in Japan. When John Bolton, then US national security advisor, visited Japan in July 2019, he reportedly demanded 4.5 times the present amount (or $8 billion). The current agreement expires at the end of March 2021 and is under negotiation for renewal.

Next, policies belonging to Type B are explained.

Economic sanctions

Since the end of the Cold War, the number of economic sanctions has increased. Although Japan was cautious about imposing economic sanctions in general, it started imposing economic sanctions against North Korea in 2006 and also imposed sanctions against Iran based on UN Security Council resolutions. However, its sanctions policy is restrained compared to that of Europe or America (except for sanctions against North Korea).

Economic coercion

China is increasingly using economic means for security or diplomatic purposes. China's economic coercion not only involves trade and finance but also restrictions on the movement of people.

Energy security

Energy security is a long-standing issue for Japan. Since the oil crises of the 1970s, gradually reducing its dependence on Middle Eastern crude oil and liquefied natural gas (LNG) imports has been the policy agenda for Japan, as the excessive reliance on Middle Eastern crude oil places it in a disadvantageous position.. Nevertheless, the rate of dependence on the Middle East has not dropped much.

Imports of LNG from Russia and the United States increased following the Great East Japan Earthquake in 2011. In Russia, the Sakhalin II project has been the largest project involving Japanese companies but, in recent years, the Yamal LNG joint development project has emerged as Russia's second-largest LNG project. Dependence on Russia carries risks, however.In particular, the United States is opposed to the excessive dependence of its allies on Russia. President Trump called on Chancellor Angela Merkel expressly to cancel the construction of Germany's Nordstream II project in June 2018.

Engagement policy

Japan and the United States have been taking a policy of engagement with regard to China. In particular, the Clinton administration separated China's Most Favored Nation (MFN) treatment from its human rights record in 1994 and allowed China to join the WTO in 2001. The Trump administration's stance that allowing China to join the WTO was a mistake suggests the end of US engagement policy toward China.

On the other hand, Japan has yet to abandon its engagement policy with China. The Regional Comprehensive Economic Partnership (RCEP) negotiations involving China were concluded in November. On the financial front, cooperation with China continues via the Chiang Mai Initiative Multilateralization (CMIM) and the ASEAN+3 Macroeconomic Research Office (AMRO).

China's Belt and Road Initiative (BRI) is another type of engagement policy. Not only do the partner countries feel thankful for China's ample funds, but China can also lease property, as in the case of Hambantota Port in Sri Lanka.

Diversification of supply chains

In the event of a security emergency, Japanese companies operating in the foreign country concerned will be held hostage, making it imperative that they diversify their supply chains. Anti-Japan protests in 2005, 2010, and 2012 prompted Japanese companies operating in China to diversify their supply chains, but their efforts have not been sufficient. In response to the spread of COVID-19, the Japanese government has made provision of more than 200 billion yen to support Japanese companies' repatriation of their production facilities to Japan or relocation of their production bases to third countries.

The Trump administration has encouraged US companies to return home. Democratic candidate Joe Biden also said he would consider a new tax incentive to allow them to return to the United States. However, American companies in China do not necessarily plan to return home.

Human security

Since the 2000s, Japan has focused on non-traditional security and human security. The stability of people's livelihoods in conflict areas and post-conflict areas, as well as the outflows of internally displaced persons and refugees from conflict areas to other countries, impose a burden on the countries concerned and, if they are Japan's friends, this affects Japan's bargaining power as well.

"Free and Open Indo-Pacific" (FOIP)

As part of the "Free and Open Indo-Pacific" (FOIP), the concept of the Blue Dot Network (BDN) among Japan, the United States, and Australia has been proposed as a type of engagement policy.

Infrastructure security

In an emergency, submarine cables could be actually severed by the enemy. If a military cable is concerned, this type of incident would belong to Type A, while incidents concerning a private cable would belong to Type B.

WTO disputes

In recent years, the number of WTO disputes that concern security has increased. Japan has also been sued by South Korea at the WTO over its export control vis-à-vis South Korea. How effectively Japan can invoke GATT Article XXI (i.e., the GATT's security-exception clause) will be the key.

Space policy

China's test destruction of one of its own satellites in 2007 shocked the world. This is because anti-satellite weapons (ASAT), the kind only seen in movies until recently, have become a reality.

4. Conclusion

As of December 2020, it appears almost certain that Joe Biden will be the next US president. Whether a new administration will be able to reverse the trend described above remains to be seen. People around the world are holding their breath to follow the situation.