How Nations Use Economic Power to Shape the World Order

Q: What is geoeconomics?

Geoeconomics is the pursuit of hegemonic influence by great powers like the U.S. and China using economic leverage—trade and financial relationships—to change the economic or political behavior of other actors in the world.

It’s applying an economic instrument in a way that says, if you do what we want, we give you one treatment. If you don’t do what we want, we give you a different treatment.

It could be tariffs. It could be sanctions. It could be China asking countries that have received Belt and Road loans to vote a certain way in the UN. It could be the U.S. telling semiconductor producers not to export to China. We’re seeing the various tools of geoeconomics employed more and more.

Q: Where did this field come from?

It’s a practice that has been used by governments for a very long time. But some of the first writing about it was Albert Hirschman’s 1945 book National Power and the Structure of Foreign Trade which examined how, during the interwar period, Germany strategically positioned its resources to be able to both project its influence and withstand pressure from countries like Great Britain.

Hirschman was an economist, but his ideas were primarily developed in political science and international political economy. Excepting for the Hirschman-Herfindahl Index, which Hirschman developed as a measure of trade dependencies, economists essentially ignored his ideas for the next 75 years.

Q: How did you come to it?

I was looking at China’s efforts to internationalize its currency with my co-authors Matteo Maggiori and Jesse Schreger. We saw that while there were clear economic reasons for China’s currency efforts including building internal capital markets, there also seemed to be geopolitical motives behind it. And similarly, China’s Belt and Road Initiative is economic development that’s being done in a way that is significantly about projecting influence.

In trying to understand these approaches that don’t quite fit current models, we stumbled on Hirschman, got really interested in his work, and decided to try to bring it into the formal economic literature.

I should note that Hirschman described these power relations with terms like “economic statecraft.” Edward Luttwak, a scholar of strategy and international studies, gets credit for coining the term “geoeconomics” in a paper in 1990.

Q: Would you explain how a geoeconomics lens helps understand China’s approach to its Belt and Road Initiative?

Through the Belt and Road Initiative, China provides loans for countries in Africa and Southeast Asia to do large infrastructure projects.

In that there are a couple of significant challenges that China faces. We know well from the sovereign debt literature that it’s hard to lend a lot to developing countries without inducing default. And infrastructure investment is also tricky. If China provides money to build a mine and the host country starts to struggle, it’s pretty easy to just expropriate the mine. Both elements involve economic relationships that in the international setting face poor legal enforcement.

We approached it by going back to the economic theories of commitment problems. If you have one relationship with another party—say, China just lends money to the developing country—the country will want to maintain the relationship only to the extent that they’d rather be able to borrow again in the future than default today. But with Belt and Road, China uses the loans as the basis for developing many different relationships simultaneously. In addition to the loans, China is providing counterparty countries access to valuable goods and services and connecting them to infrastructure and manufacturing relationships. If borrowing countries default, they lose access to all of it. Both intuitively and as we show in the forthcoming paper we published on this, that gives the counterparties a lot of incentives to maintain all the relationships.

By increasing the incentives and likelihood of repayment, China can actually lend more, which increases their economic return. In addition, they often use exclusivity clauses that say you have to hire Chinese manufacturers to build using this debt.

This approach also increases the potential for geopolitical influence. China says, given our various relationships we expect you to side with us in the next vote at the UN, or we expect you not to recognize Taiwan as a country. These are essentially the quid pro quo underlying this power relationship. China provides a benefit and expects something in return.

Q: Your work points to the U.S. and China as the hegemons using geoeconomic tools. Do their approaches differ?

Leveraging the last few decades of trade theory, we show that power comes from having products where you control a high expenditure share and that are very hard to substitute away towards another supplier. So one place to start is with the specialization differentiation between the U.S. and China.

The U.S. control over financial service provision is enormous. If you expand that to the U.S. and the Western coalition, the foreign financial service expenditure share is upwards of 80% for a lot of countries. So what’s going to be effective for the U.S. is the power to cut countries off from our financial industry—financial sanctions, exclusion from the SWIFT payments system.

China is not as dominant in manufactured goods as the U.S. is in financial services, but it controls a decent size of the market; for many countries, a relatively high fraction of their foreign expenditure on manufactured goods is directed towards China. So China’s power, right now, comes from manufactured goods, particularly the specialized ones like rare earth minerals.

Q: The U.S. is the hegemon around finance. China is the hegemon for manufacturing. AI is driving enormous economic activity. Is there a hegemon for technology?

It seems the U.S. is the closest there is. The first Trump administration essentially pioneered secondary sanctions using access to U.S. technology to keep semiconductor technology out of China.

ASML, a Dutch company that is the sole manufacturer of advanced lithography machines required for the most advanced microchips, relies on U.S. intellectual property in its production process. The secondary sanctions essentially forced the company to stop selling to China or find a new production process that didn’t rely on U.S. intellectual property. It was easier to find new markets than a new production process.

Another example tied to semiconductors is Taiwan. By and large, we think of geoeconomics as the game of great powers, but sometimes smaller countries with special inputs or goods are able to exert outsized clout.

The Taiwan Semiconductor Manufacturing Corporation has been a key source of semiconductor production for both the U.S. and China for quite some time. Because this company makes the most advanced chips in the world, the tiny little island has a safety guarantee from the U.S., which doesn’t want to lose access to chip production if China were to invade.

Q: Would you talk about how geoeconomics works in a multilateral context?

Power is not only about bilateral relationships. A lot of what I’ve described so far is what political scientists would describe as relational power, which is, I get you to do something. But there’s a much richer notion, which we call macro power and political scientists refer to as structural power. That is about how power influences a system and how power in one part of the system influences power in other parts of the system.

An example of this is the SWIFT payments system. Each potential user, in deciding to join a system, is thinking about the benefits they get. There are so many complementarities to being on a common payment system—liquidity, ease in finding people to transact with, etc.—that for any given user it makes sense. And the economic efficiency argument is that we should all load onto the same system.

But individual entities don’t internalize that as they join and grow more reliant on the system, the system becomes more attractive to everyone else. They’re not thinking that by using SWIFT the U.S. gets power over everyone in the system too. And, because so many countries are using the system, there’s not a great alternative, which gives the U.S. a particularly large amount of power to threaten to cut people off. You can make a similar argument for dollar dominance in the financial system.

We’ve highlighted this dynamic in a number of contexts. For example, it helps to understand why the U.S. is so intent on keeping Huawei telecommunications technology out of Europe. Once the technology got into a few countries, there would be strong potential strategic complementarities in adoption. But if the U.S. keeps the technology out of one country, it is less attractive for other countries to adopt it.

We have nothing to say on whether Huawei technology represented a national security risk; our argument is that from a geoeconomic perspective, if the U.S. blocks adoption in a European country where it has significant influence, that has a strong indirect benefit of helping keep it out of other areas where the U.S. may have less direct influence.

Q: Has your research pointed to the most effective ways to use geoeconomic power?

One thing we try to stress is that geoeconomic power needs to be used carefully.

At any point in time, a hegemon has many existing relationships that it can threaten to disrupt. The U.S. can go to all its trading partners and say, “We’re going to put tariffs on you unless you do X, Y, and Z.” Based on the way supply chains are structured, the U.S. can get something out of doing that. But at some point, if the U.S. is asking more than countries are willing to put up with, then, even though the alternatives are costly, they have to start looking for one.

The same is true of the dollar-based financial system. If the U.S. isn’t seen as a safe and reliable partner, the system’s going to start to adjust away. The U.S. actually benefits from maintaining a rules-based order.

It's one thing for the U.S. to step in when Russia invaded Ukraine, saying this is not acceptable and we’re going to use every tool we’ve got to stop it. That’s quite different from using geoeconomic power on a whim or rewriting the rules of the game to demand something new from partners each year.

A commitment to discipline in how a hegemon exerts influence, we argue in our work, ends up being a positive not only for other countries, but also for the hegemon itself, because rather than trying to flee, other countries will be willing to remain under its influence.

Q: Are we talking about a zero-sum game? Is there a fixed pie and the hegemons are trying to get a larger share using geoeconomic tools or is it more complicated than that?

This is something we’ve given a lot of thought to. It’s difficult to say. At a very basic level there are positive inducements—for example, China provides foreign aid loans and expands the countries’ borrowing capacity. And there are negative inducements—side with us in key political areas or we’re going to stop trading with you. When there are positive sum elements and negative sum elements, how do you net that out?

Now suppose instead that the U.S. is going to Europe and asking for more defense spending. Game theorists have known for decades that defense treaties come with free rider problems. If the U.S. threatens to put tariffs on Europe unless countries increase their defense spending to a specified amount, that may actually be kind of a public good for the Western alliance because, essentially, it’s a means of overcoming that free rider problem and enhancing the alliance’s defense capabilities.

In geoeconomics, power projection can end up with a complex mix of positive and negative properties. Did it make things better or worse? Rarely is the answer straightforward. Since these policies are designed to try to change relationships, we want to think about, what is the role and scope for intervention? We’re trying to understand the dynamics fully by developing the theory and models of geoeconomics.

Q: Would you expand on the value of formalizing the theory and models of geoeconomics?

Here’s an example. There’s a lot of talk about certain sectors being strategic, and so it’s in our nation’s interest to protect them. But Nikita Khrushchev pointed out that anything can be considered strategic. Even buttons are strategic if their absence means soldiers are too preoccupied with holding up their pants to aim their weapons.

By formalizing geoeconomics, rather than intervening in every sector that might possibly be strategic, we develop a process for structured reasoning that can inform policy. We can develop a sharper definition of power. We can measure it, at least from a model-based perspective. And then we can look empirically at, well, what’s the consequence of this? Do we see power changing between countries? Do we see countries changing their behavior toward each other?

Q: Where do you see the research going in the next few years?

A lot of our initial work was just setting up the structure of the theory, understanding the basic concepts and how both sides of the relationship respond to it. Now, I’ve received a National Science Foundation CAREER grant that will support pushing simultaneously on the theory and empirics.

On the theory side, the next big questions include what happens when you’ve got multiple great powers competing with each other. On the empirical side, where we’re really trying to make progress is understanding how firms respond when governments pursue these policies.