Did Janet Yellen just signal a new world economic order?
The war in Ukraine is momentous in its own right — the largest European war since World War II, and one of the most brutal and devastating. But it increasingly appears that the historical significance of the war could go beyond that.
An Atlantic Council speech by Treasury Secretary Janet Yellen earlier this month, described how the war could create fundamental changes in the world economic order that prioritize security concerns over economic integration. Another recent speech by ECB head Christine Lagarde also described how the war could be an economic tipping point, driving a shift from economic “efficiency to security, and globalization to regionalization.”
Yellen’s central concern was the lack of international cooperation with the U.S. effort to economically isolate Russia. It’s true that the United States has been highly effective in rallying core U.S. allies like the European Union, the UK, Japan, and Australia to participate in U.S. sanctions. These nations have instituted similar sanctions to the United States, strongly denounced Russia’s invasion of Ukraine, and at least expressed the desire to reduce trade with Russia for key commodities like energy.
This core sanctions coalition includes most of the world’s wealthiest nations and represents about half of the global economy, but it only accounts for about 15 percent of the world’s population.
This means a massive share of the world is on the sidelines to a greater or lesser degree. Countries representing more than half of the world’s population — notably U.S. rivals like China, but also key rising nations like India — either abstained or voted against the United Nations resolution to condemn Russia for its invasion and did not vote for the removal of Russia from the U.N. Human Rights Council.
Some of the world’s largest nations, notably including India and China, are significantly increasing their imports from Russia, especially commodities that are now available at prices well below world market levels.
Secretary Yellen delivered a warning to those nations that “the unified coalition of sanctioning countries will not be indifferent to actions that undermine the sanctions we’ve put in place.” It’s unclear exactly what this means, either in terms of the specific red lines that “undermine” U.S. sanctions and will trigger a coalition response, or the exact actions Washington may take in terms of secondary sanctions to punish violators.
In another recent interview, Commerce Secretary Gina Raimondo gave one example, saying that if Chinese manufacturers provided Russia with semiconductors the United States would “shut them down” by denying them the use of critical U.S. software. And Secretary Yellen hinted at an even more significant threat when she said that “China cannot expect the global community to respect its appeals to the principles of sovereignty and territorial integrity in the future if does not respect these principles now” — implying that even respect for Chinese territorial integrity may depend on Beijing’s compliance with the U.S. response to Russia’s violation of Ukrainian sovereignty.
But the Atlantic Council speech went beyond threats to outline a more profound reconsideration of what the conflict with Russia would mean for the world economic order. “Going forward,” she said, “it will be increasingly difficult to separate economic issues…from national security.” She outlined a new U.S. approach to trade based not simply on economic integration or growth but a new concept of “free but secure” trade, which would seek to re-organize global supply chains around “friend-shoring” to a limited set of trusted countries.
The extent to which the “friend-shoring” approach will require fundamental reorganization of global supply chains depends critically on the extent of its application to China. Yellen said that the world’s “willingness to embrace further economic integration” with China was now at stake in China’s response to the Russian invasion of Ukraine. But the reality is that Chinese economic integration has already happened. China is now the primary trading partner for manufactured goods of almost two-thirds of the world’s 195 nations, including many of the largest and most dynamic economies.
A U.S. approach to “friend-shoring” that seeks to create supply chains which comprehensively screen out both Russia, one of the world’s largest commodity exporters, and China, the world’s most significant manufacturing power, could have profound implications for both the world economy and U.S. domestic economy.
These implications are often framed in terms of the loss of the U.S. dollar’s status as a reserve currency, and it is true that the weaponization of the dollar through the intensive use of sanctions has already created significant and visible pressures for the fragmentation of currency blocs. But the dollar is deeply entrenched as a currency of international trade and any such shift would take time. The economic implications of a more protectionist and divided structure of global trade go well beyond the status of the dollar, to affect productivity and economic growth more broadly.
Secretary Yellen was honest about these costs in a press conference last week, stating that in rerouting supply chains through a more limited and restricted set of U.S. allies “there may be some cost to bear and permanently higher inflation, somewhat higher local costs, somewhat less efficient system, but one that is more resilient.” She added that “ideally, we would have a large group of trusted partners so that we can maintain the efficiencies that come from the global division of labor, but also feel more secure.”
In her speech, ECB head Lagarde was also explicit about the potential growth costs of a more fragmented international order, stating that the “price of increased security could in principle take the form of lower international risk-sharing and higher transitional costs.”
Over the long term, what is at stake is the extent to which the United States will shift its leadership stance in the global economy from an expansive one, aimed at global economic integration, to one aimed at creating and fostering a more segregated trading coalition of U.S. allies. This could create a new tradeoff between our security and economic interests, one which is already becoming evident in even the initial negative impacts of the current anti-Russian sanctions on the U.S., European, and world economies.
During the Cold War, the United States faced a divided world, but united under its leadership all the most economically dynamic nations. Through its innovation of post-WWII economic institutions, U.S. leadership served to economically integrate these liberal capitalist nations to a degree never before achieved. In the post-Cold War era this U.S.-led system grew to incorporate less developed and previously non-aligned nations. These new entrants fed vast stores of cheap labor into the global economy, a development that restrained inflation and increased global productivity and wealth, even as it undermined working and middle class wages in the wealthiest nations and benefited multinational corporations engaged in labor arbitrage.
When a Rand Corporation team examined U.S. international policy since WWII, the researchers credited U.S. efforts at economic integration with a profound contribution to global stability, saying that, “the interlocking set of trade agreements put in place after 1945, and the deepening process of global trade and economic integration and collaboration, has contributed to an emergent sense of a shared economic fate, the need to cooperate in dealing with recessions and crises through such means as coordinated monetary policy, and the inability of nations to prosper in opposition to these established norms.”
We may now be entering a new era, where the goal of U.S. economic statecraft is shifting from integration to dis-integration, and U.S. security is defined in terms of protection from the economic networks of potential rivals rather than fostering a unified global economic order under U.S. leadership. The costs and benefits of this course are as yet uncertain. On the one hand, the benefits of globalization have come under question in recent years. But the costs of protectionism and the benefits of global economic cooperation could exert a countervailing pressure to the desire to subordinate economic goals to great power conflict.
Even as Secretary Yellen threatened to cut economic ties with countries not cooperating with U.S. sanctions over Ukraine, her speech also outlined an ambitious agenda for global economic cooperation. She called for action in areas that included the climate transition, globally coordinated counter-cyclical spending to prevent world recession, multilateral investment in global public goods and economic development, and even implementation of agreements around international tax enforcement.
It is difficult to imagine how leadership on anything like this agenda will be possible if Washington chooses to focus its efforts on a limited set of reliable allies, even if those allies include the wealthiest European and Anglosphere countries.