The Grand Strategy: Fixed Spheres of Influence or Variable Shares?

New Rail

The rise of the populist-nationalism over the past year or so is partly predicated on a realist view of international relations.  In the realist school of thought, the nation-state is the main actor, and international relations is characterized by competition between states.  

Many take away from this that competition is competition: it takes place on different fronts simultaneously, and that strategy is more or less than same, increase one’s powers and minimize the adversaries’ power and opportunities.  Drilling down from that generalization, two broad expansion strategies emerge.  

The first is the traditional export-oriented strategy.  We are all familiar with it.  To service foreign demand, business ships their domestically produced output across the border.  There are certain policies that facilitate such a strategy, such as a weak currency, a free-trade international regime that reduces trade barriers and domestic demand often needs to be repressed to ensure.

Some see this strategy to be a developmental strategy in the sense that emerging market economies may pursue such a strategy to provide the critical scale and investment for industrialization and modernization.  However, as advanced industrial countries like Germany, Switzerland, Finland and Sweden for example, demonstrate, export-oriented strategies are not limited to emerging market economies or is moving past them some kind of natural evolution.

 Th export-oriented model fit well into the traditional approach to international relations.  Countries sought spheres of influence.  These were non-domestic areas where a country dominated.  Wars were often fought as one wanted to increase their sphere, which meant encroaching on another sphere.  Since at least the start of the 20th century, when the US was an emerging revisionist power, it objected to the sphere of influence approach.

Specifically, as several European countries (Britain, France, Germany, and Portugal) and Japan were carving up China into spheres of influence that the US defended China’s territorial integrity and offered a non-imperialist expansion strategy and the basis of a different world order.  Rather than fixed spheres of influence, the US vision was based on variable shares of the world economy.  The variability depended on one’s economic prowess not political concessions from a country’s emperor or officials.    It was the basis of what was called the Open Door.

After WWII, with European countries and Japan using tariffs to facilitate the rebuilding of domestic industries, and the over-valued dollar, US companies, developed an alternative to the export-oriented strategies.  This strategy was based on direct investment, the building of production facilities.  Service foreign demand through local production.   Since US records have been kept (more than 50 years), the sales by majority-owned affiliates have outstripped US exports.  In 2014, local sales outstripped exports by a factor of nearly 5 to 1.

As a consequence, the value-added by the affiliates of US companies contributes to local GDP is a palatable way, unlike exports.  For example, in 2014, the value-added by US affiliates accounted for nearly 32% of Ireland’s GDP, 15% of Singapore’s GDP and 4% of Australia’s GDP.

The era of floating exchange rates began with the collapse of Bretton Woods in  1971.  Floating exchange rates mean volatile exchange rates.  The US direct investment strategy helps insulate companies for the vagaries of the foreign exchange market.  Export-oriented strategies have traditionally been more sensitive to currency appreciation, but recent experience and research suggest that for many goods exports are somewhat less sensitive to currency swings than in the past.

In addition, the latest academic findings suggest that the impact of the direct investment strategy on domestic employment is more nuanced than might be suspected.  Unskilled labor hired by the foreign-based affiliate of US companies competes with unskilled labor in the US.  However, skilled labor hired abroad appears to lead to more skilled domestic workers.   If barriers are erected to deter hiring unskilled workers abroad, it does not mean more unskilled or low-skilled domestic workers would be hired.  Rather, businesses would be incentivized to replace workers with machines, of which robots are just the newest form.