Affordable geoeconomics

Even by the standards of the Trump Administration, which has gone nary a week without outraging someone with a new policy, last week’s announced deal with NVIDIA and AMD drew unusually broad opprobrium. The deal, in which the chipmakers receive export licenses to China for some of their most advance chips in exchange for 15% of the revenue from those sales,¹1 was called an “export tax,” “corporate extortion,” and “state capitalism with American characteristics.”²2 It seems the only people to defend the deal were its participants, with NVIDIA stating “America cannot repeat 5G and lose telecommunication leadership.”³3

And me. When I saw reports of the deal, my immediate thought was “Clever! I wish I’d thought of that.” My reasons differ from NVIDIA’s and perhaps the Trump Administration, but, like many Trump Administration economic and foreign policies, the deal makes geoeconomic sense to me.

“Sense? Seriously, Marvin?! And what is this geoeconomics of which you speak?”

Let me explain.

What is geoeconomics aka economic statecraft?

Geoeconomics, or as it is sometimes called, economic statecraft, is the use of economic policy to align other nations’ behaviors with your own interests, or to deter or degrade their ability to make war on you. Perhaps more accurately, albeit provocatively, one can think of it as economic warfare. The Prussian war theorist Carl von Clausowitz defined war as diplomacy by other means and economic statecraft is one of several non-kinetic (non-lethal) means of coercing other nations to a desired path when asking nicely doesn’t work.⁴4

Nothing new under the sun

While many economists, commentators and politicians have deemed economic statecraft as “unamerican” or anti-market, it is long-established American policy. From the Marshall Plan to rebuild Europe and Japan after World War II to the establishment of the Bretton Woods system, the International Monetary Fund, the World Bank, and the World Trade Organization, the US has sought to align its allies’ interests with America through economic policy. Major US allies have sought to extend their own influence via regional development banks and supranational entities like the European Union. And, as I discussed last week and more extensively in Global entropy: Enter the dragons, the West has increasingly used these institutions to align other countries with their morals.

China shows the West how it’s done

Yet the West has nothing on China. China’s Belt and Road Initiative (BRI) is the Marshall plan on steroids. As the Bretton Woods system did for the US, the BRI economically (and thus politically) ties to China a wide network of countries across Eurasia and the Indian and Pacific Oceans through trade, finance and increasingly payments systems. But BRI goes a step further. Member countries are bound to China even more tightly through physical and technological infrastructure (Huawei is one of the largest lenders in the BRI).⁵5

Malign “shaping” operations

In terms of military strategy, the BRI might be described as a decisive action, i.e. an operation undertaken to achieve a specific outcome, in this case to align countries with China. Although it threatens strategic competitors like the US, the BRI is not inherently an offensive operation of economic statecraft (though there are increasing complaints that Chinese conditional or infrastructure loans to BRI members are being used coercively). But China also has pursued less friendly forms of economic statecraft that are better seen as offensive shaping operations, actions taken to shape the battlespace for later decisive actions that may be economic or kinetic.

Strangling dissent

For instance, as I have discussed before, through its industrial policies, China has strategically cultivated monopolies or become the swing supplier in a broad range of critical inputs to global supply chains, including active pharmaceutical ingredients essential to most medicines, refined petroleum, refined rare earths and permanent magnets, and many types of semiconductors. China has deployed its stranglehold on critical supplies as weapons in conflicts with Japan in 2010 and in the escalatory phase of the US trade war earlier this year.⁶6 As Doomberg puts it, China’s strategic domination of critical industries gives it “escalation dominance” in almost any conflict.

Fight with what?

But China also has shaped the battlespace by de-industrializing its peers like the US and Europe, robbing them of the ability to fight a sustained kinetic conflict. As I described in Identity crisis and Incompatible drag, China’s massive excess capacity across industries is a feature, not a bug. It is intentional economic statecraft achieved by subsidizing selected Chinese industries on an unprecedented scale to generate immense capacity. Manufacturers in China’s strategic competitors are then washed away in the tsunami of underpriced Chinese goods. Without the manufacturing base to produce ships, tanks, missiles, drones, or airplanes, Western states – as they are learning in Ukraine – cannot even sustain a war against Russia, a far inferior economy to China, the world’s largest manufacturer.

Winning without fighting

China’s use of economic shaping operations is meant to achieve its ultimate strategic goal: to win without fighting. Through its economic policies, lawfare, information operations, and diplomatic encirclement – the full spectrum of “Unrestricted warfare”⁷7 – China seeks to degrade its adversaries’ ability to wage war to the point that they submit to China’s will without fighting, recognizing the folly of challenging a clearly superior opponent.

America cottons on

After three decades of unrelenting Chinese economic warfare the US seems to have cottoned on that it’s been in a one-sided economic war with China that has left it kinetically inferior to China in the Western Pacific and dangerously vulnerable to economic coercion. Mind you, not everyone got the memo. Most of the economics profession continues to cling to a utopian vision of the global trading system and abhors any form of (non-central bank) state interventions in the West. But judging by the number of geoeconomics institutes and rebranded former geopolitical strategists popping up, economic statecraft is going mainstream among the cool kids. More importantly, the need for some form of industrial policy is now broadly accepted by Democrats and Republicans, was a prominent feature of the Biden legislative agenda, and is perhaps the signature issue of the Trump Administration.

Congratulation, you’ve accepted economic statecraft! Now what?

Yet, confusion still reigns. Advocates of the Biden Administration’s industrial subsidies object to the Trump Administration’s tariffs, many of the Biden subsidies were in turn unwound by Republicans in the One Big Beautiful Bill, members of both camps winced at the Federal government’s direct investment in MP, a US rare earths refiner,⁸8 and as noted at the start, nearly everyone dislikes the revenue-sharing agreement with NVIDIA and AMD.

“We’ve already established that”

There’s an old joke that a man asks a woman at a bar if she’d sleep with a man for $100 million and she says, “Of course!” So, he asks, “Well, would you sleep with me for $100?” “What do you think I am, a prostitute?!” she snaps. “We’ve already established that, now we’re just haggling over the price,” he retorts.

Once you’ve decided to counter China’s economic distortions and rebuild economic resilience, the question is not whether you’ve abandoned your principles – you have – but rather how to do so most effectively. For the US, the question is even more pressing because it is reacting so late, having already allowed China to gain a dangerous advantage.

Choose your ground carefully

The first point is not to fight on your adversary’s home turf. A free, consumer-oriented society like America is never going to be able to compete on subsidies with an authoritarian, high-savings nation like China. This is especially true given that the US already has an unsustainable deficit and debt. Competing on subsidies is a war of attrition the US can’t win.

Prudence, cost efficiency and jiu-jitsu

Tariffs are an attractive strategic response to China’s subsidized overcapacity for three reasons. First, rather than drain the national treasury, tariffs generate revenue. Second, they are a more cost effective means of re-industrialization. The cost of a subsidy is born wholly by national taxpayers, but the increased supply it creates benefits the whole world. Conversely, tariffs’ costs are in part born by one’s adversary’s exporters, while their benefits accrue solely to domestic industry. Third, just as jiu-jitsu turns an opponent’s weight advantage against them, tariffs turn China’s subsidy advantage against it. Subsidizing overcapacity is costly: the fiscal cost of direct subsidies, the losses accrued by state-owned enterprises, and by banks and bad-asset managers when businesses fail. Closing America’s markets to Chinese products increases those losses, and losses are amplified further by the “tariff funnel” created as other markets restrict access to Chinese goods as a condition of trade deals with the US.

Efficacy over efficiency

Neoliberalism on both sides of the aisle dies hard, hence the bipartisan CHIPS and Science Act to subsidize semiconductor manufacturing in the US was tailored for economic efficiency over national security efficacy. The scope of the subsidy was broad – to allow markets to decide what type of chips (or their inputs) should be built in the US – and focused on creating production capacity. While US manufacturing requires all grades of chips, their criticalities differ. But broad subsidies encouraged markets to allocate capital to the highest profit opportunities, not the most critical to US national security. Further, the Act’s focus on capacity rather than minimum production does nothing to ensure sustained US supply if prices fall below marginal cost. Both characteristics make the CHIPS Act’s subsidies vulnerable to natural market fluctuations and Chinese industrial policies.

Targeted selection

In contrast, the MP investment and price support deal is structured to be effective at the cost of efficiency. The US Defense Department picked the winner, potentially reducing competition and efficiency, although in this case somewhat mitigated by the narrow field of rare earths refiners still operating in the US. In return, the US gains greater surety of a larger and sustained supply of critical minerals. By taking a stake in the MP’s preferred shares, the government provided critical capital for expansion that MP was able to leverage with private-sector loans. The Defense Department also guaranteed a price floor and committed to buy all of MP’s expanded capacity. The price floor and orders ensures that MP can sustain a profit and remain in business. But in combination with tariff protections, the Defense Department’s monopolization of MP’s supply ensures that private US demand – e.g. for autos – extends the price floor across other US rare earths refiners.

Pragmatism over principle

Contrary to opponents’ characterization of it, the revenue-sharing agreements with NVIDIA and AMD represent a triumph of pragmatism that benefits US national security, the US Treasury and both companies. The alternative advocated by some was to place controls on the chips the deal applies to. Such controls have proven ineffective – DeepSeek used controlled NVIDIA chips⁹9 – as Chinese companies just purchased them at a premium through middlemen. Under the new deal, China will now be able to legally purchase NVIDIA and AMD chips – helping to diffuse tensions with China – but the US Treasury captures the middlemen’s spread. At the margin, NVIDIA may also be correct that using their chips slows development of Huawei’s.

Homework: optimizing second best?

This is not to say that I am comfortable with governments picking winners or that the Trump Administration’s economic statecraft has been flawlessly designed. State interventions in markets amplify opportunities for corruption and may restrain innovation and productivity. But as I have shown, the world economy already is deeply distorted and has lower welfare due to China’s economic statecraft. The challenge is to design geoeconomic responses that maximize the second-best outcome (and hopefully improve global security in the process). Despite its newfound faddishness, economic statecraft remains woefully understudied in the West. Rather than build yet another n+1 iteration of the Neo-Keynesian model, perhaps more academic economists could research optimal second-best optimizations to counter harmful economic statecraft.