Friday, June 26, 2009

Economic Power as a Geopolitical Tool

Economic power has, since the dawn of civilization, been a foundation of the nation state’s standing amongst its neighbors. Indeed economic activity and in particular trade with neighboring nations is a fundamental element of society as we know it, from small tribal villages to the WTO. Thus the ability to wield trade and economic dependency as a tool of both soft power in times of peace or the erosion of war fighting capacity in times of conflict is something that has been an essential part foreign policy for time immemorial. Today in times of relative geo-political stability and an established security order, gaining economic leverage in order to achieve strategic results is becoming the favorite weapon of the world’s great rising powers. The state owned mega-corporations Gazprom of Russia and Chinalco of China have become the long arms of their respective owners, implementing policy of not only economic benefit but geo-strategic division and long term disruption of the established security order. Apparently in the world of a lone superpower and a single dominant alliance system “economic warfare” has become new great power battleground, and in a globalized economy it is fast becoming one of the most challenging.

Russia, Gazprom and West

Russia is perhaps in the unique position as the only contemporary ex superpower in existence. Just two short decades ago the Soviet Union enjoyed the most powerful conventional military forces on the planet, with the economic and political influence that enjoyed hegemonic domination over half the globe. Thus it may seem to be a bit of a paradox to label Russia as a rising power. Certainly the short period of time spent out of the superpower league stands in stark contrast to the other rising powers such as China and India, neither of which have ever enjoyed true great power status on a global scale. However Russia’s geo-strategic situation today shares much in common with India or China, and the old Bear is desperate to shake off the daemons of the 1990’s and reassert her position alongside the other global powers. Unable to challenge the west militarily, Russia has turned to economic leverage as a tool to challenge NATO’s eastward expansion into Russia’s cold war sphere of influence. In addition to the rapid economic growth these moves have provided, the policy of economic “divide and conquer” is clearly visible in the Russian Government and Gazprom’s actions over the last five years.

Gazprom was created during the last days of the Soviet Union as a state run natural gas ministry, which soon became a state owned company and Russia’s largest energy producer. Privatized during the frantic and chaotic reforms initiated by Boris Yeltsin, Gazprom appeared to be on the path to western style privatization, albeit with strict ownership controls. The company posted a loss in 1999 amid controversy over internal accounting policies and a deteriorating natural gas transportation system. During the Putin administration’s reign Gazprom was effectively nationalized with the government obtaining a controlling share under the guise reducing restrictions on share ownership criteria. Gazprom moved quickly to tap into the vast western markets the thawing of the cold war had opened up, and in the blossoming of east west economic relationships Gazprom positioned itself as the primary natural gas supplier to the EU, with cheap abundant reserves and several overland pipelines. The relationship fostered between the growing EU and Gazprom was initially quite productive, with little Russian government interference or apparent politicization of management.

Only after the Russian government gained a controlling share in Gazprom was Putin able to effectively wield the massive economic power the energy relationship with Europe provided. By 2006 Gazprom provided most the natural gas to eastern Europe and a significant share to Germany and France, and while it remained in Russia’s economic interest to not allow anything to disrupt the relationship, the economic dependency on an authoritarian and increasingly assertive Russia was not something that sat easily with many Europeans, and it was in a dispute with Belarus that Russia began to flex her economic muscles.

During the 1990’s Russia continued her subsidization of eastern European gas supplies, leading to a huge price disparity between gas sold to Western Europe and the former Soviet block. In 2006 Russia signaled an abrupt shift to this policy by tripling the price it demanded from Belarus per cubic meter of gas, although this level was still far below what western Europeans played. A longstanding dispute over oil erupted between the two nations, with Belarus imposing a tariff on oil transited to Western Europe. Belarus may have been the instigator of this dispute; however the action taken by Russia was both drastic and far reaching. Initially Gazprom threatened to cut off all Natural Gas flowing through Belarus, which entailed a significant impact for the rest of Europe situated downstream. On January 8 2007, Russia actually cut off oil supplies running through Belarus. This was the first indication that Russia would use its monopoly over supply to achieve strategic results and capitulation by a smaller power. However worse was to come, and the economic battlefield would be in the Ukraine.

A very similar story ran its course in the Ukraine. Long enjoying subsidized natural gas prices, in 2006 the Ukraine was faced with a similar price hike. In the resulting dispute Gazprom stopped supplies moving through Ukraine, leaving much of eastern and central Europe without heating in the grips of winter. The Russians claimed that Ukrainian companies had been siphoning gas out of the pipeline that was intended for other European customers. Whether or not this is the case the Russian reaction was telling and dramatic, a dispute with the Ukraine led to severe economic and personal pain for Eastern Europe and its people. Russia demonstrated to Europe that it would not hesitate to cut off hydrocarbon supplies over a rather minor economic dispute with the Ukraine. Eastern Europe awoke to the reality that its massive dependence on Russian natural gas supplies was akin to an economic sword of Damocles hanging, now rather precariously, over their heads.

To make things worse in August of 2008 Russia invaded her neighbor in the South Caucuses, Georgia, with the pretext of Georgian aggression in its breakaway province of South Ossetia. This action had two primary consequences for Eastern and Central Europe;
  1. Russia demonstrated that it could mount significant military campaigns within the former soviet union, (with almost no justification), and the west would do nothing of value to help.
  2. The only other major natural gas supply diversification option for Eastern Europe is the South Caucasus Pipeline (SCP). This multinational pipeline project is designed to connect the central Asian Hydrocarbon fields to the European market, without passing through Russian territory. With no other feasible Natural Gas supplies and no immediate alternatives to natural gas, Eastern and Southeastern Europe (and to a smaller extent Central Europe) have a choice between several Russian pipelines or the South Caucasus Pipeline. However the SCP passes through Georgia on its way from the Caspian to the Black Sea, terminating on the black sea port of Supsa. Currently the SCP only transports oil however a natural Gas component is planned. SCP infrastructure was heavily targeted by Russian air power during the conflict, severely degrading the emplaced infrastructure.

Thus, although the August war failed to bring a Russian friendly regime to power in Tibilisi (which would have given Moscow control of the SCP by proxy), the Russians both demonstrated their ability to interdict the only other major pipeline system in operation in Eastern Europe, with only a minimal pretext and without direct western intervention (and disrupted the pipeline already in place). Now Eastern and Central Europe are faced with the situation that a strategically critical energy supply are controlled virtually by a single power, one that has demonstrated its ability and intent to disrupt energy supplies under its direct control for political reasons, and use military force to interdict diversification options. In short, Eastern Europe’s (and to a lesser extent Central Europe’s) energy security is dependant on the prevailing mood in the Kremlin.

The strategic implications of this economic dependency are fourfold:

  1. Hydrocarbon supplies provide Moscow with a lever that can be used to apply pressure on Eastern Europe very effectively, a geographical region that Moscow sees as vital to its future security. It is a primary strategic objective for Moscow to push her influence as far west as possible due to the lack of a geographical anchor for her borders on the North European plane.
  2. The partial dependency of major European powers such as Germany on Russian natural gas buys Moscow more room to maneuver in the former Soviet Union. If Moscow plans on any other military operations in Central Asia or the Caucasus the Germans and Eastern Europeans will be less willing to press the issue, lest their energy supplies be jeopardized. Neither the Germans nor the Eastern Europeans will be likely to get significantly involved either politically, economically or militarily if Russia were to repeat the war with Georgia elsewhere in the former Soviet Union. Thus this increases the Russians military options before it meets serious resistance from the Europeans. Germans are unlikely to go cold over Turkmenistan or Tajikistan.
  3. Given the above point, European energy dependence goes to achieving another Russian strategic objective, the destabilization of NATO. As Russia continues to reassert itself in the former Soviet Union the Anglo-Saxon powers are sure to resist, however its the central European powers with something to loose and very little to gain from confronting Russia in central Europe or the Caucuses. Although a Central Asian conflict would not affect NATO directly, the difference in policy response between the continental European powers and the Anglo-Saxon block will. If the Russians apply pressure in far eastern Europe and the Baltic states Germany will also be less inclined to intervene than the Anglo Saxon block, and that could cause a significant rift (there are more reasons than energy security for Germany’s apathy towards another confrontation with Russia).
  4. Energy supplies provide Russia with the ability to destabilize the current regime in Kiev. The Ukraine is strategically vital to Russia, and Russia proper would be nye indefensible if the Ukraine was allowed to join a western alliance. Thus destabilization and eventual overthrow of the current pro western regime in Kiev is an immediate strategic objective for Moscow, and the use of energy supplies provides a very powerful lever as it dramatically effects the lives of every day Ukrainians.

Clearly the use of economic levers has become the primary mechanism used by Moscow to achieve strategic goals in Eastern Europe, in addition to providing the political space to allow more direct methods to be utilized.

China, Chinalco and Australia

The Peoples Republic of China (PROC) and the Commonwealth of Australia have enjoyed a long standing and mutually beneficial economic partnership for almost 30 years. The massive Chinese economic expansion that has been driven by cheap exports to western markets has funded a massive industrialization process. Driven by a massive need for raw materials, PROC looked for a partner who could assure regular supply in a geographically location. Australia fit the bill perfectly. The economic boom that the world enjoyed in the first 8 years of this century drove Chinese expansion at a dizzying pace, which pushed commodity prices to all time highs. River’s of Chinese money flowed into Canberra’s coffers as incredibly profitable commodity contracts supercharged the Australian economy, with sustained 4.5% Real GDP growth rates. By 2008 the Australian GDP reached the $1AUD trillion mark. Although the mining sector only account for ~5% of Australia’s GDP, the massive profitability of commodity contracts meant that the multiplier effect of these exports was significantly enhanced.

This burgeoning economic relationship had significant strategic implications however. Since world war two Australia has been closely aligned with the U.S., the latter being Australia’s ultimate security guarantor. Australia is part of the “ABC” alliance group, meaning Australia, Britain & Canada. This “Anglo-Saxon block” is the U.S.’ closet alliance structure, receiving privileged technology transfer and intelligence sharing opportunities. Australia is one of two key US allies in the Asia Pacific region, anchoring the US’ southern flank in the region with Japan in the north. These two alliances are the cornerstone of the US position in the western pacific, with two modern, wealthy, dynamic, competent and capable partners at the north and south ends of Asia. This alliance system provides the US with the ability not only to geographically dominate the entire pacific but act as the geographical anchor to any containment strategy for rising East Asian powers.

The US-Aus alliance is why China’s economic relationship with Australia is important on a strategic level. Ever since Australia realigned from strategic dependency on the UK to the US its economic interests have not been aligned with its security relationships. Prior to 1939, the single largest market for Australian exports was the UK and its empire in the Indian Ocean basin. Thus retaining access to markets in the UK was economically vital to Australia, and why it deployed very large forces (per capita) to defend the Suez Canal in both world war one and world war two. Australia’s primary security partner, the UK, was also its largest economic partner. However once Australia’s principle security partner became the US its economic interests diverged from its security interests. Australia is a recourse exporter, so is the US. Thus the guarantor of its security is also an economic competitor.

Now Australia’s largest export markets are no longer British dominions but Japan and China, the great Asian product exporters. The relationship with Japan is strategically benign because Japan and Australia are part of the same alliance system. The relationship with china has the potential to be destabilizing however, simply because the US and China are competitors. From a security viewpoint, Australia has become the southern anchor to the US’s containment of China. The Australian sphere of influence (Indonesia, Papua New Guinea & Oceania), which is becoming more pronounced as Australia’s national power continues to grow, acts as natural buffer for growing Chinese influence. Wherever China seeks security and economic relationships within Australia’s sphere of influence it will find already standing and long established security, political and economic relationships with Australia as the regions leading power. Additionally Australia provides the US a secure base to interdict the Melaka Straights and conduct operations in South East Asia in the event of a shooting war with China. Thus the Australian alliance is very valuable to Washington. Conversely Australia has far more to gain economically from China than it does from the US. This contradiction between Australia’s security and economic relationships is a significant vulnerability in the U.S’s alliance system, particularly as that economic relationship continues to grow.

And it has been growing of late. After the fall of Lehman Brothers in 2008 and the global recession that followed many Australian mining companies have been experiencing significant financial difficulties, primarily due to the inability of some firms to find adequate credit in the post Lehman Brothers credit environment, and also due to the collapse in commodity prices. Seeing an opportunity to increase economic influence in Australia, and improve their market position various state owned Chinese mineral companies have either invested in or attempted to invest in Australian mining companies. An example is the $1.2 Billion AUD purchase of OzMinerals’ mining facilities in South Australia by the Chinese government owned MinMetals. The largest economic move by Beijing was the proposed $19.5 Billion USD investment in Rio Tinto by Chinese recourse giant Chinalco (also state owned). If the deal had gone through it would have given Chinalco a significant market advantage, considering Rio Tinto and Chinalco enjoy a customer/supplier relationship. Economically the investment would have been a very good one for Chinalco and PROC, from that point on Chinalco’s bargaining position would have been far stronger during contract negotiations, and Rio would have been effectively locked into the Chinalco relationship. However Rio walked away from the deal after strong public and shareholder opposition to the proposal, it is possible that the Australian government could have vetoed the deal on national interest grounds.

While the Chinalco deal made great economic sense to the Chinese it also served significant strategic interests. Increasing economic ties between China and Australia, while improving the Chinese position in the relationship simultaneously, increases the potential for dissention within the US’ political alliance structure. Let me qualify this, if there was a major, multi theatre regional conflict between the two powers it is inconceivable that Australia would not enter on the side of its closest ally with its full capability.

However that is not the most likely conflict scenario in East Asia. In a small and limited conflict over Taiwan, after the cessation of hostilities (and likely Chinese defeat) China and the U.S would have powerful economic incentives to return to reasonably amicable relations. Without the US market Chinese exports will have to destination (a disastrous outcome for the Chinese Communist party and the nations territorial integrity), and the US will loose mountains of Chinese investment and cheap imports. Thus the symbiotic and critical economic relationship they have will compel both sides to resume semi-normal economic interaction almost immediately. China would not be in a position to punish the US economically (they have more to loose). However Australia is much more vulnerable. Although hardly crippling economically, the loss of Chinese export contracts would have significant and tangible effects on GDP and employment in Australia. It is likely that the extremely profitability of the recourse sector has been responsible for the above trend growth seen in the last 10 years. This could amount to between $5 billion AUD and $10 billion AUD p.a. at current prices when the multiplier effect is considered, at the upper end almost half to Australia’s aggregate defence spend. For a conflict in which no vital Australian interests are at stake, Australia would pay a heavy price for its involvement in the defence of Taiwan.

Therefore it is likely that the US may not count on military assistance from one of its closest allies in a high intensity conflict against an able foe in their geographical area. It is at least reasonable to assume hesitation on Canberra’s part to enter the conflict, considering the cost. Deepening this relationship means widening the gap between Australia’s security interests and its economic interest, which will increase the possibility that Australia will not intervene in a conflict over Taiwan and not peruse as committed a containment strategy as would have been the case other wise.


Clearly the massive government owned enterprises in the two potentially antagonistic rising global powers are being used as instruments of state power, and although the use is typically more obvious in the case of Russia, both nations are perusing wider geostrategic goals. Of course this phenomenon is not limited to rising powers; the west has been using similar tactics for decades. The US effectively controls the global trade system through global naval domination, and has the ability to exclude any nation from free global trade. When it exercises this power it is usually through U.N. sanctions, however only the USN has the ability to enforce sanctions on a global scale.

However this is usually a use of military force under a UN banner, the west rarely uses economic dependence of potential enemies in the manner Moscow and Beijing do. This is a dramatic shift from the cold war, where the eastern and western blocks were totally economically independent, with very little economic interaction between the two. In the new era of globalization and the global economy, economic interaction provides significant opportunities for traditional geopolitical maneuvers which would have been backed by military force in the past. In real terms Russia posses very little threat to Germany, but through Natural Gas supply manipulation Russia has the ability to move Berlin’s position. Additionally China posses very little realistic threat militarily to Australia, particularly an Australia what is part of the US block, however with the ability to turn off the tap of Chinese money Beijing has the ability to heavily influence policy in Canberra. Of course that does not suggest Russia can invade Poland without a German reaction, or China can establish naval bases or launch amphibious campaigns in Indonesia or Papua without an Australian militarily reaction, nevertheless it does afford them more options.

Additionally it must be said that the economic relationship between Gazprom and Eastern Europe or Chinalco and Australia has been initiated with the objective of providing government with an economic lever. Russia had Natural Gas, Europe needed it, Australia had minerals, and China needed them. However these state owned corporations are instruments of state power, make no mistake. And while perusing economic objectives, geopolitical objectives can also be achieved.

These consequences of economic interaction must be assessed by policymakers when economic decisions are made. Global economics is now a battlefield between the major global power blocks, in a way it has never been before. This is clearly a consequence of the massive military inferiority any power has under the US, and another asymmetrical form of exercising state power.