THE UNIVERSITY OF CHICAGO

CUTTING OFF YOUR NOSE?

A REIGNING POWER’S COMMERCIAL CONTAINMENT OF A MILITARY

CHALLENGER

A DISSERTATION SUBMITTED TO

THE FACULTY OF THE DIVISION OF THE SOCIAL SCIENCES

IN CANDIDACY FOR THE DEGREE OF

DOCTOR OF PHILOSOPHY

DEPARTMENT OF POLITICAL SCIENCE

BY

DONG JUNG KIM

CHICAGO, ILLINOIS

JUNE 2015
 UMI Number: 3711668

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To My Parents
 TABLE OF CONTENTS

List of Figures v

List of Tables vi

Abbreviations vii

Abstract viii

Acknowledgments x

Chapter 1. Introduction 1

Chapter 2. Theory 19

Chapter 3. Britain’s Economic Response to the German Challenge, 1898-1914 41

Chapter 4. U.S. Economic Response to the Japanese Challenge, 1939-1941 80

Chapter 5. U.S. Economic Response to the Soviet Challenge, 1947-1950 107

Chapter 6. U.S. Economic Response to the Resurgent Soviet Threat, 1979-1982 133

Chapter 7. U.S. Economic Response to the Chinese Challenge, 2008- 151

Chapter 8. Conclusion 196

Bibliography 213

iv
 LIST OF FIGURES
Figure 1-1 Case Selection 15

Figure 2-1 Theoretical Predictions 32

Figure 7-1 China’s Major Export Destinations 181

v
 LIST OF TABLES
Table 1-1 Explanations for the Reigning Power’s Economic Response 10

Table 3-1 Composition of the National Product of Britain 45

Table 3-2 Industrial Distribution of the National Income of Britain in 1907 45

Table 3-3 Britain’s Major Exports 46

Table 4-1 Major U.S. Exports to Japan 86

Table 4-2 Major U.S. Economic Actions against Japan 98

Table 5-1 “Free World” Trade with the Sino-Soviet Bloc 120

Table 6-1 Western Exports to the Soviet Union, 1979-1982 143

Table 7-1 U.S. MNCs Value Added to U.S. GDP 157

Table 7-2 U.S. MNCs Total Sales in the World 157

Table 7-3 Related Party Share of Major U.S. Imports from China 159

Table 7-4 Examples of Major U.S. Industries’ Gains by Purchasing from China 161

Table 7-5 Goods Supplied by Majority-Owned U.S. Affiliates in China 163

Table 7-6 Foreign Competitors of Major U.S. MNCs 164

Table 7-7 Revealed Comparative Advantage Based on Domestic Value Added 167
Embodied in Gross Exports of Manufacturing Goods

Table 7-8 Major U.S. Merchandise Exports to China 171

Table 7-9 EU-28’s Major Merchandise Exports to Chin 173

Table 7-10 Alternative Suppliers of Certain Raw Materials for China 175

vi
 ABBREVIATIONS

AMTORG Amtorg Trading Corporation

ATP Advanced Technology Products

COCOM Coordinating Committee for Multilateral Export Controls

EU European Union

MNC Multinational Corporation

NAFTA North American Free Trade Agreement

NATO North Atlantic Treaty Organization

OECD Organization of Economic Cooperation and Development

OPEC Organization of the Petroleum Exporting Countries

TPP Trans Pacific Partnership

USITC United States International Trade Commission

WTO World Trade Organization

vii
 ABSTRACT
Why does a reigning great power maintain trade ties with a military challenger, knowing that the

gains from trade contribute to the challenging power’s military ascendance? Why does a reigning

state not supplement military balancing by reducing its trade ties with a challenging state? This

dissertation addresses this puzzle by offering a theory that explains the conditions under which a

reigning power decides to maintain (or abandon) extant commerce with a challenging power

while balancing against that country militarily. This theory suggests that the nature of bilateral

trade and the structure of international commercial relationships jointly constrain the reigning

power’s economic options vis-à-vis the challenging power. First, when the reigning power’s

leading industries depend heavily on economic inputs from the challenger to enhance their

allocative and productive efficiency and market competitiveness, restricting bilateral trade would

inflict significant damage on the reigning power’s own economic capacity. Second, if alternative

partners exist for the challenging state to replace the reigning state’s position in its foreign

commerce, then abandoning trade would have only a limited impact on the challenger’s

economic performance.

When these two conditions are present, and bilateral trade is restricted, the reigning state

risks losing more economic capacity than the challenging state. Accordingly, without the trade

ties, the reigning state’s relative power position vis-à-vis the challenger would be weakened. It

follows that, in an attempt to maximize its own power, the reigning state would maintain

commercial ties with the challenging state. Only when its leading industries’ dependence on

challenger’s economic inputs is low and no alternative trading partners exist for the challenging

state, can the reigning power inflict relative losses on the challenger by abandoning bilateral

viii
trade. Thus, the reigning state would restrict trade with the challenging state in order to

complement military counterbalancing only in limited circumstances.

Drawing on original archival research in the United Kingdom and the United States, my

theory is tested through case studies of relations between reigning powers and challenging

powers since the late nineteenth century: (1) Britain’s response to the German challenge between

1898 and1914, (2) the U.S. response to Imperial Japan between 1939 and 1941, (3) the U.S.

response to the Soviet Union between 1947 and 1950, (4) the U.S. response to the USSR during

the Carter administration between 1979 and 1980, and (5) the U.S. reaction to the USSR during

the Reagan administration between 1981 and 1982. Moreover, I use my theory to examine the

U.S. reaction to the Chinese challenge in the West Pacific since the late 2000s. In each case

study, I pit my theory against two alternative explanations: one emphasizes the role of domestic

interest groups, and the other focuses on the use of economic inducements.

The case studies above suggest that the reigning powers behaved much as my theory

predicts. Britain decided to maintain trade ties with Wilhelmine Germany despite intensifying

military tensions because restricting trade would have inflicted greater harm on itself. Similarly

in line with my predictions, the U.S. was able to effectively sever its trade ties with Imperial

Japan before the Pacific War and the Soviet Union in the early stages of the Cold War as it could

inflict relative losses on both adversaries. Meanwhile, two U.S. administrations subsequently

responded to the resurgent Soviet threat in diverging ways—these divergent responses reflected

different assessments regarding the U.S. ability to impose losses on the USSR. I conclude that

the variations in my two explanatory factors are what constrained British and U.S. decisions

toward their challenging powers. I also find that persuasive evidence in support of competing

theories is largely absent.

ix
 ACKNOWLEDGMENTS

This dissertation was made possible by the support and encouragement of many individuals. First

and foremost, I would like to thank the members of my committee. I thank my chair John

Mearsheimer for his unflinching support and challenging mind. John taught me that our job as

political scientists is to identify important questions and offer simple answers. In my darkest

moments, John persuaded me that “perseverance is genius.” Bob Pape provided some of the best

advice on developing and testing a theory, and arranged opportunities for invaluable feedbacks.

Charles Lipson always asked questions which led me to develop my argument, and identified

several important implications of my work that I will develop in future versions. My committee

members are the models of thoughtful scholar, principled academic, and inspiring teacher to

which I aspire.

This project has also benefited from the advice and support of my colleagues. I received

countless helpful comments from the participants of the Program for International Security

Policy (PISP), the Chicago Project on Security and Terrorism’s writing workshop, and the Belfer

Center’s International Security Brown Bag Seminar Series. I am particularly thankful for

suggestions provided by David Benson, Ahsan Butt, Jon Caverley, Bonnie Chan, Adam Dean,

Gene Gerzhoy, Eric Hundman, Morgan Kaplan, Stephanie Kelly, Kazu Kimura, Doyoung Lee,

Chad Levinson, Katy Lindquist, Dan Magruder, M. J. Reese, Sebastian Schmidt, Yubing Sheng,

Paul Staniland, John Stevenson, and Kevin Weng. Kathy Anderson and Susan Lynch, two of the

most competent people I have ever met, deserve special appreciation for their assistance. My

apologies to anyone that I may have forgotten. It was fortunate to be part of a vibrant intellectual

community at the University of Chicago.

x
 My research was given generous support by the Korea Foundation for Advanced Studies

(KFAS), the Smith Richardson Foundation, and the Belfer Center for Science and International

Affairs at Harvard Kennedy School. If I were not selected as a recipient of the KFAS’s doctoral

fellowship, I would not have pursued a PhD in the first place. I thank President In-kook Park of

the KFAS for financial support, as well as for inviting me to take part in the Foundation’s diverse

academic endeavors. The Smith Richardson Foundation’s World Politics and Statecraft

Fellowship enabled me to conduct an archival research in Britain. The Belfer Center’s

International Security Program provided me with extraordinary opportunities to interact with

some of the world’s brightest minds and sharpen my argument. Among many people I met at the

Belfer Center, I especially thank Steven Miller, Sean Lynn-Jones, Richard Rosecrance, and

Stephen Walt.

I owe a debt of gratitude to those who advised me to pursue a career in academia. My

long-time advisor and mentor, Professor Shin-wha Lee, gave me her unrelenting support while I

completed my PhD. Professors In-Taek Hyun, Hyug Baeg Im, Nae-Young Lee, Hyeok Yong

Kwon, Dong Sun Lee, Yong Wook Lee, and Gilbert Rozman also influenced my choice of a

career.

None of this would have been possible without the support of my family. I dedicate this

dissertation to my parents, Myung Hwan Kim and Eun Uk Lee, for being a constant source of

love and encouragement throughout my life. I am grateful for the countless small and large

sacrifices they have made so that I could pursue all my interests, academic and otherwise. I also

thank Sung Eun Kim—my wife, my best friend, and the most talented colleague I know—for her

love and patience. I am truly lucky to be in love with Sung, a person who was strong and wise

enough to endure an anxious job candidate while writing her own PhD dissertation and carrying

xi
a baby. Finally, my son, Hajin Kim, was born by the time I was completing my dissertation. I

was so fortunate that I could secure enough time for Hajin. He is the source of my happiness and

hope.

xii
 CHAPTER 1

INTRODUCTION

The absence of significant limitations on U.S. trade with China poses an important puzzle for

scholars studying China’s rise as a potential dominant power in Northeast Asia. Theorists agree

that the emergence of one particularly powerful state in a great power region has heralded the

onset of fierce geopolitical competition.1 Thus, from the perspective of a reigning power in the

international system, appropriate military and economic countermeasures should be taken against

the newly powerful state in order to preserve international stability and its privileged position.2

Specifically, the reigning power has good reason to reduce bilateral trade and thereby disrupt its

potential competitor’s economic gains, especially when it has strengthened military balancing to

counter challenges to the status quo.3 The U.S., however, has not targeted China’s heavy

dependence on foreign trade as a means of hampering China’s further ascendance, even as

1
For instance, see Robert Gilpin, War and Change in World Politics (New York: Cambridge University Press,
1981); Robert Gilpin, “The Theory of Hegemonic War,” Journal of Interdisciplinary History, Vol. 18, No. 4 (Spring
1988), pp. 591-613; Paul Kennedy, The Rise and Fall of the Great Powers: Economic Change and Military Conflict
from 1500 to 2000 (New York: Vintage Books, 1989); John J. Mearsheimer, The Tragedy of Great Power Politics
(New York: W. W. Norton, 2001); Joseph S. Nye, Jr. “The Case for Deep Engagement,” Foreign Affairs, Vol. 74, No.
4 (July/August 1995), pp. 90-102; A.F.K. Organski and Jacek Kugler, The War Ledger (Chicago: University of
Chicago Press, 1980); Robert Powell, In the Shadow of Power (Princeton, N.J.: Princeton University Press, 1999),
pp. 115-148; and Kenneth N. Waltz, “Structural Realism after the Cold War,” International Security, Vol. 25, No. 1
(Summer 2000), pp. 32-39.
2
In particular, the U.S. historically has utilized economic and military means simultaneously in dealing with a
security challenger. Robert J. Art, A Grand Strategy for America (Ithaca, N.Y.: Cornell University Press, 2003),
p.113-120.
3
Economic capacity and military power are intimately linked to one another. Thus, countering a military challenger
requires addressing both economic and military dimensions. For the relationship between military and economic
capacities, see Edward Harllett Carr, The Twenty Years’ Crisis, 1919-1939 (New York: St. Martin’s Press, 1966), p.
108; Robert Gilpin, U.S. Power and the Multinational Corporation (New York: Basic Books, 1975), p. 35;
Mearsheimer, Tragedy of Great Power Politics, p. 46; and Kenneth N. Waltz, Theory of International Politics (New
York: McGraw Hill, 1979), p. 131.

1
Washington has declared “pivot to Asia” and strengthened internal and external balancing efforts

in the West Pacific to cope with the Chinese challenge.4

Why is there inconsistency between a reigning great power’s military and economic

policies in dealing with a challenging power? Why does a reigning state not supplement military

balancing by reducing its trade ties with a challenging state? Although scholars have explored

the historical development and future prospects of competition between reigning and challenging

powers, most studies confine their attention to the possibility of large-scale military contests

between the two states.5 Moreover, while these scholars agree that differential economic growth

is the root cause of the leading great power’s security concerns, they do not offer a convincing

explanation for why the reigning power does not address economic exchanges with the

challenging power.

Extant major international relations theories also fall short of answering these questions.

For realists, security concerns should lead the reigning power to eschew deep economic

cooperation with the challenging state.6 If states seek to preserve or enhance their relative power

position in the international system, as realists predict, the reigning power should actively thwart

4
Depending on the model used for estimation, the size of the effect of trade on China’s economic growth differs.
However, few doubt that international trade has contributed to China’s economic growth. For instance, see Yilmaz
Akyüz, “Export Dependence and Sustainability of Growth in China,” China and World Economy, Vol. 19, No. 1
(2011), pp. 1-23; “How Fit Is the Panda?,” The Economist, September 27, 2007; John Knight and Sai Ding, China’s
Remarkable Economic Growth (Oxford: Oxford University Press, 2012); Justin Yifu Lin, Demystifying the Chinese
Economy (New York: Cambridge University Press, 2012); Xiaohui Liu, Peter Burridge, and P. J. N. Sinclair,
“Relationship between Economic Growth, Foreign Direct Investment, and Trade: Evidence from China,” Applied
Economics, Vol. 34, No. 11 (2002), pp. 1433-1440; and Dani Rodrick, “What’s So Special about China’s Exports?”
China and World Economy, Vol. 14, No. 5 (September 2006), pp. 1–19.
5
For instance, in addition to fn. 1, see Charles L. Glaser, “Will China’s Rise Lead to War? Why Realism Does Not
Mean Pessimism” Foreign Affairs, Vol. 90, No. 2 (April 2011), pp. 80-91; Jack S. Levy, “Declining Power and the
Preventive Motivation for War,” World Politics, Vol. 40, No. 1 (October 1987), pp. 82-107; John A. Vasquez, The
War Puzzle Revisited (New York: Cambridge University Press, 2009), pp. 90-127. Also see the special issue of
International Interactions (Vol. 29, No. 4 (2003), pp. 269-364) on China’s rise and its implications.
6
Joseph M. Grieco, “Anarchy and the Limits of Cooperation: A Realist Critique of the Newest Liberal
Institutionalism,” International Organization, Vol. 42, No. 3 (Summer 1988), pp. 485-507; Mearsheimer, Tragedy of
Great Power Politics, 51-53; Waltz, Theory of International Politics, pp. 104-107.

2
the challenging power’s economic growth whenever it is feasible. Thus, if trade burgeons

between the reigning and challenging powers despite rising military competition, realism’s main

propositions regarding state behavior and international cooperation are dealt a potentially serious

blow.7 Similarly, theories that focus on the security implications of foreign trade, and thus

predict less economic exchange between military competitors, are hard to be applied to explain

the commercial exchanges between the reigning and challenging states.8

The inconsistency between the reigning state’s economic and military measures is no less

puzzling for liberal and constructivist theorists.9 For many liberal scholars, international

institutions facilitate the exchange of information and solve the problems of transaction cost,

monitoring and bargaining, and thereby compel states to actively engage in cooperation and

avoid security conflict.10 From a different liberal perspective, absolute gains in trade should

prevent the reigning power from adopting serious competitive security policies against the

challenging power.11 For constructivists, either friendship, rivalry, or enmity should be the

7
For realism’s pessimism about international cooperation, see David A. Baldwin, ed., Neorealism and
Neoliberalism: The Contemporary Debate (New York: Columbia University Press, 1993); James D. Fearon,
“Bargaining, Enforcement, and International Cooperation,” International Organization, Vol. 52, No. 2 (Spring
1998), pp. 269-305; Robert Jervis, “Realism, Neoliberalism, and Cooperation: Understanding the Debate,”
International Security, Vol. 24, No. 1 (Summer 1999), pp. 42-63; and John J. Mearsheimer, “The False Promise of
International Institutions,” International Security, Vol. 19, No. 3 (Winter 1994/95), pp. 5-49.
8
For security externalities argument, Joanne Gowa, Allies, Adversaries, and International Trade (Princeton, N.J.:
Princeton University Press, 1994); and Joanne Gowa and Edward D. Mansfield, “Alliances, Imperfect Markets, and
Major-Power Trade,” International Organization, Vol. 58, No. 4 (Autumn 2004), pp. 775-805.
9
I exclude regime type-based theories because the puzzle that motivates this study is extensive trade ties between a
democratic state and an authoritarian state. For the role of democracy in interstate cooperation, see Charles Lipson,
Reliable Partners: How Democracies Have Made a Separate Peace (Princeton, N.J.: Princeton University Press,
2003). For the role of regime type in interstate trade, see Edward D. Mansfield, Helen V. Milner, and B. Peter
Rosendorff, “Free to Trade: Democracies, Autocracies, and International Trade,” American Political Science Review,
Vol. 94, No. 2 (June 2000), pp. 305-321.
10
For classic treatment of international institutions, see Robert O. Keohane, After Hegemony (Princeton, N.J.:
Princeton University Press, 1984). Also see Robert O. Keohane and Lisa L. Martin, “The Promise of Institutionalist
Theory,” International Security, Vol. 20, No. 1 (Summer 1995), pp. 39-51; and Mearsheimer, “The False Promise of
International Institutions.”
11
For a recent study on the pacifying effect of commerce, see Gerald Schneider and Nils Petter Gleditsch, eds.,
Assessing the Capitalist Peace (New York: Routledge, 2012). Also see Edward D. Mansfield and Brian M. Pollins,
eds., Economic Interdependence and International Conflict: New Perspectives on an Enduring Debate (Ann Arbor,
M.I.: The University of Michigan Press, 2003); and Patrick J. McDonald, The Invisible Hand of Peace: Capitalism,

3
dominant intersubjective identity in one bilateral relationship.12 Thus, if these arguments are

correct, we should not observe serious security competition between economically linked states

in the first place. In other words, international institutions or absolute gains from trade would

dampen military competition between the reigning and challenging powers. However, this is not

the case in contemporary relations between the U.S. and China. Security tensions rose while the

two countries were establishing cordial trade ties and were actively participating in or creating

international institutions. Both enmity and friendship are abundantly observable in bilateral

relations between the two powers.13 In short, constructivism and liberal theories cannot

adequately account for a condition where extensive economic cooperation and increasing

security tensions coexist.

Moreover, although some theorists do show that military competitors or even warring

states might continue trading with each other, they tend to focus on relations between great

powers in balanced multipolarity.14 In an anarchic international structure where military power is

evenly distributed among multiple states, it can be reasonably suggested that every state is the

other’s potential enemy. Therefore, each state has strong incentives to maintain trade ties even

with its current adversary in order to avoid relative loss vis-à-vis other countries or out of fear of

future conflict with them.15 However, the international structure in which the competition

the War Machine, and International Relations Theory (New York: Cambridge University Press, 2009).
12
See Alexander Wendt, Social Theory of International Politics (New York: Cambridge University Press, 1999),
chapter 7.
13
For instance, see Avery Goldstein and Edward D. Mansfield, eds., The Nexus of Economics, Security, and
International Relations in East Asia (Stanford, C.A.: Stanford University Press, 2012); and Gilbert Rozman,
Northeast Asia’s Stunted Regionalism (New York: Cambridge University Press, 2004).
14
For instance, see Peter Liberman, “Trading with the Enemy: Security and Relative Economic Gains,”
International Security, Vol. 21, No. 1 (Summer 1996), pp. 147-175; and Suzanne Werner, “In Search of Security:
Relative Gains and Losses in Dyadic Relations,” Journal of Peace Research, Vol. 34, No. 3 (August 1997), pp. 289-
302. Also see Jack S. Levy and Katherine Barbieri, “Trading with the Enemy during Wartime,” Security Studies, Vol.
13, No. 3 (Spring 2004), pp. 8-18.
15
For this argument, see Duncan Snidal, “Relative Gains and the Pattern of International Cooperation,” American
Political Science Review, Vol. 85, No. 3 (September 1991), pp. 701-726.

4
between the reigning and challenging powers takes place is often not multipolar. During the Cold

War, the international structure was bipolar. Since the end of the Cold War, the structure has

been unipolar.

In sum, the incongruity between the reigning power’s economic and military policies in

its relations with a challenging state remains largely unexplored in the study of international

relations. This dissertation seeks to address the puzzle by offering a balance of power theory of

the reigning power’s decision over extant commerce with the challenging power.

The Argument

A reigning power refers to the state that commands the largest material capacity among the

leading members of the international system. It is a status quo state because the present

distribution of power between major states is favorable to its security. Its interest hence lies in

preserving existing balance of power.16 A challenging power implies a major state in a great

power region—Europe or Northeast Asia—that has grown particularly powerful in comparison

to its immediate neighbors. In other words, the challenging state refers to a potential regional

hegemon.17 The challenging power, moreover, is a revisionist state.18

16
For the nature of a reigning great power, see Stephen M. Walt, Taming American Power: The Global Response to
U.S. Primacy (New York: W. W. Norton, 2006).
17
For regional hegemony, see Mearsheimer, Tragedy of Great Power Politics, pp. 40-42.
18
Here, “revisionist” simply refers to a state that intends to change the existing balance of power in search of
security. I do not consider revisionism as normative, ideological, or domestic political attributes. For the concept of
revisionist and status quo states, see Jason W. Davidson, The Origins of Revisionist and Status-quo States (New
York: Palgrave, 2006); Ian Hurd, “Breaking and Making Norms: American Revisionism and Crises of Legitimacy,”
International Politics, Vol.44, Nos. 2–3 (March 2007), pp. 194–213; Alastair Iain Johnston, “Is China a Status Quo
Power?” International Security, Vol. 27, No. 4 (Spring 2003), p. 56; Randall L. Schweller, Deadly Imbalances:
Tripolarity and Hitler’s Strategy of World Conquest (New York: Columbia University Press,1998); and Randall L.
Schweller and Xiaoyu Pu, “After Unipolarity: China’s Visions of International Order in an Era of U.S. Decline,”
International Security, Vol. 36, No. 1 (Summer 2011), pp. 41-72.

5
 My theory explains a reigning power’s policy changes regarding major trade with a

challenging power.19 Maintaining trade ties means complying with the current political

arrangements that regulate major trade with the challenging state. In contrast, abandoning trade

ties refers to the adoption of policies designed to diminish major commercial exchanges with the

challenger.20 I assume the reigning power sees the challenging power as its major security threat,

and in response has begun to focus its military forces against that country and strengthened

military alignments with other states. I also assume that there are ongoing commercial exchanges

between the reigning and challenging states, and those exchanges contribute to the challenger’s

economic performance. Finally, I assume that domestic mobilization or reallocation to replace

foreign trade results in a decrease of a state’s economic capacity.

In this dissertation, I suggest that the reigning power’s decision to maintain or abandon

existing trade ties with the challenging power can be best understood as an effort to maximize its

own relative power position. Here, maximizing power means that the state makes a choice that

promises it the largest possible gains, defined in terms of material power, under the constraints

imposed by the nature of interaction with others.21 In this context, when the reigning state

reconsiders extant commerce with the challenger, it would try to make a choice that yields the

19
For theoretical simplicity, I consider my dependent variable as a dichotomous variable. Moreover, I do not confine
attention to military-related or dual-use products, because, from the neoclassical economic perspective, all goods can
be considered strategic. See Lisa L. Martin, Coercive Cooperation: Explaining Multilateral Economic Sanctions
(Princeton, N.J.: Princeton University Press, 1992), p. 267, fn. 2. Also see Tor Egil Førland, “‘Economic Warfare’
and ‘Strategic Goods’: A Conceptual Framework for Analyzing COCOM,” Journal of Peace Research, Vol. 28, No.
2 (1991), p. 192.
20
For restrictive economic measures, see David A. Baldwin, Economic Statecraft (Princeton, N.J.: Princeton
University Press, 1985), pp. 40-42; and Michael Mastanduno, Economic Containment (Ithaca, N.Y.: Cornell
University Press, 1992), pp. 39-63.
21
In other words, the state makes a strategic choice when it interacts with others. For the definition of strategic
choice, see David A. Lake and Robert Powell, Strategic Choice and International Relations (Princeton, N.J.:
Princeton University Press, 1999).

6
best outcome for its own relative power position, rather than simply attempting to increase its

power in brute fashion.

I argue that the reigning state does not diminish trade ties with the challenging state

despite ongoing military counterbalancing efforts because restricting bilateral trade would inflict

greater harm on itself. Under certain conditions, maintaining extant commercial ties better serves

the reigning state’s own relative power position. Following the insights of mainstream trade

economists, I presume that trade contributes to a state’s material capacity by enhancing

allocative and productive efficiency and market competitiveness, thereby allowing the state to

increase its overall economic performance and create more wealth.22 When assessing the impact

of restricting trade with the challenging state, then, the reigning state would gauge who would

lose more in terms of economic efficiency and performance without bilateral trade.23

I hypothesize that two factors jointly constrain the reigning state’s decision: the

dependence of its leading industries on the challenger’s economic inputs, and the presence of

alternative trading partners for the challenging state. First, when its leading industries depend

heavily on economic inputs from the challenger to enhance allocative and productive efficiency

and market competitiveness, restricting bilateral trade inflicts significant damage on the reigning

power’s own economic capacity. Second, if alternative partners exist for the challenging state to

replace the reigning state’s position in its foreign commerce, severing trade would only have

limited impact on the challenger’s economic performance. At the same time, the challenger’s

alternative partners would diminish the reigning power’s economic capacity by making it

22
For instance, see Cletus Coughlin, “The Controversy over Free Trade,” Federal Reserve Bank of St. Louis Review,
Vol. 84, No. 1 (Jan./Feb. 2002), pp. 1-22; Elhanan Helpman, “The Structure of Foreign Trade,” Journal of Economic
Perspectives, Vol. 13, No. 2 (Spring 1999), pp. 121-144; Paul R. Krugman, Maurice Obstfeld, and Marc J. Melitz,
International Economics: Theory and Policy, ninth edition (New York: Addison-Wesley, 2012). Also, see Klaus
Knorr, The War Potential of Nations (Princeton, N.J.: Princeton University Press, 1956), pp. 199-201.
23
Adopting this view on trade makes it very difficult to quantify the exact extent of each state’s potential loss.
Nonetheless, I can identify which country would lose more in the absence of bilateral trade.

7
difficult to divert exports away from the challenging state while introducing frictions with these

countries.

When these two conditions are present, and bilateral trade is restricted, the reigning

state’s economic performance would diminish significantly, while the challenging state would

maintain its overall economic capacity. The reigning state thus risks losing more economic

capacity than the challenging state. Accordingly, without the trade ties, the reigning state’s

relative power position vis-à-vis the challenger would be weakened. It follows that, in an attempt

to maximize its own power, the reigning state would maintain commercial ties with the

challenging state. Only when its leading industries’ dependence on challenger’s economic inputs

is low and no alternative trading partners exist for the challenging state, can the reigning power

restrict trade ties and maintain its overall economic efficiency and competitiveness while

inflicting losses on the challenging state’s economic performance. Thus, only in limited

circumstances, the reigning power would abandon bilateral trade in order to improve its relative

power position and complement military counterbalancing.

Alternative Explanations

An alternative theory explaining the reigning power’s decision must be able to account for the

incongruity between its military and economic policies in dealing with the challenging power.

Thus, I do not consider theories that correlate more security competition and less economic

cooperation (and vice versa) as alternative explanations.

I test my theory against two alternative theories. First, the reigning state—which is not a

unitary actor—might maintain trade ties with the challenging state because of the influence of

certain domestic interest groups. In this view, economic ties with the challenging power

8
sustained over a protracted period of time establishes commercial interest groups within the

reigning state. Even when security concerns increase, these interest groups function as a political

coalition that would try to influence their home country’s economic policies toward the

challenger.24 If these groups prove to be more influential than other societal groups that want to

restrict trade with the challenging state, their preferences would be translated into the

maintenance of trade ties with the challenging power. In contrast, if they lose the domestic

competition for influence, the reigning state would restrict trade with the challenging state.

Second, for some scholars, continuing commerce between the two powers might reflect

the reigning state’s use of positive economic inducements to shape the challenger’s behavior.25 In

this perspective, the reigning state would utilize the promise of economic gains alongside

military countermeasures to coerce or deter the challenger. In a similar vein, the reigning power

could use negative economic sanctions in conjunction with military force to shape the

challenger’s behavior. The choice among these economic strategy is likely to be determined by

the prospects of absolute economic gains from bilateral trade. When large absolute gains exist,

the reigning state would be incentivized to utilize positive economic inducements and thus

maintain trade ties with the challenger.26 When only small mutual gains exist, severing bilateral

24
For the role of domestic commercial interests, see Scott L. Kastner, “When Do Conflicting Relations Affect
International trade?” Journal of Conflict Resolution, Vol. 51, No. 4 (August 2007), pp. 664-688; Paul A.
Papayoanou and Scott L. Kastner, “Sleeping with the (Potential) Enemy: Assessing the U.S. Policy of Engagement
with China,” Security Studies, Vol. 9, No. 1 (1999), pp. 157-187. Also see Levy and Barbieri, “Trading with the
Enemy during Wartime”; and Steven E. Lobell, The Challenge of Hegemony: Grand Strategy, Trade, and Domestic
Politics (Ann Arbor, M.I.: The University of Michigan Press, 2003). The role of domestic economic interests,
moreover, has been emphasized in the international political economy literature. For instance, see Michael J.
Hiscox, “The Domestic Sources of Foreign Economic Policies,” in John Ravenhill ed., Global Political Economy,
third edition (Oxford: Oxford University Press, 2011), chapter 4; Robert Keohane and Helen Milner eds.,
Internationalization and Domestic Politics (New York: Cambridge University Press, 1996); and Helen V. Milner,
“The Political Economy of International Trade,” Annual Review of Political Science, Vol. 2 (1999), pp. 91-114.
25
For diverse economic strategies, see David A. Baldwin, Economic Statecraft (Princeton, N.J.: Princeton
University Press, 1985), pp. 40-42; and Michael Mastanduno, Economic Containment (Ithaca, N.Y.: Cornell
University Press, 1992), pp. 39-63. Also see Michael Mastanduno, “Economic Statecraft, Interdependence, and
National Security: Agendas for Research,” Security Studies, Vol. 9, No. 1 (1999), pp. 303-5.
26
This logic has mainly been advanced in policy-relevant writings in the United States. For instance, see Richard N.

9
trade or adopting negative economic sanctions would become a more attractive option for the

reigning state.

Table 1-1. Explanations for the Reigning Power’s Economic Response

Theory Causal Logic Predictions

Certain commercial interest
groups compete with other
Commercial
groups to influence leaders’
Interest
decision on trade with the
challenging state.
The reigning state uses provision
of economic gains or loss
Economic alongside military
Statecraft countermeasures to shape
(coerce or deter) the challenging
state’s behavior.
The reigning state’s ability to
improve relative power position
through a security diseconomy is
determined by its leading
Balance of Power industries’ dependence on
economic inputs from the
challenger and the existence of
alternative trading partners for
the challenging state.
Trade ties are maintained if pro-
trade interest groups prevail in
domestic competition and exert
sufficient influence on leaders’
decisions. If they lose in domestic
competition, trade ties will be
severed.
Positive economic inducements are
used if significant absolute gains
result from bilateral trade.
Negative economic sanctions are
adopted when small absolute gains
are involved in bilateral trade.
The reigning state diminishes trade
with the challenger only when its
leading industries are not
dependent on the economic inputs
from the challenging state and
alternative trading partners do not
exist for the challenger. Otherwise,
trade ties will be maintained.

As summarized in Table 1-1, my theory and the two alternative explanations suggest

logically consistent theoretical predictions of the reigning power’s decision to maintain or

abandon commerce with the challenging power. In this dissertation, I examine which theory best

describes the evidence for the reigning state’s decision.

A few words are in order regarding what this dissertation does and does not intend to

explain. The theory presented in this study explains the extent to which a reigning power is

Haass and Meghan L. O’Sullivan, Honey and Vinegar: Incentives, Sanctions, and Foreign Policy (Washington,
D.C.: Brookings Institute Press, 2000); Henry M. Paulson, “A Strategic Engagement: Strengthening U.S.-Chinese
Ties,” Foreign Affairs, Vol. 87, No. 5 (September October 2008), pp. 59-77; and Condoleezza Rice, “Promoting the
National Interest,” Foreign Affairs, Vol. 79, No. 1 (January/February 2000), pp. 45-62.

10
incentivized to manipulate existing commerce with a challenging power in order to complement

military balancing, not the equilibrium outcome of the interaction between the two powers. In

order to explain the outcome of interaction, a different theory is needed to explain the

challenging power’s behavior, as well as its economic development strategy.

Moreover, I confine my attention to trade relations rather than all economic exchanges

between the competing powers. To be clear, I do not argue that trade is the only area where the

reigning power can potentially affect the challenger’s economic growth. To the contrary, I

acknowledge that other economic relations, most notably in finance and foreign direct

investment, can have a very pervasive influence on the two competing states’ economic capacity.

Still, I focus on trade and omit other dimensions of economic relations in order to avoid

extrapolating my theory. For instance, international trade and finance involve different actors,

agendas, and policies, and thus affect the overall wealth of the country in different ways. An

analysis of international finance and investment, then, is likely to require different theoretical

frameworks. This task is reserved for a different project.

Research Strategy

I utilize the case study method to test my theory and the two alternative explanations. Indeed,

case study is the only available method for testing the three theories because the form of great

power competition addressed in this study—sometimes referred to as “hegemonic competition”

—has very rarely occurred in modern history. This form of great power competition has been

taken seriously by scholars and practitioners because of its pervasive influence on international

politics, rather than the frequency of its occurrence. Experimental research, which is often

11
considered to be the best methodology for deriving causal inference, is also not a viable method

for this project.

Still, the case study method does allow one to test a causal theory.27 Further, case study

has a unique advantage in tracing whether the causal mechanisms—the steps that make up the

link between the independent variable and the outcome—are corroborated by historical

evidence.28 It also allows the researcher to determine how well the proposed theory explains the

outcome when compared with competing theories, as well as account for the influence of other

confounding factors.

In this dissertation, I analyze the entire set of cases that satisfy the scope conditions of my

theory rather than examine a few selected cases. I do this because, when a very small number of

cases are available for empirical tests, leaving one case unexamined significantly undermines the

argument, since that case may be an outlier to the theory. The most important scope conditions of

my theory are as follows: the reigning power has adopted or strengthened military

countermeasures against the challenging power (strengthened internal and external balancing),

and there are ongoing commercial exchanges between the two states. In addition, I focus on

relations between the great powers that have achieved a significant level of industrialization,

because commerce between or with non-industrialized economies is fundamentally different

27
To test a causal theory, one needs to confirm contemporaneous variation between the dependent and independent
variables, time sequence between the dependent and explanatory variables, and non-spuriousness of the relationship
between the variables. The case study method allows the researcher to test if the proposed theory satisfies these
conditions. For the testing of causal theories, see Jack Snyder, “Richness, Rigor, and Relevance in the Study of
Soviet Foreign Policy,” International Security, Vol. 9, No. 3 (Winter, 1984/85), pp. 89-108; and Arthur L.
Stinchcombe, Constructing Social Theories (Chicago, I.L.: The University of Chicago Press, 1968).
28
For instance, see Henry E. Brady and David Collier, eds., Rethinking Social Inquiry: Diverse Tools, Shared
Standards (New York: Rowman and Littlefield, 2004); Alexander L. George and Andrew Bennett, Case Studies and
Theory Development in the Social Sciences (Cambridge, M.A.: MIT Press, 2005); and Stephen Van Evera, Guide to
Methods for Students of Political Science (Ithaca, N.Y.: Cornell University Press, 1997).

12
from trade between the industrialized powers. Thus, I look at cases of reigning power-

challenging state relations since the late-nineteenth century.

Which countries were reigning powers in modern history and which were potential

regional hegemons in Europe or Northeast Asia? Identifying the reigning powers is relatively

simple. There is a consensus that the United States has maintained the position of reigning state

since the end of the First World War.29 From the mid-nineteenth century to World War I, I

consider Britain the reigning power that commanded more material capacity than other great

powers.30 Although some suggest that Britain’s industrial capacity was surpassed by the U.S. at

the turn of the twentieth century and by Germany in the late 1900s, others show that Britain

maintained its preeminent position in terms of overall economic capacity until World War I.31

Identifying a challenging power is slightly more complex. A major state can become a

potential dominant power in the region where it resides by developing a material capacity

surpassing that of other nearby powers, or by the retrenchment or precipitous decline of other

powerful states in its immediate region. Wilhelmine Germany, Nazi Germany, and China since

the late 2000s are potential regional hegemons that emerged through the former path. Imperial

Japan became a potential hegemon of Asia as the European powers that were present in Asia—

Britain, France, and the Soviet Union—concentrated on European affairs and left Asia aside,

especially after 1939. In contrast, the Soviet Union emerged as a potential Eurasian hegemon in

the immediate aftermath of World War II as it achieved significant industrial development while

29
The indices of national material capacity that I use in this dissertation include the Correlates of War Project’s
National Material Capabilities Dataset (version 4.0), historical GDP data compiled by B.R. Mitchell, and the
“economic dominance index” from Arvind Subramanian, Eclipse: Living in the Shadow of China’s Economic
Dominance (Washington, D.C.: Peterson Institute for International Economics, 2011).
30
Some might suggest that Britain was the leading great power before World War II. This is not true. The British
economy was significantly smaller than the U.S. economy during the interwar years.
31
See Subramanian, Eclipse, chapter 2. Also, the U.S. was not an active participant of great power politics until the
First World War.

13
most other major states in Asia and Europe were devastated by the war. Nonetheless, all these

five powers—Wilhelmine Germany, Nazi Germany, Imperial Japan, the Soviet Union, and

China—satisfy the definition of a challenging state that is presented above.

In this dissertation, I conduct six case studies: (1) Britain’s response to the German

challenge between 1898 and1914, (2) the U.S. response to Imperial Japan between 1939 and

1941, (3) the U.S. response to the Soviet Union between 1947 and 1950, (4) the U.S. reaction to

the USSR during the Carter administration between 1979 and 1980, (5) the U.S. reaction to the

USSR during the Reagan administration between 1981 and 1982, and (6) the U.S. response to

China since 2008. In each of these relations, the reigning power strengthened military balancing

against its challenging power while significant economic ties existed between them.32

As summarized in Figure 1-1, these cases reflect clear variations in the independent

variables of my theory. Also, these cases constitute “tough tests” for my theory.33 Britain and the

U.S. are often considered to be liberal democratic states in which relative power calculations

were unpopular and not widely endorsed in their democratic political processes.34 In contrast,

32
I do not examine Britain’s response to the rise of the U.S. in the nineteenth century. Different from other potential
regional hegemons in Europe and Northeast Asia, the U.S. achieved military dominance in North America by the
mid-nineteenth century before it became a major industrialized power. Also, Britain did not adopt serious military
balancing measures against the U.S. Therefore, British-U.S. relations do not satisfy the scope condition of my
theory. For British-U.S. relations in the nineteenth century, see Kenneth Bourne, Britain and the Balance of Power
in North America, 1815-1908 (Berkeley, C.A.: University of California Press, 1967); and David L. Dykstra, The
Shifting Balance of Power: American-British Diplomacy in North America, 1842-1848 (Lanham, M.D.: University
Press of America, 1999). I also do not consider post-World War II Germany and Japan as potential regional
hegemons because these two states were “semi-sovereign states” that hosted a large number of U.S. forces and
depended on the U.S. for their security. See Mearsheimer, Tragedy of Great Power Politics, p. 382. Also see Peter J.
Katzenstein, A World of Regions: Asia and Europe in the American Imperium (Ithaca, N.Y.: Cornell University
Press, 2005). Finally, I exclude the U.S. response to Nazi Germany because all major bilateral commerce
disappeared through the U.S. enforcement of the Neutrality Act and the adoption of the “cash and carry” policy in
1939, before Washington adopted serious military countermeasures against Berlin. Thus, this case also does not
satisfy the scope conditions of the theory.
33
For this type of case studies, see George and Bennett, Case Studies and Theory Development in the Social
Sciences, pp. 120-123; Harry Eckstein, “Case Study and Theory in Political Science,” in F. Greenstein and N.
Polsby, eds., Handbook of Political Science, Vol. 7: Strategies of Inquiry (Reading, M.A.: Addison-Wesley, 1975),
pp. 79-135.
34
For the unpopularity of power-based explanations in Britain and the U.S., see Carr, The Twenty Years’ Crisis;
Robert G. Gilpin, “No One Loves a Political Realist,” in Benjamin Frankel, ed., Realism: Restatement and Renewal

14
domestic interest groups and absolute economic gains—the core explanatory factors of the two

alternative explanations—should be particularly influential in these liberal countries. Further, the

cases are familiar historical developments and hence allow other researchers to replicate the

empirical tests.

Figure 1-1. Case Selection

Existence of Alternative Trading Partners for
the Challenging Power
Yes No

British response to Germany,

1898-1914
High
U.S. response to China,
Leading 2008- (?)
Industries’
Dependence on
Inputs from the U.S. response to Japan,
Challenger 1939-41
U.S. response to the USSR, U.S. response to the USSR,
Low
Reagan Administration 1947-50
U.S. response to the USSR,
Carter Administration

Moreover, by examining U.S. responses to the Soviet Union at three different historical

moments, I can control for the effect of diverse confounding factors and more clearly illustrate

the impact of the independent variables. While the Cold War endured over half a century, the

U.S.-USSR military competition did not escalate continuously. During certain periods, tensions

decreased, and the two superpowers often engaged in détente. These three cases represent the

years during which the U.S. strengthened military balancing against the Soviet Union,

(London: Frank Cass, 1996), pp. 3-27; and John J. Mearsheimer, “Realism, the Real World, and the Academy,” in
Michael Brecher and Frank P. Harvey, eds., Realism and Institutionalism in International Studies (Ann Arbor: The
University of Michigan Press, 2002), pp. 23-33.

15
recognizing the emerging or resurgent threat from the USSR, while trade ties existed between the

two powers.35 In other words, I examine the U.S. economic responses to the Soviet Union during

the early stage of the Cold War and the period that is often called the beginning of “the New

Cold War” or “the Second Cold War.”

Contributions of the Dissertation

The findings of this dissertation have important theoretical and policy implications. This

dissertation solves a puzzle that is not well accounted for in existing international relations

literature. Contrary to realist arguments, I show that relative power considerations can constrain

a state to maintain economic ties with a major security competitor. The main causal mechanism

is derived from the nature of bilateral trade and the structure of international trade that is

embedded within the broader international political structure. I also demonstrate that a power-

based approach yields a more convincing explanation for a specific dimension of interstate

commercial exchange than theories that have shown strength in explaining international

economic relationships.36

Moreover, I aim to provide a building block for a more sophisticated theorization of

states’ balancing behavior. Most scholars would agree that military balancing works better when

35
One might suggest that, by the end of the 1970s, the Soviet Union was indeed a declining power rather than a
challenging power. In retrospect, however, after a brief period of détente, the USSR reemerged as the most
threatening state for the U.S. and remained a formidable competitor until the mid-1980s.
36
In addition, this study contributes to the literature on economic sanctions and containment. While many in this
scholarship have emphasized the importance of denying alternative trading partners, I show that their logic is
incomplete unless the economic condition of the state that wields economic tools and additional economic factors
are taken into account. For instance, see Bruce W. Jentleson, Pipeline Politics: The Complex Political Economy of
East-West Energy Trade (Ithaca, N.Y.: Cornell University Press, 1986); Martin, Coercive Cooperation; and
Mastanduno, Economic Containment. Although Daniel Drezner emphasizes the calculation of opportunity costs in a
state’s decision to impose economic sanctions, he does not present a causal theory that explains what determines that
calculation. See Daniel W. Drezner, The Sanctions Paradox: Economic Statecraft and International Relations (New
York: Cambridge University Press, 1999).

16
it is complemented by appropriate economic policies. Still, the implications of foreign trade for

balancing strategies and the international balance of power have been largely dismissed among

security studies scholars, especially with many scholars’ analytic focus on the U.S. Contrary to

the great power protagonists of the previous eras, the U.S. was distinguished by its vast domestic

market and surprisingly low reliance on foreign trade. As Nicholas Spykman observed more than

seventy years ago, “apart from the need for strategic raw materials, foreign trade is, for the

nation as a whole, a contribution to comfort, not a prerequisite of subsistence as it is for the

overpopulated regions of Western Europe and Eastern Asia.”37 Accordingly, high politics could

be effectively separated from low politics in many scholars’ worldviews, and the trade of

strategic materials was often considered within the purview of military power. This conclusion,

however, is misleading given the large quantity and extent of present-day foreign trade, and the

heavy dependence on foreign commerce found in all major states. Even the United States’

average trade-to-GDP ratio between 2009 and 2011 reached 28.4 percent.38 Thus, the

implications of overall international commerce for the balance of power in the international

system deserves more theoretical attention. This dissertation intends to fill this information gap.

This project also contributes to the ongoing debate in the U.S. on the future of its

relationship with China. Until recently, Washington might have utilized economic “carrots” to

shape Beijing’s behavior. However, it is unclear whether Washington should continue such a

policy if China grows even more powerful or openly challenges the United States’ position in the

37
Stephen D. Krasner, Defending the National Interest: Raw Materials Investments and U.S. Foreign Policy
(Princeton, N.J.: Princeton University Press, 1978); Nicholas J. Spykman, America's Strategy in World Politics: The
United States and the Balance of Power (Hamden, C.T.: Archon Books, 1970), p. 273
38
World Trade Organization (WTO), Trade Profiles 2012 (Geneva: WTO, 2012), p. 180. While realists assert that
great powers are not highly dependent on foreign trade, ideally with less than fifteen percent trade-to-GDP ratio, all
major states today do not satisfy this condition. According to Waltz, states are heavily dependent on international
trade when they “import and export 15 percent or more of their gross national products yearly.” Waltz, Theory of
International Politics, pp. 141-2.

17
international system. Moreover, extensive economic ties between the two countries have created

a dilemma in U.S. policy on China, especially since Washington has strengthened military

presence in Asia and security alignment with the countries that surround China. I aim to

addresses this dilemma in U.S. policy toward China, while also shedding light on the question of

what constitutes a sound economic complement to its military grand strategy.

Roadmap

The rest of this dissertation proceeds as follows. Chapter 2 lays out my theory and the alternative

explanations. In Chapters 3, 4, 5, and 6, I test the theories against the historical record, utilizing

both primary and secondary sources. Chapter 7 extends my analysis to a contemporary context,

the U.S. response to the Chinese challenge. Chapter 8 summarizes my findings and concludes.

18
 CHAPTER 2

THEORY

This chapter explains a reigning power’s decision to maintain or abandon extant trade ties with a

challenging power against which it has adopted military counterbalancing measures. My theory

suggests that the reigning state will maintain commerce with the challenging state if restricting

trade would inflict greater harm on itself. The reigning power severs trade with the challenger

only when it can improve its relative power through a security diseconomy. This chapter begins

by identifying the scope conditions of the theory. Then, after defining the dependent variable, I

explain how two factors jointly constrain the reigning state’s decision regarding trade with the

challenging state. Finally, I lay out the alternative explanations so that I can pit my theory against

them in the chapters that follow.

Some caveats need to be mentioned before I proceed. My theory intends to explain the

extent to which a reigning power is incentivized to manipulate existing commerce with a

challenging power in order to complement military countermeasures; it does not aim to address

the equilibrium outcomes from interaction between reigning and challenging states. I also do not

argue that that the two competing great powers are incapable of making domestic economic

adjustments to cope with changes in bilateral commerce. Nonetheless, all else being equal, a

state’s economic capacity would diminish, however marginally, if its international economic

activities were to be replaced by domestic activities for non-market reasons. I suggest that the

reigning state would avoid a choice that might incur a greater loss for its own economy.

19
Conversely, if it would impose even a small relative loss on the challenger, the reigning state

would sever bilateral trade to supplement ongoing military balancing.

Scope Conditions

I make a set of assumptions in order to pin down the context of relations between the reigning

and challenging powers to which my theory applies. I assume the reigning power has reinforced

or deployed its military forces—in particular, its major combat units—against the challenging

power. At the same time, the reigning state might have strengthened formal and informal military

alignments with the countries that are located near the challenging state. Put bluntly, the reigning

state has responded to the challenging state through internal and external balancing. Meanwhile,

I assume that ongoing commerce exists between the reigning and challenging states, which

issues from trade ties that were constructed before security competition became apparent.1 I

consider that this bilateral trade contributes to the challenger’s industrial performance.

I also presume that the reigning power is not a “global hegemon,” which is altogether

immune to the challenge from other states. Instead, I assume an international structure which is a

balance of power system where the reigning state still cares about its relative power.2

Conversely, the challenging power should not have achieved military dominance in the region

where it resides, so that military projection by the reigning power to the challenger’s region is

1
Hence, I do not agree with the “rational expectations hypothesis,” which suggests that states eschew economic
cooperation ex ante when they expect to face military dispute in the future. Current security competitors might have
built economic ties at time t-1 because they were not certain whether they would be competitors at time t. Also, the
risk of not being in a potential adversary’s market might be larger than the risk of being in that country. See James
D. Morrow, “How Could Trade Affect Conflict?,” Journal of Peace Research, Vol. 36, No. 3 (July 1999), pp. 481-
489.
2
For this distinction, see Robert A. Pape, “Soft Balancing against the United States,” International Security, Vol. 30,
No. 1 (Summer 2005), pp. 11-12.

20
still possible. If the challenging state has already achieved, or is about to attain, outright military

superiority in its own region, the trajectory of the competition between the reigning and

challenging powers would be dramatically different.

Finally, I assume that both the reigning and challenging powers are industrialized

countries, and that international commerce generates positive returns to their economy. If trade

results in negative returns, a state’s economic capacity would diminish the more it trades with

others. In this case, bilateral trade should disintegrate regardless of political considerations.

In addition to these assumptions, two points need clarification before laying out my

theory. First, I define power as states’ material resources.3 These material capabilities are mainly

comprised of military force and latent or economic power. These two major components of

power are intimately linked to one another because military force rests on wealth, and

amendments in relative wealth imply changes in the distribution of military power.4 As various

scholars assert, “the economic, military, and other capabilities of nations cannot be sectored and

separately weighted,”5 “power is an indivisible whole,”6 and “there is a long-run harmony

between wealth and power.”7 In short, states care about their comprehensive material capacities.

3
Scholars who adopt this definition of power explicitly reject the notion of power as a relational concept or as an
influence on outcomes. For instance, see John J. Mearsheimer, The Tragedy of Great Power Politics (New York: W.
W. Norton, 2001), chapter 3; Kenneth N. Waltz, Theory of International Politics (New York: McGraw Hill, 1979),
pp. 131, 185-195; and William C. Wohlforth, The Elusive Balance: Power and Perceptions during the Cold War
(Ithaca, N.Y.: Cornell University Press, 1993), pp. 1-10. The famous definition of power as a “relationship concept”
is given by Robert Dahl. See Robert Dahl, “The Concept of Power,” Behavioral Science, Vol. 2, No. 3 (July 1957),
pp. 202-3. Also see David A. Baldwin, “Power Analysis and World Politics: New Trends versus Old Tendencies,”
World Politics, Vol. 31, No. 2 (January 1979), pp. 161-194.
4
Robert Gilpin, U.S. Power and the Multinational Corporation (New York: Basic Books, 1975), p. 35. Also see
Dale C. Copeland, The Origins of Major War (Ithaca, N.Y.: Cornell University Press, 2000); Robert Gilpin, War and
Change in World Politics (New York: Cambridge University Press, 1981); and Paul Kennedy, The Rise and Fall of
the Great Powers: Economic Change and Military Conflict from 1500 to 2000 (New York: Vintage Books, 1989).
5
Waltz, Theory of International Politics, p. 131.
6
Edward Harllett Carr, The Twenty Years’ Crisis, 1919-1939 (New York: St. Martin’s Press, 1966), p. 108.
7
Mearsheimer, Tragedy of Great Power Politics, p. 46. Original quotation is from Jacob Viner, “Power versus
Plenty as Objectives of Foreign Policy in the Seventeenth and Eighteenth Centuries,” World Politics, Vol. 1, No. 1
(October 1948), p. 10.

21
 Second, I follow the insights of mainstream trade economists, and do not hold the view

that commerce contributes to national power simply by allowing the state to sell goods in foreign

markets and accumulate more resources. In this regard, I distance myself from views which

focus on the balance of payments and consider only surplus or exports as the state’s gains. 8

Instead, I view that trade renders states to specialize in producing some goods while purchasing

others from abroad based on their comparative or competitive advantages. By doing so, states

increase their industrial efficiency (by rationalizing resource allocation and reducing cost), their

economies of scale and market competitiveness, and hence enhance the overall performance of

their economy while obtaining larger welfare gains.9 In this context, I posit that imports

contribute to the national economy by allowing it to enhance allocative and productive efficiency

and market competitiveness. Exports affect a state’s economic performance by helping it to

achieve greater economies of scale, consequently increasing efficiency and competitiveness.

8
In other words, I do not build my theory on mercantilist or nationalist approaches to foreign trade. For different
views on the implication of trade to national power, see Robert Gilpin, Global Political Economy: Understanding
the International Economic Order (Princeton, N.J.: Princeton University Press, 2001).
9
For instance, see Cletus Coughlin, “The Controversy over Free Trade,” Federal Reserve Bank of St. Louis Review,
Vol. 84, No. 1 (Jan./Feb. 2002), pp. 1-22; Elhanan Helpman, “The Structure of Foreign Trade,” Journal of
Economic Perspectives, Vol. 13, No. 2 (Spring 1999), pp. 121-144; Paul R. Krugman, Maurice Obstfeld, and Marc
J. Melitz, International Economics: Theory and Policy, ninth edition (New York: Addison-Wesley, 2012). For a
similar view, see Klaus Knorr, The War Potential of Nations (Princeton, N.J.: Princeton University Press, 1956), pp.
199-201. For diverse mainstream economic theories of trade, see Andrew B. Bernard, J. Bradford Jensen, Stephen J.
Redding, and Peter K. Schott, “Firms in International Trade,” Journal of Economic Perspectives, Vol. 21, No. 3
(Summer 2007), pp. 105-130; Donald R. Davis, “Intra-Industry Trade: A Heckscher-Ohlin-Ricardo Approach,”
Journal of International Economics, Vol. 39, No. 3 (November 1995), pp. 201-226; Ronald R. Davis and David E.
Weinstein, “An Account of Global Factor Trade,” American Economic Review, Vol. 91, No. 5 (December 2001), pp.
1423-1453; Stephen S. Golub and Chang-Tai Hsieh, “Classical Ricardian Theory of Comparative Advantage
Revisited,” Review of International Economics, Vol. 8, No. 2 (May 2000), pp. 221-234; Paul Krugman, “Scale
Economies, Production Differentiation, and the Pattern of Trade,” American Economic Review, Vol. 70, No. 5
(December 1980), pp. 950-959; James R. Markusen, “The Boundaries of Multinational Enterprises and the Theory
of International Trade,” Journal of Economic Perspectives, Vol. 9, No. 2 (Spring 1995), pp. 169-189; John Romalis,
“Factor Proportions and the Structure of Commodity Trade,” American Economic Review, Vol. 94, No. 1 (March
2004), pp. 67-97.

22
The Dependent Variable

The dependent variable of this study is the reigning power’s decision to maintain or abandon

existing policy arrangements that govern major trade with the challenging power. The reigning

state would have agreed on or unilaterally declared the terms of trade as it began to engage in

economic exchanges with the challenging state, and the commercial relationship between the two

countries would have evolved based on those arrangements. Maintaining trade ties thus means

complying with the current political arrangements that regulate major trade with the challenger,

as well as sustaining the trajectory of extant policies.10 In contrast, abandoning trade ties refers to

the adoption of policies designed to diminish major commercial exchanges with the challenger

and, in effect, create a security diseconomy.11 This abandonment aims to block the challenging

power’s access to the reigning state’s market, goods, service, technology, and factors of

production, and thereby diminish the challenger’s welfare gains.12

The areas of commerce that might be reconsidered by the reigning power include both

ordinary and strategic or “dual-use” goods, because, from the neoclassical economic perspective,

10
Political agreements over trade can be dynamic rather than static. For instance, trading states usually agree to
gradually open up their markets to each other and adopt liberal economic measures in order to reduce adjustment
costs. In this case, although the content and extent of economic exchanges might expand over time, it does not mean
that the trading states have made a new political agreement. For instance, see Taiji Furusawa and Edwin L-C Lai,
“Adjustment Costs and Gradual Trade Liberalization,” Journal of International Economics, Vol. 49, No. 2
(December 1999), pp. 333-361.
11
The term “diseconomy” in this context does not refer to a factor which is responsible for the increase in cost, the
concept used in production economics. For instance, see Staffan Canbäck, Phillip Samouel, and David Price, “Do
Diseconomies of Scale Impact Firm Size and Performance? A Theoretical and Empirical Overview,” Icfai Journal
of Managerial Economics, Vol. 4, No. 1 (2006), pp. 27-70. I follow Gowa’s use of the term “security diseconomy”
which implies the relative absence of tight commercial exchanges between security competitors. See Joanne Gowa,
Allies, Adversaries, and International Trade (Princeton, N.J.: Princeton University Press, 1994).
12
The reigning power’s policy options include embargo, boycott, tariff increase, tariff discrimination, withdrawal of
most favored nation status, blacklist, quotas, license denial, and preclusive buying, as well as preferential policies in
trade with other countries. For diverse economic strategies, see David A. Baldwin, Economic Statecraft (Princeton,
N.J.: Princeton University Press, 1985), pp. 40-42; and Michael Mastanduno, Economic Containment (Ithaca, N.Y.:
Cornell University Press, 1992), pp. 39-63.

23
all goods can be considered “strategic.”13 Technological exchanges and the trade of dual-use

goods can enhance the challenging state’s power by enabling it to develop and deploy more

sophisticated military forces. Thus, the reigning state has strong incentives to reconsider the

trade of such goods with the challenger. At the same time, the reigning power would also

envisage restricting the trade of ordinary goods as well. Although it might not be directly related

to military force, the trade of ordinary goods facilitates resource allocation and rationalizes the

economy, and in turn helps a state to generate more latent power. Hence, the reigning state

would be incentivized to diminish ordinary economic exchanges with the challenging state and

prevent it from expanding its resource base for military power. Accordingly, I focus on policy

changes regarding major trade items, rather than confining attention to military-related products.

In a similar vein, I posit that, if it decides to abandon bilateral trade, the reigning state

would impose restrictions on both major exports to and imports from the challenging state. The

reigning state’s exports contribute to the challenging state’s economy by enabling the challenger

to increase productive and allocative efficiency and overall economic performance. Likewise,

imports from the challenger allow the challenging state to increase the economies of scale and

efficiency. Hence, affecting the challenger’s material capacity requires the simultaneous

manipulation of both imports and exports. When the reigning state decides to maintain ties, both

major exports and imports would continue.14

13
See Lisa L. Martin, Coercive Cooperation: Explaining Multilateral Economic Sanctions (Princeton, N.J.:
Princeton University Press, 1992), p. 267, fn. 2 Also see Tor Egil Førland, “‘Economic Warfare’ and ‘Strategic
Goods’: A Conceptual Framework for Analyzing COCOM,” Journal of Peace Research, Vol. 28, No. 2 (1991), p.
192. For evaluations of the recent exchanges of “sensitive” or “dual-use” goods, see Ian Davis, The Regulation of
Arms and Dual-Use Exports: Germany, Sweden, and the UK (Oxford: Oxford University Press, 2002); Ian F.
Fergusson and Paul K. Kerr, “U.S. Export Control System and the President’s Reform Initiative,” CRS Report to
Congress, July 2011.
14
In other words, I consider my dependent variable as a dichotomous variable. This allows me a parsimonious
theorization of the reigning state’s response.

24
A Balance of Power Explanation

My point of departure is the well-known observation that, in the competitive international realm,

states seek power in order to ensure their security.15 Important state behaviors also reflect the

necessity of improving its relative power position.16 This does not mean, however, that states

behave as reckless aggressors. As a roughly rational actor, the state tries to make a choice that

yields the best outcome for its relative power within the constraints imposed by the nature of

interactions with others.17

When confronted by the challenging state, the reigning state would carefully gauge how

the challenger’s and its own capabilities would be altered if bilateral commerce were to be

restricted. If its own material resources might decrease more than those of the challenger without

bilateral trade, maintaining extant commercial ties would be the better alternative for the reigning

state. In other words, the reigning state tries to make a strategic choice about trade with the

challenging state that maximizes its own relative power position, and only imposes restrictions

on bilateral trade when it can enhance its own relative power.18

In order to explain this assessment, I must address the reigning and challenging states’

efficiency and competitiveness gains—and thus gains in overall economic performance—that are

15
Mearsheimer, Tragedy of Great Power Politics, pp. 32-36; Waltz, Theory of International Politics, pp. 118, 126-
127. Also see Gilpin, War and Change, pp. 87-88. All structural realists, both defensive and offensive variants,
acknowledge that states are positional actors and pursue relative power rather than absolute power. They diverge in
assessing the magnitude of power that a state needs to obtain in order to ensure its safety. For an overview of realist
theories, see Jeffrey W. Taliaferro, “Security Seeking under Anarchy,” International Security, Vol. 25, No. 3 (Winter
2000/01), pp. 128-161.
16
Contrary to Waltz, Mearsheimer suggests that structural realism can be used to explain state behavior as well as
systemic outcomes by understanding how the international system constrains states to take a certain set of actions.
Mearsheimer, Tragedy of Great Power Politics, pp. 53, 422. Also see Colin Elman, “Horses for Courses: Why Not
Neorealist Theories of Foreign Policy?” Security Studies, Vol. 6, No. 2 (Autumn 1996), pp. 7-53.
17
John J. Mearsheimer, “Reckless States and Realism,” International Relations, Vol. 23, No. 2 (June 2009), p. 244.
18
For strategic choice in international relations, see David A. Lake and Robert Powell, Strategic Choice and
International Relations (Princeton, N.J.: Princeton University Press, 1999).

25
related with exports to and imports from each other. I will then be able to determine whether the

reigning state would encounter more loss than the challenging state by severing bilateral trade. I

suggest that two factors in conjunction can account for this assessment. The first explanatory

factor mainly accounts for the impact of imports from the challenging state on the reigning

state’s economic performance. The second explanatory factor determines the challenger’s ability

to replace import and export trade with the reigning state, and thus the challenging state’s

capacity to sustain its current level of economic performance. This factor also accounts for the

reigning state’s ability to divert exports away from the challenging state.

Leading Industries’ Dependence on Economic Inputs from the Challenger

I argue that one key determinant of the reigning state’s decision is the extent to which its leading

industries depend on economic inputs from the challenging state. Before changing extant policy

on commerce with the challenger, the reigning state would examine whether such a decision

would affect its own economic efficiency and competitiveness. One might suggest that, as the

largest advanced economy in the world, the reigning power’s general economic performance will

not likely be deeply affected by severed trade with one particular state. However, the reigning

state’s economic capacity can be significantly undermined if its trade with the challenger entails

obtaining economic inputs that have large impact on the performance of its major industries but

are highly inelastic in supply. These economic inputs may be merchandise, technology, services,

factors of production, or what some trade economists call “tasks.”19

19
I do not specify the economic inputs the reigning power purchases from the challenging power because the
content of trade varies dramatically over time and across space. The key point here considers whether, and to what
extent, the challenging power contributes to the performance of the reigning power’s economy. For diverse contents
of trade, see William Milberg and Deborah Winkler, Outsourcing Economics: Global Value Chains in Capitalist
Development (New York: Cambridge University Press, 2013), chapter 1. Also see Gene M. Grossman and Esteban
Rossi-Hansberg, “Trading Tasks: A Simple Theory of Offshoring,” American Economic Review, Vol. 98, No. 5,
(December 2008), pp. 1978-97.

26
 This dependence can be considered significant, or high, when two conditions are met.

First, the leading industries that drive the reigning power’s economic growth attain productive

efficiency and market competitiveness by purchasing certain economic inputs from the

challenging power. Second, the inputs from the challenger are difficult to substitute with inputs

from a different foreign country because other states are incapable of providing inputs of similar

quality at an equivalent price and in the required quantity. If at least one of these two conditions

is absent, the reigning state’s dependence on economic inputs from the challenger can be

considered low.

When its leading industries are highly dependent on the inputs from the challenging

power, the reigning power will encounter a number of economic problems if it abandons bilateral

trade. Once it restricts trade, the domestic price of goods that rely on inputs from the challenging

state will rise in the reigning state, decreasing real income in the country. The reigning power

would also need to undergo a process of industrial restructuring and resource reallocation to

replace the inputs domestically. This reduces the efficiency and output of its economy.

Moreover, the reigning state’s leading industries would lose competitiveness or sales in domestic

and foreign markets because the per unit price of its products would rise. Consequently, those

industries would generate less wealth for the country, decreasing its overall economic capacity.

The size of the reigning state’s loss would further increase when processing or value-added trade

is taken into account.20

When its leading industries do not depend heavily on economic inputs from the

challenger, the reigning state would not be concerned by these potential losses. The reigning

20
For the implication of processing or value-added trade, see Bernard, Jensen, Redding, and Schott, “Firms in
International Trade”; Robert Feenstra. “Integration of Trade and Disintegration of Production in the Global
Economy,” Journal of Economic Perspectives, Vol. 12, No. 4 (Fall 1998), pp. 31-50; Markusen, “The Boundaries of
Multinational Enterprises and the Theory of International Trade.”

27
power’s leading industries would continue to be efficient and competitive, and the reigning

state’s overall economic performance would be maintained.

The Existence of Alternative Trading Partners for the Challenger

The second determinant of the reigning state’s calculation is the availability of alternative trading

partners for the challenging state.21 Before restricting trade with the challenging power, the

reigning power would examine whether it could effectively prevent the challenging state from

replacing bilateral trade through trade with others, and thereby diminish the challenger’s

economic performance.22 The reigning state would also need to know whether it could sustain its

economic activities that are related to current exports to the challenger.23 Moreover, the reigning

power would scrutinize other sources of potential loss, arising from interactions with states

exogenous to the bilateral relationship with the challenger.

Alternative partners or “third states” refer to a state or group of states that can replace the

reigning state’s position in the challenging state’s foreign trade.24 I focus on whether or not other

21
As Albert Hirschman observes “a country menaced with an interruption of trade with a given country has the
alternative of diverting its trade to a third country; by so doing it evades more or less completely the damaging
consequences of the stoppage of its trade with one particular country. The stoppage or the threat of it would thus lose
all its force.” See Albert O. Hirschman, National Power and the Structure of Foreign Trade, expanded edition
(Berkeley, C.A.: University of California Press, 1980), p. 29. Also see Martin, Coercive Cooperation. I extend this
idea to the balance of power competition, beyond its conventional application to coercive disputes.
22
Note that I assume the challenger obtains certain economic gains—in terms of productive and allocative efficiency
or market competitiveness—through trade with the reigning power. Here, I do not specify whether or not the
challenging state trades heavily with the reigning state. The key point is whether the reigning state would be able to
prevent the challenging state from obtaining economic benefits that arise from extant bilateral trade. When only
small commercial exchanges exist between the two states, the magnitude of relative loss that the reigning state can
inflict on the challenging state is minor. Nonetheless, regardless of the size of this relative loss, the reigning state
would impose restrictions on bilateral commerce if it can make the challenger worse off because there is an ongoing
military competition.
23
When the reigning state’s exports to the challenging state are very small and have only minor implication for both
countries, the reigning state can simply ignore its exports in bilateral trade.
24
Rather than specifying the dimensions of trade where the challenging state finds its alternative partners, I focus on
whether other states can replace the reigning state in all dimensions of the challenging state’s foreign commerce. I
take this approach because the content and form of bilateral trade change dramatically across time and space. It can
be presumed that, in some bilateral trade, one side is either asymmetrically dependent on imports from the other,
exports to the other, or on both exports and imports. In addition, a bilateral trade relationship can be dominated by
inter-industry, intra-industry, inter-firm, or intra-firm trade. These possibilities suggest that one needs to make a

28
states can assume the role of the reigning state in the challenging state’s economic activities

linked to foreign commerce. When alternative trading partners exist for the challenging state

which could replace the reigning state, restricting trade would not only be ineffective but would

also make it difficult for the reigning power to divert exports away from the challenger. Also,

frictions with other states would incur relative losses for the reigning power.

First, the availability of alternative trading partners means that the challenging state can

continue the economic activities that would have otherwise relied on the reigning power’s inputs.

Like the reigning state, the challenger could have achieved productive and allocative efficiency

and market competitiveness through bilateral trade. Thus, the reigning power’s restrictions on

exports can weaken the challenging state’s economic capacity if the challenger cannot substitute

these imported economic inputs with those from a different country. Alternative trading partners

solve this problem, allowing the challenger to maintain its economic performance.

Second, the challenger can divert the exports that would have gone to the reigning state to

or through its alternative partners, thereby preserving the economic performance associated with

exports to the reigning power. When rapidly growing alternative markets exist, the challenger

can simply redirect its exports to these new markets. Even when such modification is difficult,

third states will eventually purchase more from the challenging state as their exports to the

challenger increase by replacing the reigning state and as they concentrate on producing certain

goods that could be sold to the challenging state. The challenging power is thus able to divert a

certain portion of its prior exports to the reigning state towards its alternative partners.

choice between two options when theorizing the reigning state’s ability to thwart the challenging state from
replacing bilateral trade: one can either make the theory more complex and accurate by incorporating explanatory
factors that can account for all the possible variations in the form and content of bilateral trade, or one must adhere
to the principle of parsimony by remaining at a higher level of abstraction. I choose to pursue the latter option.
Multiple variables can be considered and numerous hypotheses can be tested when one conducts a large-N test.
However, this is not a viable option for this project because the great power competition I consider has only rarely
occurred in history.

29
 Moreover, when third states and the reigning power have similar economic structures and

produce similar goods, and depend heavily on inputs from the challenger for their leading

industries, the challenging state’s exports can be further absorbed by alternative partners were

the reigning state stop importing from the challenger. As third states continue to expand their

exchanges with the challenger, obtaining important economic inputs, they achieve greater

economies of scale. As a result, they become more competitive than the reigning state, and come

to replace it on the market. Hence, third states would expand their share of the global market

while also encroaching on the reigning power’s domestic market. As third states’ sales increase,

the challenging power’s exports to those states also increase: third states will purchase more

from the challenging state to either expand the production of goods for which they now have a

competitive advantage (vis-à-vis the reigning power), or in order to further specialize in making

certain goods, importing others from the challenger. Consequently, a certain portion of the

challenging state’s previous exports to the reigning state can be absorbed by its alternative

partners.

Third, these alternative trading partners can undermine the ability of the reigning state to

efficiently divert sales away from the challenger. Third states are likely to be alternative partners

for the challenging state precisely because they provide goods or economic inputs that are similar

to those offered by the reigning state. In this condition, the reigning state must compete with

third states in the market if it wants to divert its exports away from the challenging power,

towards other countries. It would be difficult, however, for the reigning state to outperform its

competitors because the challenger’s alternative partners become more competitive on the

market as they benefit from the increased economies of scale achieved through new trade with

30
the challenging state. Thus, the reigning state’s surplus products cannot be easily absorbed by

other foreign markets.25

Finally, frictions with the challenger’s alternative trading partners can diminish the

reigning state’s economic capacity. Since restrictive trade policies can disrupt the overall flow of

goods, services, and other economic factors across countries, and thereby adversely affect

economic growth, third states would protest the reigning state’s restrictions on commerce with

the challenging state. Moreover, since an effective security diseconomy requires impeding all

trade with the challenging power, the reigning state would need to pressure other states to avoid

trade with that country. Pressuring with negative incentives, however, can be problematic if third

states coordinate retaliation against the reigning power. Meanwhile, given the necessarily large

size of the challenging power’s market, the quantity of positive incentives needed to win support

from alternative states is likely to be significant; hence, it would be very costly for the leading

power to compensate others for the losses caused by abandoning trade with the challenger.26 The

costs of engaging with third states can adversely affect the reigning power’s material capacity

vis-à-vis the challenger.

If alternative partners do not exist for the challenging power, these concerns would not

arise for the reigning power. The challenging state would not be able to maintain current levels

of economic efficiency and competitiveness. In addition, the reigning state could divert a

significant portion of its sales away from the challenging state. Here, the absence of alternative

trading partners for the challenging state implies that other states do not possess sufficient

25
Moreover, all else being equal, third states’ overall sales on the market would increase, and the reigning power’s
overall market share would decrease.
26
Thus, for the reigning power, the existence of alternative trading partners poses a form of collective action
problem. For classic treatment of this issue, see Mancur Olson, The Logic of Collective Action (Cambridge, M.A.:
Harvard University Press, 1971).

31
surplus products for exports or are incapable of increasing production. This means a large

demand exists for the goods produced by the reigning state, both in third states and in other

foreign markets. Thus, the reigning state could effectively redirect its exports and maintain the

economic performance tied to exports to the challenging state. Further, the reigning state would

not need to be concerned about frictions with other countries.

Theoretical Predictions

Figure 2-1. Theoretical Predictions

Existence of Alternative Trading Partners for

the Challenging Power
Yes No

I II
High
Leading Industries’ Maintain Ties Maintain Ties (?)
Dependence on
Inputs from the
Challenger III IV
Low
Maintain Ties Abandon Ties

I argue that these two factors in conjunction determine the reigning state’s decision regarding

commerce with the challenging state.27 Figure 2-1 summarizes how these two factors interact and

affect the reigning power’s decision.28

27
One might suggest that the reigning state would take bilateral trade seriously only when the size of trade is large
and the reigning power’s decision is determined by the magnitude of bilateral commercial exchanges. Contrary to
this perspective, I posit that the reigning state has good reason to reconsider extant trade with the challenger even
when the absolute size of bilateral commerce is small because there is ongoing military competition, and thus, the
reigning power would want, however marginally, to diminish the challenging power’s capacity. Moreover, I control
for the effect of the size of commercial exchanges by comparing two U.S. administrations’—Carter and Reagan—
responses to the resurgent Soviet threat.
28
It should be noted that these two factors are described as dichotomous variables for analytic simplicity. In reality,

32
 In the first case, the challenging state can find alternative trading partners while the

reigning state’s leading industries depend heavily on economic inputs from the challenger. In this

situation, the reigning power will maintain trade ties with the challenging power (Cell I) because

restricting bilateral trade would inflict greater harm on its own economic capacity. If it were to

abandon bilateral trade, the reigning state’s economic capacity would diminish significantly

since its leading industries would lose the efficiency and competitiveness that were attained by

purchasing economic inputs from the challenging state, and would thus generate less wealth. The

reigning power would also find it difficult to divert its current exports away from the challenging

power because other suppliers of similar goods would become more competitive on the market,

while its own products would become more expensive. Further, the reigning state might

experience frictions with third states, which would create relative loss vis-à-vis the challenger. In

contrast, the challenging state could sustain its economic performance through trade with

alternative partners. Conversely, maintaining trade ties allows the reigning state to preserve at

least its current relative power position. Thus, out of fear of losing its own power, the reigning

state will choose to maintain trade ties with the challenger.

In the second case, the reigning state’s leading industries are highly dependent on

economic inputs from the challenging state and the latter state also cannot find alternative trading

partners. In this context, the reigning power is likely to maintain trade ties with the challenging

power (Cell II). Without bilateral trade, the reigning state’s leading industries would lose

efficiency and competitiveness, and, accordingly, the reigning power’s overall economic

capacity would diminish significantly. Moreover, the reigning state might find it difficult to

divert exports. Even though some demand for the reigning state’s goods exists in other foreign

both explanatory factors can be considered as continuous variables. Also, the outcomes described here are ideal-
types.

33
markets, that demand would be offset by the increased price of its products. Similarly, it would

be difficult for the challenging state to maintain its current level of economic performance due to

the loss of imports from and exports to the reigning state. In this case, the question of whether

the outcome of the security diseconomy favors the reigning state or the challenging power would

be decided by their respective capacity to mobilize and reallocate domestic resources.

Still, even if the challenging state might suffer significant economic loss, the reigning

power cannot be certain whether it can eventually make the challenging power worse off than

itself.29 In this condition, given the ongoing security competition, the reigning state is likely to be

risk averse, and would decide to maintain bilateral trade ties.30 By maintaining extant trade ties,

the reigning state could at least preserve the current balance of power with certainty. This

scenario, however, is unlikely to be observed in the modern world where multiple economic and

resource centers exist and states have different economic structures.31

In the third case, the reigning state’s leading industries are not highly dependent on

inputs from the challenging power and the challenging state can find alternative trading partners.

Under these conditions, the reigning state would not abandon bilateral trade (Cell III). Based on

the continuing efficiency and competitiveness of its leading industries, the reigning state would

29
In this case, if the challenging state’s economy in general relied only marginally on trade with the reigning state,
the reigning power would lose more once it severed bilateral trade. However, even if the challenger’s economy
depended heavily on trade with the reigning state, the reigning state would not be able to know the exact extent of
the challenging state’s potential loss. For this, the reigning state would need information regarding the challenging
state’s ability to make domestic adjustments, and how the challenger’s economic capacity would appear after that
adjustment. This assessment requires very specific data on the challenging state’s domestic economic activities.
These data, however, are usually unknown to foreign observers.
30
For the tendency to choose status quo under difficult circumstances, see Raquel Fernandez and Dani Rodrik,
“Resistance to Reform: Status Quo Bias in the Presence of Individual-Specific Uncertainty,” American Economic
Review, Vol. 81, No. 5 (Dec., 1991), pp. 1146-1155; and William Samuelson and Richard Zeckhauser, “Status Quo
Bias in Decision Making,” Journal of Risk and Uncertainty, Vol. 1, No. 1 (1988), pp. 7-59.
31
In most international systems, economically powerful states other than the reigning and challenging states exist.
Although great military powers are usually also great economic powers, some states, for instance Germany and
Japan during the Cold War, qualify as economic powers but not as great military powers. Some smaller states, such
as Belgium and the Netherlands before World War I, had advanced economies and large domestic markets.

34
be able to minimize its economic loss in this case. Nonetheless, the reigning state does not

abandon extant trade ties with the challenging state because doing so would only undermine its

own sales and export-related economic benefits, while the challenger could acquire important

economic inputs from other states and divert its exports. Furthermore, friction with third states

can incur relative loss for the reigning state. Therefore, the reigning state cannot inflict any

significant loss on the challenging state, and will try to maintain its access to the challenger’s

market by preserving existing policy arrangements.

In the final scenario, the challenger cannot find alternative trading partners and the

reigning power’s major industries are not highly dependent on economic inputs from the

challenger. Under these conditions, the reigning state will abandon bilateral trade with the

challenging state (Cell IV). In this case, the reigning power can sustain its own economic

performance since its leading industries would remain efficient and competitive. It will also

effectively divert exports away from the challenging power because a large demand for its goods

exists on the market and its products would remain competitive. In contrast, since it cannot

replace imports from and exports to the reigning state, the challenger would face economic loss

accruing from decreased productive and allocative efficiency and market competitiveness, and a

consequent decrease of overall economic capacity. Moreover, the reigning power does not need

to be concerned about the adverse economic consequences that result from its interactions with

other states. By severing bilateral trade, the reigning state can thus improve its own relative

power position.

35
Alternative Explanations

My argument can be contrasted with two alternative theories. Since I investigate the puzzle of

trade ties between security competitors, theories that predict no or less security competitions

between economically interdependent states cannot be considered alternative explanations.32 If

their arguments were correct, we would not observe significant security competition emerging

between economically linked states in the first place. Similarly, theories that predict more

economic exchanges between military allies and decreasing trade between adversaries cannot be

considered alternative explanations. I consider two alternative explanations, both of which (at

least partly) emphasize the importance of absolute gains from trade.

Commercial Interest Groups

For some scholars, foreign policy decisions reflect the preference of and interaction between

societal actors. They focus on systemic domestic effects that operate within the state and explore

how and which domestic interests are aggregated and translated into foreign policy.33 In this

approach, individual or group interests struggle to influence political decisions so that their

preferences are better represented than those of competing groups. Although a state’s choice of

foreign policy takes into account both its preferences and external constraints, these scholars

analytically prioritize state preferences that represent certain domestic interests.34

32
For an excellent treatment of this puzzle, see Jack S. Levy and Katherine Barbieri, “Trading with the Enemy
during Wartime,” Security Studies, Vol. 13, No. 3 (Spring 2004), pp. 1-47.
33
For an overview of this approach, see Helen V. Milner, Interests, Institutions, and Information: Domestic Politics
and International Relations (Princeton, N.J.: Princeton University Press, 1997).
34
For instance, see Andrew Moravcsik, “Taking Preferences Seriously: A Liberal Theory of International Politics,”
International Organization, Vol. 51, No. 4 (Autumn 1997), pp. 513-53.

36
 In this view, economic ties with the challenging power that are sustained for a protracted

period of time establish powerful interest groups within the reigning state. Even when security

concerns increase, these interest groups function as a political coalition that attempts to influence

their home country’s economic policies toward the challenging state. They compete with groups

that want to diminish trade ties, and exert pressure on the government to continue commercial

exchanges.35 If these economic interest groups prove to be more influential than other societal

groups within the reigning state, their preferences are translated into a friendly economic policy

toward the challenging state. In this approach, since the state is not a unitary actor, the reigning

power can adopt competitive military and cooperative commercial policies at the same time.

Still, the groups that benefit from trade ties with the challenger might not be able to exert

a dominant influence on the leader’s decisions, again as a result of domestic political

competition. For instance, in the context of intense domestic debate over the relationship with the

challenging state, the security-focused group can align with economic groups that lose from

current trade policy and successfully influence the reigning state’s economic decisions toward

the challenger. In this case, the reigning power would be compelled to restrict commercial ties

with the challenging power. Nonetheless, if this theory’s causal logic is correct, domestic

competition led by commercial interest groups should be the driving force behind the reigning

state’s adoption of certain economic measures toward the challenger. From this discussion, one

set of hypotheses can be derived:

35
For the role of domestic commercial interest groups in international political competition, see Scott L. Kastner,
“When Do Conflicting Relations Affect International trade?” Journal of Conflict Resolution, Vol. 51, No. 4 (August
2007), pp. 664-688; Paul A. Papayoanou and Scott L. Kastner, “Sleeping with the (Potential) Enemy: Assessing the
U.S. Policy of Engagement with China,” Security Studies, Vol. 9, No. 1 (1999), pp. 157-187. Also see Steven E.
Lobell, The Challenge of Hegemony: Grand Strategy, Trade, and Domestic Politics (Ann Arbor, M.I.: The
University of Michigan Press, 2003); and Kevin Narizny, The Political Economy of Grand Strategy (Ithaca, N.Y.:
Cornell University Press, 2007).

37
 Commercial Interest Hypotheses: A. The reigning power maintains trade ties with the
challenger when commercial interest groups within the country exert sufficient influence
on the government to continue economic exchanges; B. If those groups lose in the domestic
competition, the reigning power restricts trade with the challenging power.

Economic Statecraft

According to the proponents of economic statecraft, a state might use the provision of economic

benefit and loss, or positive and negative economic sanctions, to shape the behavior or even the

preferences of other states.36 In this view, economic tools can be a better means than military

force for manipulating a competitor’s calculation since they might entail less costs. With the

spread of economic globalization, manipulating commercial exchanges was often viewed as a

particularly effective alternative for coercing or deterring others.37

Economic sanctions can rely on both negative and positive inducements and can focus

on either short-term and specific concessions or long-term and fundamental changes to the

targeted state’s domestic political structure. Negative economic sanctions, which are more

widely studied in the sanctions literature, seek to lower the aggregate economic welfare of a

target state by reducing its access to international trade and coerce the target state to change the

course of its behavior.38 In contrast, positive economic sanctions employ the promise of

economic benefits to affect the behavior of a target state.39 Short-term sanctions seek to alter the

36
See Baldwin, Economic Statecraft, pp. 40-42 and Mastanduno, Economic Containment, pp. 39-63. Using
economic inducements, therefore, is a form of coercion or deterrence.
37
For the benefits of using economic sanctions instead of military force, see Gary Clyde Hufbauer, Jeffrey J. Schott,
Kimberly Ann Elliott, and Barbara Oegg, Economic Sanctions Reconsidered. 3rd edition (Washington, D.C.:
Peterson Institute for International Economics, 2007). States that prefer to attain political ends through economic
means, namely the trading states, are particularly likely to see using economic inducements as an alternative to
military force. See Richard Rosecrance, The Rise of the Trading State (New York: Basic Books, 1986).
38
This definition is from Robert A. Pape, “Why Economic Sanctions Do Not Work,” International Security, Vol. 22,
No. 2 (Fall 1997), pp. 93-4.
39
Michael Mastanduno, “Economic Statecraft, Interdependence, and National Security: Agendas for Research,”
Security Studies, Vol. 9, No. 1 (1999), p. 303. Also see Miroslav Nincic, “Getting What You Want: Positive
Inducements in International Relations,” International Security, Vol. 35, No. 1 (Summer 2010), pp. 138-183.

38
calculation of the target government regarding specific foreign or domestic policies. Long-term

sanctions intend to reconfigure the domestic balance of power between competing political

groups within the target state, sometimes by inducing popular revolt to overthrow the

government.40

Extending this logic, the reigning state can utilize the promise of economic gains

alongside military countermeasures to coerce or deter the challenger. In a similar vein, the

reigning power can use negative economic sanctions in conjunction with military force to shape

the challenger’s behavior. The reigning power’s choice of economic strategy is likely to be

determined by the prospects of absolute economic gains from bilateral trade. When large

absolute gains exist—and the challenger has a lot of economic benefits to lose—the reigning

state would be incentivized to utilize positive economic inducements, and would thus maintain

trade ties with the challenger.41 When only small mutual gains exist, severing bilateral trade or

adopting negative economic sanctions would become a more attractive option for the reigning

state. From this discussion, one set of hypotheses can be derived:

Economic Statecraft Hypotheses: A. When large absolute gains are involved in bilateral
trade, the reigning power maintains trade ties with the challenger in order to shape the
challenging state’s behavior; B. When small absolute gains are involved in bilateral trade,
the reigning power abandons trade ties with the challenger in order to shape the
challenging state’s behavior.

40
Mastanduno, Economic Containment, 52-57. Also see Pape, "Why Economic Sanctions Do Not Work," p. 94.
41
This logic has mainly been advanced in policy-relevant writings in the United States. For instance, see Richard N.
Haass and Meghan L. O’Sullivan, Honey and Vinegar: Incentives, Sanctions, and Foreign Policy (Washington,
D.C.: Brookings Institute Press, 2000); Henry M. Paulson, “A Strategic Engagement: Strengthening U.S.-Chinese
Ties,” Foreign Affairs, Vol. 87, No. 5 (September October 2008), pp. 59-77; and Condoleezza Rice, “Promoting the
National Interest,” Foreign Affairs, Vol. 79, No. 1 (January/February 2000), pp. 45-62.

39
Conclusion

My theory and the two alternative explanations present logically consistent theoretical

predictions on the reigning power’s decision on commerce with the challenging power. Their

arguments are also based on distinct causal logics. In chapters that follow, I test which theory

yields more convincing explanation for the reigning power’s decision, paying particular attention

to whether the causal mechanisms each sets forth are corroborated by empirical evidence.

40
 CHAPTER 3

BRITAIN’S ECONOMIC RESPONSE TO THE GERMAN

CHALLENGE, 1898-1914

A spiral of security competition marked British-German relations in the years leading up to the

First World War.1 While the balance of power shifted in Germany’s favor on the European

continent, the geographical proximity of the two countries meant that Germany’s increasing

power threatened Britain’s security. More evidently, Germany’s naval buildup launched by the

Navy Laws of 1898 and 1900, reinforced by a series of Novelle, posed a direct threat to the

defense of the British Empire’s maritime lifeline as well as the safety of the homeland. Britain, in

response, strengthened internal and external balancing efforts against Germany. It reinforced the

Royal Navy’s home-water fleet (including the creation of the Channel Fleet), actively engaged in

a naval arms race with Germany, carefully prepared plans for a European war, and signed the

Entente Cordiale with France which eventually evolved into the Triple Entente.2

1
For the spiral dynamics in military competition between Britain and Germany, see Robert Jervis, Perception and
Misperception in International Politics (Princeton, N.J.: Princeton University Press, 1976), pp. 62-67; L.C.F. Turner,
Origins of the First World War (New York: Norton, 1970); Jack L. Snyder, The Ideology of the Offensive Military
Decision Making and the Disasters of 1914 (Ithaca, N.Y: Cornell University Press, 1984); and Stephen Van Evera,
“The Cult of the Offensive and the Origins of the First World War,” International Security, Vol. 9, No. 1 (Summer
1984), pp. 58-107. This, however, does not mean that Britain did not attempt rapprochement with Germany before
the First World War. In 1906, when the Moroccan Crisis was being resolved, Britain and Germany took serious
measures to recover their relationship. For instance, see Foreign Office General Correspondence from 1906-1966,
FO 371/75 and FO 371/79. Also see Sean M. Lynn-Jones, “Détente and Deterrence: Anglo-German Relations, 1911-
1914,” International Security, Vol. 11, No. 2 (Fall 1986), pp. 121-150.
2
For Britain’s military response to the German challenge, see David French, British Economic and Strategic
Planning, 1905-1915 (London: George Allen and Unwin, 1982); Michael Howard, The Continental Commitment:
The Dilemma of British Defence Policy in the Era of Two World Wars (London: Maurice Temple Smith Ltd., 1972);
Paul M. Kennedy, The Rise and Fall of British Naval Mastery (New York: Scribner, 1976), chapter 8; Nicholas A.
Lambert, Planning Armageddon: British Economic Warfare and the First World War (Cambridge, M.A.: Harvard
University Press, 2012); Paul M. Kennedy, The Rise of the Anglo-German Antagonism, 1860-1914 (London: G.
Allen and Unwin, 1980); C. J. Lowe and M. L. Dockrill, The Mirage of Power, British Foreign Policy 1902-14,
volume 1 (New York: Routledge, 2002), pp. 1-28; and Samuel R. Williamson, The Politics of Grand Strategy:
Britain and France Prepare for War, 1904-1914 (Cambridge, M.A.: Harvard University Press, 1969).

41
 At the same time, Britain found the need and opportunity to reconsider its economic

relationship with Germany.3 During the decade before the Great War, the susceptibility to

foreign competition in the market and the relative ascendance of other industrialized powers had

led many British to doubt the future of Britain’s relative power position. For many, Britain was

becoming an inefficient nation when it came to competition in the international arena.4 As one

journalist asked in 1905, a pressing concern for contemporaries was “Will the Empire which is

celebrating one centenary of Trafalgar survive for the next?”5 This pessimism, and the need to

improve Britain’s relative economic, political, and military performance, was widely shared

across party and factional lines, although many refused to adopt an extreme view on the fate of

Britain.6 Even in debates over domestic policies, such as the Education Bill and Land Reform,

reformists emphasized their policies’ instrumental value in bolstering Britain’s relative position

in the international system.7

In stark contrast to Britain’s relative decline, Germany seemed to possess a young and

vigorous economy. It was widely agreed that the German military threat rested upon the

spectacular achievements of German industry.8 In particular, the country’s rising commercial

strength was one of the main drivers of Germany’s differential growth. Indeed, Germany in its

growth path remained highly dependent on foreign trade, with a 34 percent average trade-to-

3
Francis Oppenheimer, Stranger Within (London: Faber and Faber, 1960), p. 158; Aaron L. Friedberg, The Weary
Titan: Britain and the Experience of Relative Decline, 1895-1905 (Princeton, N.J.: Princeton University Press,
1988), pp. 24-6.
4
See G. R. Searle, The Quest for National Efficiency: A Study in British Politics and Political Thought, 1899-1914
(Berkeley, C.A.: University of California Press, 1971).
5
Quoted in Ibid, p. 5.
6
James D. Startt, Journalists for Empire (New York: Greenwood Press, 1991), pp. 1-5.
7
Paul Readman, “The Liberal Party and Patriotism in Early Twentieth Century Britain,” Twentieth Century British
History, Vol. 12, No. 3 (2001), p. 273; Paul Readman, Land and Nation in England: Patriotism, National Identity,
and the Politics of Land, 1880-1914 (Suffolk: Boydell Press, 2008).
8
Frans Coetzee, For Party or Country: Nationalism and the Dilemmas of Popular Conservatism in Edwardian
England (New York: Oxford University Press, 1990), p. 42; Ross J. S. Hoffman, Great Britain and the German
Trade Rivalry, 1875-1914 (Philadelphia, P.A.: University of Pennsylvania Press, 1933), chapters 2 and 3.

42
GDP ratio between 1897 and 1905, which increased to 38 percent between 1909 and 1913.9

Britain was also running a large deficit in trade with Germany, which was about 6 million

pounds in 1895, but increased to 24 million pounds in 1905 and to 39 million pounds in 1913.10

Accordingly, Britain had good reason to reassess its commercial relationship with Germany. This

reassessment, of course, was part of a broader rethinking concerning the future of the British

economy. Still, it was evident that Germany was the major target in Britain’s economic

reconsiderations.

Heated debates ensued as to whether Britain should maintain or abandon existing policy

arrangements in its trade with Germany. For some leaders of the Unionist government (coalition

of the Conservatives and the Liberal Unionists), the key to reinvigorating Britain’s relative

power lay in abolishing its open trade policy and constructing a form of all-British Zollverein.11

The proposals to abandon extant free trade policy, however, were not substantiated as an

effective means of enhancing Britain’s power vis-à-vis Germany. Because such a revision was

expected to inflict greater harm on the British economy and result in Britain’s further relative

decline, maintaining current commercial policy toward Germany was proven to be the best

available strategy for Britain’s relative clout.

In this chapter, I demonstrate that Britain’s economic choice in balancing militarily

against Germany is consistent with the predictions of my theory. As my theory suggests, when

its leading industries depended heavily on German economic inputs and alternative trading

9
Kenneth N. Waltz, Theory of International Politics (New York: McGraw Hill, 1979), p. 212. Also see Peter J.
Katzenstein, “International Interdependence: Some Long-Term Trends and Recent Changes,” International
Organization, Vol. 29, No. 4 (Autumn 1975), pp. 1021-1034.
10
B. R. Mitchell, International Historical Statistics: Europe 1750-2000 (New York: Palgrave Macmillan, 2003),
pp.662-3.
11
Arthur Balfour, “Insular Free Trade,” August 1, 1903 (Cab37/65/47); Charles W. Boyd ed., Mr. Chamberlain’s
Speeches, vol. 2 (London: Constable and Company, Ltd., 1914), pp. 140-82. For the motivations behind
Chamberlain’s promotion of tariff reform, see Sydney H. Zebel, “Joseph Chamberlain and the Genesis of Tariff
Reform,” Journal of British Studies, Vol. 7, No. 1 (November 1967), pp. 131-157.

43
partners existed for Germany, Britain chose to maintain trade ties with its security challenger.

Moreover, by examining the sixteen year period before World War I, during which Britain

experienced economic recessions, near-war crises with Germany, and major changes in national

leadership, I show that my argument is not undermined by the presence of diverse confounding

factors. Furthermore, I find that the two alternative explanations are not well corroborated by

historical evidence.

Leading Industries’ High Dependence on German Economic Inputs

Before World War I, trade between Britain and Germany was highly specialized and

complementary, with Germany supplying Britain with nearly one quarter of its imported

manufactured goods.12 Britain’s leading industries depended heavily on German economic inputs

to ensure their advantage in the competitive international market, while many imports from

Germany could not easily be substituted by a different foreign country. Restricting trade with

Germany would have diminished those industries’ productive efficiency and market

competitiveness, and thus might have damaged Britain’s overall material capacity.

The Structure of the British Economy

In order to understand the implications of trade with Germany for Britain’s economic

performance, the structure of the British economy before World War I needs to be examined. As

Table 3-1 shows, by 1907 Britain’s economic growth was led by manufacturing, mining,

construction, trade, and transportation, which in sum generated about 65 percent of its GDP. As

12
For major commodities traded between Britain and Germany, see Treasury, “The Fiscal Problem,” August 20,
1903 (Cab 37/66/55), pp. 52, 56.

44
the first country that achieved industrialization, Britain’s economic strength lay in making

industrial products, with a rapidly shrinking share of “first industries.” Britain also possessed

strong “tertiary” sectors, including transport, trade, banking, insurance, finance, and commercial

services.13

Table 3-1. Composition of the National Product of Britain (percentage of GDP)

Agriculture, Manufactures, Government,

Trade, Transport Housing
Forestry, Fishing mining, construction defense
1861 19 41 20 5 8
1871 15 42 25 4 8
1881 12 43 25 4 9
1907 6 37 28 3 7
Source: Peter Mathias, The First Industrial Nation, Second Edition (London: Methuen, 1983), p. 223.

The composition of national income in 1907, summarized in Table 3-2, allows a closer

look at Britain’s economic structure. About 18 percent of its national income came from

commerce, 9.5 percent from transport, and 10.1 percent from professional activities that were at

least partly related to international trade, reflecting Britain’s central position in global commerce.

Other large sources of income were engineering and metal manufacturing, including the

production of machines and vessels, and the textile and clothing industries which had been

Britain’s central industries since the early nineteenth century.

Table 3-2. Industrial Distribution of the National Income of Britain in 1907

Value at current prices Percentage of National

(£m.) Income
Agriculture, forestry, fishing 120.1 6.0
Mines and quarries 119.4 6.0
Engineering and metal manufacture 154.3 8.2
Textile and clothing 159.5 8.0
Food, drink, and tobacco 85.5 4.3
Paper and printing 32.6 1.6
Chemicals 21.0 1.1

13
Peter Mathias, The First Industrial Nation, second edition (London: Methuen, 1983), p. 225.

45
 Table 3-2 (continued)

Value at current prices Percentage of National

(£m.) Income
Wood industries 20.6 1.0
Miscellaneous manufactures 29.4 1.5
Gas, electricity, water 31.0 1.6
Building and contracting 74.4 3.7
Rents of dwellings 148.4 7.4
Commerce 358.4 18.0
Transport 188.9 9.5
Government and defense 59.6 3.0
Professions, charities and
202.5 10.1
miscellaneous
Domestic service 75.8 3.8
Income from abroad 143.8 7.2
Source: Phyllis Deane and W. A. Cole, British Economic Growth 1688-1959, Second Edition (Cambridge:
Cambridge University Press, 1969), p. 175

Table 3-3. Britain’s Major Exports

Textiles Iron and Steel Machinery Coal Vehicles etc

£m. % £m. % £m. % £m. % £m. %
1880-9 113.8 49 35.3 15 11.8 5 10.5 5 - -
1890-9 104.3 44 32.5 14 16.1 7 17.5 7 1.1 0
1900-9 126.2 38 45.7 14 23.8 7 32.9 10 8.4 3
1910-19 200.2 40 62.9 12 27.0 5 50.0 10 9.4 2
Source: Mathias, The First Industrial Nation, p. 434

Meanwhile, Britain’s export trade to the world was dominated by a few categories of

goods. As Table 3-3 shows, Britain’s most important export items were textiles, which accounted

for approximately 40 percent of its exports in the early twentieth century, followed by iron and

steel products, coal, and machinery. One major export item that is not well accounted for in usual

trade statistics is the export of services.14 Between 1901 and 1913, profits from the sales of

services such as shipping, insurance, and banking were larger than any export of merchandise.

Britain earned 110.6 million pounds every year through the export of services between 1901 and

14
Peter Cain, “Political Economy in Edwardian England: The Tariff Reform Controversy,” in Alan O’Day, ed., The
Edwardian Age: Conflict and Stability (Hamden, C.T.: Archon Books, 1979), pp. 38-9.

46
1905, 136.5 million pounds between 1906 and 1910, and 152.6 million pounds between 1911

and 1913.15

From these data, the leading industries that drove Britain’s economic growth before the

First World War can be pinned down. Those leading industries were concentrated in the

manufacturing and commerce sectors, and included textiles, iron and steel, engineering

(machinery), shipbuilding, shipping, and insurance and banking. Until 1914, trade with Germany

had large ramifications for the performance of these industries. By purchasing certain goods

from German firms, rather than buying them from the home market, Britain’s leading industries

could maintain international competitiveness, increase profit margins, and contribute to their

home country’s economic clout.

The Reliance of Britain’s Leading Industries on German Inputs

THE SHIPBUILDING-SHIPPING-INSURANCE/BANKING LINKAGE

Before the war, a huge portion of Britain’s national wealth was generated by the broadly defined

commerce sector, which was built on an intimate linkage between shipbuilding, shipping, and

insurance/banking. The backbone of Britain’s global leadership in this sector was its

competitiveness in shipbuilding, which utilized extensively imported German goods. Restricting

trade with Germany could have adversely affected Britain’s superiority in shipbuilding, and in

turn could have diminished its dominance in shipping and in the insurance and banking

industries.

British shipbuilders had a large number of domestic and international customers and

maintained superiority until the First World War because the vessels they produced were cheaper

15
Mathias, The First Industrial Nation, p. 279.

47
than the ships of comparable quality made by builders in other countries.16 During the transition

from wooden to iron and then steel ships in the late nineteenth century, British shipbuilders

successfully kept the cost of production low and established their international competitiveness,

while facing challenges from other industrialized powers.17

The German steel that was “dumped” into the British market played an important role in

maintaining this competitiveness that was achieved by the turn of the century.18 As the Treasury

reported to the Cabinet in 1903, by utilizing imported cheap German metals “Our ship-builders

are thus enabled to build ships at a very low price, and these they sell to the Germans.”19 Even in

the hearings conducted by the protectionist-backed Tariff Commission, witnesses noted the cost-

saving effect of German imports.20 British shipbuilders’ reliance on German steel increased

throughout the 1900s. By 1912-1913, about 43 percent of all steel castings and 10 percent of all

steel plates that were consumed in Britain came from Germany, and the shipbuilding industry

was one of the best customers of these steel.21

Moreover, the British shipbuilding industry achieved high degrees of efficiency by

purchasing components, machinery, and other equipment from outside suppliers.22 Among these

suppliers, much of the electrical equipment and parts were produced by Germany or German

16
Sydney Pollard, “British and World Shipbuilding, 1890-1914,” The Journal of Economic History, Vol. 17, No. 3
(September 1957), pp. 443-4
17
Sidney Pollard and Paul Robertson, The British Shipbuilding Industry, 1870-1914 (Cambridge, M.A.: Harvard
University Press, 1979), pp. 37-48.
18
Cain, “Political Economy in Edwardian England,” p. 45; Kennedy, The Rise of the Anglo-German Antagonism, p.
300. This, however, does not mean that the cost of materials and equipment was the only determinant of Britain’s
competitiveness in shipbuilding.
19
Treasury, “The Conditions and Effects of “Dumping””, July 7, 1903 (Cab. 37/65/42), p. 5.
20
The Tariff Commission, Report of the Tariff Commission, vol. 4, The Engineering Industries (London: P. S. King
and Son, 1909), paragraphs 497-546.
21
Pollard, “British and World Shipbuilding,” pp. 439-440.
22
Ibid. Being a major assembly industry, prosperity in shipbuilding had a large impact on the activities of its
supplying industries such as machinery and engineering, and iron and steel. See Pollard and Robertson, The British
Shipbuilding Industry, 1870-1914, p. 6.

48
subsidiaries in Britain such as Siemens.23 British shipbuilders increasingly relied on these

electrical products to operate their yards, as well as to equip their vessels. Also, steel ships were

impossible to build without reliable machine tools, and Germany remained the world’s leading

supplier of machine tools.24 As such, trade with Germany helped the British shipbuilding

industry keep production costs low. Britain maintained superiority in shipbuilding in the period

before the war, producing up to 60.6 percent of the world’s new vessels between 1909 and

1913.25 During the decades leading up to 1914, the annual value of new merchant vessels built in

British shipyards accounted for approximately 1.25 percent of Britain’s GDP.26

Britain’s advantage in shipbuilding played another more important role in its economy:

this advantage helped Britain to dominate the lucrative shipping industry. Until the First World

War, the world’s major shipping companies were concentrated in Britain and carried not only

British goods but also transported cargo between third countries. The British mercantile marine

was able to become the shipper of the world because it could buy cheaper ships in large numbers,

thereby accumulating the largest fleet of commercial ships. Indeed, British shipping companies

were also major owners of British shipbuilding firms. For instance, Lord Furness, the greatest

individual ship-owner of the world, was at the same time chairman or director of four

shipbuilding and marine engineering companies.27 By 1890, Britain alone had more registered

tonnage than the rest of the world combined, and British shippers owned 33.4 percent of the

world’s tonnage by 1914.28 Income from shipping services was very large, reaching an annual

23
Mathias, The First Industrial Nation, p. 384.
24
Samuel B. Saul, Studies in British Overseas Trade 1870-1914 (Liverpool: Liverpool University Press, 1960), p.
31.
25
Saul, Ibid.; Pollard, “British and World Shipbuilding,” p. 427
26
Pollard and Robertson, The British Shipbuilding Industry, p. 6.
27
Ibid., p. 92.
28
Mathias, The First Industrial Nation, p. 286; Pollard, “British and World Shipbuilding,” p. 432.

49
average of 100 million pounds between 1911 and 1913.29 Minimizing the cost of ship production

was important to maintaining the competitive advantage in this important industry, especially

considering that challengers to the British shipping industry often emerged, such as the U.S.’

International Mercantile Marine and Germany’s Hamburg-Amerika Linie.30

The effects of Britain’s advantage in shipbuilding extended beyond the shipping industry.

Its central role in the global shipping industry ensured Britain’s virtual monopoly of the

insurance industry and, to some extent, the banking industry. As is the case today, the early

twentieth century maritime transportation of goods and people was insured, and British shippers

signed contracts almost exclusively with British insurance companies such as Lloyd’s. As Peter

Mathias observes, “In a very real sense the evolution of London as the world’s main centre of

international banking, finance and insurancing was a function of the dominance of British

shipping in world trade.”31

ENGINEERING AND MACHINERY

Britain’s engineering and machinery industry also relied on German industrial products to

enhance productive and allocative efficiency and market competitiveness. This industry was not

only important for the wealth it produced, but also for its pervasive impact on the activities of

almost all industrial sectors of the modern economy. Because all major powers concentrated on

developing their engineering and machinery industry, market competition in this sector had

become very severe.

29
Phyllis Deane and W. A. Cole, British Economic Growth 1688-1959, second edition (Cambridge: Cambridge
University Press, 1969), p. 234; Mathias, The First Industrial Nation, p. 282.
30
For the U.S. challenge in the shipping industry, see Vivian Vale, The American Peril: Challenge to Britain on
North Atlantic, 1901-04 (Manchester: Manchester University Press, 1984).
31
Mathias, The First Industrial Nation, p. 287.

50
 As its defining characteristic, the engineering and machinery industry was concerned

with the processing of metals, transforming them into machinery and goods for further use in the

operation of other industries.32 Starting in the late nineteenth century, Britain purchased large

amounts of intermediate iron and steel products from Germany. By doing so, British engineering

and machinery companies could produce final goods at a lower price and expand their sales on

the international market. As the Duke of Devonshire, one of the most influential Liberal

Unionists and former chairman of an iron and steel company, observed, “Nobody that I am

aware of buys iron or steel [from Germany] to look at or to put in his pocket. The purchasers of

iron and steel are a thousand different classes of manufacturers who convert iron and steel into

hundreds of thousands of articles of general utility and advantage…”33

Further, Britain was a major buyer of German machinery such as electricity generating

plants and electrical equipment, increasingly depending on these to operate factories and make

final engineering products. For technological and administrative reasons, Britain was slow to

develop the newest electrical industry, with the exception of its production of electric cables.34

Accordingly, as Francis Oppenheimer, the British Consul in Frankfurt, reported in 1909, “the

United Kingdom receives from Germany machines for the newer branches of manufacture, e.g.,

electro-technical machines, and mining machines, etc., in which the technical development of

Germany strives to excel.”35

32
Roderick Floud, The British Machine Tool Industry, 1850-1914 (Cambridge: Cambridge University Press, 1976),
p. 4.
33
Hansard’s Parliamentary Debates, 4th Series, Vol. 130 (February 19, 1904, House of Lords) (London: Wyman
and Sons, Ltd.), paragraph 361. For similar view, see Percy Ashley, “Foreign Competition in British Markets”,
Balfour Papers, Vol. 98 (Add MS 49780), pp. 120-123. Also see Andrew Marrison, British Business and Protection
1903-1932 (Oxford: Clarendon Press, 1996), pp. 148-150; J. H. Clapham, An Economic History of Modern Britain,
vol. 3 (Cambridge: Cambridge University Press, 1938), pp. 122-3.
34
For the British adoption of electricity for industrial and other purposes, see Clapham, An Economic History of
Modern Britain, pp. 128-142.
35
Quoted in Hoffman, Great Britain and the German Trade Rivalry, p. 107.

51
THE IRON AND STEEL INDUSTRY

Britain’s iron and steel industry was the sector that was hardest hit by German encroachment on

the market.36 The loss of market share that occurred was mainly due to Britain’s failure to adjust

to technological development and reduce costs.37 In contrast, Germany’s competitive advantage

in producing iron and steel allowed it to achieve further growth in investment and to adopt the

latest technology.

However, even in the iron and steel industry, importing cheap German metals enabled

many British companies to maintain or increase their export trade. By purchasing semi-

manufactured German steel, British iron/steel producing companies could make final products at

a lower price and expand their sales in rapidly expanding markets such as the United States and

Britain’s own dominions and colonies. In other words, many German iron and steel imports were

used as raw materials to manufacture more sophisticated final steel products. Also, foreign

competition was often seen as having a modernizing, rather than destructive, impact on this

industry.38 Moreover, Germany supplied basic steel and special products such as tungsten and

spiegeleisen, minerals that were used to improve the quality of steel but were not produced in

Britain.39 Thus, as Charles Ritchie, the Chancellor of the Exchequer, said to the Cabinet, “cheap

iron and steel have, beyond doubt, recently enabled us to compete advantageously in the trade

for finished iron and steel goods, not merely in neutral markets, but, I believe, even in the

German home market, to the loudly-expressed dissatisfaction of the German manufacturers

36
For Britain’s loss of market share in this industry, see Robert Allen, “International Competition in Iron and Steel,
1850-1913,” The Journal of Economic History, Vol. 39, No. 4 (December 1979), pp. 911-937; Marrison, British
Business and Protection 1903-1932, p. 139.
37
Mathias, The First Industrial Nation, pp. 378-381.
38
W. E. Minchinton, The British Tinplate Industry (Oxford: Clarendon Press, 1957), pp. 85-6; Geoffrey Tweedale,
Sheffield Steel and America: A Century of Commercial and Technological Interdependence, 1830-1930 (Cambridge:
Cambridge University Press, 1987), pp. 180-1.
39
Clapham, An Economic History of Modern Britain, pp. 152-3; Saul, Studies in British Overseas Trade, p. 32.

52
themselves.”40 In the hearings conducted by the Tariff Commission, witnesses from the iron and

steel industry also confirmed that buying cheap German products was important to maintaining

competitiveness.41

THE TEXTILE INDUSTRY

Although the textile industry was no longer producing the largest wealth for the British economy

by the late nineteenth century, it still generated a significant portion of Britain’s GDP and textiles

remained a major export item until 1914. As one of the pioneers of the Industrial Revolution,

however, Britain’s textile industry faced severe international competition as more states achieved

industrialization. In response, British textile manufacturers concentrated increasingly on the

developing and semi-developed Far East and Empire markets where traditional-style goods were

more popular.42 Moreover, by the beginning of the twentieth century, British textile producers

were obsessed with reducing production costs to remain competitive on their most profitable

markets.43

To ensure price advantage, the textile industry wanted to keep the cost of machinery and

raw materials as low as possible.44 Imposing restrictions on German imports was likely to raise

the price of the goods that the textile industry relied on. Consequent increases in production costs

would render British textiles less attractive on the competitive market. While free trade helped to

keep the price of machinery and materials low, Britain could ensure that “the cost of production

40
Charles T. Ritchie-Chancellor of Exchequer, “Preferential Tariffs,” September 9, 1903 (Cab. 37/66/58), pp. 2-3.
41
For instance, see The Tariff Commission, Report of the Tariff Commission, Vol. 1 The Iron and Steel Trades
(London: P. S. King and Son, 1904), paragraph 432.
42
Mathias, The First Industrial Nation, p. 381.
43
P. F. Clarke, “The End of Laissez Faire and the Politics of Cotton,” The Historical Journal, Vol. 15, No. 3
(September 1972), p. 493. For Britain’s continuing cost advantage, see John C. Brown, “Imperfect Competition and
Anglo-German Trade Rivalry: Markets for Cotton Textiles before 1914,” The Journal of Economic History, Vol. 55,
No. 3 (September 1995), pp. 494-527.
44
Kennedy, Rise of the Anglo-German Antagonism, p. 302.

53
in Great Britain including the cost of building and equipping mills is, on the whole, lower than

on the Continent, or in the United States.”45

For the textile industry, chemicals were another important item imported from Germany.

Facing severe international competition, British textile producers increasingly concentrated on

manufacturing more value-added textiles and cloths. This shift required better and cheaper dying

chemicals.46 Germany was the leader in the production and industrial application of chemicals to

the extent that other industrialized powers could pose no serious challenge.47 Hence, most of

Britain’s synthetic dyestuffs were purchased from Germany. In 1913 Britain imported 90 percent

of this material from Germany.48

The Implications of German Inputs for Britain’s Economic Performance

As long as imported German goods played a central role in enhancing the performance of

Britain’s major industries, it was evident to Britain that no unilateral loss could be inflicted on

Germany by restricting trade. To the contrary, Britain would encounter significant loss in the

form of decreased efficiency, competitiveness, and real income. As Herbert Henry Asquith,

Prime Minister beginning in 1908 said of German imports, “In the first place, many of these

things could be made cheaper and better abroad. In the second place, a very large proportion of

these so-called manufactures were really raw material in an intermediate stage, brought here for

British industry to exercise further processes upon it.”49 In this condition, as the Treasury

45
The Tariff Commission, Report of the Tariff Commission, Vol. 2 The Textile Trades. Part I. The Cotton Industry
(London: P. S. King and Son, 1905), paragraph 81.
46
From 1890-1894 to 1900-1904, the share of bleached, printed and dyed piece-goods, and miscellaneous cotton in
all cotton exports had risen from 50 percent to 66.11 percent (by value). See Marrison, British Business and
Protection, p. 183.
47
Treasury, “The Fiscal Problem,” August 20, 1903 (Cab. 37/66/55), p. 42; Mathias, The First Industrial Nation, p.
384.
48
Clapham, An Economic History of Modern Britain, pp. 128-9; Saul, Studies in British Overseas Trade, p. 37.
49
The Times ed., Speeches by the Rt. Hon. H. H. Asquith from His Firs Appointment as a Minister of the Crown in
1892 to His Accession to the Office of Prime Minister April 1908 (London: Printing House Square, 1909), p. 190; H.

54
reported to the Unionist Cabinet, shutting off trade with Germany would increase the costs of

production within Britain’s leading and competitive industries, and place Britain in a worse

position for competition on the market.50 Britain would not only be less competitive on other

great power markets, but also on the markets of its own dominions and colonies which became

very important for a number of Britain’s major exports.51 Moreover, since restricting trade ties

with Germany would increase the cost of producing manufactured goods for home consumption,

Britain’ real income would diminish.52 These assessments were corroborated by the experience

of the British industries that used sugar as raw material and suffered from the bounties on

imported sugar in the early 1900s.53

Further, imports from Germany could not be easily substituted since no foreign country

could provide similar goods at equivalent quality and price. Most notably, although the United

States was another major producer of iron and steel, its products could not replace the goods

from Germany because U.S. production was not great enough to satisfy the demand of even its

own rapidly expanding domestic market. The Treasury informed the British Cabinet that “it must

be borne in mind that the United States are still importing pig and manufactured iron for their

home market.”54 The fact that Germany was the primary target of the Conservatives’ campaign

against dumping corroborates that Germany was the major provider of cheap industrial goods to

Britain with no potential substitute. Moreover, although Britain was certainly capable of

H. Asquith, Trade and the Empire (London: Methuen and Co, 1903), pp. 47, 57-8.
50
Treasury, “Will Our Purchasing Power Run Short?” September 25, 1903 (Cab. 37/66/62), pp. 5-6. Also see
Balfour Papers, Vol. 98 (Add MS 49780), p. 2; “Preferential Duties,” May 9, 1899, Fiscalia (T 168/54); and Board
of Trade, “The Export Policy of Trusts in Certain Foreign Countries,” August 1903 (Cab. 37/66/57).
51
Cain, “Political Economy in Edwardian England,” p. 50.
52
Campbell-Bannerman Papers, Vol. 38 B (Add MS 41243 B), p. 69; Treasury, “The Conditions and Effects of
“Dumping””, July 7, 1903 (Cab. 37/65/42).
53
“Price of Sugar,” November 7, 1904, Miscellaneous Memoranda (T168/64).
54
Treasury, Ibid. Also see Balfour Papers, Vol. 98 (Add MS 49780), pp. 101-2, 121.

55
increasing the production of iron, steel, and manufactured goods at home, erecting barriers to

German imports would mean harming its own leading sectors to preserve waning industries.55

Thus, unimpeded access to German economic inputs was viewed as important for

Britain’s economic performance.56 Alfred Marshall, the leading economist of the time and a

close economic advisor to Prime Minister Arthur Balfour, elaborated on this point in his advice

to the Unionist Cabinet: “it is not merely expedient−it is absolutely essential−for England’s

hopes of retaining a high place in the world, that she should neglect no opportunity of increasing

the alertness of her industrial population in general, and her manufacturers in particular; and for

this purpose there is no device to be compared in efficiency with that of keeping her markets

open to the new products of other nations, and especially to those of American inventive genius

and of German sedulous thought and scientific training.”57 This view was shared by the Liberal

Party and a number of powerful figures in the Unionist government.

The Existence of Alternative Trading Partners for Germany

Before 1914 (and until the latter stage of World War I), Britain could not effectively prevent

Germany from finding alternative trading partners. Britain recognized that Germany might be

able to replace its imports from the British Isles and Empire. At the same time, Germany

possessed alternative markets in other industrialized powers, the Eurasian hinterland, and the

American states. Also, Britain was not in a position to organize the collective actions which

would have constrained Germany’s foreign trade.

55
Cain, “Political Economy in Edwardian England,” pp. 44, 49.
56
Percy Ashley, “Letter to Mr. Balfour,” July 4, 1903, Balfour Papers, Vol. 98 (Add MS 49780).
57
Alfred Marshall, “Memorandum on Fiscal Policy and International Trade (a Memorandum to Arthur Balfour),”
August 31, 1903, Fiscalia (T 168/54), p. 39.

56
Germany’s Capacity to Divert Imports from Britain
In the decade before the First World War, Britain’s exports to Germany were mainly comprised

of staple goods, including coal, fish, certain classes of textiles and yarns, machinery, and iron

and steel products.58 These goods accounted for about two-thirds of British exports to Germany

by value.59 More importantly, the British overseas possessions supplied about 12 percent of all of

Germany’s raw material and food demands by 1913. Although Britain’s share in Germany’s

imports of raw materials was steadily diminishing—from 15 percent of its total raw material

imports in 1890 to 8.1 percent in 1913—the Empire’s share continued to increase.60 The large

flow of raw materials and foodstuffs from the British Empire to Germany might suggest that, as

proponents of naval blockade advocated, London could effectively restrict exports to Berlin if

need be.61

However, pessimistic voices were also strong. They argued that Britain could not

effectively thwart Germany from replacing its British imports with imports from other countries.

First, many of the economic inputs that Germany purchased from Britain were readily available

on the international market. As early as 1903, the Balfour Cabinet was informed that Britain had

only limited leverage to affect the German economy by manipulating exports because “there are

few of her exports which other countries need so urgently as to be willing to take them from her

at largely increased cost; and because none of her rivals would permanently suffer serious injury

through the partial exclusion of any products of hers with which England can afford to

58
Treasury, “The Fiscal Problem,” August 20, 1903 (Cab37/66/55), p. 56. The composition of Britain’s exports to
Germany remained largely unchanged until the war.
59
Lambert, Planning Armageddon, pp. 159-160.
60
Kennedy, The Rise of the Anglo-German Antagonism, pp. 294-5.
61
For an extensive study of this issue, Lambert, Planning Armageddon, chapter 4. Also see Avner Offer, The First
World War: An Agrarian Interpretation (New York: Oxford University Press, 1989).

57
dispense.”62 Similarly, Percy Ashley explained to Prime Minister Balfour that “The taxation of

exports is only expedient, on economic grounds, where the country imposing it has a monopoly

(absolute or practical) of the commodity taxed, and where the foreign demand for that article is

intense,” but Britain had “practical monopoly [in exports] only in goods such as steam coal and

jute.”63 Later in the decade, Llewellyn Smith, representing the Board of Trade, asserted that

Germany could easily substitute British goods with ones from rival foreign suppliers. According

to Smith, denying Germany access to British goods would only cause temporary inconveniences

with no broader implications for longer-term economic development.64

Moreover, while Germany had an enormous demand for foreign foodstuffs, the United

States, Russia, and later Argentina, had become its chief suppliers of food by the eve of World

War I.65 If Britain had tried to control the flow of food from its dominions into Germany—as it

actually did when the war broke out—these supplying countries could have replaced the British

Empire. As Eyre Crowe, Senior Clerk at the Foreign Office, claimed based on Francis

Oppenheimer’s influential 1909 report, “the pressure which could be put on [Germany’s]

resources as regards imported food supplies and raw materials is very slight.”66

Second, Britain’s capacity to prevent Germany from substituting British economic

inputs would be sharply limited due to the presence of neutral states. Regardless of their position

on the effectiveness of naval blockade, British officials agreed that Germany could effectively

divert its trade through neutral ports, most notably Antwerp and Rotterdam, if Britain were to

62
Marshall, “Memorandum on Fiscal Policy and International Trade,” p. 39.
63
Balfour Papers, Vol. 98 (Add MS 49780), p. 3.
64
Lambert, Planning Armageddon, p. 160.
65
According to Offer, Germany’s major source of wheat shifted from Russia to Argentina before the war. Offer, The
First World War, p. 289. For the influence of German businessmen in Latin America, see Philip Dehne, “From
“Business as Usual” to a More Global War: The British Decision to Attack Germans in South America during the
First World War,” Journal of British Studies, Vol. 44, No. 3 (July 2005), pp. 516-535.
66
Quoted in Lambert, Planning Armageddon, p. 108.

58
impose a blockade.67 According to Francis Oppenheimer, the Dutch and Belgian ports were

“quasi-German,” and could allow Germany to conduct its trade in a roundabout way, making it

“doubtful whether the blockade would in the long run prove really effective.”68 Indeed, the fear

of German incorporation of the Low Countries into Germany’s economic and political sphere

rose repeatedly in Britain. In particular, the Netherlands naturally exhibited strong Anglophobia

in the immediate aftermath of the Boer War.69 Northern Europe was another major route through

which Germany could divert its imports. Prohibiting Germany’s neutral trade would have been

problematic because it could have antagonized powerful neutral states such as the United States,

the outcome of which might have been disastrous for Britain.70

The unfeasibility of thwarting Germany’s ability to conduct trade through neutral

countries was not fully realized before World War I.71 Nevertheless, when the war broke out, the

pessimists’ predictions proved to be prescient. Even after the British Expeditionary Force

suffered a nearly sixty percent loss in casualties by November 1914 and public antagonism

toward the Axis powers soared, Britain’s economic measures against Germany were far from

comprehensive.72 Food and raw materials flowed into Germany through its backdoors in

Belgium, Italy, the Netherlands, and Scandinavia.73 From August 1914, grain shipments from

German companies in South America to neutral Scandinavian ports saw an unprecedented

expansion.74 The U.S. continued to export cotton, refined ore, oil, meat, and other foodstuffs to

67
Lambert, Planning Armageddon, pp. 164-6.
68
Quoted in Offer, The First World War, p. 289.
69
Hoffman, Great Britain and the German Trade Rivalry, pp. 295-300.
70
As Edward Grey argued in 1915, “The blockade of Germany was essential to the victory of the Allies, but the ill-
will of the United States meant their certain defeat.” Lambert, Planning Armageddon, p. 373.
71
French, British Economic and Strategic Planning, pp. 28-30; Dehne, “From “Business as Usual” to a More Global
War,” pp. 521-2.
72
David French, British Strategy and War Aims (London: George Allen and Unwin, 1986), p. 58.
73
John McDermott, “A Needless Sacrifice: British Businessmen and Business As Usual in the First World War,”
Albion, Vol. 21, No. 2 (Summer, 1989), pp. 263-282.
74
Dehne, “From “Business as Usual” to a More Global War,” p. 523.

59
the neutral ports.75 While U.S. exports to Europe almost quadrupled with the beginning of the

war, it was presumed that most of these expanded exports were heading for Germany.76 In short,

many of the British restrictions on exports against Germany were ineffective as long as

alternative suppliers existed and Britain could not seize their trade.

Germany’s Capacity to Divert Exports to Britain

Until 1913, Germany’s major export items were manufactured goods such as chemicals,

machinery, ironware, coal, cotton cloth, woolen cloth, and beet sugar, in order of export values.77

Britain was certainly one of Germany’s most important export destinations, and this condition

could have given London some leverage over Berlin in commercial matters.78 Nonetheless, this

optimistic view was unlikely to materialize. If Britain had restricted the import of German goods,

Germany could have effectively diverted them to other large foreign markets.

Germany had large and rapidly growing alternative markets in Europe and America

where its products were more competitive than British goods. In the early 1900s, Germany was

already outperforming British firms in the manufacture and sale of industrial products.79 Its

exports to Belgium and the Netherlands for their domestic consumption alone were larger than

the exports to Britain. In France, German firms were encroaching on British market share, and

the two states’ exports to France were almost equal by 1913. In Italy and Switzerland,

geographical proximity allowed Germany’s advantage, and in the Scandinavian market,

Germany was exporting approximately 40 million pounds compared to Britain’s 20 million

75
Between 1914 and 1916, American exports to the European states other than Britain, France, and Germany
increased from 387 million dollars to 1,063 million dollars. See U.S. Department of Commerce, Historical Statistics
of the United States, Colonial Times to 1970 (Washington, D.C.: Department of Commerce, 1975), p. 903
76
Lambert, Planning Armageddon, p. 423.
77
Kennedy, The Rise of the Anglo-German Antagonism, p. 293.
78
For instance, see “Draft Despatch from the Marquess of Lansdowne to Sir F. Lascelles,” May 1903, Fiscalia (T
168/59)
79
Cain, “Political Economy in Edwardian England,” p. 36.

60
pounds in 1912. With its ally, Austria-Hungary, Germany maintained a predominant position,

exporting about 59 million pounds while Britain exported 10 million pounds in 1912. Germany

also maintained an advantage in the Russian market. On the eve of the war, German export trade

to Russia was almost four times larger than Britain’s in value.80 With regard to German iron

products, it was expected that the United States could readily absorb them if Britain had

restricted importation of those products.81

Germany’s capacity to divert its exports away from Britain was also recognized by

British leaders. For instance, the Duke of Devonshire argued “It is not easy to see that our power

of competing in neutral markets would be increased by the adoption of that proposal [protective

tariffs]. If America or Germany wants to “dump” they will “dump” somewhere. If they cannot

“dump” here, they will be driven to “dumping” in neutral markets in which we compete with

them.”82 The Treasury also informed the Cabinet that “if a competitor can deliver here at a profit,

a fortiori, he can do the same in a neutral market common to both.”83

Potential Frictions with Germany’s Alternative Partners

If Britain had abandoned free trade policy with Germany, it might have faced significant losses

originating from frictions with other countries. In particular, Britain could have been exposed to

retaliation from Germany and other industrialized states.84 Imposing tariffs against German

goods was likely to induce a commercial war in which Britain lacked advantage, especially

considering that Germany had reached several continental agreements on tariffs by the late

80
Hoffman, Great Britain and the German Trade Rivalry, pp. 114-138. Also, Germany’s exports to Eastern Europe
rapidly expanded due to geographical proximity. See Marshall, “Memorandum on Fiscal Policy and International
Trade,” p. 30.
81
Treasury, “The Conditions and Effects of “Dumping””, July 7, 1903 (Cab. 37/65/42).
82
Hansard’s Parliamentary Debates, 4th Series, Vol. 130 (February 19, 1904, House of Lords) (London: Wyman
and Sons, Ltd.), paragraphs 361. Also see paragraphs 348-50; 354-64.
83
Treasury, “The Conditions and Effects of "Dumping””, July 7, 1903 (Cab. 37/65/42), p. 9.
84
“Preference Tariffs within the Empire,” May 26, 1903, Fiscalia (T 168/54).

61
nineteenth century. For instance, the “Caprivi treaties” or “the second European network”

opened many protected markets, including Austria-Hungary, Russia, Italy, Switzerland, and

Belgium, to German exports, while maintaining tariffs against British goods.85 Britain was given

minimum tariffs on goods that these protectionist states considered important for their economic

development.86 In 1905, as one British journal observed, “Germany has, by the conclusion of

commercial treaties with many Powers, secured for the German industries on the Continent of

Europe to the disadvantage of our own industries, and she is now assiduously working for a

Central European Customs Union of States to which Union she means to be the most favoured,

and almost the sole, purveyor of manufacturing articles.”87

Although this treaty system required adjustments, with frictions emerging frequently

between the members, its basic structure was retained until World War I.88 Even in 1911, the

Board of Trade reported to the Cabinet that Germany was Britain’s keenest trade competitor, but

was in an advantageous position when compared with Britain because it was successfully

advancing commercial treaties with the European states.89 For instance, on the eve of World War

I, Russia became one of Germany’s chief suppliers of raw materials and foodstuffs, and about 45

percent of Russia’s total trade was with Germany.90 Thus, it would have been very difficult for

85
Gerald W. Balfour, “The Central European Commercial Treaty Situation and Our Position in Relation Thereto,”
August 11, 1903 (Cab. 37/65/52). Also see Percy Ashley, “The German Tariff Controversy” Balfour Papers, vol. 98
(Add MS 49780), pp. 68-89.
86
For the British assessment of the unfair foreign tariffs against British goods, see the Board of Trade,
“Memorandum on the Comparative Incidence of Foreign and Colonial Import Tariffs on the Principal Classes of
Manufactures Exported from the United Kingdom,” Confidential Reports and Memoranda prepared by the Board of
Trade, relative to Trade, Employment, Immigration, etc (Add MS 88906/23/14), pp. 9-17.
87
Hoffman, Great Britain and the German Trade Rivalry, pp. 103-105.
88
Germany experienced a tariff war with Russia between 1891 and 1894. However, this controversy was resolved
with the signing of a new tariff treaty in 1894. See “Commercial Diplomacy, 1860-1902,” September 1903, Fiscalia
(T. 168/54), pp. 35-39.
89
Sydney Buxton, “Commercial Negotiations with Portugal,” March 17, 1911 (Cab. 37/105/29).
90
Erik Gartzke and Yonatan Lupu, “Trading on Preconceptions: Why World War I War Not a Failure of Economic
Interdependence,” International Security, Vol. 36, No. 4 (Spring 2012), p. 131.

62
Britain to garner support from other European powers for its economic restrictions against

Germany.

In addition, restricting trade with Germany would have caused frictions in Britain’s

relations with its own colonies and dominions. Collaborating with the members of the British

Empire against Germany’s foreign trade was not a realistic option for Britain. With the exception

of Canada, no colonial government was willing to adopt a discriminatory policy toward Germany

in favor of products from the mother country.91 For instance, Lord George Hamilton warned the

Cabinet that for India, “The free trade system, on which it [India’s foreign trade] is based, has so

far resulted in widening markets for its exports, and in cheap imports from abroad... If, however,

the principle of differential treatment of British imports, for the Benefit of the United Kingdom,

and other members of the Empire, is introduced, with its concomitant risks and sacrifices, into

the Indian tariff system, the change will inevitably present itself to the Native mind as implying

the abandonment of principles in which it has never heartily acquiesced, and which, it conceives,

has hitherto stood in the way of India’s industrial advance.”92

Outcome: The Maintenance of Trade Ties with Germany

Throughout the 1900s, Britain considered two trade policy options in attempts to cope with the

German challenge and reverse its own relative decline. All major political groups, whether

Unionist or Liberal, asserted that the economic policy they proposed would better serve and

enhance Britain’s relative power position. Maintaining trade ties with Germany prevailed

91
Lord Balfour of Burghleigh, “Fiscal Policy,” August 19; September 1, 1903 (Cab. 37/65/54); Charles T. Ritchie,
“Preferential Tariffs,” September 9, 1903 (Cab. 37/66/58), pp. 8-9.
92
Lord George Hamilton, “Preferential Tariffs in Their Application to India,” June 10, 1903 (Cab. 37/65/39). Also
see Curzon of Kedleston, “Cotton Duties in India,” The Times, June 2, 1908.

63
because, under the conditions discussed above, it proved to be the better alternative for

preserving Britain’s relative material clout.

A New Option for Britain: Protection and Preference

In 1903, the Unionist government, led by Joseph Chamberlain and backed by Arthur Balfour,

proposed a revision of Britain’s traditional free trade policy. For these leaders, abandoning free

trade was the first step to restoring Britain’s relative power position.93 Chamberlain clearly

argued upon “the essential thing to keep in mind—namely, that the greatness of a nation is not to

be measured by a comparison with its own past, but by its relative position in the councils of the

world.”94 While military competition with Germany intensified, it soon became evident that

Germany was the primary target of the Unionist campaign for “Tariff Reform.” Two intimately

linked policies were prescribed by these Unionists: tariff and retaliation against trade with

Germany, and preference on trade with the colonies.

First, many supporters of tariff reform thought that Britain could undermine Germany’s

prosperity by diminishing German imports through tariffs and retaliation.95 In their view, the

absence of protectionism in Britain had contributed to the growth of German industrial strength

by allowing German companies to encroach on the world’s largest British market, while

diminishing the market share of British firms. They asserted that protectionism was inevitable in

the new international economic environment where powerful competitors emerged. As a result,

they argued that Britain had to adopt protectionist measures in order to punish the unfair

93
Boyd ed., Mr. Chamberlain’s Speeches, pp. 140-82. The need for tariff reform emerged in the late nineteenth
century. For earlier debate on tariff reform, see Benjamin H. Brown, The Tariff Reform Movement in Great Britain
1881-1895 (New York: AMS Press, 1966). Also see Andrew J. Marrison, “The Development of a Tariff Reform
Policy during Joseph Chamberlain’s First Campaign, May 1903-February 1904,” in W. H. Chaloner and Barrie M.
Ratcliffe, eds., Trade and Transport (Manchester: Manchester University Press, 1977), pp. 214-241.
94
Quoted in Friedberg, The Weary Titan, p. 72.
95
Hoffman, Great Britain and the German Trade Rivalry, p. 285.

64
practices of foreign governments, secure the domestic market, and encourage the growth and

innovation of Britain’s traditionally powerful industries. Subscribing to the obsolete doctrine of

free trade would only erode Britain’s industrial basis and even undermine its great power

position in the long term.96

Second, the Unionists proposed to strengthen commercial ties within the British Empire

and intended to turn much of Britain’s trade into its imperial channels. For these leaders, the

British Empire, producing a wide variety of goods and generating enormous wealth, was an asset

that other great powers did not possess. It was thus suggested that, by “knitting our somewhat

loosely connected Empire more closely together, not merely in matters political and military, but

in matters commercial too,” Britain would be able to compete more effectively with rapidly

growing powers such as Germany.97 Economic unification in the form of imperial federation or

“Colonial Zollverein” would stimulate Britain’s industrial growth and compensate for its

deficiencies, as well as provide new resources to preserve Britain’s relative power position.98

The Unionists advocated protectionist policies as their solution to the challenges faced by

Britain, adopting them as a major campaign agenda in the general elections of the 1900s, and as

the official policy of the party in 1907.99 Powerful political groups such as the Tariff Reform

League backed the Unionist case for protectionism until the First World War.100

96
Cain, “Political Economy in Edwardian England,” pp. 41-2.
97
Arthur J. Balfour, “Insular Free Trade,” August 1, 1903 (Cab. 37/65/47).
98
Cain, “Political Economy in Edwardian England,” pp. 42-3; Coetzee, For Party or Country, p. 56.
99
For examples of the Unionist Party’s continued focus on Tariff Reform throughout the 1900s, see the exchanges
between Arthur Balfour and Austen Chamberlain in February 1907, in Balfour Papers, Vol. 98 (Add MS 49780), pp.
236-254, Robert Cecil and Hugh Cecil, “Memorandum: The Taxes on Food,” March 6, 1912, Tariff Reform,
Including Papers on Canadian Tariffs, and Economic Arrangements between Canada and Germany (Add MS
88906/23/17), and Lord Lansdowne’s memos and mails in Miscellaneous Foreign and Domestic Papers of Lord
Lansdowne (Add MS 88906/23/22).
100
Andrew S. Thompson, “Tariff Reform: An Imperial Strategy, 1903-1913,” The Historical Journal, Vol. 40, No. 4
(1997), pp. 1033-1054.

65
A Better Alternative: The Maintenance of Extant Policy
A different option for Britain in addressing the German challenge and maximizing its own

relative power position was to maintain its extant free trade policy. In this view, Britain lacked

effective tools for hampering Germany’s further growth. It was also suggested that restricting

trade would only harm Britain’s own economic performance and “drag our country back into the

dangers and errors of a discredited past.”101 As many Liberals claimed, “patriotism,” defined as

actions that helped Britain enhance its relative power position, was in the service of free trade.102

The adverse consequences of abandoning free trade policy and reducing trade ties with

Germany were first recognized within the Unionist Party where the revisionist policy originated.

Indeed, disagreements over the impact of tariff reform caused a crisis within the Unionist

Cabinet in 1903.103 Although Prime Minister Arthur Balfour tried to persuade his Cabinet

members that the free trade dogma no longer served Britain’s current position in the international

system, some leading Cabinet figures were adamant that revising extant trade policy would only

make Britain worse off.104 The Duke of Devonshire replied to Balfour that adopting

protectionism would “do more harm to ourselves than goods to our Colonial relations, or to

improve treatment by our foreign rivals.”105 Charles Ritchie, the Chancellor of the Exchequer,

agreed, arguing that Britain had much more to lose by adopting protectionism.106 Lord Balfour of

Burleigh went further, saying “I am profoundly convinced that any departure from the policy of

101
Asquith, Trade and the Empire, pp. 33-4.
102
A. K. Russell, Liberal Landslide: The General Election of 1906 (Hamden, C.T.: Archon Books, 1973), pp. 65-70
103
“The Cabinet Crisis of 1903: Correspondence between the Prime Minister and the Duke of Devonshire,” 1903
(Cab. 37/76/82); Political Papers (Add MS 88906/22/28). Also see E. H. H. Green, “The Political Economy of
Empire, 1880-1914,” in Andrew Porter ed., The Oxford History of the British Empire, vol. 3 (Oxford: Oxford
University Press, 1999), pp. 364-5.
104
Arthur J. Balfour, “The Cabinet Crisis of 1903: Correspondence between the Prime Minister and the Duke of
Devonshire, No. 7,” August 27, 1903 (Cab. 37/76/82)
105
Duke of Devonshire, “The Cabinet Crisis of 1903: Correspondence between the Prime Minister and the Duke of
Devonshire, No. 8,” August 27, 1903 (Cab. 37/76/82).
106
Charles T. Ritchie, “Preferential Tariffs,” September 9, 1903 (Cab. 37/66/58).

66
free trade...will be the first real blow to the prosperity of our British commerce.”107 The view of

Unionist free traders was corroborated by leading economists and supporters of imperial unity,

most notably Percy Ashley and Alfred Marshall, who warned that Britain had little to gain but

much to lose by abandoning free trade.108

Still, the proposal to reconsider trade ties with Germany was more thoroughly refuted by

the Liberal Party. The Liberals agreed with the ends of the Tariff Reform, but they disagreed

with the means. Most Liberal free traders did not dismiss the fact that Britain was losing much of

its market share to Germany in many of its traditional industries, and was waging a daunting

struggle with that country.109 As the Liberal leader Herbert Henry Asquith argued,

“do not let it be supposed that because we are driven to defend the citadel of Free
Trade we, therefore, think that all is for the best and are content with a policy of
folded hands. That there are disquieting features in our industrial as in our social
conditions no honest observer, certainly no member of the party of progress, will
be found to deny. We have seen industries in which we ought to have maintained
our supremacy falling behind, and in some cases entirely taken away from us by
our competitors.”110

Henry Campbell-Bannerman, the Liberal Prime Minister from 1906 to 1908, also acknowledged

that Free Trade should not be regarded as a panacea, but rather as Britain’s best available

option.111

For the Liberals, protectionism was truly “unpatriotic” and would only have diminished

Britain’s capacity to compete with Germany.112 Abandoning extant free trade policy would have

107
Hansard’s Parliamentary Debates, 4th series, Vol. 130 (February 18, 1904, House of Lords) (London: Wyman
and Sons, Ltd.), paragraph 162.
108
Percy Ashley, “Letter to Mr. Balfour,” Balfour Papers, Vol. 98 (Add MS 49780); Marshall, “Memorandum on
Fiscal Policy and International Trade.”
109
The Times, Speeches by the Rt. Hon. H. H. Asquith, pp. 167-8.
110
Ibid, pp. 185-6. Also see “A Dissection by Mr. Asquith,” The Manchester Guardian, May 22, 1903.
111
See Campbell-Bannerman Papers, Vol. 38 B (Add MS 41243 B), pp. 44-5.
112
For the “free trade nationalism” of Edwardian Britain, see Frank Trentmann, “National Identity and Consumer
Politics: Free Trade and Tariff Reform,” in Donald Winch and Patrick K. O’Brien, eds., The Political Economy of
British Historical Experience, 1688-1914 (Oxford: Oxford University Press, 2002), pp. 215-242.

67
raised the cost of production, harbored inefficiency, lowered output and employment, strangled

imperial commerce, and nurtured corruption.113 Germany, in contrast, would have been able to

divert its trade away from Britain, maintaining its economic performance.114 Moreover, while

Germany relied heavily on raw materials from the British Empire, it was not certain whether

Britain’s colonies would have supported the mother country’s imperative to diminish exports to

Germany while supplying Britain at a lower price. To the contrary, restricting the British

Empire’s imports from Germany would have induced furor from the colonies, as they would

have been forced to purchase British goods instead of cheaper and better German industrial

products. Thus, protectionism and preference might have weakened the unity of the British

Empire and impaired Britain’s material strength.115

Accordingly, the Liberal Party asserted that abandoning extant trade policy would have

inflicted greater harm on Britain, rather than improving its relative economic clout. A move

toward restrictive measures, most notably through the adoption of retaliatory policies, would

only have made Britain worse off. Leading the debate with the Unionists, Asquith made this

point clear:

“Why do we—we Liberals, we Free Traders—why do we decline to assent to

such a policy? Not because…it conflicts with some abstract proposition in some
obsolete creed…not because we are craven…who are afraid to meet force with
force. Nothing of the sort. If we oppose retaliation as a policy it is because we
believe that experience shows—and to experience, and experience alone, we

113
Cain, “Political Economy in Edwardian England,” p. 44; Anthony Howe, Free Trade and Liberal England, 1846-
1946 (Oxford: Clarendon Press, 1997), pp. 247-249; Readman, “The Liberal Party and Patriotism in Early Twentieth
Century Britain,” pp. 281-288. For the focus on efficiency in Edwardian Britain, see Searle, The Quest for National
Efficiency. Also see Bernard Semmel, The Rise of Free Trade Imperialism: Classical Political Economy, the Empire
of Free Trade and Imperialism 1750-1850 (Cambridge: Cambridge University Press, 1970).
114
For instance, see Balfour Papers, Vol. 98 (Add MS 49780), p. 3; Hansard’s Parliamentary Debates, 4th Series,
Vol. 130 (February 19, 1904, House of Lords) (London: Wyman and Sons, Ltd.), paragraphs 348-50, 354-64;
Marshall, “Memorandum on Fiscal Policy and International Trade”; Treasury, “The Conditions and Effects of
"Dumping””, July 7, 1903 (Cab. 37/65/42), p. 9.
115
Asquith, Trade and the Empire, p. 16; Balfour Papers, Vol. 98 (Add MS 49780), p. 45; Robert Giffen, “Customs
Duties and Free Trade,” The Times, April 2, 1902; Robert Giffen, “The Dream of a British Zollverein,” The
Nineteenth Century, No. 303 (May 1902), pp. 693-705.

68
 should appeal—that in practice it is fatal as a weapon of offence, and in the vast
majority of cases it is infinitely more mischievous to those who use it than to
those against whom it is directed.”116

“[R]etaliation as a practice we should suffer a great deal more injury ourselves

than any we should inflict on the other States concerned.” 117

“Believe me, as all experience shows, you will inflict far more and far severer
wounds upon yourselves than upon the industrial rivals of your own once you
begin to play with the boomerang of retaliation. Do not let us in a fit of
hypochondria commit industrial suicide, for when all is said and done that is what
it comes to.”118

At a time when Britain was encountering internal and external challenges, as John

Morley, a leader of the powerful Radical faction in the Liberal Party, argued, free trade was

Britain’s best available way of “keeping her powder dry, and of keeping her resources in

steadfast charge.”119 Even the most ardent defenders of free trade, for instance the Cobden Club,

did not advocate free trade on the basis of convictions alone. Instead, they argued that Britain

had more to lose by restricting trade considering its main industries’ linkage to foreign inputs

and competition in foreign markets. According to Harold Cox, the Secretary of the Cobden Club,

“the Protection can only diminish national wealth,” and thus was detrimental to other national

objectives, most importantly the unity and prosperity of the British Empire.120 Maintaining

traditional free trade policy was the best means of maximizing Britain’s gains, defending its

position of leadership in the international system, and cementing the British Empire.

116
Asquith, Trade and the Empire, p. 12; Hansard’s Parliamentary Debates, Vol. 126 (July 23, 1903), paragraph
145. Also see the statement of Winston Churchill, the President of the Board of Trade, in Hansard’s Parliamentary
Debates, Vol. 3 (March 30, 1909), paragraph 292.
117
Balfour Papers, Vol. 98 (Add MS 49780) p. 256.
118
Ibid. 258-9.
119
Hansard’s Parliamentary Debates, 4th series, Vol. 129 (February 8, 1904, House of Commons) (London: Wyman
and Sons, Ltd., 1904), cols 634, 644.
120
Harold Cox ed., British Industries under Free Trade (London: T. Fisher Unwin, 1903), pp. ix-xvi. Also see
Harold Cox, Mr. Balfour’s Pamphlet: A Reply, 3rd Impression (London: T. Fisher Unwin, 1903).

69
Britain’s Choice: The Maintenance of Trade Ties with Germany
While Britain responded to the German threat through internal and external balancing, both the

Unionist (1895-1905) and Liberal (1905-1915) Cabinets chose not to restrict commerce with

Germany. The Unionists could not find enough imperatives to abandon free trade while they

were in office and the proponents of a trade policy revision continuously failed to develop a

convincing rationale for protectionism or to present evidence in support their claim. As one

journal observed, “No one attempted to show how, had we been a protectionist country, we

should have prevented the more rapid proportionate growth of countries like the United States

and Germany.”121 In contrast, foreign policy leaders of the Liberal Cabinet, recognized by their

contemporaries as astute practitioners of realpolitik, were adamant that free trade was the best

alternative for maintaining Britain’s competitiveness vis-à-vis Germany, as well as for

preserving Britain’s relative power position.122 Even the economic recessions between 1907 and

1908, the accelerating naval arms race with Germany, and the experience of near-war situations

during the Moroccan Crises did not affect the British decision to maintain trade ties with

Germany.

Consequently, Britain did not adopt either preferential policy or retaliatory tariffs on

trade with Germany until 1914. Although the British government implemented some minor

economic measures in order to counter German encroachment on the British market, including

121
“Free Trade and the Position of Parties,” Edinburgh Review, Vol. 199, No. 408 (January-April 1904), pp. 547-55.
122
For a contemporary view of the Liberal Cabinet’s foreign policy leaders, see “Letters from Joseph Chamberlain
to Lord Northcote,” May 29, 1906, Henry Stafford, 1st Baron Northcote: Papers (PRO 30/56/1). For the composition
and practice of the Liberal Cabinet’s foreign policy leaders, see Francis H. Hinsley, ed., The Foreign Policy of Sir
Edward Grey (New York: Cambridge University Press, 1977); Kennedy, Rise of the Anglo-German Antagonism, pp.
334-5; Thomas G. Otte, The Foreign Office Mind: The Makings of British Foreign Policy, 1865-1914 (Cambridge:
Cambridge University Press, 2011); Keith Robbins, Sir Edward Grey (London: Cassell, 1971); Zara S. Steiner, The
Foreign Office and Foreign Policy, 1898-1914 (Cambridge: Cambridge University Press, 1969); Steiner, Britain
and the Origins of the First World War, pp. 171-190; and Keith M. Wilson, The Policy of the Entente (Cambridge:
Cambridge University Press, 1985).

70
the Merchandise Marks Act of 1887 and the Patent Law of 1907, these were not powerful

enough to alter the trajectory of overall commerce between the two countries.123

Alternative Explanations

Britain’s behavior with regard to commerce with Germany before the outbreak of the First World

War is consistent with the predictions of my theory. Constrained by its leading industries’ high

dependence on German products in ensuring efficiency and competitiveness, and recognizing the

presence of alternative trading partners for Germany, Britain maintained its extant free trade

policy toward Germany until 1914 despite intensifying military competition. Restrictions on

bilateral trade would have inflicted greater harm on the British economy.

In contrast, the two alternative explanations are not empirically well supported.124 As

discussed in the previous chapter, theories that focus on the effect of absolute gains from trade

on military competition or the impact of military contests on economic exchanges are hard to be

123
The Merchandise Marks Act of 1887 made it obligatory to print the country of origin on imported goods while
the Patent Law of 1907 made it mandatory for companies that used British patents to produce a certain portion of
their goods on British soil.
124
Some might suggest that the fear of Russian aggression led Britain to eschew adopting comprehensive
counterbalancing measures against Germany. This view, however, is not historically supported. Although there is
good reason to believe that Britain was concerned by growing Russian power, this does not mean that the potential
threat from Russia was salient enough to shape London’s course of action toward Berlin. While the threat posed by
Russia was mainly related to the defense of India, Germany threatened the safety of the British homeland and the
balance of power on the European Continent. In other words, the Russian threat and the German threat were
different in kind and magnitude. Moreover, against the German challenge, Britain not only launched its own naval
buildup, but also carefully prepared for economic warfare which would be adopted hand in hand with the
deployment of military forces to aid the French if a war with Germany broke out. Britain never made similar
military preparations against other great powers. These circumstances suggest that the Russian threat was not as
salient as some scholars suggest, or that Britain’s response to Germany was not closely related to the fear of Russian
aggression in Central Asia. For Britain’s concerns about Russia’s expansion in Central Asia, see Tanisha M. Fazal,
State Death: The Politics and Geography of Conquest, Occupation, and Annexation (Princeton, N.J.: Princeton
University Press, 2007), pp. 123-8; Ira Klein, “The Anglo-Russian Convention and the Problem of Central Asia,
1907-1914,” Journal of British Studies, Vol. 11, No. 1 (1971), pp. 126-47; Wilson, The Policy of the Entente, pp. 2-
3, 15. For the reasoning underlying Britain’s balancing policies against Germany, see Foreign Office, “Memorandum
on the Present State of British Relations with France and Germany,” January 1, 1907 (Cab. 37/86/1).

71
considered as alternative explanations. If the former argument was right, we should not have

observed the emergence of serious security competition between Britain and Germany in the first

place. If the latter theory was correct, trade should have diminished between Britain and

Germany as their military competition intensified. I thus consider two alternative explanations,

one focusing on domestic interest group politics and the other positing the use of positive

economic inducements by the reigning state.

First, for the commercial interest hypothesis to show that its causal mechanism works, the

reigning power’s leaders should choose to maintain the current trade policy toward the

challenger in response to domestic interest groups that want to sustain trade ties with the

challenging state. The hallmark of this approach is a bottom-up process whereby domestic

groups mobilize themselves to protect commercial interests and their interactions with other

societal groups and national leaders, mainly through activities related to elections. Second, for

the positive economic inducements hypothesis to hold, British leaders should have chosen to

maintain trade ties with Germany because continuing commerce was considered an effective

means of shaping Germany’s behavior. The British case, however, reveals that either the causal

mechanisms of these two alternative explanations do not function as expected, or that the

evidence that supports their claims is not sufficient.

The Ambiguous Influence of Commercial Interests

Contrary to the expectations of the commercial interest hypothesis, it is uncertain whether the

preferences of British commercial groups that wanted to maintain open trade with Germany were

actually translated into a corresponding foreign policy. During the two decades before World

War I, commercial groups did not compete vigorously against one another based on their

diverging performance under extant free trade policy, nor did they lobby the government heavily

72
in order to protect their sector-specific interests.125 To be clear, there is a very strong relationship

between the Liberal Party’s promotion of free trade and its landslide victory in the general

election of 1906. In the campaign for the 1906 general election, 98 percent of the addresses made

by Liberal candidates mentioned why Britain had to maintain free trade policy.126

One major problem here is that, even if a strong correlation can be observed between the

voters’ support for free trade and the Liberal Party’s promotion of free trade policy, a closer look

reveals that this relationship was not established by trade interests per se. Standard trade models

(the theories underlying the domestic politics-based alternative explanation) suggest that the

economic groups who benefit from open trade will support free trade while those who lose will

oppose it. However, in pre-World War I Britain, it was difficult to make clear distinctions among

different commercial interests based on their performance under free trade. As pointed out in the

hearings by the Tariff Commission, it was hard to determine which particular industries were at

risk from German encroachment, since many less competitive sectors also benefited from the

purchase of cheap imported German materials. Even Britain’s waning industries, such as the iron

and steel industry, were not completely disadvantaged by German market expansion. Thus, it

remains ambiguous which commercial groups supported free trade with Germany and which

opposed it.127

In contrast, there is good reason to believe that the elections in this period were

characterized by economic voting on social welfare issues.128 Historians suggest that, between

1903 and 1913, a very salient issue that divided British citizens concerned social reform and

125
Thus, it can be suggested that the main theoretical proposition and causal mechanisms of this alternative
explanation are not historically well corroborated.
126
Russell, Liberal Landslide, pp. 65-7.
127
For instance, see The Tariff Commission, Report of the Tariff Commission, paragraphs 425, 432, 438-470; and
The Tariff Commission, Report of the Tariff Commission, paragraph 92.
128
In other words, social welfare might be the true causal factor that could make the correlation between the support
for free trade and the Liberal Party’s promotion of continuing free trade spurious.

73
welfare programs.129 As Campbell-Bannerman noted, the strategic issue that could lead to the

Liberal victory was reform, and free trade assumed its central position within the context of

social reform.130 Specifically, the Unionist Party intended to combine domestic social reform

with tariff reform, arguing that the future of Britain lay in resuscitating the unity of the British

people and their collective identity. In contrast, the Liberal Party made it clear that the Unionist

policies would not do any good for the welfare of the people. Rather, it would harm the common

people’s standard of living by increasing the price of food and diminishing their real income.131

In this context, the Liberal message during the General Election of 1906 was very

straightforward: “If you want your loaf, you must shut up Joe [Joseph Chamberlain].”132 The

Liberals also propagated the view that the Unionist campaign for tariff reform was “Grinding the

Poor” or benefited only “Property and Privilege,” 133 allowing them to prevail in the domestic

electoral competitions of the early twentieth century where working class votes became very

important.

A related problem with the commercial interests hypothesis is that British domestic

politics of this period, including politics over trade policy, showed some signs of class-based

interactions, rather than being dominated by clashing commercial interests. In the early twentieth

century, the Conservatives were becoming the party of business and commerce, while the

business element declined within the Liberal Party. The Liberals, moreover, focused on social

129
Ewen H. H. Green, The Crisis of Conservatism: The Politics, Economics and Ideology of the British
Conservative Party, 1880-1914 (London: Routledge, 1996); Alan Sykes, Tariff Reform in British Politics 1903-1913
(Oxford: Clarendon Press, 1979), pp. 210-238. For the centrality of social reform program in the Liberal Party, see
E. J. Feuchtwanger, Democracy and Empire, Britain 1865-1914 (London: Edward Arnold, 1985), pp. 286-320.
130
Campbell-Bannerman Papers, Vol. 38 B (Add MS 41243 B), pp. 59-60.
131
Geoffrey R. Searle, A New England? Peace and War 1886-1918 (New York: Oxford University Press, 2004), pp.
344-5.
132
Russell, Liberal Landslide, pp. 65-7.
133
Campbell-Bannerman Papers, Vol. 38 B (Add MS 41243 B), p. 60.

74
changes and actively mobilized working-class votes, while trying to consolidate their position on

the center-left of British politics.134

The diverging electoral outcomes across the districts throughout the 1900s are more

reflective of this class-based politics than of differentials in economic performance under free

trade. In the Liberal victories in the general elections of 1906 and 1910, voters in the industries

that benefited from open trade supported the Liberals alongside those in “losing” industries. For

instance, of the 153 seats in England where the working class was concentrated, the Liberals won

138 seats in the election of 1906, and the Liberal free traders prevailed even in districts where

competition from foreign firms was fierce.135 Conversely, in the 1906 election, both Tariff

Reform Unionists and Unionist Free Traders lost their seats.136 In the elections of 1910, the

central agenda was the Liberal Party’s “People’s Budget” which tried to expand social spending

dramatically, and the Liberals’ campaign slogan was “the peers [of the House of Lords] versus

the people.”137 As the economist Alfred Marshall observed in the immediate aftermath of the

1910 election, “the division between the districts…does not run with the interests of the

population in T.R. or F.T. [Tariff Reform or Free Trade].”138 In this context, public support for

the Liberal Party should not be conflated with the influence of commercial interests.

Moreover, the argument that British leaders persistently made foreign policy decisions in

response to domestic interests is misleading. Put differently, many important foreign policy

134
Feuchtwanger, Democracy and Empire, pp. 276-7; Howe, Free Trade and Liberal England, pp. 256-266. Also
see Roy Jenkins, Asquith: Portrait of a Man and an Era (New York: Chilmark Press, 1964), pp. 134-175.
135
Mark R. Brawley, Power, Money, and Trade: Decisions that Shape Global Economic Relations (Peterborough,
Ontario: Broadview Press, 2005), pp. 244-5.
136
Coetzee, For Party or Country, p. 71.
137
Coetzee, Ibid, pp. 117-126; Howe, Free Trade and Liberal England, pp. 278-9.
138
Quoted in Frank Trentmann, “The Transformation of Fiscal Reform: Reciprocity, Modernization, and the Fiscal
Debate within the Business Community in Early Twentieth-Century Britain,” The Historical Journal, Vol. 39, No. 4
(December 1996), p. 1008.

75
decisions, whether security or economic, were made through a “top-down” process.139 Rather

than serving as simple agents of their constituencies, leaders also actively formulated and

mobilized public support. The controversial tariff reform campaign was officially launched by

Joseph Chamberlain’s speech at Birmingham in May 1903, and elite and public mobilization in

support of his policy was formulated only after his announcement of the new trade program,

rather than shaping Chamberlain’s proposal.140 Likewise, the Unionist Prime Minister Arthur

Balfour advocated protectionist policies through a speech at Sheffield in October 1903 only after

intense discussions in the Cabinet.141 Further, evidence suggests that the Unionist Party’s tariff

reform program itself emerged as a last resort when the Unionist defeat in the general election of

1906 had become certain.142 Similarly, the Liberals dashed into the fight against protectionism

and endorsed free trade in the elections because it could unite the factions within the Liberal

Party that disagreed on most other matters.143 Liberal leaders such as Campbell-Bannerman and

Asquith found the controversy over protectionist policy opportune because it was creating

division within the Unionist Party, which in turn advanced the Liberals’ position in the

elections.144

139
Some might suggest that foreign economic relations were not within the realm of foreign policy leaders in the
Cabinet and Foreign Office. This is not true. The Foreign Office conducted commercial diplomacy and negotiations
with other countries. British consuls in major commercial centers around the globe communicated with the Foreign
Office. Moreover, the Foreign Office and the Foreign Secretary were continuously informed about international
economic exchanges and economic developments in foreign countries. For an example of the Foreign Office’s
involvement in economic matters, see the correspondence on German economic affairs in FO 368/25.
140
See Andrew J. Marrison, “The Development of a Tariff Reform Policy during Joseph Chamberlain’s First
Campaign, May 1903-February 1904,” in W. H. Chaloner and Barrie M. Ratcliffe, eds., Trade and Transport
(Manchester: Manchester University Press, 1977), pp. 214-241.
141
Arthur J. Balfour, “Speeches on Fiscal Policy,” October 13, 1903 (Cab. 37/66/64); “The Cabinet Crisis of 1903:
Correspondence between the Prime Minister and the Duke of Devonshire,” 1903 (Cab. 37/76/82); Charles T.
Ritchie, “Preferential Tariffs,” September 9, 1903 (Cab. 37/66/58).
142
See “Letters from Arthur Balfour to Lord Northcote” and “Letters from Joseph Chamberlain to Lord Northcote”
in Henry Stafford, 1st Baron Northcote: Papers (PRO 30/56/1).
143
Anthony Howe, Free Trade and Liberal England 1846-1946 (Oxford: Clarendon Press, 1997), pp. 244-6, 256-
266. Also see Herbert Henry Asquith, Fifty Years of Parliament, vol. 2 (London: Cassell and Company, 1926), pp. 7-
13.
144
Campbell-Bannerman Papers, Vol. 5 (Add MS 41210), pp. 225-230; Spender Papers, Vol. 3 (Add MS 46388), pp.
52, 55.

76
 Notwithstanding these points, if leaders had adhered to public views in foreign policy

matters, Britain would have adopted more competitive economic and security policies toward

Germany given the strong and widespread anti-German sentiment of the time.145 British leaders,

nonetheless, took care not to agitate Germanophobia and avoided mobilizing those feelings to

win support. Foreign policy leaders of the Liberal Cabinet between 1906 and 1914—including

Herbert Henry Asquith, Edward Grey, and Richard Haldane—were Liberal Imperialists who

were sensitive to domestic interference in foreign affairs and tried to avoid populist policies.146

The Absence of Positive Economic Inducements

There is, likewise, no good evidence to show that Britain seriously considered using positive

economic inducements as a means of shaping Germany’s behavior. Rather than utilizing the

promise of economic gains, the heart of British security policy toward Germany lay in adopting

appropriate internal and external balancing measures, as well as planning for economic

warfare.147 As Richard Haldane told the German Ambassador in 1912, “the theory of the balance

of power forms an axiom of English foreign policy and has led to the English leaning towards

France and Russia.”148 Moreover, since the importance of maintaining naval supremacy was

almost unanimously agreed upon, meeting the German challenge in the naval race won wide

support.149 When the economic tools were actually brought to the fore, Britain carefully prepared

145
For anti-German sentiment among the British public, see Hoffman, Great Britain and the German Trade Rivalry,
pp. 224-272; Kennedy, The Rise of the Anglo-German Antagonism, pp. 361-385; David Silby, The British Working
Class and Enthusiasm for War, 1914-1916 (New York: Frank Cass, 2005).
146
For the importance of leaders in Britain’s foreign relations, see Hinsley, ed., The Foreign Policy of Sir Edward
Grey; Otte, The Foreign Office Mind; Robbins, Sir Edward Grey; Steiner, The Foreign Office and Foreign Policy.
Also see Herbert Henry Asquith, Memories and Reflections, 1852-1927 (Boston: Little, Brown, and Company,
1928), pp. 264-285.
147
See French, British Economic and Strategic Planning; Howard, The Continental Commitment; and Williamson,
The Politics of Grand Strategy; and Lambert, Planning Armageddon.
148
Quoted in Wilson, The Policy of the Entente, p. 60.
149
For the British, as the Liberal leader Herbert Henry Asquith stated, “The command of the sea, however important
and however desirable it may be to other Powers, is, to us, a matter of life and death.” The Times, Speeches by the

77
for economic warfare, which would be implemented hand in hand with the deployment of

military forces if a war with Germany broke out.150

Meanwhile, few influential leaders or powerful political groups existed in the British

government to endorse economic exchanges with Germany as a means of ameliorating security

tensions. Contrary to some observations, the Radical wing of the Liberal Party—the group that

sometimes embraced the idea of the pacifying effect of trade—was weakened at the Cabinet

level around 1908. By that year, the old and powerful leaders of the Radicals were largely absent

within the Cabinet: Prime Minister Campbell-Bannerman died in April 1908, James Bryce left

Britain to serve as an Ambassador in Washington, Lord Ripson resigned from the Cabinet in

October 1908, and John Morley’s position was weakened by having accepted a peerage.151 In

contrast, the younger generation of Radical foreign policy leaders, most notably David Lloyd

George and Winston Churchill, were not particularly “radical,” as recognized by their

contemporaries. For instance, as Lord Esher observed, “Lloyd George, in his heart, does not care

a bit for economy, and is quite ready to face parliament with any amount of defeat, and to “go”

for a big Navy. He is plucky and an Imperialist at heart, if he is anything.”152 Lloyd George and

Churchill not only chose to side with the Imperialists in important foreign policy matters, but

also eventually joined the Liberal Imperialists in 1911.153 Moreover, although the Liberal

Radicals often protested the excessive investment in building new warships, their view was

based on the assessment that the extent of German naval expansion was exaggerated or unclear,

rather than on their disagreement with the importance of Britain’s maritime superiority.154

Rt. Hon. H. H. Asquith, p. 309.

150
For a comprehensive study of this strategy, see Lambert, Planning Armageddon.
151
Searle, The Quest for National Efficiency, pp. 171-2.
152
Maurice V. Brett ed., Journals and Letters of Reginald, Viscount Esher, vol. 2 (London: I. Nicholson and
Watson,1934), p. 370.
153
Steiner, Britain and the Origins of the First World War, pp. 140-1.
154
For instance, Asquith, as Chancellor of the Exchequer (the Cabinet position which pushed Asquith to side with

78
Furthermore, most Radicals eventually accepted Foreign Secretary Edward Grey’s policy toward

the European continent, which was based on strict realpolitik principles, because they could offer

no convincing alternative.155

Hence, except for a few pacifists, the majority of the Cabinet did not advocate for the

peace-creating effects of trade. As Edward Grey pointed out, embracing the pacifist view (the

one most clearly endorsed by Norman Angell, himself a Labour Party Member of Parliament)

was premature when one considered the nature of international politics on the European

continent.156

Conclusion

Britain’s decision to maintain extant free trade policy toward Germany can be best understood as

a choice to maximize its own relative power position. Since Britain’s leading industries

depended heavily on German economic inputs to increase their efficiency and competitiveness,

and Germany could find alternative trading partners, diminishing trade with Germany would

have inflicted greater harm on Britain’s relative power. Thus, both a number of influential

Unionist leaders and the Liberal Party that was in power beginning in 1906 promoted the

maintenance of extant free trade policy as the best choice for Britain. This argument is further

strengthened by the absence of persuasive competing explanations.

the Radicals in military expenditure), wrote to Prime Minister Campbell-Bannerman that the Navy was building its
claims for a larger navy based on vague assumptions, while other powers’ program and capability were not clear.
See “Asquith to Campbell-Bannerman,” October 30, 1906, Campbell-Bannerman Papers, Vol. 5 (Add MS 41210)
pp. 273-279. By the spring of 1909, nonetheless, most Liberals, including the Radicals, agreed that Britain needed to
build more warships to counter Germany. Feuchtwanger, Democracy and Empire, pp. 351-2.
155
Steiner, Britain and the Origins of the First World War, pp. 144-154.
156
Edward Grey, “A Sense of the Waste of War,” Manchester, February 3, 1914, in Duncan Brack and Tony Little
eds., Great Liberal Speeches (London: Politico’s Publishing, 2001), p. 282.

79
 CHAPTER 4

U.S. ECONOMIC RESPONSE TO THE JAPANESE

CHALLENGE, 1939-1941

By 1939, the expansion of the Japanese Empire, which began with China in the early 1930s,

reached Southeast Asia. Japan was propagating the creation of “the New Order” in Asia (often

called the Greater East Asia Co-Prosperity Sphere), a political-economic entity dominated by

Tokyo’s military and economic preeminence that excluded foreign influence in the East Asian

region.1 This vision of a new regional order went beyond mere political propaganda: although

weaker than the European great powers, Japan achieved by the late 1930s the only significant

concentration of power in Asia. As Britain and France encountered Nazi Germany’s aggression

in Europe, their military presence in the Asian sphere of influence diminished dramatically. The

Soviet Union was also focused on the developments and opportunities on its European front,

paying only scant attention to the Far East. Under these conditions, as Secretary of State Cordell

Hull noted, Japan was embarking on a project to become a hegemon in Asia.2

The U.S. soon discovered that it was the only power that could meet the Japanese

challenge. Undoubtedly, U.S. strategic interests lay in Europe, and the eyes of the Roosevelt

administration, both houses of the Congress, and the American media were largely fixed on the

1
Kenneth Colegrove, “The New Order in East Asia,” The Far Eastern Quarterly, Vol. 1, No. 1 (November 1941),
pp. 5-24; Joyce Lebra-Chapman, ed., Japan's Greater East Asia Co-prosperity Sphere in World War II: Selected
Readings and Documents (New York: Oxford University Press, 1975); Harold Sprout, “Changing Power Relations
in the Pacific,” The Annals of the American Academy of Political and Social Science, No. 215 (May 1941), pp. 107-
114. For the British and other countries’ concern about the formation of a Japan-led political order, see “The
Ambassador in Japan (Grew) to the Secretary of State, January 7, 1939, Foreign Relations of the United States
(FRUS hereafter), 1939, Vol. 3, p. 478.
2
“The Secretary of State to the Ambassador in Japan (Grew),” October 18, 1939, FRUS, 1939, Vol. 3, p. 587.

80
deteriorating security environment in Western Europe. This, however, did not mean that

Washington would acquiesce to Japan’s southward advance, or to its control of resource-rich

Southeast Asia and the region’s sea lines of communication. Preventing an East Asia dominated

by one country clearly became an important interest of the U.S., a maritime power with

important stakes in the Pacific.3 Moreover, the U.S. was physically present in the West Pacific,

still wielding sovereignty over the Philippines and other territories in the region. As Chief of

Staff General George Marshall told his staff, “it was the policy of the United States to defend the

Philippines.”4 Thus, as the war in Europe was creating a power vacuum in Asia, it became

obvious that the U.S. had to play a leadership role in filling that void.5

In response to Japan’s bid for regional hegemony, the U.S. adopted military

countermeasures.6 On April 15, 1939, Roosevelt transferred the United States Fleet from the

Atlantic to the Pacific.7 In May 1940, the U.S. Fleet was ordered to stay at Pearl Harbor instead

of its regular base in southern California.8 The majority of the U.S. naval forces remained there

until 1941, even after the need to strengthen the Atlantic fleet rose.9 At the same time, the

3
Russell F. Weigley, “The Role of the War Department and the Army.” in Dorothy Borg and Shumpei Okamoto eds.,
Pearl Harbor as History: Japanese-American Relations 1931-1941 (New York: Columbia University Press, 1973),
p. 202
4
Quoted in Ibid, p. 182.
5
Herbert Feis, The Road to Pearl Harbor: The Coming of War between the United States and Japan (Princeton,
N.J.: Princeton University Press, 1950), p. 59; Jonathan G. Utley, Going to War with Japan 1937-1941 (Knoxville,
T.N.: The University of Tennessee Press, 1985), pp. 62, 83.
6
Moreover, the U.S. military had long possessed war plans to defeat Japan and siege its homeland, known as “Plan
Orange.” This plan was first written before World War I, but continued to evolve throughout the 1930s until the
outbreak of the Pacific War. See James H. Herzog, Closing the Open Door: American-Japanese Diplomatic
Negotiations, 1936-1941 (Annapolis, M.D.: Naval Institute Press, 1973); Edward S. Miller, War Plan Orange: The
U.S. Strategy to Defeat Japan, 1897-1945 (Annapolis, M.D.: Naval Institute Press, 1991).
7
Utley, Going to War with Japan, pp. 57-8.
8
Scott D. Sagan, “From Deterrence to Coercion to War: The Road to Pearl Harbor,” in Alexander L. George and
William E. Simons eds., The Limits of Coercive Diplomacy, 2nd edition (Boulder, C.O.: Westview Press, 1994), pp.
59, 63.
9
Despite the opinion of Chief of Naval Operations Harold Stark who wanted to send nearly a quarter of the Pacific
Fleet to the Atlantic, Roosevelt decided to transfer only one carrier and one destroyer squadron, based on the advice
of Cordell Hull who told the President that it was not a good time to weaken the forces in the Pacific. Michael A.
Barnhart, Japan Prepares for Total War: The Search for Economic Security, 1919-1941 (Ithaca, N.Y.: Cornell
University Press, 1987), p. 221.

81
Philippines defense was reinforced: five submarines were sent to Manila in November 1940, and

by July 1941, General Douglas MacArthur was recalled to serve as the commander of American

armed forces in the islands, the War Department announced that the Philippine Commonwealth

armed forces were called into the service of the U.S., and new long-range bombers were

deployed in the Philippines.10 Moreover, after the fall of France, the funds to build a two-ocean

navy were finally secured.11 When this buildup was complete, the U.S. would obtain clear naval

superiority in the Pacific, and join the remnants of the British and the Dutch forces in Asia to

fend off Japan.

At the same time, the U.S. adopted restrictive economic measures against Japan. The

crux of the U.S. strategy toward Japan was standing on the defensive in the Pacific and deterring

Japan’s aggression until the war in Europe was settled. In the meantime, Washington intended to

weaken Japan economically so that it could deal with Tokyo more easily once the European

question was solved. Imposing restrictions on bilateral trade played an important role in

achieving this strategic goal. During the years leading up to the Pacific War, the U.S. was able to

adopt diverse forms of restrictions on commerce with Japan and eventually sever bilateral trade

entirely. The low dependence American industries on Japanese economic inputs and the absence

of alternative trading partners for Tokyo meant that those restrictions inflicted almost a unilateral

loss on the adversary.

10
Weigley, “The Role of the War Department and the Army.” pp. 180-184. Also see Scott D. Sagan, “The Origins of
the Pacific War,” The Journal of Interdisciplinary History, Vol. 18, No. 4 (Spring 1988), pp. 893-922.
11
Stephen E. Pelz, Race to Pearl Harbor: The Failure of the Second London Naval Conference and the Onset of
World War II (Cambridge, M.A.: Harvard University Press, 1974), p. 217

82
Leading Industries’ Low Dependence on Japanese Economic Inputs

In the 1930s, bilateral trade between the U.S. and Japan was highly complementary.12 Japan’s

major exports to the U.S. were comprised of raw silk and textiles, which together accounted for

about 75 percent of all Japanese sales in the U.S. market. The other 25 percent consisted of

agricultural and natural specialties, fishery products, hat materials, used parts, housewares,

ceramics, celluloid products, sun goggles, and toys.13 In exchange, the U.S. sold Japan metal

goods, raw cotton, oil and oil products, and machinery.14

Among the economic inputs the U.S. obtained from Japan, the most important was raw

silk. Since the beginning of its industrialization in the late nineteenth century, the Japanese

government nurtured the country’s sericulture industry, such that Japan became the world’s

leading provider of raw silk.15 On average between 1937 and 1941, raw silk comprised 62

percent of all Japanese exports to the U.S. in value terms.16 Japanese raw silk was processed in

U.S. mills to manufacture silk textiles, and American clothing and hosiery industries in turn

produced a variety of silken cloths, accessories, and stockings. These silk textiles and final silk

12
William Lockwood, “American-Japanese Trade: Its Structure and Significance.” The Annals of the American
Academy of Political and Social Science, No. 215 (May 1941), p. 88. One scholar goes far enough to claim that the
U.S.-Japanese trade was “almost entirely complementary and nearly a paradigm of classical economics.” See James
R. Herzberg, A Broken Bond: American Economic Policies toward Japan, 1931-1941 (New York: Garland
Publishing, 1988), p. v.
13
U.S. Department of Commerce, Foreign Commerce and Navigation of the United States, calendar years 1938-
1942 (Washington, D.C.: Government Printing Office, 1938, 1940, 1942). Also see Edward S. Miller, Bankrupting
the Enemy: The U.S. Financial Siege of Japan before Pearl Harbor (Annapolis, M.D.: Naval Institute Press, 2007),
pp. 33-47
14
Japan was the U.S.’ third largest export market, only next to Britain and Canada. See Mira Wilkins, “The Role of
U.S. Business,” in Dorothy Borg and Shumpei Okamoto eds., Pearl Harbor as History: Japanese-American
Relations 1931-1941 (New York: Columbia University Press, 1973), p. 372
15
Lockwood, “American-Japanese Trade,” pp. 86-7; Miller, Bankrupting the Enemy, pp. 18-20.
16
In 1937, Japan’s raw silk export to the U.S. was 99,572,976 dollars (out of 195,086,088 dollars of total exports to
the U.S.), in 1938 83,651,240 dollars (out of 131,633,050 dollars), in 1939 106,951,079 dollars (out of 161,095,302
dollars), in 1940 105,311,440 dollars (out of 156,932,929 dollars), and in 1941 51,807,250 dollars (out of
82,476,927 dollars). U.S. Department of Commerce, Foreign Commerce and Navigation of the United States.

83
products were sold not only in U.S. but also in other foreign markets. Throughout the decades

prior to World War II, growing demand for stylish silken cloths and hosiery helped a number of

U.S. firms to prosper, while creating a considerable number of jobs for American workers.17 In

short, Japanese raw silk was a crucial material for the U.S. silk textile industry and related

clothing industries, as well as for a significant number of retail businesses.

However, this did not mean that the economic inputs from Japan, including silk, had a

deep impact on the overall performance of the U.S. economy. By 1938, the largest portion of the

U.S. national income came from manufacturing (12,208 million dollars), followed by trade

(8,019 million dollars), services (6,995 million dollars), agriculture (6,140 million dollars),

transportation and communication (5,381 million dollars), mining and quarrying (1,429 million

dollars), construction (1,359 million dollars), finance (1,341 million dollars), and electric light

and power and gas (1,267 million dollars).18 Although raw silk from Japan was important for

certain U.S. companies, it could have affected only a small portion of the textile industry and

retail business as a whole. It was also evident that, for a highly industrialized country such as the

U.S., the textile industry was not the leading sector that drove national economic growth in the

first place.

Moreover, most other imports from Japan were consumer goods that were

inconsequential to the activities of the leading U.S. industries. American individuals and

families, too, could simply sustain their living standards without the Japanese goods. In fact, for

many people, silk was a luxury good which remained inaccessible in any case. Silk was also

being challenged by rayon and nylon, which emerged as alternative materials for hosiery. 19 One

17
Miller, Bankrupting the Enemy, pp. 21-30.
18
Bureau of the Census, Historical Statistics of the United States, 1789-1945 (Washington, D.C.: Government
Printing Office, 1949), p. 14.
19
Lockwood, “American-Japanese Trade,” pp. 89-90; Miller, Bankrupting the Enemy, pp. 149-150.

84
item that was not captured in the statistics on merchandise trade was Japanese gold purchased by

the U.S., but this gold did not have any serious impact on the performance of the industry or on

the living standards of consumers.20 Thus, as a Navy Department report suggested, “Doubtless

industry could manage without silk, although the lack of it would cause a considerable

dislocation of labor now employed in the industry…Stopping other imports from Japan would

not cause any great hardship in the United States, although the general effect on industry would

be adverse.”21

Before World War II, although the U.S. obtained a large quantity of important economic

inputs from East Asia, including rubber, tin, chrome, manganese, nickel, and tungsten, none of

these came from Japan.22 The items Japan exported to the U.S. could, in contrast, have only a

minimal effect on the overall performance of the U.S. economy. Accordingly, as the Export

Control Administration reported to the Roosevelt administration in the spring of 1941, the U.S.

could effectively ban imports from Japan without worrying about the adverse economic

consequences.23

Absence of Alternative Trading Partners for Japan

In the 1930s, the Japanese economy depended heavily on a number of economic inputs from the

U.S., and Japan could not find alternative foreign suppliers. War in Europe made other

20
Between 1937 and 1940, the U.S. purchased about 693,000,000 dollar worth of gold from Japan. See Lockwood,
“American-Japanese Trade,” p. 90.
21
“The Director of the War Plans Division of the Navy Department (Turner) to the Chief of Naval Operations
(Stark),” July 19, 1941, FRUS, 1941, Vol. 4, p. 840.
22
By 1939, U.S. imports from East Asia were larger than imports from any other part of the world. British Malaya,
the Netherlands East Indies, and the Philippines shipped more than half a billion dollars’ worth of goods to the U.S.
in 1940, accounting about a fifth of all U.S. imports. See Jonathan Marshall, To Have and Have Not: Southeast
Asian Raw Materials and the Origins of the Pacific War (Berkeley, C.A.: University of California Press, 1995), pp.
x, 7-14.
23
Miller, Bankrupting the Enemy, p. 148.

85
industrialized powers and resource rich areas of the world incapable of replacing the U.S. sales

to Japan. The U.S. was also in a position to organize joint economic restrictions against Japan

and to pressure others to eschew overtaking its current sales to Japan. Further, Japan was unable

to divert its exports that had been going to the U.S.

Economic Inputs from the U.S.

Table 4-1. Major U.S. Exports to Japan (in thousand dollars)

1939 1940 1941

Total U.S. exports 232,183 227,199 59,900
Ferrous Metals
Iron and steel scrap 32,526 16,971 -
Steel ingots, blooms,
billets, slabs, sheet bars, 5,639 6,578 129
tin-plate bars
Iron and steel bars and
4.414 10,065 31
Rods
Petroleum products
Crude oil 20,923 15,875 6,939
Gasoline 7,366 16,230 6,648
Lubricating oil 5,182 10,991 9,423
Raw cotton 42,498 29,608 6,566
Machinery and Vehicles 35,504 30,261 2,574
Copper 27,566 24,621 5,072
Other metals (aluminum,
brass and bronze, lead, 9,059 6,378 1,727
molybdenum, nickel, zinc)
Wood pulp 1,948 7,133 1,689
Fertilizer materials 2,207 2,450 954
Source: Department of Commerce, Foreign Commerce and Navigation of the United States, 1940, 1942
(Washington D.C.: Government Printing Office, 1940, 1942).

Japan was a resource poor country that needed to import large quantities and a wide variety of

foreign goods for its economic growth. For Japan, the U.S. was the key provider of important

economic inputs that were needed to run its factories and produce industrial goods. Between

1932 and 1939, Japan ranked as the third largest export market for the U.S., and half of all U.S.

exports to Asia were destined to Japan.24 A few categories of goods dominated U.S. exports to

24
Wilkins, “The Role of U.S. Business,” p. 372.

86
Japan: as Table 4-1 shows, until the outbreak of the Pacific War, Japan’s purchases from the U.S.

consisted primarily of cotton, ferrous and non-ferrous metals, machinery, petroleum products,

and wood pulp.

Many of the goods Japan obtained from the U.S. were bottleneck items for an

industrialized economy; their absence thus had large repercussions on the performance of the

Japanese economy. As its industrialization continued, Japan faced a growing demand for iron

and steel. Japan’s steel production, nonetheless, was dependent on imported scraps, since it

relied on the scrap-centered steel production method which allowed it to produce a large quantity

of high quality steel at a lower cost.25 Still, as a recent industrializer, Japan did not possess a

large enough stock of scraps to produce steel itself, and the U.S. was a major source of scraps for

the world. A similar situation emerged with regard to copper, magnesium, molybdenum, and

vanadium.26 Japan not only did not possess sufficient raw materials to produce these metals, but

also did not have enough scraps within the country to satisfy industrial demands. Moreover,

Japan was heavily dependent on U.S. machine tools and machinery, products that were vital to

maintain key industries. By 1938, the U.S. was supplying over 60 percent of Japan’s machinery

and machine tools demands, with Germany running a distant second.27

For Japan’s textile industry, American raw cotton was a crucial raw material. As in many

newly industrialized countries, the expansion of Japan’s manufacturing was led by the textile

industry. In the 1930s, Japan’s cotton textile industry expanded to become the world’s second

largest, behind only the U.S., and sold about half of its products in foreign markets. Japanese

25
Barnhart, Japan Prepares for Total War, p. 144
26
Ibid; Miller, Bankrupting the Enemy, pp. 81-2, 90.
27
Barnhart, Japan Prepares for Total War, p. 144

87
mills purchased American long-staple raw cotton to produce higher quality cotton textiles or to

blend the long-staple cotton with cheaper short-staple cotton from India.28

Finally, Japan relied heavily on the U.S. for its oil and oil products, obtaining from the

U.S. about 80 percent of its fuel needs. For special oil products such gasoline, that figure rose as

high as 90 percent. This dependence remained consistent largely because Japan lacked the

technology, personnel, and know-how to refine high-grade gasoline from crude oil. Furthermore,

unlike Germany, Japan did not possess the technology or resources to produce synthetic oil.29

Indeed, Japan faced an overall shortage of trained technicians and cutting-edge technologies that

could have helped it achieve technological innovation and become less dependent on foreign

economic inputs.30

Absence of Alternative Foreign Suppliers for Japan

Despite some earlier assessments which suggested that Japan might be able to divert imports

from the U.S., by the autumn of 1939, it became evident that Washington could effectively deny

Japan alternative trading partners.31 Since war started in Europe in September of that year, only

the U.S. had significant surplus metals, machine tools, and crude and refined petroleum that

could be sold to a foreign country.32 Britain, France, and the Netherlands, the three European

states that controlled most of resource-rich Southeast Asia and could replace the U.S. in Japan’s

import trade, were saving resources for their war efforts and were willing to take parallel actions

28
Lockwood, “American-Japanese Trade,” pp. 87-8; Miller, Bankrupting the Enemy, p. 33.
29
Barnhart, Japan Prepares for Total War, p. 146.
30
Kurt Bloch, “Japanese War Economy,” The Annals of the American Academy of Political and Social Science, No.
214 (May 1941), p. 17. Also, see E. E. Penrose, “Japan’s Basic Economic Situation,” The Annals of the American
Academy of Political and Social Science, No. 215 (May 1941), pp. 2-3.
31
For earlier assessments that Japan could find alternative trading partners, see “Memorandum by Mr. Roy Veatch,
of the Office of the Adviser on International Economic Affairs,” March 21, 1939, FRUS, 1939, Vol. 3, pp. 521-3;
Herzberg, A Broken Bond, p. 69.
32
Miller, Bankrupting the Enemy, p. 32.

88
with the U.S. over trade with Japan. Resource-rich Latin American countries were expected to

follow the lead of the U.S. under the threat of political pressure. Meanwhile, Germany and the

Soviet Union were reluctant or unable to expand trade with Japan. Moreover, Japan did not have

alternative markets to which it could divert its exports to the U.S.

BRITAIN

Japan could not divert its importation of metals, cotton, and oil from the U.S. to Britain or the

British Commonwealth around the world. As World War II broke out, Britain erected controls

around the “fortified sterling area” in order to secure its resources for war, while at the same time

closely coordinating its export restrictions with the U.S.33 London also imposed controls on the

export of raw materials from India and Malaya and restricted export licenses in those areas.34 In

iron ore trade with Japan, Britain diminished exports from Malaya by about forty percent. By

1941, Britain intended to further restrict the Malayan export of iron ore to Japan if the U.S. was

prepared to do the same in the Philippines; Britain also proposed limiting the export of pig iron

from India.35 Tin and lead exports were controlled as well.36 U.S. controls on exports of nickel to

Japan were to be coordinated with Canada, the world’s leading producer of the metal.37 Cotton

exports from India were to be reduced to whatever level the U.S. decided to diminish its own

exports.38

33
Ibid.
34
“The First Secretary of the British Embassy (Thorold) to Mr. T. K. Finletter, Special Assistant to the Secretary of
State,” August 21, 1941, FRUS, 1941, Vol. 4, p. 862
35
“Memorandum by the Assistant Secretary of State (Acheson) to the Secretary of State,” September 22, 1941,
FRUS, 1941, Vol. 4, p. 883. Britain also controlled export of bauxite, manganese, cotton, foodstuffs, and eire. “The
British Minister (Hall) to the Assistant Secretary of State (Acheson),” September 13, 1941, FRUS, 1941, Vol. 4, pp.
873-875.
36
“The Consul General at Singapore (Patton) to the Secretary of State,” February 27, 1941, FRUS, 1941, Vol. 4, p.
788.
37
Barnhart, Japan Prepares for Total War, p. 179
38
“Memorandum by the Assistant Secretary of State (Acheson) to the Secretary of State,” September 22, 1941,
FRUS, 1941, Vol. 4, p. 884.

89
 In general, Britain was not a reluctant follower of the U.S. plan, but rather a provider of

new ideas that would more effectively limit Japan’s access to important economic inputs.39 As

early as January 1939, the British ambassador in Japan was leading studies on the effects of

economic sanctions against Japan and sharing his findings with the U.S. mission in Tokyo. The

British government officially proposed, furthermore, that it would work closely with the U.S.

and share its historical experiences if Washington decided to adopt economic restrictions.40 In

November 1940, the British Cabinet’s Interdepartmental Committee on Far Eastern Affairs

suggested controlling the movement of the world’s tanker fleet as a new tactic to affect Japan’s

oil stockpile. Since Japan did not have the capacity to transport large quantities of oil across

oceans, this measure was expected to be particularly effective and easy to adopt.41 Indeed, Japan

could not find enough tankers to carry home even the limited quantities of oil that it secured in

Southeast Asia.42

Britain also cooperated with the U.S. in limiting oil export from the Persian Gulf to

Japan. It controlled about half of all oil fields in that region, and showed full willingness to

support the U.S.43 As one U.S. official observed, “Lord Halifax [British Foreign Secretary] had

39
This, however, does not mean that Britain was always in harmony with the U.S. Britain often considered making
new commercial arrangements with Japan. In such cases, the Roosevelt administration warned that it was against the
interest of the U.S. For instance, once Britain considered making some concession to Japan in order to prevent
Tokyo selling raw materials to Germany through the Trans-Siberian Railways, the U.S. made it clear that “this
Government would therefore naturally view with concern action by any other Government which would serve to tie
the hands of that Government vis-à-vis Japan, or to assure the Japanese Government alternative supplies should
supplies be cut off from the United States...the Government of the United States could not look with equanimity
upon the conclusion of any arrangement between Great Britain and Japan which would operate arbitrarily to divert
Japan’s purchases from the markets of the United States to the markets of the British Commonwealth.” See “The
Department of State to British Embassy,” May 21, 1940, FRUS, 1940, Vol. 4, p. 571.
40
“The British Embassy to the Department of State,” January 25, 1939, FRUS, 1939, Vol. 3, pp. 490-493. Also see
“The Ambassador in Japan (Grew) to the Secretary of State,” January 30, 1939, FRUS, 1939, Vol. 3, p. 495.
41
Irvine H. Anderson, Jr., “The 1941 De Facto Embargo on Oil to Japan: A Bureaucratic Reflex,” Pacific Historical
Review, Vol. 44, No. 2 (May, 1975), p. 213.
42
Irvine H. Anderson, Jr., The Standard-Vacuum Oil Company and United States East Asian Policy, 1933-1941
(Princeton, N.J.: Princeton University Press, 1975), pp. 155-6.
43
“Memorandum of Conversation, by the Secretary of State,” March 3, 1941, FRUS, 1941, Vol. 4, pp. 788-791.

90
said to the Secretary that the British Government was prepared to regulate exports of Persian oil

and to take the risk of trouble with the Shah of Persia—which they were sure that they would

have—in order to get adoption by the United States and Great Britain of a common policy in

action which would make the said common policy effective.”44 Thus, from 1938 to 1940, oil

export from the Persian Gulf area to Japan was “small in absolute amount and almost negligible

in comparative amount.”45

THE NETHERLANDS AND FRANCE

The Netherlands Indies was the most likely destination from which Japan might search for oil if

the U.S. imposed restrictions on its own exports. The Dutch authorities and oil companies in this

region, however, were deeply concerned about Japan’s southward advance for raw materials and

were very reluctant to increase their petroleum sales to Japan. Japan’s efforts to assure them of

its benign intentions in Southeast Asia continuously failed. As one Japanese diplomat said to a

U.S. official, “the Dutch are not friendly to us.”46

Hence, Japan could not easily replace its oil imports from the U.S. with oil from the

Netherlands Indies. For instance, in Batavia on October 8, 1940, Japan asked for 1,100,000 long

tons of aviation grade crude oil, 1,150,000 long tons of other crude oils, 400,000 long tons of

aviation gasoline over 87 octane, and 500,000 long tons of other products. To these requests, the

major oil producers—Standard Vacuum and Royal Dutch Shell—offered only 120,000 long tons

of aviation grade crude oil, 640,000 long tons of other crude oil, 33,000 long tons of aviation

gasoline over 87 octane, and 312,500 long tons of other products.47 Moreover, the Netherlands

44
“Memorandum by the Adviser on Political Relations (Hornbeck),” March 21, 1941, FRUS, 1941, Vol. 4, p. 799.
45
Ibid, p. 798.
46
“Memorandum by the Consul General at Batavia (Dickover) of a Conversation with the Japanese Consul General
(Saito),” February 2, 1940, FRUS, 1940, Vol. 4, p. 2
47
One long ton is equivalent to 2,240 lbs. See Anderson, The Standard-Vacuum Oil Company and United States

91
East Indies were not a perfect substitute for Japan because they did not produce “the amount

which the Japanese need and which they are trying to get from this country [U.S.].”48

Meanwhile, the French authorities were willing to participate in restrictive economic

measures against Japan. In fact, by early 1939 France had already “cut off all deliveries of iron

from French Indo-China to Japan,” and was requesting Britain to do the same in the Malaya.49

France was also willing to coordinate its policy toward Tokyo with Britain and the U.S. in an

effort to counter Japan’s aggression and to prepare for war in Europe.50 Even after the fall of

France and the rise of the Vichy regime, French Indo-China’s showed a clear reluctance to sell

large quantities of raw materials to Japan.51

LATIN AMERICA

Japan could potentially obtain oil, cotton, and some classes of metal from the Latin American

countries. However, the U.S. was able to actively coordinate restrictions against Japan with the

governments in the Western Hemisphere. Washington could also exercise political pressure

toward the South American governments if they were to resist U.S. export controls. For instance,

it was suggested that “Refusal to sell to Japan might be made a part of Pan-American

cooperation, and a condition favorable for securing United States loans.”52 This pressure could

be applied to the Brazilian cotton and Peruvian tungsten and vanadium that Japan was interested

East Asian Policy, p. 154; Barnhart, Japan Prepares for Total War, pp. 166, 207; “Memorandum by the Advisor on
Political Relations (Hornbeck),” January 11, 1941, FRUS, 1941, Vol. 4, p. 778.
48
“Memorandum by the Advisor on Political Relations (Hornbeck),” July 19, 1940, FRUS, 1940, Vol. 4, p. 587.
49
“Memorandum of Conversation, by the Chief of the Division of European Affairs (Moffat),” April 19, 1939,
FRUS, 1939, Vol. 3, pp. 529-530.
50
“Memorandum of Conversation, by the Chief of the Division of Far Eastern Affairs (Hamilton),” June 5, 1939,
FRUS, 1939, Vol. 3, pp. 538-540. Also see Cordell Hull, The Memoirs of Cordell Hull (New York: The Macmillan
Company, 1948), pp. 717-730.
51
Anderson, “The 1941 De Facto Embargo on Oil to Japan,” pp. 218-9.
52
“Memorandum by the Adviser on Political Relations (Hornbeck) to the Under Secretary of State (Welles), January
16, 1941, FRUS, 1941, Vol. 4, pp. 781-2. Also see Hull, The Memoirs of Cordell Hull, pp. 688-700, 813-830.

92
in purchasing.53 Also, although surplus oil was available in Latin America, the U.S. could restrict

the movement of tankers and pressure the companies that were operating oilfields, thereby

denying Japan’s access to those oil sources.

THE AXIS POWERS AND THE SOVIET UNION

For Japan, Germany and Italy could have become alternative sources to obtain machinery,

machine tools, and automobiles and parts.54 This substitution was unlikely to be successful,

however, first as a result of Japan’s overall political relations with Germany and Italy and later

because of the two countries’ stockpiling of machinery and machine tools for their own war

efforts. Until the signing of a formal alliance treaty between Germany, Italy, and Japan on

September 27, 1940, Japan’s relations with Germany was not particularly friendly. To the

contrary, Japan was often at odds with Germany, especially after the signing of the German-

Soviet Pact in August 1939. This agreement dismayed Japan because the Soviet Union was

providing aid to the Chinese.55 Hence, in early 1940, as Cordell Hull observed in a conversation

with the British Foreign Secretary Lord Halifax, “It seems that he has had information from

trusted sources that the Japanese Government is frankly favorable to the Allied cause in the

present European war and that the Japanese military had never had a more profound shock than

when they received word of Hitler’s agreement with Soviet Russia. They detest the Russians

anyhow and now they have no longer any trust in Germany.”56 Under these circumstances, it was

difficult to expect that Germany and Italy would readily serve as alternative trading partners for

Japan.

53
Barnhart, Japan Prepares for Total War, p. 179.
54
“Memorandum by Mr. Joseph M. Jones of the Division of Far Eastern Affairs,” April 20, 1939, FRUS, 1939, p.
532.
55
Feis, The Road to Pearl Harbor, pp. 32-37.
56
“The Secretary of State to the Ambassador in Japan (Grew),” January 6, 1940, FRUS, 1940, Vol. 1, pp. 635-6.

93
 Still, even after the treaty with Germany and Italy was signed, followed by the signing of

the Neutrality Pact with the Soviet Union, it was difficult for Japan to expand trade with the Axis

Powers and to replace its imports from the U.S. By September 1940, Washington was informed

that an arrangement was being made to enable the transit of supplies from Germany to Japan via

the Trans-Siberian Railroad.57 If successful, this would have allowed Japan to replace certain

U.S. products with goods from Europe, and safely carry them home over land, thus evading

British control over maritime transports. However, Germany maintained stringent controls on its

exports as war in Europe intensified, without leaving sufficient surplus machinery and machine

tools that could be sold to Japan. Indeed, instead of German sales to Japan, the possiblity of

Japan supplying Germany with Southeast Asian raw materials through the Soviet Union won

more attention.58 The political agreement with the Soviets also did not have enough spillover

effect on Japan’s commerce with or through the USSR.59 Controversies between Japan and the

Soviet Union over territorial concessions—the Soviet Union demanding the southern part of

Sakhalin as well as some islands—were difficult to resolve.60 Notwithstanding these

developments, Germany’s invasion of the USSR rendered it impossible for Japan to obtain

German goods through the Soviet Union.

57
“The Ambassador in the Soviet Union (Steinhardt) to the Secretary of State,” September 23, 1940, FRUS, 1940,
Vol. 1, p. 649. For the development of the rapprochement between Japan and the Soviet Union, see “The
Ambassador in the Soviet Union (Steinhardt) to the Secretary of State,” November 1, 1940, FRUS, 1940, Vol. 1, p.
670; “The Secretary of State to the Ambassador in Japan,” November 7, 1940, FRUS, 1940, Vol. 1, p. 672.
58
For instance, in early 1941 it was reported that 100 cars per day were moving westward vis the Trans-Siberian.
“The Ambassador in the Soviet Union (Steinhardt) to the Secretary of State,” April 24, 1941, FRUS, 1941, Vol. 4,
pp. 966-7.
59
“The Ambassador in the Soviet Union (Steinhardt) to the Secretary of State,” May 27, 1941, FRUS, 1941, Vol. 4,
p. 972)
60
“The Ambassador in the Soviet Union (Steinhardt) to the Secretary of State,” November 28, 1940,” FRUS, 1940,
Vol. 1, pp. 676-7; “The Ambassador in the Soviet Union (Steinhardt) to the Secretary of State,” December 27, 1940,
FRUS, 1940, Vol. 1, p. 679; “The Ambassador in the Soviet Union (Steinhardt) to the Secretary of State,” May 27,
1941, FRUS, 1941, Vol. 4, p. 972.

94
JAPAN’S INABILLITY TO DIVERT TRADE WITH THE U.S.

In sum, if the U.S. were to restrict exports to Japan, Tokyo could not easily replace those U.S.

products with goods from other countries. Potential alternative sources of raw materials and

industrial products were willing to cooperate with Washington or did not have a sufficient

surplus of products to supply Japan. The largest producers of raw materials in Asia, the British

Empire and the Netherlands East Indies, were ready to take parallel actions with the U.S.61 The

preclusive buying of raw materials by the U.S. further drained those available for Japan.62

Germany and Italy were too far away and did not possess enough surplus goods or the specific

supplies for which the Japanese vied.

Moreover, Japan did not have alternative markets to which it could divert its exports to

the U.S. The war in Europe left the U.S. as the only country that could purchase large quantities

of silk, since all other major states were trying to save resources for their war efforts or were

concentrating on war production. For similar reasons, Japan faced great difficulty in finding

other countries to absorb its export of consumer goods, which comprised a significant portion of

its sales in the U.S.63 Many countries were saving money for war.

Accordingly, as one U.S. official concluded, “It is probable that Japan’s present economy

could not withstand the combined effects of an import and export embargo enforced by Group A

and B [U.S., Britain, France, the Netherlands, and their possessions in the Asia-Pacific region].

The tremendous shock which that economy would sustain from a simultaneous loss of export

61
“Memorandum by the Assistant Secretary of State (Acheson) to the Secretary of State,” September 22, 1941,
FRUS, 1941, Vol. 4, pp. 881-884
62
Robinson Newcomb, “American Economic Action Affecting the Orient,” The Annals of the American Academy of
Political and Social Science, No. 215 (May 1941), p. 133.
63
Miller, Bankrupting the Enemy, p. 155.

95
markets and sources of raw materials would probably necessitate immediate state control and

operation of industry and trade.”64

Outcome: Imposition of Restrictions on Trade with Japan

Its leading industries’ low dependence on economic inputs from Japan and the absence of

alternative trading partners for Tokyo endowed the U.S. with freedom of action in restricting

commerce with Japan.65 In response to Japanese aggression, the U.S. thus adopted restrictive

measures on bilateral trade, as well as strengthening its military presence against Japan.

By restricting commerce with Japan, Washington intended to weaken Japan’s strength so

that it would become less capable of dominating Asia and disturbing supplies of raw materials

from Asia to the U.S.66 Once the danger of Germany dominating Europe was contained, the U.S.

would directly face Japan, aided by the British if possible. In the meantime, as one report to the

State Department suggested, it was expected that “a joint embargo by the United States, British

Empire countries, and the Dutch East Indies would limit the life of Japan’s war efforts to the size

64
“Memorandum by Mr. Joseph M. Jones of the Division of Far Eastern Affairs,” April 20, 1939, FRUS, 1939, p.
532.
65
This does not mean that inter-departmental disagreements did not exist in the U.S. For instance, see Dean
Acheson, Present at the Creation: My Years in the State Department (New York: W. W. Norton and Company,
1969), pp. 9-47.
66
“Mr. John Carter Vincent of the Division of Far Eastern Affairs to the Adviser on Political Relations (Hornbeck),”
January 20, 1939, FRUS, 1939, Vol. 3, pp. 483-4; Marshall, To Have and Have Not, p. 26. Some claims that the U.S.
imposed restrictions on exports to Japan to conserve resources domestically. This view, however, is not convincing.
First, some countries were allowed to buy goods that the U.S. embargoed against Japan, implying that surplus
products did exist in the U.S. Second, conservation was not the primary cause of scrap embargo against Japan. The
retained scrap was not vitally needed for U.S., although increasing demand for scrap certainly existed (see Feis, The
Road to Pearl Harbor, pp. 106-7). Roosevelt himself had publicly proclaimed that there was no shortage of scrap in
the US (see Barnhart, Japan Prepares for Total War, p. 187). Third, the problem of oil shortage was mostly
fictitious. Japan mainly purchased oil from U.S. West Coast where oil was abundant, while the shortage occurred in
East Coast (see Miller, Bankrupting the Enemy, pp. 181-190).

96
of her stock piles.”67 Also, while Japan needed dollars to purchase raw materials from the world,

if the U.S. stopped buying from Japan, Tokyo’s foreign currency reserve would dry out. 68

Table 4-2 summarizes the major U.S. decisions restricting trade with Japan. A prelude to

the upcoming comprehensive economic restrictions was the “Moral Embargo” of 1938, which

informally forbade selling arms, munitions, or instruments of war to Japan and China. After

Japan's bombing of Chinese civilians, the Department of State announced that, “with great regret

issue any licenses authorizing exportation, direct or indirect, of any aircraft, aircraft armament,

aircraft engines, aircraft parts, aircraft accessories, aerial bombs or torpedoes to countries the

armed forces of which are making use of airplanes for attack upon civilian populations.”69 Also,

the State Department requested major oil and engineering companies to stop selling or delivery

of “plans, plants, manufacturing rights or technical information, or of related patents, processes,

or engineering assistance” to Japan.70 Although these “requests” were informal and asked for

voluntary participation, U.S. businesses responded favorably and followed the instructions from

the State Department. For instance, the United Oil Products Company decided not to fulfill its

contract with the Japan Gasoline Company for the production of high grade fuel.71 Many other

companies took similar actions. Consequently, Japan protested that Washington was

implementing a “discriminatory export embargo.”72

67
“Memorandum by the Adviser on Political Relations (Hornbeck) to the Under Secretary of State (Welles),”
January 16, 1941, FRUS, 1941, Vol. 4, pp. 782
68
The yen was not accepted in most countries from which Japan would purchase raw materials. “Memorandum by
Mr. Joseph M. Jones of the Division of Far Eastern Affairs,” April 20, 1939, FRUS, 1939, p. 531.
69
“The Chief of Arms and Munitions Control, Department of State (Green), to 148 Persons and Companies
Manufacturing Airplane Parts” July 1, 1938, in FRUS: Japan, 1931-1941 (Japan hereafter), Volume 2, pp. 201-2
70
“Memorandum by the Chief of the Division of Controls (Green),” FRUS, 1939, Vol. 3, pp. 549-550.
71
“The Japanese Ambassador (Horinouchi) to the Secretary of State,” January 6, 1940, in Japan, Vol. 2, pp. 206-7.
72
Ibid.

97
 Table 4-2. Major U.S. Economic Actions against Japan73

1938 June 11 “Moral embargo” on export of aircraft, armaments, engine parts, accessories, aerial
bombs, and torpedoes
1939 July 26 Washington announced termination of the 1911 U.S.-Japan Treaty of Commerce
and Navigation, effective January 26, 1940
December 15 Moral embargo expand to include molybdenum and aluminum
December 20 Equipment and information relating to the production of high quality aviation
gasoline added to the embargo list
1940 January 26 U.S.-Japan Treaty of Commerce and Navigation abrogated
July 2 National Defense Act. Congress gave the president authority to subject U.S.
exports to a licensing system
July 26 Restrictions placed on the issuance of export licenses for aviation motor fuel and
lubricating oil, tetraethyl lead, and heavy melting scrap
October 16 All exports of iron and steel scrap to Japan restricted
December 10 Restrictions placed on export of iron and steel products
1941 January 10 Export of copper, brass and bronze, zinc, nickel, potash, and semi-manufactured
products made from these materials put under export license
July 26 President froze Japanese assets in U.S.
August 1 Sharper restrictions on oil and gasoline export to Japan. Silk imports from Japan
ended.

The second major U.S. action regarding trade with Japan was the abrogation, in July

1939, of the Treaty of Commerce and Navigation between the United States and Japan (signed in

1911). Abrogating this treaty had powerful consequences because it removed legal barriers for

more far-reaching actions. As some in the U.S. press observed, the abrogation was “clearing the

decks for action.”74 Following the declaration of abrogation, by December 1939, the State

Department introduced plans for deliberate restrictive measures against Japan, including (i) a

continuation of the policy of discouraging extension of credits to Japan, (ii) a continuation of the

existing moral embargo, (iii) a denial of trade agreement rates to Japan (under the Trade

Agreement Act, the president could discriminate against countries whose acts or policies are

viewed as obstructing the expansion of U.S. commerce), and (iv) the imposition of additional

duties on imports from Japan.75

73
Added based on Wilkins, “The Role of U.S. Business,” p. 372.
74
Utley, Going to War with Japan, p. 63.
75
“Memorandum prepared in the Department of State,” December 29, 1939, FRUS, 1939, Vol. 3, p. 551-2

98
 While these two measures did not induce a precipitous decrease in bilateral trade,

Roosevelt’s proclamation on July 2, 1940 marked the beginning of comprehensive restrictions on

trade with Japan.76 The fall of France gave the Roosevelt administration strong incentives to

more actively respond to the rapidly changing global security environment. The U.S. was now

willing to utilize its position as the major supplier of Japan’s industries.77 Thus, as the National

Defense Act gave the president authority to subject U.S. exports to a licensing system, Roosevelt

set up a powerful scheme to control many goods that were being sold to Japan. Within a year,

259 items, including petroleum products, tetraethyl lead, iron and steel scrap, machinery and

machine tools, and non-ferrous metals (copper, brass and bronze, zinc, nickel, potash, and

articles using them), were put under license.78 The export of most of these goods was limited to

friendly nations. Further, multi-agency task forces were established in early 1941 and produced

evaluations of the impact of embargoing U.S. goods on Japan’s economic performance.79 As

such, the U.S. developed a policy arrangement that could be used to wage economic warfare

against Japan.80 Japan recognized as much, calling these U.S. policy measures a “virtual

embargo” imposed against it.81

76
For the proclamations by the Roosevelt administration and controlled items, see Subcommittee on International
Trade and Commerce of the Committee on International Relations, 94th Congress, 2nd Session, Trading with the
Enemy: Legislative and Executive Documents Concerning Regulation of International Transactions in Time of
Declared National Emergency (Washington, D.C.: GPO, 1976).
77
Pelz, Race to Pearl Harbor, p. 222.
78
For instance, see “Proclamation No. 2413, Signed by President Roosevelt, July 2, 1940,” Japan, Vol. 2, pp. 211-
213; “Proclamation No. 2417, Signed by President Roosevelt, July 26, 1940,” Japan, Vol. 2, pp. 216-7; and
“Regulations Governing the Exportation of Articles and Materials Designated in the President’s Proclamation of
July 2, 1940, Issued Pursuant to the Provision of Section 6 of the Act of Congress Approved July 2, 1940,” Japan,
Vol. 2, pp. 213-5; “Proclamation No. 2423, Signed by President Roosevelt, September 12, 1940, Japan, Vol. 2, pp.
220-1; “Proclamation No. 2451, Signed by President Roosevelt, December 20, 1940, Japan, Vol. 2, p. 236.
79
Miller, Bankrupting the Enemy, pp. 118-120.
80
Utley, Going to War with Japan, p. 95.
81
“The Japanese Embassy to the Department of State,” August 3, 1940, Japan, Vol. 2, pp. 219-220.

99
 By July 1941, the export control system was firmly in effect, resulting in a sharp decrease

in U.S. trade with Japan.82 Applications for the export of wood pulp, metals and manufactures,

machinery and vehicles, rubber and manufactures, and chemicals and related products (except

certain pharmaceuticals) were denied. Although raw cotton was not included on the control list,

its monthly export to Japan diminished to about $600,000 during the first six months of 1941,

from the $4,000,000 monthly average of 1938.83

In petroleum products, although significant amounts of oil continued to be sold to Japan,

the U.S. government issued directives and revoked a number of specific and general licenses in

order to limit its export to Japan. On April 8, 1941, the Division of Control withheld processing

export licenses for crude oil, lubricating oil, and gasoline.84 The State Department also

recommended placing containers for petroleum products, in particular steel drums, under license,

so that Japan would be unable to carry home U.S.-produced oil.85 A Petroleum Coordinator for

National Defense was designated to facilitate inter-departmental cooperation on oil exports to

Japan.86 Thus, total Japanese procurement of American petroleum and petroleum products

declined, from 33.2 million barrels in 1938, to 29.9 million barrels in 1939, to 24.9 million

barrels in 1940, and to 12.6 million barrels in the first seven months of 1941. Japan’s total

stockpile of oil also declined from 51.4 million barrels in April 1939 to 49.6 million barrels in

April 1940 and to 48.9 million barrels in April 1941.87 By August 1941, all licenses for the

82
“The Director of the War Plans Division of the Navy Department (Turner) to the Chief of Naval Operations
(Stark),” July 19, 1941, FRUS, 1941, Vol. 4, pp. 836-840.
83
The Under Secretary of State (Welles) to President Roosevelt,” July 31, 1941, FRUS, 1941, Vol. 4, pp. 846-848.
84
“Memorandum by the Assistant Chief of the Division of Controls (Price) to the Administrator of Export Control
(Maxwell),” June 21, 1941, FRUS, 1941, Vol. 4, p. 822.
85
“The Chief of the Division of Controls (Green) to the Administrator of Export Control (Maxwell),” January 1941,
FRUS, 1941, Vol. 4, pp. 783-4.
86
“Vice President Wallace to the Secretary of State,” May 10, 1941, FRUS, 1941, Vol. 4, pp. 815-6; “The Petroleum
Coordinator for National Defense (Ickes) to the Administrator of Export Controls (Maxwell),” June 11, 1941, FRUS,
1941, Vol. 4, p. 818.
87
Anderson, The Standard-Vacuum Oil Company and United States East Asian Policy, pp. 155, 224, 230.

100
export of petroleum products were revoked, except for those governing sales in the Western

Hemisphere, to the British Empire, Egypt, Netherlands Indies, Unoccupied China, and the

Belgian Congo.88 During the summer of 1941, a powerful and comprehensive control agency, the

Economic Defense Board, was established, chaired by Vice President Henry Wallace.89

U.S. restrictions on trade with Japan climaxed with the freezing of Japanese assets in July

1941. By this measure, Japan lost its ability to buy from the U.S., and could no longer sell goods

on the U.S. market.90 By mid-September, 1941, a de facto, full scale embargo against Japan was

in place.

Alternative Explanations

In contrast to my argument, the two alternative theories are not well supported empirically. For

the domestic interest explanation to prove whether its causal mechanism is working, the

commercial groups that benefited from trade with Japan should have tried to protect their interest

in the decision making process of the U.S. government. Although they might have failed to affect

the national decision, those interest groups should have actively protested the adoption of more

stringent measures or at least tried to protect their vested interests. In order for the economic

statecraft explanation to be supported, the U.S. should have adopted restrictive economic

measures against Japan to shape Tokyo’s behavior. In other words, the U.S. should have utilized

negative economic sanctions to coerce Japan to stop its aggression in Asia. The evidence that

lends support to these claims, however, is insufficient.

88
“The Acting Secretary of State to Collectors of Customs,” August 1, 1941, FRUS, 1941, Vol. 4, p. 850
89
Miller, Bankrupting the Enemy, p. 205.
90
Miller, Bankrupting the Enemy, pp. 191-204.

101
Commercial Interests as “Patriots”

Contrary to the expectations of the domestic interest-based explanation, commercial interest

groups were invisible or largely irrelevant in the making of the Roosevelt administration’s

decisions against Japan. First, when the U.S. government considered imposing restrictions on

trade with Japan, business groups that traded with Japan did not actively defend their economic

stakes. Instead, as many historians agree, those who might suffer economic losses actively

supported restrictive U.S. policies rather than being vocal about their interests.91 Of note, when

the relationship with Japan deteriorated in 1939, American businessmen who benefited from

flourishing trade with Japan in the 1930s “not only became champions of preparedness, but they

argued that their leadership was indispensable in preparing America for war.”92

Second, the relationship between the U.S. government and American economic interests

was close to a two-way interaction, rather than reflecting a bottom-up process. In implementing

restrictive policy, State Department officials contacted and dissuaded American firms from doing

more business with Japan. In turn, U.S. business leaders consulted with the government on

whether they should proceed with ongoing contracts with Japan. For instance, when Japan

intended to purchase eleven million dollars’ worth of steel from the United States Steel Company

for construction in Manchukuo, J. P. Morgan and Company on its behalf contacted State

Department officials to inquire about the opinion of the U.S. government.93 Similarly, the Mesta

91
Herzberg, A Broken Bond, pp. 211-2; Peter C. Hoffer, “American Businessmen and the Japan Trade, 1931-1941: A
Case Study of Attitude Formation,” Pacific Historical Review, Vol. 41, No. 2 (May, 1972), pp. 189-205; Marshall,
To Have and Have Not, pp. 58-9; John W. Masland, “Commercial Influence upon American Far Eastern Policy,
1937-1941,” Pacific Historical Review, Vol. 11, No. 3 (Sep., 1942), pp. 281-299; Roland N. Stromberg, “American
Business and the Approach of War 1935-1941,” The Journal of Economic History, Vol. 13, No. 1 (Winter, 1953), pp.
58-78; Wilkins, “The Role of U.S. Business,” pp. 341-376.
92
Hoffer, “American Businessmen and the Japan Trade,” p. 202.
93
“Memorandum of Conversation, by the Adviser on Political Relations (Hornbeck),” January 13, 1939, FRUS,
1939, Vol. 3, pp. 482-3.

102
Machine Company, producing steel works equipment, consulted the State Department as to

whether the U.S. government was imposing or considering embargoes.94

These developments suggest that the business groups were not simply moved by

economic interests alone. Instead, the position of commercial interest groups was in large part

determined by security considerations. In other words, business groups acted as if they were

“patriots,” rather than seekers of profit.

Dubiousness of Economic Statecraft

There is some evidence that lends support to the claim that the U.S. utilized economic

restrictions to affect Japan’s behavior. However, there is also strong evidence that the U.S. did

not deliberately implement economic statecraft to coerce Japan. In short, this alternative

explanation is only partly corroborated by the U.S.-Japan case.

First, contrary to the causal mechanism articulated by the economic statecraft

explanation, the evidence suggests that the U.S. did not tell Japan that economic restrictions were

imposed because of its bad behavior. For a policy to qualify as economic statecraft, the

sanctioning government must convey the target state that economic restrictions are being adopted

to punish certain behavior. It should lucidly state what it wants the target state to do. This was

not the case when the U.S. imposed embargoes on iron and steel scrap, machine tools, and oil,

the three most important items Japan obtained from the U.S. for its industrial performance.

Moreover, throughout 1940, when Japan protested unfair treatment by the U.S., the State

Department answered that the new controls did not aim to punish Japan’s behavior in Asia.95 For

94
“Memorandum of Conversation, by the Assistant Chief of the Division of Far Eastern Affairs (Ballantine),”
January 24, 1939, FRUS, 1939, Vol. 3, pp. 488-9.
95
Feis, The Road to Pearl Harbor, p. 94.

103
instance, when the U.S. imposed controls on all kinds of iron and steel scrap exports in

September 1940, Japan protested by stating “the Japanese government finds it difficult to

concede that this measure was motivated solely by the interest of national defense of the United

States...In view of the fact that Japan has been for some years the principal buyer of American

iron and steel scrap, the announcement of the administrative policy, as well as the regulations

establishing license system in iron and steel scrap cannot fail to be regarded as directed against

Japan, and, as such, to be an unfriendly act.”96 To this, the Department of State responded “It

having been found by the appropriate agencies and authorities of this Government that the

restrictions on exportation to be effected by the regulations under reference are necessary in the

interest of national defense, the Government of the United States perceives no warrantable basis

for a raising of question by any other government, in the circumstances—not of this

Government’s making—which prevail today in international relations, with regard to the

considerations which necessitate the adoption by the Government these measures of

conservation.”97 Secretary of State Cordell Hull also told the Japanese ambassador that “it was

only at the height of our national defense preparations that we were imposing a few embargoes

on important commodities.”98 Similarly, with regard to machine tools, the U.S. government told

the Japanese representatives that restrictions on those items were imposed for national defense.99

When the U.S. imposed comprehensive restrictions on oil, Japan was told that “the additional

restrictions on exports of petroleum products are being put into effect because of the defense

96
“The Japanese Embassy to the Department of State,” October 7, 1940, Japan, pp. 223-4.
97
“The Department of State to the Japanese Embassy,” October 23, 1940, Japan, p. 229.
98
“Memorandum by the Secretary of State,” October 8, 1940, Japan, p. 226.
99
“Memorandum by the Assistant Secretary of State (Berle),” November 30, 1940, Japan, p. 230.

104
needs of the United States.”100 Oil shortage in the East Coast was another explanation that the

U.S. offered to Japan in imposing tighter embargo on oil.

Second, there are reasons to doubt whether the U.S. actually believed that economic

restrictions were useful tools in changing Japan’s behavior. Instead, some evidence suggests that

the embargoes were aimed at weakening Japan rather than coercing it. In January 1939, in the

aftermath of the “moral embargoes” against the Japanese aggression in China, one official

suggested “It is believed that nothing short of defeat in war would, within the foreseeable future,

“get Japan out of China”. But the objective of the measures contemplated is not to “get Japan out

of China”, as desirable an accomplishment as that would be. The objective is to prevent Japan

from consolidating her position in China and drawing sufficient strength therefrom to allow for

further aggressive action in other fields which would seriously menace our interests and probably

lead us to war.”101 Ambassador Grew also confirmed that “anything short of force can lead to

substantial moderation of Japanese policy in China” and that he “therefore cannot

conscientiously recommend to his Government recourse to economic sanctions.”102 In the

summer of 1941, it was viewed that tougher sanctions could weaken Japan and give the U.S. a

military advantage, rather than being effective in changing Japan’s thinking.103

100
“Memorandum by the Chief of the Division of Far Eastern Affairs (Hamilton),” July 22, 1941, FRUS, 1941, Vol.
4, p. 834.
101
“Mr. John Carter Vincent of the Division of Far Eastern Affairs to the Adviser on Political Relations (Hornbeck),”
January 20, 1939, FRUS, 1939, Vol. 3, pp. 483-4
102
“The Ambassador in Japan (Grew) to the Secretary of State,” January 7, 1939, FRUS, 1939, Vol. 3, pp. 478-481.
103
Marshall, To Have and Have Not, p. 128.

105
Conclusion

U.S. restrictions on commerce with Japan were driven by the need to weaken Tokyo’s capacity

to dominate East Asia, while ongoing war in Europe remained Washington’s primary concern.

Once the German question was settled, the U.S. would then deal with Japan’s bid to become a

hegemon in Asia. Leading U.S. industries’ low dependence on economic inputs from Japan and

the absence of alternative trading partners for the challenging state allowed the U.S. to adopt

diverse restrictive measures over trade with Japan, and eventually to sever bilateral trade.

106
 CHAPTER 5

U.S. ECONOMIC RESPONSE TO THE SOVIET

CHALLENGE, 1947-1950

The Soviet Union emerged from World War II as the single significant concentration of power in

the international system aside from the United States. Despite some expectations of a cooperative

post-war relationship, the two powers soon found themselves on a collision course.1 Expansion

of the Soviet sphere of influence in Eastern Europe, communist encroachment in the Middle

East, Greece and Turkey, and the growing assertiveness of the Kremlin provoked a response

from the U.S. to draw a clear line that the USSR should not cross.2 Joseph Stalin also recognized

that the Soviet Union was encountering what he referred to as the “Anglo-American bloc.”3

Accordingly, by 1947, a strategy of containment was being formulated in Washington, although

1
During World War II, significant commercial exchanges emerged between the U.S. and the USSR, mainly based
on the Lend-Lease agreements. By September 1945, the Lend-Lease aid reached 11 billion dollars. The Soviets also
benefited from U.S. credits for trade, and expected that further aid and loans would follow after the war. See
Alexander Baykov, Soviet Foreign Trade (Princeton, N.J.: Princeton University Press, 1946), p. 77; “Memorandum
by the Under Secretary of State for Economic Affairs to the Secretary of State,” December 3, 1946, Foreign
Relations of the United States (FRUS hereafter), 1946, Vol. 6, p. 859; “Memorandum by Mr. Emilio G. Collado,
Deputy on Financial Affairs to the Assistant Secretary of State for Economic Affairs,” February 4, 1946, FRUS,
1946, Vol. 6, pp. 823-825; Philip Hanson, The Rise and fall of the Soviet Economy (London: Longman, 2003), p. 45.
2
U.S. strategic position toward the USSR during the formative stage of the Cold War is clearly summarized in a
NSC-approved telegraph to the U.S. ambassador in Moscow, which contained a message to be delivered to Stalin. In
this communication, Ambassador Walter Bedell Smith was instructed to inform Stalin “1.That any further
encroachment by the Soviet Union, by countries under its control, or by Communist parties dominated by it, beyond
the present limits of Communist power, would be regarded by this country as an act of Soviet aggression. 2. That it
is definitely not true that this Government is aiming in any way, shape or form at an imperialistic expansion of its
own power or at the preparation of military aggression against the Soviet Union or any other country in Eastern
Europe or elsewhere.” See “Lovett to Smith,” April 24, 1948, FRUS, 1948, Vol. 4, p. 835. Also see “The
Ambassador in the Soviet Union to the Secretary of State,” April 5, 1946, FRUS, 1946, Vol. 6, pp. 732-736; “Report
by the National Security Council to President Truman (NSC 5/2),” February 12, 1948, FRUS, 1948, Vol. 4, p. 50;
Melvyn P. Leffler, “The American Conception of National Security and the Beginning of the Cold War, 1945-48,”
The American Historical Review, Vol. 89, No. 2 (April 1984), pp. 346-381; Thomas G. Paterson, On Every Front:
The Making and Unmaking of the Cold War (New York: W. W. Norton, 1992), p. 65.
3
“The Ambassador in the Soviet Union to the Secretary of State,” June 1, 1946, FRUS, 1946, Vol. 6, p. 758.

107
the U.S. was still reluctant to be entangled in Eurasian affairs.4 The Truman Doctrine, the

National Security Act of 1947, and the decision to rebuild U.S. military forces forecasted an all-

out Cold War confrontation.5

Emerging security tensions between the two superpowers soon had repercussions on

bilateral commerce. In the immediate aftermath of World War II, the USSR needed considerable

imports from the U.S. in order to rebuild or further develop its iron and steel, coal, chemicals,

and transport industries and power plant installations.6 The Soviet Union was also obsessed

about “catching up” to the advanced economies’ technological superiority, which required

continued exchanges with the leading U.S. companies and technicians.7 Further, the USSR had

demands for industrial goods that would help to build a strong industrial foundation for the

military.8 As George Kennan observed in 1946, the Soviet leaders “view international trade for

themselves a means of increasing Soviet strategic economic strength and of achieving economic

independence.”9 Although its ultimate goal was to create an autarchic economic bloc, the Soviet

Union needed U.S. economic inputs for a protracted period of time.10

4
For the U.S. containment of the USSR, see John Lewis Gaddis, Strategies of Containment (New York: Oxford
University Press, 2005).
5
In 1947, the Truman administration began to rebuild U.S. military. The Army was to be expanded from its existing
542,000 personnel to 790,000 by June 1948. It was also planned to purchase 1,165 aircrafts. The number of active
navy combat ships was to be increased to reach 280 by June 1947. See Secretary of Defense, September 27, 1947,
Records of the Secretary of Defense, RG 330, National Archives and Records Agency (quoted in Frank Cain,
Economic Statecraft during the Cold War (London: Routledge, 2007), pp. 1-2). Still, during 1947, the U.S. wanted
to be careful about the deployment of its forces on the European Continent and to the Mediterranean because doing
so would require significant mobilization of the country. See “Memorandum by the Joint Chief of Staff to the
Secretary of Defense,” January 8, 1948, FRUS, 1948, Vol. 4, p. 8.
6
Baykov, Soviet Foreign Trade, pp. 80-82. Also see Nikolai Mikhailov, “The Soviet Peacetime Economy,” Foreign
Affairs, Vol. 24, No. 4 (July, 1946), pp. 633-637
7
Hanson, Rise and fall of the Soviet Economy, p. 30.
8
Michael Mastanduno, Economic Containment: CoCom and the Politics of East-West Trade (Ithaca, N.Y.: Cornell
University Press, 1992), p. 72.
9
“The Chargé in the Soviet Union to the Secretary of State,” January 16, 1946, FRUS, 1946, Vol. 1, p. 1274.
10
Legislative Reference Service of the Library of Congress, A Background Study on East-West Trade, 89th
Congress, 1st Session (Washington, D.C.: U.S. Government Printing Office, 1965), p. 4.

108
 Between 1947 and 1950, the U.S. effectively severed all major commercial ties with the

Soviet Union. Its leading industries’ low dependence on economic inputs from the USSR and the

absence of alternative trading partners for the Soviet Union ensured the U.S. that it could impose

relative losses on the USSR by abandoning bilateral trade. Diminishing commercial exchanges

served as the economic equivalent of political containment, and the strategy was expected to help

deny the Soviets’ economic gains and to delay further growth of its military power.11

With regard to the economic relations of the early Cold War, many have focused on the

European Recovery Program (the Marshall Plan). Instead, this chapter explores Washington’s

decisions on trade ties with the Soviet Union, adopted to complement military and other

economic endeavors against the Kremlin. If the Marshall Plan aimed to strengthen Europe’s

position as a counterweight against Soviet expansion, severing trade was expected to weaken the

Soviet Union’s economic basis of military power. While the USSR refused to join the Marshall

Plan, it nonetheless wanted to retain trade ties with the U.S. to facilitate its industrial

development. Abandoning trade ties with the Soviet Union started as a U.S. initiative.

Leading Industries’ Low Dependence on Soviet Economic Inputs

When World War II ended, the U.S. was the only industrialized country that did not suffer

foreign military assaults on its industrial facilities. Moreover, although the U.S. mobilized its

economy for war, the portion of civilian sectors that was converted for military production was

considerably smaller compared with other states. Consequently, between 1947 and 1950, most

U.S. industries were very competitive, and in general remained not highly dependent on foreign

11
Philip J. Funigiello, American-Soviet Trade in the Cold War (Chapel Hill. N.C.: The University of North Carolina
Press, 1988), p. 34; Mastanduno, Economic Containment, p. 71.

109
inputs. The U.S. possessed well developed and prospering manufacturing, wholesale and retail

trade, finance, agriculture, services, forestry and fisheries, and transportation sectors. Each of

these industries was competitive and generated a significant portion of U.S. national wealth. The

American labor force was well dispersed in these industries, reflecting the fact that the U.S. had

a diversified economic structure.12 The U.S. was also a net exporter during this period, and it was

the creditor and supplier of industrial products to the world. Even after the post-war

demobilization started and Europe and Japan recovered, the U.S. economic position in the

international system was not to be challenged easily.

Economic inputs from the Soviet Union and its satellites had some ramifications for the

U.S. economy, but they were not inelastic enough to affect the performance of leading U.S.

industries. Major U.S. imports from the USSR included chrome, fur, manganese, and platinum

group metals.13 Among these, a change in the trade of non-ferrous metals could have had

significant implications for the U.S. economy because they were used for steel production. Since

steel was the sinew of a modern economy, being an essential product for heavy industries,

manufacturing, and construction sectors, disturbances in steel production would have generated

significant spillover effect and might have weakened the strength of the economy as a whole.

The import of fur had only a negligible impact on the U.S. economy, except for the business of

certain firms.14

The U.S., however, could find alternative foreign suppliers of metal that could replace the

USSR. For manganese, India became the primary target for diverting the Soviet imports. Thus,

12
Bureau of the Census, Historical Statistics of the United States: Colonial Times to 1970, Bicentennial Edition
(Washington, D.C.: Government Printing Office, 1975), pp. 239-40.
13
“United States Policy on Trade with the Soviet Union and Eastern Europe,” November 26, 1947, FRUS, 1948,
Vol. 4, p. 490.
14
“Report by the Ad Hoc Subcommittee of the Advisory Committee of the Secretary of Commerce,” May 4, 1948,
FRUS, 1948, Vol. 4, p. 537.

110
by the end of 1947, the U.S. had dispatched experts to investigate and expand manganese mining

and transportation facilities there. The Union of South Africa, Cuba, the Gold Coast, and Mexico

were other sources where the U.S. could purchase diverse non-ferrous metals. Major steel

producers such as United States Steel and Bethlehem Steel also increased investment in Brazil to

replace the import of manganese ore from the Soviet bloc.15 In 1949, the Interdepartmental

Manganese Coordination Committee reported that, during 1949, while shipments from the USSR

had become negligible, the U.S. could obtain 1.4 million tons of manganese against an industrial

requirement of about 1.6 million tons. This shortage was noticeable, but was not considered

disastrous to the U.S. manganese requirement.16 For chrome, the Philippines replaced the Soviet

Union as the largest supplier to the U.S.17

In short, the overall U.S. economic performance was only minimally affected by changes

in imports from the Soviet Union and its sphere of influence. Even in sectors where those inputs

were critical, the supply from the USSR could be replaced through trade with other foreign

states.

Absence of Alternative Trading Partners for the USSR

The majority of trade between the two powers was comprised of the U.S. exporting its goods to

the Soviet Union. Although the Soviet Union’s imports from the U.S. were small in quantity,

reaching only 150 million dollars in 1947, over two-thirds of this trade consisted of the U.S.

selling machinery and vehicles—goods that were important for the USSR’s post-war

15
Thomas G. Paterson, Soviet-American Confrontation: Postwar Reconstruction and the Origins of the Cold War
(Baltimore, M.D.: Johns Hopkins University Press, 1973), p. 69.
16
“Manganese Supply Position Continue to Be Serious,” April 25, 1949, FRUS, 1949, Vol. 5, pp. 105-6.
17
Paterson, Soviet-American Confrontation, p. 73.

111
reconstruction and further industrial development.18 In 1947, U.S. officials recognized that no

alternative trading partner existed for the USSR’s procurement of these goods from abroad.

Since most other industrialized countries were recovering from the war, it was expected that no

country could expand production and replace the U.S. as a supplier of machinery, vehicles, and

other industrial products for the Soviet Union. The U.S., moreover, was able to establish a

coordinated control scheme with the potential alternative suppliers of industrial goods.

Limited Supply of Equivalent Goods in the Post-War Environment

During the first few years after the end of World War II, there was simply no state that could

replace the U.S. as the supplier of important industrial products, if Washington were to stop

exporting its machinery and industrial equipment to the Soviet Union.

First, while they were recovering from the war, other industrialized states did not possess

sufficient surplus products to take up U.S. sales to the Soviet Union. In Britain, France, West

Germany, and Japan, domestic demand for machinery and industrial products was enormous.

Those goods were needed to rehabilitate their own factories and rebuild the infrastructures and

cities, and no state but the U.S. had large amounts of surplus goods for export. For instance, U.S.

officials assessed that the Soviet Union wanted to purchase diesel and electric locomotives,

precision instruments, cranes, machine tools, electric generating equipment, blast furnaces,

machinery for mines, and refineries from the West.19 However, as the Ad Hoc Subcommittee of

the Advisory Committee of the Secretary of Commerce reported, “It is probable that at the

present time much of this equipment cannot be obtained elsewhere in the desired qualities and

18
Department of Commerce, Export Control, Thirteenth Quarterly Report (Washington, D.C.: Government Printing
Office, 1950), pp. 25-7; “Report by the Ad Hoc Subcommittee of the Advisory Committee of the Secretary of
Commerce,” May 4, 1948, FRUS, 1948, Vol. 4, pp. 537-8.
19
“United States Policy on Trade with the Soviet Union and Eastern Europe,” November 26, 1947, FRUS, 1948,
Vol. 4, p. 490.

112
quantities, if at all.”20 Although Western Europe was selling a small quantity of industrial

products to the Eastern bloc, it was expected that the industrialized economies would not be able

to expand their sales and replace the U.S. because “Western Europe is already selling all that it

can produce currently. It cannot increase exports of complex equipment rapidly.”21 In short, at

least in the near term, the Western bloc countries were unable to increase the production of

machinery and equipment that were equivalent to those made by the U.S. As a result, other

countries could not serve as a replacement provider of goods to the USSR.

Second, the USSR had difficulty exploiting its newly acquired sphere of influence in

Eastern Europe to obtain goods for industrial development. Before World War II, compared with

the relatively backward Russia, Eastern European countries achieved significant industrial

development. East Germany before its division was also part of the most advanced economy in

Europe. If these countries had their industrial centers well preserved, they could have become

major suppliers of machinery and equipment to the Soviet Union.22 Yet, ravaged by the war, the

industrial capability of East European countries to supply for the USSR was significantly

limited.23 Moreover, by 1947, the USSR had already stripped Romania, Hungary, Bulgaria, and

Finland, as well as East Germany, by forcing them to pay for reparations.24 Meanwhile, the

Soviet Union could not simply continue exploiting the East European countries. As a leading

international banker noted in late 1947, the Soviet Union was having trouble “trying to hold”

Eastern Europe together economically because it could not meet the economic needs of the

20
“Report by the Ad Hoc Subcommittee of the Advisory Committee of the Secretary of Commerce,” May 4, 1948,
FRUS, 1948, Vol. 4, p. 538.
21
Ibid, pp. 541-2.
22
Alec Nove, An Economic History of the USSR 1917-1991, third edition (New York: Penguin Books, 1992), p. 323.
23
Robert A. Pollard, Economic Security and the Origins of the Cold War, 1945-1950 (New York: Columbia
University Press, 1985), p. 137
24
Herbert Feis, “The Conflict over Trade Ideologies,” Foreign Affairs, Vol. 25, No. 2 (January 1947), pp. 223.

113
region.25 Since Europe was being divided into two camps, the USSR had to organize its own

economic bloc rather than simply extracting resources from the states under its control.26

Moreover, Germany’s industrial core was the Ruhr-Rhine area, located in the western

part of Germany and administered by the U.S. and Britain, so that would not serve as a source of

supplies for the USSR. When the Soviets demanded plants and equipment from the western

zone, the U.S. denied shipment of industrial reparations from that area. As Secretary of State

James Byrnes made clear, the U.S. was determined to adopt a “First Charge Principle,” which

prioritized German productivity increases to pay for Western imports, rather than replying to

Soviet reparation demands.27

Third, with regard to some “bottlenecks” for industrial development, the USSR could not

divert its U.S. imports because the U.S. possessed a technological advantage unmatched by other

industrialized countries. Soviet leaders, including Stalin, recognized that the machinery made by

the U.S. was qualitatively superior, though expensive, and they wanted to maintain the flow of

goods which began under the Lend-Lease arrangements.28 Furthermore, as long as building

highly mechanized mass-production factories was a central goal of the Soviet Union’s economic

development programs, maintaining access to U.S. machinery, technology, and entrepreneurial

skill was needed. The U.S. was where the “Fordist” modern manufacturing system, a model that

25
Paterson, Soviet-American Confrontation, pp. 118-9.
26
James K. Libby, “CoCom, Comecon, and the Economic Cold War,” Russian History, Vol. 37 (2010), pp. 135-142;
and Robert Mark Spaulding, “Trade, Aid, and Economic Warfare,” in Richard H. Immerman and Petra Goedde eds.,
The Oxford Handbook of the Cold War (New York: Oxford University Press, 2013), p. 396. For trade within the
Soviet bloc, see Edward Ames, “International Trade without Markets: The Soviet Bloc Case,” The American
Economic Review, Vol. 44, No. 5, (December 1954), pp. 791-807.
27
Thomas J. McCormick, America’s Half-Century: United States Foreign Policy in the Cold War (Baltimore, M.D.:
The Johns Hopkins University Press, 1989), p. 68.
28
Paterson, Soviet-American Confrontation, pp. 59-60. Until 1946, the Soviet Union had been a major benefactor of
U.S. loans and aid. See “Memorandum by the Under Secretary of State for Economic Affairs to the Secretary of
State,” December 3, 1946, FRUS, 1946, Vol. 6, p. 859; “Memorandum by Mr. Emilio G. Collado, Deputy on
Financial Affairs to the Assistant Secretary of State for Economic Affairs,” February 4, 1946, FRUS, 1946, Vol. 6,
pp. 823-825.

114
the Soviets wanted to mimic in their factories, originated.29 Thus, as a representative of

AMTORG, the Soviet state trading company in the U.S., stated in 1947, the Soviet Union was

eager to sustain friendly relationships with major U.S. firms.30 Leading U.S. companies such as

General Electric reported to the State Department that the USSR wanted to sign contracts even

when they imposed stiffer terms, as instructed by the Department, because the Soviets wanted

the most advanced products that were only available from the U.S.31

Establishment of a Coordinated Control Scheme

The U.S., at the same time, was in a position to derive cooperation and support from other

industrialized countries in denying the USSR’s access to machinery and industrial equipment. A

number of states in Western Europe had the potential to reemerge as suppliers of advanced

industrial products once they recovered; if these states regained industrial vigor, they could

become alternative partners for the USSR in certain products. Furthermore, while the U.S. was

helping the recovery of many states, the possibility of transshipment and resale of the U.S.

European Recovery Program aid to the Eastern bloc became an important issue of concern. The

recipients of U.S. industrial products could resell them to the USSR to obtain profit beyond the

market price, or utilize U.S. economic assistance to produce goods that the Soviet Union wanted

to purchase in the market at a very high price.32

29
Charles S. Maier, “The World Economy and the Cold War in the Middle of the Twentieth Century,” in Melvyn P.
Leffler and Odd Arne Westad eds., The Cambridge History of the Cold War (Cambridge: Cambridge University
Press, 2010), p. 50.
30
Paterson, Soviet-American Confrontation, p. 60.
31
Ibid, p. 67.
32
“Export Controls to Eastern Europe,” March 9, 1948, FRUS, 1948, Vol. 4, pp. 523-4; “The United States High
Commissioner for Germany (McCloy) to the Secretary of State,” October 17, 1949, FRUS, 1949, Vol. 5, p.155;
“The Secretary of State to Certain Diplomatic Offices,” January 12, 1950, FRUS, 1950, Vol. 4, p. 66. Also see, U.S.
Congress, Senate, Committee on Interstate and Foreign Commerce, Export Controls and Policies in East-West
Trade, 82nd Congress, 1st Session (Washington, D.C.: Government Printing Office, 1951), pp. 2-6.

115
 In gaining cooperation from other states, the U.S. had two major considerations. First, it

intended to impose strict and immediate control on military-relevant trade (the items later

classified as 1A goods).33 As Secretary of State George Marshall stated, controlling key

commodities that would contribute to the Soviet Union’s military power should be thoroughly

and immediately replicated by Western Europe.34 In this matter, the U.S. was willing to exert

pressure on the western countries. For instance, closely tracing British natural rubber exports to

the Soviet Union with U.S. naval intelligence, Marshall dissuaded Britain from selling that

strategic good to the USSR.35 Second, at the same time, the U.S. allowed some East-West trade

to facilitate the West European recovery, with the aim of bolstering Europe’s capacity to become

an effective counterweight against Soviet expansion.36 U.S. officials realized that Western

Europe needed grain, timber, coal, and potash from Eastern Europe for its recovery, and allowing

trade in these goods to continue would reduce U.S. burdens.37 Western European states’ faster

recovery would enable them to counter the Soviet Union without more investments from the U.S.

Still, the bottom line in the U.S. position on trade with the Soviet bloc was persuading

Western Europe to follow suit with the U.S. As the Policy Planning Staff suggested, “we must

face the bitter fact that in present circumstances any increase in the economic strength of the

33
For the definition of the 1A and 1B goods, see “The Secretary of State to Certain Diplomatic Offices,” June 12,
1950, FRUS, 1950, Vol. 4, pp. 147-148.
34
“Control of Exports to the Soviet Bloc,” March 26, 1948, FRUS, 1948, Vol. 4, p. 527; “Marshall to Harriman,”
August 27, 1948, FRUS, 1948, Vol. 4, p. 566.
35
“Marshall to Douglas (Ambassador in UK),” FRUS, 1948, Vol. 4, pp. 554-5. Frank M. Cain, “Exporting the Cold
War: British Response to the USA’s Establishment of COCOM, 1947-51,” Journal of Contemporary History, Vol.
29, No. 3 (July 1994), pp. 505-6, 508-9
36
See “Marshall to Sawyer,” July 9, 1948, FRUS, 1948, Vol. 4, p. 551 and enclosed “Memorandum for the
Secretary,” FRUS, 1948, Vol. 4, pp. 552-3; “Control of Exports to the Soviet Bloc,” March 26, 1948, FRUS, 1948,
Vol. 4, pp. 527-8; and “Export Controls and Security Policy (NSC 69/1),” August 21, 1950, FRUS, 1950, Vol. 4, pp.
167-8.
37
“Report by the Ad Hoc Subcommittee of the Advisory Committee of the Secretary of Commerce,” May 4, 1948,
FRUS, 1948, Vol. 4, p. 537.

116
Soviet Union and the satellite countries will be used to oppose, rather than to promote, the

interests of real European recovery, unless some compulsion operates in the other direction.”38

Thus, the U.S. started negotiations with the Western European countries, which

eventually resulted in the formation of the Coordinating Committee for Multilateral Export

Controls (COCOM) and the adoption of a common control list. Talks with the European states

began based on a bilateral framework, starting from the meetings with the British and expanding

to negotiations with France, the Benelux countries, Denmark, Austria, and Norway. States such

as Italy, Greece, Turkey, Ireland, Iceland, and Portugal were not taken seriously because they

were not capable of replacing U.S. exports to the USSR.39 After a series of bilateral exchanges,

the negotiations began to take a multilateral form, led by tripartite meetings between the U.S.,

Britain, and France.40 In these meetings, a common control list gradually emerged, although

Britain and France presented the “Anglo-French list” which was less restrictive than the U.S. list

and hence induced frictions with Washington.41 By late 1949, the U.S., Britain, France, Italy, the

Benelux countries, and Denmark agreed on a tentative common control list, establishing an

informal regime to monitor East-West trade. The Consultative Groups was also created for joint

policy making and execution. In late 1950, the member countries agreed to adopt the control list

proposed by the U.S.42

Two developments helped the U.S. to attain a formalized multilateral arrangement and

substantiate the denial of the Soviet Union’s access to important industrial goods. First,

observing the USSR’s growing aggressiveness, a general consensus emerged among the West

38
“United States Policy on Trade with the Soviet Union and Eastern Europe,” November 26, 1947, FRUS, 1948,
Vol. 4, p. 493.
39
“Marshall to Harriman,” August 27, 1948, FRUS, 1948, Vol. 4, p. 567.
40
Alan P. Dobson, U.S. Economic Statecraft for Survival 1933-1991 (New York: Routledge, 2002), p. 106.
41
Ian Jackson, The Economic Cold War: America, Britain and East-West Trade, 1948-63 (New York: Palgrave,
2001), p. 33; Mastanduno, Economic Containment, p. 75
42
Jackson, The Economic Cold War, pp. 41, 57, 62.

117
European states that agreeing on a common export control scheme was needed to enhance their

security.43 Intensifying Cold War tensions throughout 1948 and 1949 pressed the Europeans to

follow the U.S. lead. As British diplomats asserted at a meeting of the Organization for European

Economic Cooperation in January, 1949, it was seen as imperative for Western Europe to take a

similar course of action with Washington and to delay the Soviet Union building up its military

power.44 Outbreak of war on the Korean peninsula in June 1950 and a materializing fear of

Soviet military aggression in Europe consolidated Western European thinking about the need for

trade controls.45

Second, based on its unique position after World War II, the U.S. set thrusts for common

control policy at important junctures.46 In the meetings with British and French delegates, U.S.

representatives continuously persuaded the European countries to adopt a list as extensive as that

of the U.S., moving the negotiation forward when it might otherwise have faced an impasse.47

Once the Economic Cooperation Administration (ECA) established offices in the European

countries to implement the Marshall Plan, its officials regularly asked the governments of

participating countries to abide by the U.S. embargo lists. They also made requests to

immediately terminate existing contracts with Eastern Europe for commodities that were directly

related to the Soviet Union’s military buildup.48 Moreover, when neutral states’ trade with the

43
“George W. Perkins to Secretary of State,” November 7, 1949, FRUS, 1949, Vol. 5, p. 37-8; Ian Jackson,
“Economics and the Cold War,” in Richard H. Immerman and Petra Goedde eds., The Oxford Handbook of the Cold
War (New York: Oxford University Press, 2013), p. 57.
44
Jackson, The Economic Cold War, p. 31
45
Mastanduno, Economic Containment, pp. 89-90; Roberts Osgood, NATO: The Entangling Alliance (Chicago, I.L.:
University of Chicago Press, 1962), p. 69; Vibeke Sørensen, “Economic Recovery versus Containment: The Anglo-
American Controversy over East-West Trade, 1947-51,” Cooperation and Conflict, Vol. 24 (1989), p. 70.
46
Dobson, U.S. Economic Statecraft, p. 112. For U.S. avoidance of using overt pressure toward the Europeans, see
the exchanges in “The Secretary of Commerce to the Executive Secretary of the National Security Council,” FRUS,
1950, Vol. 4, p. 83; and “Memorandum by the Acting Secretary of State for European Affairs (Thompson) to the
Secretary of State,” May 2, 1950, FRUS, 1950, Vol. 4, p. 101.
47
Cain, Economic Statecraft during the Cold War, p. 30.
48
Cain, “Exporting the Cold War,” p. 509.

118
Soviet bloc was creating a disharmony among the western countries, inducing strong French

protest in particular, the U.S. actively negotiated with the neutrals to join the West.49 Further,

while West Germany’s legal status for multilateral negotiations was not fully established, the

U.S. observed its own control list and imposed strict restrictions on West German exports to the

Eastern bloc.50

Meanwhile, domestic pressures in the U.S. pushed the Truman administration and

Western Europe to develop a common control scheme on trade with the Eastern bloc.51 In

particular, Congress exerted strong pressures on the White House to disallow any European

recipient of the Marshall Plan aid from exporting goods to a non-participating country of the

Marshall Plan. Through legislation such as the Mundt Amendment, the Foreign Assistance Act

of 1948, the Export Control Act of 1949, the Kem Amendment of 1951, and the Battle Act of

1951, both the House and the Senate forced the Truman administration to pressure the European

allies to adopt control measures as stringent as those of the U.S.52 The U.S. government might

have mediated these overt pressures on Western Europe, but the European countries nonetheless

acknowledged the seriousness of the U.S. concern, sometimes expressing resentment at the

breaching of their sovereignty by the political leaders in Washington.53

49
“Ambassador in France (Caffery) to the Acting Secretary of State,” January 19, 1949, FRUS, 1949, Vol. 5, p.69;
Sørensen, “Economic Recovery versus Containment,” pp. 75-6
50
“The Chancellor of the Federal Republic of Germany to the Chairman of the Allied High Commission for
Germany,” February 2, 1950, FRUS, 1950, Vol. 4, pp. 73-4.
51
For the view emphasizing the impact of U.S. pressure, see Gunnar Adler-Karlsson, Western Economic Warfare
1947-1967 (Stockholm: Almqvist and Wiksell, 1968), pp. 22-28; and Richard J. Ellings, Embargoes and World
Power (Boulder, C.O.: Westview Press, 1985), p. 80.
52
Adler-Karlsson, Western Economic Warfare, pp. 22-28, 45-49. Also see U.S. Congress, Senate, Committee on
Interstate and Foreign Commerce, Export Controls and Policies in East-West Trade, 82nd Congress, 1st Session
(Washington D.C.: Government Printing Office, 1951); and Ian Jackson, “Economics,” in Saki R. Dockrill and
Geraint Hughes eds., Palgrave Advances in Cold War History (New York: Palgrave Macmillan, 2006), pp. 170-1.
53
Cain, “Exporting the Cold War,” pp. 512-519; Cain, Economic Statecraft during the Cold War, 33-39; Jackson,
The Economic Cold War, pp. 90-110.

119
In sum, in the immediate aftermath of the Second World War, the Soviet Union was not in a

position to replace its U.S. imports with goods from other countries. Other industrialized

countries were incapable of or unwilling to capitalize on U.S. restrictions of its own exports, and

the U.S. and its allies came up with a common control scheme. Even though Western Europe’s

trade with the Eastern bloc continued, it did not grow significantly during this period. West

European exports to the Soviet bloc grew only slightly from 622.8 million dollars in 1948 to

626.1 million dollars in 1951.54 A different estimate suggests that the COCOM states’ exports to

the European Soviet bloc remained at about 37 percent of the 1937 level between 1949 and 1950,

and decreased to about 35 percent of the 1937 level in 1951.55 As Table 5-1 shows, the U.S. and

its allies’ exports to the Sino-Soviet bloc was in decline starting from 1947.

Table 5-1. “Free World” Trade with the Sino-Soviet Bloc (millions of dollars)

Bloc as percentage Bloc as percentage

Free World Exports of total free world Imports of total free world
exports imports
1947 2,006 4.1 1,425 2.7
1948 1,969 3.7 2,008 2.4
1949 1,667 3.0 1,797 2.0
1950 1,545 2.7 1,727 2.9
1951 1,689 2.2 1,883 2.3
1952 1,438 1.9 1,634 2.0
1953 1,389 1.9 1,631 2.1
Source: Legislative Reference Service of the Library of Congress, A Background Study on East-West Trade, 89th
Congress, 1st Session (Washington D.C.: U.S. Government Printing Office, 1965), p. 5.

These developments were significant achievements for the U.S. because, since the West

was recovering from the war, their foreign trade in general was growing dramatically. Stagnation

in the level of exports to the Soviet bloc implied that other industrialized economies were not

replacing the U.S., even though they became more capable of increasing the production of

54
Dobson, U.S. Economic Statecraft for Survival, pp. 98-99.
55
U.S. Congress, Senate, Committee on Foreign Relations, East-West Trade, Hearing before the Committee on
Foreign Relations, 83rd Congress, 2nd Session, April 9, 1954 (Washington, D.C.: Government Printing Office,
1954), p.5.

120
machinery and equipment.56 As such, the U.S. could effectively deny alternative trading partners

for the Soviet Union.

Outcome: Severance of Trade Ties with the USSR

Its leading industries’ low dependence on economic inputs from the Soviet Union and the

absence of alternative trading partners for the USSR enabled the U.S. to implement restrictive

commercial policies. Such policies were expected to inflict almost a unilateral loss on the Soviet

Union’s economic strength, and at the same time to complement the gradually developing

military containment strategy. As Adler-Karlsson observes, the main purpose of U.S. restrictions

on trade with the Soviet Union was contributing to the U.S. power superiority vis-à-vis the

Soviet Union.57

Until 1947, the U.S. was committed by treaties and trade agreements to treat the Soviet

bloc countries as most-favored nations and not to engage in discriminatory practices.58 Those

arrangements included Treaty of Friendship, Commerce and Navigation with Poland, signed in

1931, Treaty of Friendship, Commerce and Consular Rights with Finland of 1934, a Reciprocal

Trade Agreement with Finland of 1936, Treaty of Friendship, Commerce, and Consular Rights

with Hungary of 1925, Treaty of Commerce with Serbia of 1881 (currently in effect with

Yugoslavia), General Agreement on Tariffs and Trade currently in force with Czechoslovakia,

Provisional Commercial Agreement with Romania of 1930, reinstated in March 1948, and

56
Adler-Karlsson, Western Economic Warfare, p. 46; Dobson, U.S. Economic Statecraft, pp. 98-99.
57
Adler-Karlsson, Western Economic Warfare, p. 5; Ellings, Embargoes and World Power, pp. 72-3; and Jackson,
The Economic Cold War, 18.
58
“United States Policy on Trade with the Soviet Union and Eastern Europe,” November 26, 1947, FRUS, 1948,
Vol. 4, p. 491.

121
Commercial Agreement with the USSR of 1937.59 Of note, the 1937 agreement with the Soviet

Union was still in effect and contained the provision that exports from the U.S. to the USSR shall

“in no case be subject to any rules or formalities other than or more burdensome than those to

which the like products may be subject when consigned to the territory of any third state.”60

Other policy arrangements over trade such as the Lend-Lease program were not extended

because their terms were applicable only during wartime.

The U.S. started to reconsider its trade relations with the USSR around 1946. Observing

Soviet interest in purchasing surplus U.S. properties and its potential negative impact on the

U.S., in January 1946, Ambassador in Moscow Averell Harriman warned Washington that “our

Government should not make any more isolated economic arrangements with the Soviets until

we have an over-all understanding with them about outstanding economic matters.”61 The U.S.

also refused to provide loans to the Soviet Union to purchase American goods, while it provided

similar credit to the British.62 In the spring of 1947, the Truman administration announced that it

would continue the comprehensive system of export controls that was adopted during World War

II, in order to concentrate on assisting the Western European countries.63 In July 1947, President

Truman signed the Second Decontrol Act that gave to the executive the authority to maintain

controls on materials that could be utilized for U.S. foreign policy purposes.64 This legislation

59
See FRUS, 1948, Vol. 4, p. 552, fn. 3.
60
“United States Policy on Trade with the Soviet Union and Eastern Europe,” November 26, 1947, FRUS, 1948,
Vol. 4, p. 494.
61
“The Ambassador in the Soviet Union to the Secretary of State,” January 19, 1946, FRUS, 1946, Vol. 6, p. 820.
Also see “Memorandum by the Chief of the Division of Eastern European Affairs to the Under Secretary of State,”
January 21, 1946, FRUS, 1946, Vol. 6, pp. 820-1.
62
Moscow’s unwillingness to return the equipment provided by Washington under Lend-Lease was at the center of
this decision. See “Memorandum by the Under Secretary of State for Economic Affairs to the Secretary of State,”
December 3, 1946, FRUS, 1946, Vol. 6, pp. 858-9; “The Secretary of State to the Ambassador in the Soviet Union,”
December 23, 1946, FRUS, 1946, Vol. 6, pp. 860-2; “Outline of Main Points of Settlement Proposed by the United
States Side,” June 25, 1947, FRUS, 1947, pp. 696-702.
63
Funigiello, American-Soviet Trade in the Cold War, p. 33
64
Secretary of Commerce, First Quarterly Report under the Second Decontrol Act of 1947 (Washington, D.C.:
Government Printing Office, 1947), p. iii.

122
allowed for a very flexible interpretation, permitting “virtually unlimited control over all

shipments we may decide to place under license.”65

Later in 1947, the U.S. made important decisions that eventually resulted in the severance

of trade ties with the Soviet Union. In autumn 1947, Secretary of Commerce Averrell Harriman

started reviewing trade policy toward the Soviet Union and Eastern Europe. This review led

Harriman to articulate the virtual cessation of trade with the Soviet bloc, and make a proposal to

the NSC to take all necessary measures to prohibit export of important commodities to that

region.66 Harriman’s advocacy for trade restrictions was reinforced by the USSR’s refusal to join

the European Recovery Program, and by the suspicion that grew since the formation of the

Cominform by the Soviet Union.67 By November 1947, as the Policy Planning Staff observed,

“There is general agreement that it is not desirable for U.S. merchandise or technology to go

forward, directly or indirectly, to the Soviet Union or its satellites, where these shipments would

increase Soviet military potential or operate to the detriment of the European recovery

program.”68

In November 1947, Harriman submitted a paper to the NSC which became the

framework of the U.S. approach on trade with the Soviet bloc:

“The National Security Council therefore considers that U.S. national security
requires the immediate termination, for an indefinite period, of shipments from the
United States to the USSR and its satellites of all commodities which are critically
short in the United States or which would contribute to the Soviet military
potential. This result, however, should be achieved if possible without any overt act
of arbitrary discrimination against the USSR and its satellites.

65
“United States Policy on Trade with the Soviet Union and Eastern Europe,” November 26, 1947, FRUS, 1948,
Vol. 4, p. 491.
66
Jackson, The Economic Cold War, p. 18-19
67
Many believed that the Cominform was created to sabotage the Marshall Plan and Europe’s recovery. See
“Control of Exports to the USSR and Eastern Europe,” November 14, 1947, FRUS, 1948, Vol. 4, p. 506;
“Immediate U.S. Economic Policy toward Soviet Sphere (EWP D-9/i),” November 19, 1947, FRUS, 1948, Vol. 4, p.
499.
68
“United States Policy on Trade with the Soviet Union and Eastern Europe,” November 26, 1947, FRUS, 1948,
Vol. 4, pp. 491, 495, 496.

123
 The National Security Council therefore recommends, in the interests of
economic recovery, world peace, and, in turn, U.S. national security, that Europe,
including the USSR, and such affiliated areas as the Secretary of State may
designate, should be declared a recovery zone to which all exports should be
controlled. Exports to any country in this zone should be permitted only when (a)
the country furnishes adequate justification for its requirements, (b) European
recovery and world peace are served thereby, and (c) the position of the United
States is not adversely affected.”69

In this statement, it was evident that U.S. trade controls targeted the USSR and its sphere

of influence, and that the U.S. intended to restrict export of almost all goods to the Soviet bloc.

U.S. officials were well aware that the Soviet Union would not satisfy the three conditions. Still,

Washington wanted to legitimize its decisions and deny any propaganda advantage to Moscow,

while also avoiding blame that it was responsible for the division of Europe. Hence, by

designating all of Europe as a “recovery zone” and obliging all European countries to provide

detailed economic data if they were to import from the U.S., Washington intended to mask an

overt discrimination against the USSR. At the same time, these conditions were expected to

contribute to removing potential legal and practical loopholes in the control scheme.70 Moreover,

since the goods that the U.S. sold to the USSR were mainly comprised of industrial products that

were at least partly related to the industrial basis of military power, controlling commodities

“which would contribute to the Soviet military potential” meant that the U.S. would restrict

most, if not all, of its sales to the USSR.

In December 1947, President Truman approved Harriman's proposal to the NSC with

only minor revisions.71 He ordered the Commerce Department to implement what was to be

called the “R” procedure, which intended “to provide for export license control of all shipments

69
“Control of Exports to the USSR and Eastern Europe,” November 14, 1947, FRUS, 1948, Vol. 4, p. 506.
70
“United States Policy on Trade with the Soviet Union and Eastern Europe,” November 26, 1947, FRUS, 1948,
Vol. 4, p. 492.
71
“Control of Exports to the USSR and Eastern Europe,” December 17, 1947, FRUS, 1948, Vol. 4, p. 512.

124
to Europe and dependent territories, which are regarded as a recovery area.”72 As the NSC

Director Sidney Souers observed, the “R” procedure theoretically achieved “total control of

shipments to Eastern Europe without apparent discrimination.”73

The decision by the NSC was soon translated into powerful regulations. In mid-January,

1948, the Department of Commerce announced that, starting from March, all U.S. exports to

Europe were required to obtain individually validated licenses.74 The controls were to be

imposed expediently and extensively. On March 9, 1948, the Department of Commerce reported

that, with regard to the goods that were under its authority, “all shipments to the USSR and

satellite countries, regardless of whether or not the goods concerned are in scarce supply in the

United States, have been subject to individual licensing since March 1.”75 The export control

scheme proved to be very effective, as confirmed by U.S. chiefs of missions in the Eastern bloc

countries.76 In April, 1948, the licenses issued for Eastern European destinations amounted to

$1,435,200 worth of goods, of which $1,323,000 was for shipments by relief agencies, while

licenses for commercial exports amounted to only $116,574. This was a dramatic decrease in

commercial exchanges, since in the previous year average monthly exports to the same

destination were $27,115,000 and nearly all of them were commercial in character.77 Hence, a

number of officials concluded by April 1948 that the U.S. was effectively imposing a virtual

embargo on exports to the Eastern bloc.78

72
“The “R” Procedure for Export Control,” undated, FRUS, 1948, Vol. 4, pp. 512-3; “Department of Commerce
Press Release,” January 15, 1948, FRUS, 1948, Vol. 4, p. 514.
73
Pollard, Economic Security and the Origins of the Cold War, p. 162
74
Funigiello, American-Soviet Trade in the cold War, p. 36; Paterson, Soviet-American Confrontation, p. 71.
75
“Export Controls to Eastern Europe,” March 9, 1948, FRUS, 1948, Vol. 4, p. 523.
76
“Conclusions and Recommendations of the London Conference of October 24-26 of United States Chiefs of
Mission to the Satellite States,” FRUS, 1949, Vol. 5, p. 31.
77
“Memorandum by the Assistant Secretary of State for Economic Affairs (Thorp) to the Secretary of State
(Marshall),” May 6, 1948, FRUS, 1948, Vol. 4, p. 543; “East-West Trade Developments,” June 14, 1948 (Bureau of
Economic Affairs Files: Lot 54D361), FRUS, 1948, Vol. 4, p. 548.
78
“Report by the Ad Hoc Subcommittee of the Advisory Committee of the Secretary of Commerce,” May 4, 1948,

125
 The U.S. also strengthened institutional frameworks to support export control. In 1947,

an ad hoc sub-committee, chaired by the Commerce Department, was established to assist

restrictions on exports to the Soviet bloc, under the interdepartmental Advisory Committee on

Exports (renamed Advisory Committee on Requirements since1948). On March 10, 1948, the

Truman administration assigned the Ad Hoc Committee to make recommendations for the

establishment of an organization that would orchestrate peacetime economic measures against

the Soviets.79 The Technical Steering Committee, comprised of officials from the Departments of

Defense, State, Commerce, Agriculture, and the Central Intelligence Agency, was also ordered to

present a comprehensive list of items that were to be controlled.80 Further, legal basis for export

control was strengthened by 1949. While the Truman administration’s decision in December

1947 relied on the Second Decontrol Act, the Export Control Act of 1949 gave the Department

of Commerce greater authority to control goods “that were likely to make a significant

contribution to the military potential of the Communist country for which it was destined."81 By

1950, as the State Department noted, the U.S. export control system that was in effect was

exceedingly comprehensive and restrictive.82

In sum, the U.S. objective in severing extant trade ties with the Soviet Union was to

“inflict the greatest economic injury to the USSR and its satellites.” It was expected that

Washington could effectively “minimize the damage to the U.S. and the Western Powers.”83

FRUS, 1948, Vol. 4, p. 539.

79
Cain, “Exporting the Cold War,” p. 504
80
Ibid, p. 505. This committee presented a list comprised of two categories of goods: 1A (items with direct and
indirect military application) and 1B (the remainder, to be controlled based on case by case, and items that have
military implication when sold in large quantities).
81
Legislative Reference Service of the Library of Congress, A Background Study on East-West Trade, 89th
Congress, 1st Session (Washington, D.C.: U.S. Government Printing Office, 1965), p. 38.
82
“The Secretary of State to Certain Diplomatic Offices,” April 26, 1950, FRUS, 1950, Vol. 4, pp. 87-93.
83
“Memorandum of Conversation by the Acting Advisor to the Division of Occupied Areas Economic Affairs,”
FRUS, 1948, Vol. 4, p, 525. Also see Dobson, U.S. Economic Statecraft for Survival, p. 89; William J. Long, U.S.
Export Control Policy: Executive Autonomy vs. Congressional Reform (New York: Columbia University Press,

126
Thus, starting in 1947, the U.S. imposed restrictions on most exports to the Eastern bloc. It was

meaningless to distinguish whether the U.S. economic strategy against the Soviets could be

identified as economic warfare or strategic embargo, since in practice the distinction between

different types of economic measures disappeared.84 Also, as Michael Mastanduno points out,

U.S. officials believed that Soviet industrial potential could not be separated from its military

potential, and they consequently refused to distinguish between the two. In their view, export

controls “must be broad and deep enough to affect the entire production complex of the Soviet

state.”85 This implied that the U.S. was determined to deny Soviet access to American goods

even when those goods were only marginally related with the military.

Alternative Explanations

In contrast to my argument, the evidence supporting the two alternative explanations is

insufficient. First, if the commercial interest group hypothesis were correct, the groups and

individuals who had stakes in continuing trade with the Soviet Union should have tried to defend

their interests when the U.S. government contemplated export controls. Those interest groups

should have failed to influence governmental decisions to sustain trade ties because they were

proven to be less influential than other groups that wanted to sever ties. Even if these economic

interests were small in number, they should have competed with the more powerful groups at

least to have their voices heard. Second, for the economic statecraft hypothesis to prove that its

1989), p. 15.
84
For different interpretations of U.S. strategy, see Jackson, The Economic Cold War, pp. 4-7. For the
indistinguishability of different strategies, see Tor Egil Førland, “‘Economic Warfare’ and ‘Strategic Goods’: A
Conceptual Framework for Analyzing COCOM,” Journal of Peace Research, Vol. 28, No. 2 (1991), p. 196.
85
Mastanduno, Economic Containment, p. 71. Also see “The Secretary of State (Acheson) to the Embassy in the
United Kingdom,” FRUS, 1950, Vol. 4, pp. 174-76. Adler-Karlsson, Western Economic Warfare, p. 5.

127
causal mechanism is at work, the U.S. should have imposed restrictions on exports to shape the

USSR’s behavior through negative economic sanctions. Neither of these two claims, however,

are substantiated by historical evidence. No significant domestic interest group that benefited

from trade with the Soviet Union endorsed trade with the USSR. The U.S. also did not expect

that it could affect the Soviet Union’s course of action through economic means.

Absence of Domestic Pressure to Preserve Trade Ties

During and in the immediate aftermath of World War II, there were powerful advocates of trade

ties with the Soviet Union in the U.S. For many U.S. officials and entrepreneurs, including

Secretary of Commerce Henry Wallace and President of the United States Chamber of

Commerce Eric Johnston, the USSR was seen as the perfect destination for American industrial

and consumer goods, and it was expected that the two countries would easily construct a

complementary economic relationship. Furthermore, as the Russian Economic Institute of New

York noted in December 1944, “the Soviet Union represents potentially the largest market the

world ever saw.” Russia’s potential as a market was viewed as so great that it might be able to

mitigate the economic downturn that was expected to follow the post-war demobilization.86

Leading U.S. companies such as Chase National Bank, Dupont, General Electric, International

Telephone and Telegraph, Radio Corporation of America, Warner Brothers, and Westinghouse

were actively engaged in trade with the Soviet Union. They continued to receive orders from the

USSR in 1946, and by the end of that year approximately fifty U.S. companies held technical

assistance agreements with the Soviet Union.87

86
Funigiello, American-Soviet Trade in the Cold War, pp. 9-10.
87
Paterson, Soviet-American Confrontation, pp. 57-8, 63.

128
 However, when the Truman administration began to reconsider trade ties with the Soviet

Union, these economic groups did not try to advance their interests or to pressure the

government. Instead, the commercial interests publicly opposed trading important items with the

Eastern bloc or openly supported export controls that were being adopted by the administration.88

For instance, representing about 2,000 firms that were engaged in international trade, Joseph

Sinclair, Secretary of Commerce and Industry Association of New York, testified that “Most

foreign traders recognized the necessity for a continuation of export controls under present

international economic and political conditions, although, with the exception of a few who have

actually profited as a result of such controls, American exporters believe that export licensing

should be instituted and maintained only when absolutely necessary to carry out our international

commitments and for the political and economic security of the country.”89 Major companies that

traded heavily with the Soviet Union also chose not to oppose the embargo, in order to avoid the

risk of being charged with “trading with the enemy.”90 As Dresser Industries stated in 1947, the

prevalent position of the business community was that “if accepting further business from those

people is inimical to the over-all interest of the United States, then we do not want any part of

such business.”91

Further, while Congress bombarded the administration to impose more stringent

measures against trade with the Soviet Union, no noticeable voice representing economic

interests in East-West trade was observed.92 Indeed, bipartisan support emerged for the Truman

88
Long, U.S. Export Control Policy, p.24.
89
U.S. Congress, Senate, Committee on Banking and Currency, Extension of Export Controls Hearings, 81st
Congress, 1st Session, 1949, p. 186.
90
Mastanduno, Economic Containment, p. 74. Also see Cain, Economic Statecraft during the Cold War, pp. 33-39.
91
Paterson, Soviet-American Confrontation, p. 67.
92
Jackson, The Economic Cold War, p. 15; Paterson, Soviet-American Confrontation, p. 264.

129
administration’s restrictions on exports.93 Under these circumstances, business groups had to be

sensitive to the rising public anti-communist sentiments, and they thus refrained from

challenging export controls that were being considered by the administration. In short, there is

little evidence that supports the causal mechanism of the domestic interest hypothesis, because

the process of interest groups competing with one another was absent in the first place.

Not a Case of Economic Statecraft

During the last days of World War II, the U.S. considered that economic exchanges could be an

effective means of shaping the Soviet Union’s future behavior. For some U.S. officials, trade

with the USSR would establish peaceful relations between the two countries while also

establishing “a model for the other countries in the world.”94 For instance, Alexander

Gerschenkron emphasized that the U.S. should incorporate the Soviet Union into the world

economy to avoid political friction and to reconstruct world trade.95 Further, between 1945 and

1946, economic ties were often viewed as a useful way of weakening the Soviet Union’s control

of Eastern Europe.96

In this context, it might be argued that the U.S. used two forms of economic statecraft to

shape the Soviet Union’s behavior during the early stage of the Cold War: (1) positive economic

inducements by proposing that the USSR join the Marshall Plan, and (2) negative sanctions by

imposing restrictions on exports. These two propositions, however, are not well supported

93
Especially, Republican Senator Arthur Vandenberg played a crucial role in deriving bipartisan support for
President Truman. See Dean Acheson, Present at the Creation (New York: W. W. Norton, 1969), pp. 221-225.
94
Funigiello, American-Soviet Trade in the Cold War, pp. 10-11; Paterson, Soviet-American Confrontation, pp. 3-8.
95
Alexander Gerschenkron, Economic Relations with the USSR (New York: The Committee on International
Economic Policy, 1945).
96
Pollard, Economic Security and the Origins of the Cold War, p. 161.

130
empirically. U.S. policies over trade with the USSR did not aim to dictate certain behavior to the

Kremlin.

First, not only was the sincerity of inviting the USSR to the European Recovery Program

dubious, but the invitation also did not aim to shape the Soviet Union’s behavior. Before George

Marshall’s famous speech in June 1947, the U.S. was stipulating a European economic

federation without assuming the participation of Eastern Europe, and it expected that

incorporating the USSR might paralyze U.S. efforts to stabilize Europe.97 Later, U.S. officials

feared that potential Soviet participation would be for “destructive than constructive purposes.”98

Indeed, the proposal to the Soviets to join the Marshall Plan in part aimed to avoid the blame that

the U.S. was responsible for the division of Europe.99 In the unlikely event of the Kremlin

joining the European Recovery Program, the U.S. would be able to weaken the USSR’s control

over its European satellites.100 In short, the European Recovery Program was not an economic

“carrot” to affect Moscow’s behavior.

Second, the U.S. decision to restrict exports was not intended to shape the behavior of the

Soviet Union, because no message or demand was delivered to the Kremlin. The U.S. did not

state what Soviet actions it intended to punish.101 In fact, the U.S. recognized that negative

economic sanctions would not be able to coerce the Soviet Union. As the Office of International

Trade Policy of the State Department reported, economic tools would not change the Soviet

Union’s behavior because “Its [the Soviet Union’s] population has long been accustomed to a

97
“Summary of Discussion on Problems of Relief, Rehabilitation and Reconstruction of Europe,” May 29, 1947,
FRUS, 1947, Vol. 3, p. 235. Also see “The Director of the Policy Planning Staff to the Under Secretary of State,”
March 23, 1947, FRUS, 1947, Vol. 3, p. 228.
98
“The Ambassador in the Soviet Union to the Secretary of State,” June 23, 1947, FRUS, 1947, Vol. 3, p. 266.
99
Acheson, Present at the Creation, p. 232; Hadley Arkes, Bureaucracy, the Marshall Plan, and the National
Interest (Princeton, N.J.: Princeton University Press, 1972), p. 53; Diane B. Kunz, Butter and Guns: America’s Cold
War Economic Diplomacy (New York: The Free Press, 1997), p. 34.
100
Funigiello, American-Soviet Trade in the Cold War, pp. 30-31.
101
Førland, “‘Economic Warfare’ and ‘Strategic Goods’,” p. 192.

131
low standard of living. It also has an autocratic government that can see to it that low living

standards are maintained and human, as well as natural, resources are utilized in the interests of

state planning objectives.”102 Instead, the aim of U.S. export control was making the Soviet

Union weaker, as it was suggested in the same report: “It is true, however, that by a system of

controls the western world can retard the rate at which the Soviet Union continues industrial

development and thereby augments its aggressive war potential. This is precisely the policy that

is now being followed by the United States.”103

Conclusion

The Truman administration decided to sever trade ties with the Soviet Union because the U.S.

could weaken the USSR’s relative power. The Soviet Union’s inability to divert its American

imports and leading U.S. industries’ low dependence on Soviet products created the condition for

such a decision. By imposing almost complete restrictions on exports, the U.S. intended to delay

the USSR’s economic growth as well as its military buildup. Accordingly, within a few years

after 1947, trade between the two superpowers had virtually disappeared.

102
“Comments on Moscow’s Despatch No. 558,” October 1, 1949, FRUS, 1950, Vol. 4, pp. 107-8.
103
Ibid, 108.

132
 CHAPTER 6

U.S. ECONOMIC RESPONSE TO THE RESURGENT

SOVIET THREAT, 1979-1982

By the end of 1979, the U.S. encountered a resurgent threat from the Soviet Union, which

marked the beginning of “the New Cold War.” The Carter and Reagan administrations responded

to the Soviet challenge by strengthening military countermeasures, both internally and

externally. At the same time, each of the two presidents found the need to reconsider the

commercial ties with the Soviet Union that had been established during the détente of the 1970s.

However, their assessment of the U.S. ability to inflict economic loss on the USSR diverged.

While both administrations knew that the leading U.S. industries did not depend heavily on

Soviet economic inputs, they had different views about the availability of alternative trading

partners for the USSR. Accordingly, their economic responses to the Soviet Union differed

significantly.

This chapter presents a brief comparative study of the two successive U.S.

administrations’ economic responses to the same challenging power. The previous chapters

demonstrated how the presence or absence of the two explanatory factors constrained a reigning

state’s economic decisions toward a challenger power. However, the cases I study represent the

decisions of reigning states at distinct historical moments or in different parts of the world.

Furthermore, the competitions between the reigning state and the challenger occurred under

different level of economic and technological developments, as well as under distinct distribution

of power around the globe. In short, there are important control variables that need to be

133
considered in order to demonstrate that my causal logic is sufficiently robust. To address this

problem, I conduct a time series analysis, examining how variations in only one explanatory

factor—the existence of alternative trading partners for the challenger—during a short period of

time have resulted in different outcomes.1 As such, comparing the Carter and Reagan

administrations’ responses to the Soviet challenge has the advantage of mitigating some

challenges in empirical investigation.

One potential criticism must be addressed from the outset. As is widely acknowledged

today, the Soviet economy started to stumble beginning at least as early as the latter half of the

1970s.2 This might suggest that the Soviet Union by the late 1970s was indeed a declining power

rather than a potential regional hegemon, which would imply that this case does not satisfy the

scope condition of my theory. In retrospect, however, the USSR remained a formidable

competitor for the U.S. until the mid-1980s. Evidence also suggests that the U.S. government

continued to presume that the Soviet Union had significant economic potential, although it was

later found out to be largely inflated.3 Thus, the U.S. decisions regarding commerce with the

USSR during the latter stages of the Cold War can be taken as a case in point to investigate how

a reigning power responds to a challenging power economically.

1
The other explanatory factor, dependence on challenger’s economic inputs, remained low during the period I
examine in this chapter.
2
For instance, see Stephen G. Brooks and William C. Wohlforth, “Economic Constraints and the End of the Cold
War,” in William C. Wohlforth, ed., Cold War Endgames: Oral History, Analysis, Debates (University Park, P.A.:
Penn State University Press, 2002), pp. 273-309.
3
For instance, see General Accounting Office, "Soviet Economy: Assessment of How Well the CIA Has Estimated
the Size of the Economy," September 1991 (GAO/NSIAD-91-274).

134
U.S. Response to the Soviet Challenge, 1979-1980

In December 1979, the détente between the U.S. and the Soviet Union was decisively

undermined by the military intervention of the USSR in Afghanistan. Having suffered criticism

for its lack of response to Soviet military assistance in Angola, Ethiopia, and South Yemen, as

well as in Central America, and having watched the Soviet deployment of SS-20 intermediate

range missiles in Europe, the Carter administration finally implemented a major revision of its

strategy toward the Soviet Union.4 The U.S. intended to utilize both military and economic

measures in confronting Soviet aggression. On the military side, Washington formally

recognized the Middle East-Persian Gulf area as a region of crucial security interest, and

declared that “the Persian Gulf shall have highest priority for improvement of strategic lift and

general purpose forces in the Five Year Defense Program.”5 Consequently, the Rapid

Deployment Joint Task Force was officially established in March 1980 and the U.S. strengthened

local capabilities to counter Soviet advancement.

At the same time, commercial links with the USSR that were established throughout the

1970s became a major target of revision for the Carter administration. Trade between the two

countries mainly involved Soviet importation of U.S. grains and small quantities of high-

technology goods, and the American purchase of Soviet raw materials. By 1979, total U.S.

exports to the Soviet Union amounted to 3.4 billion dollars, with grains accounting for 2.6 billion

dollars, manufactured-goods amounting to 600 million dollars, and high technology products

4
John Lewis Gaddis, Strategies of Containment (New York: Oxford University Press, 2005), pp. 348-9; Robert G.
Kaiser, “U.S.-Soviet Relations: Goodbye to Détente,” Foreign Affairs, Vol. 59, No. 3 (1980), pp. 500-521.
5
See Presidential Directive/NSC-62; and Jimmy Carter, “State of the Union Address Delivered before a Joint
Session of the Congress,” January 23, 1980. As Brzezinski put it, “the Persian Gulf shall have highest priority for
improvement of strategic lift and general purpose forces in the Five Year Defense Program.” Zbigniew Brzezinski,
Power and Principle: Memoirs of the National Security Advisor, 1977-1981 (New York: Farrar, Strauss and Giroux,
1983), pp. 454.

135
accounting for around 200 million dollars.6 These exports were suspected of contributing to the

Soviet Union’s economic vitality and, by extension, its military capability.

Leading Industries’ Low Dependence on Soviet Inputs

Throughout the 1970s, U.S. imports from the Soviet Union were small in quantity and no leading

U.S. industry depended on imported Soviet products to enhance productive efficiency or

competitiveness in the market. By the mid-1970s, major Soviet exports to the U.S. included

petroleum and petroleum products, nonferrous metals, and metalliferous ores and metal scrap.7

From January to November of 1979, in nonagricultural imports from the Soviet Union, gold

bullion accounted for 442 million dollars, palladium for 56 million dollars, ammonia for 50

million dollars, nickel for 16 million dollars, platinum for 14 million dollars, titanium for 13

million dollars, and chrome ore for 12 million dollars.8

For the U.S., imports from the Soviet Union could be easily obtained from other

exporters or sometimes even ignored due to their relatively minor importance to most U.S.

industries. As the Secretary of Commerce Philip Klutznick observed with regard to import from

the USSR, “It is very small, and it has been comprised of things like metals which can generally

be found elsewhere.”9 Except for some raw materials that could be easily substituted from

different countries, the U.S. did not rely on Soviet manufactured products. The rationale,

according to one U.S. official, was as follows: “American consumers have expressed little

6
U.S. Congress, Senate, Committee on Banking, Housing, and Urban Affairs, Subcommittee on International
Finance, U.S. Embargo of food and Technology to the Soviet Union, Hearings, 96th Congress, 2nd Session, January
22 and March 24, 1980, p. 21.
7
Franklin D. Holzman, “U.S.-Soviet Economic Relations,” Final Report to National Council for Soviet and East
European Research, April 1980, pp. 25-33.
8
U.S. Congress, U.S. Embargo of food and Technology to the Soviet Union, p. 45, fn 1.
9
Ibid, p. 45.

136
demand for Eastern manufactured goods that are usually inferior to Western quality, although in

recent years one is seeing more clothing, textiles and shoes from the East on the U.S. market.”10

Absence of Alternative Trading Partners for the USSR

While most U.S. industries did not depend on imports from the Soviet Union, the Carter

administration’s economic measures toward the USSR were deeply affected by the assessment of

the availability of alternative trading partners for Moscow. Considering the nature of extant U.S.-

Soviet trade, this implied that the U.S. government carefully examined whether the USSR could

divert its imports trade with the U.S. once Washington decided to impose restrictions. The U.S.

anticipated that no foreign country would be able to replace its position in the Soviet Union’s

procurement of foreign supplies.

First, the Carter administration expected that the Soviet Union would be unable to find

alternative sources to replace U.S. grains. By 1979, the U.S. was supplying approximately 83

percent of Soviet imports of coarse grain and 65 percent of its imports of wheat. After a poor

harvest in 1979, Moscow was expected to import about 35 million tons of grain, and 25 million

tons were to be purchased from the U.S.11 Grains were bottleneck items in the Soviet economy,

and ensuring a stable supply of foreign grains was essential for the success of Brezhnev’s

program of increasing Soviet meat consumption and labor productivity.12 Further, grain trade

was seen to have security implications as well. As Deputy Secretary of Defense, W. Graham

10
U.S. Congress, Senate, Subcommittee on International Economic Policy of the Committee on Foreign Relations,
East-West Economic Relations, Hearings, 97th Congress, 1st Session, September 16, 1981, p. 5.
11
Animesh Ghoshal, “Going against the Grain: Lessons of the 1980 Embargo,” World Economy, Vol. 6, No. 2 (June
1983), pp. 183-4.
12
Most of the grains U.S. exported to the USSR were feed grains for livestock. Brezhnev intended to utilize
imported grains to increase Soviet livestock herds, and expected that the enlargement of meat consumption would
lead to the increase of labor productivity. Thus, restrictions on grain exports were expected to cause a distress
slaughter of Soviet livestock herds. Peggy L. Falkenheim, “Post-Afghanistan Sanctions,” in David Leyton-Brown,
ed., The Utility of International Economic Sanctions (New York: St. Martin’s Press, 1987), p. 111; Robert L.
Paarlberg, “Lessons of the Grain Embargo,” Foreign Affairs, Vol. 59, No. 1 (Fall 1980), pp. 157-8.

137
Claytor observed, “The Soviets are making special demands on their economy to support their

forces. The U.S. grain embargo increased the strain on that economy. Poor agricultural

production is a particularly heavy burden for the Soviet leadership.”13

Washington expected that it could restrict the Soviet Union’s access to foreign grains

because no foreign country was capable of replacing the U.S. In the process leading up to

Carter’s imposition of grain embargoes, the Agriculture Department reported to the President

that no other country had the productive capacity to replace U.S. grain exports to the Soviet

Union.14 Secretary of Commerce Philip Klutznick also confirmed that “Grain exports to the

Soviet Union are an area in which the United States possesses considerable leverage. It would be

difficult for any other nation to effectively supply the Soviet’s near term grain needs, even if we

did not have the cooperation which most other supplier nations have now promised us.”15 Some

went far enough to suggest that the U.S. was an “OPEC of grain,” with “potentially more control

over world food supplies than Saudi Arabia has over oil.”16

At the same time, other grain exporting countries assured that they would not capitalize

on U.S. restrictions on its grain exports. After a conference with the representatives of Australia,

Canada, the European Community, and Argentina in Washington D.C. on January 12, 1980, the

U.S. stated that “there is general agreement among the export representatives here that their

Governments would not directly or indirectly replace the grain that would have been shipped to

the Soviet Union prior to the actions announced by President Carter.”17 This agreement was

interpreted as implying that all major grain exporters agreed to cooperate in order to achieve “our

13
U.S. Congress, U.S. Embargo of food and Technology to the Soviet Union, p. 89.
14
Brzezinski, Power and Principle, p. 431.
15
U.S. Congress, U.S. Embargo of food and Technology to the Soviet Union, p. 28.
16
Ibid., pp. 2, 10.
17
Ibid, p. 63. Also see Homer E. Moyer and Linda A. Mabry, “Export Controls as Instruments of Foreign Policy:
The History, Legal Issues, and Policy Lessons of Three Recent Cases,” Law and Policy in International Business,
Vol. 15, No. 1 (1983), pp. 43-4.

138
common purpose.”18 Consequently, according to Under Secretary of the Department of

Agriculture Dale Hathaway, “Under the most extreme conditions, the USSR will be able to

import no more than 26 million of the 35 million they apparently had hoped to import from all

sources. And our best estimate is that even with the minimum operation, they will get no more

than 22 million metric tons.”19 From the U.S. perspective, no other measure was as costly to the

Soviet Union as the imposition of grain embargoes.20

Second, the Carter administration envisaged that other advanced economies would not

take advantage of the U.S. in high technology exports. Indeed, in response to Carter’s plan of

denying Soviet Union access to important industrial products, U.S. allies committed themselves

not to capitalize on U.S. actions or to increase sales of the items that the U.S. intended to ban.

British and Canadian governments promised to adopt tighter restrictions on high technology

exports to the USSR. Japan supported U.S. sanctions by promising not to agree on new joint

development projects with the Soviet Union. President Giscard d’Estaing of France assured

Carter that French firms would not supply the high-technology goods the U.S. cut off. West

German Chancellor Helmut Schmidt also articulated the need for solidarity in the West and

agreed not to replace U.S. exports to the Soviet Union.21 Accordingly, at the inception of

Carter’s imposition of trade restrictions against the USSR, it was expected that the U.S. could

effectively deny alternative partners to the Soviet Union in many important trade domains. 22

18
U.S. Congress, U.S. Embargo of food and Technology to the Soviet Union, p. 118.
19
Ibid, p. 54.
20
Cyrus R. Vance, Hard Choices: Critical Years in America’s Foreign Policy (New York: Simon and Schuster,
1983), p. 389.
21
Falkenheim, “Post-Afghanistan Sanctions,” p. 120; Michael Howard, “Return to the Cold War?” Foreign Affairs,
Vol. 59, No. 3 (1980), pp. 465-6; Lisa L. Martin, Coercive Cooperation: Explaining Multilateral Economic
Sanctions (Princeton, N.J.: Princeton University Press, 1992), p. 193.
22
Moyer and Mabry, “Export Controls as Instruments of Foreign Policy,” pp. 45-6; U.S. Congress, U.S. Embargo of
food and Technology to the Soviet Union, p. 119.

139
Outcome: Severance of Trade Ties
Throughout 1979 and 1980, as it was expected that the Soviet Union would suffer relative losses,

the Carter administration actively imposed restrictions on most important dimensions of

commerce with the Soviets. In the 1970s, U.S. administrations since Nixon had continuously

relaxed controls on exports, although trade arrangements between the U.S. and the Soviet Union

were often challenged by Congress.23 The new economic measures by the Carter administration

were thus reversing the trajectory of increasing economic exchanges between the two countries

that had begun in 1972.

In grains trade, the U.S. withheld delivery of 17 million tons from the 25 million tons

contract for 1979/1980, shirking its commitment to the 1975 grain agreement.24 By extension of

the grain embargoes, phosphate exports were also banned. In high-technology trade, the

Commerce Department first froze all existing licenses for export to the Soviet Union and stopped

processing new license or renewal requests in January 1980, which was soon followed by more

stringent export guidelines in March 1980. Under the new control policies, the U.S. adopted a

“no-exceptions” approach, which implied that the U.S. would no longer allow exceptions for

U.S. firms to evade the Coordinating Committee (COCOM) control list. By September 1980,

only 281 of the 476 suspended licenses were reinstated and the extent of control expanded to

“process know-how to militarily relevant industrial sectors” in the Soviet Union.25

23
See Kazimierz Grzybowski, “United States-Soviet Union Trade Agreement of 1972,” Law and Contemporary
Problems, Vol. 37, No. 3 (Summer, 1972), pp. 395-428; Daniel Yergin, “Politics and Soviet-American Trade: The
Three Questions,” Foreign Affairs, Vol. 55, No. 3 (April, 1977), pp. 517-538. For U.S. domestic constraints due to
human rights issues, see Bruce W. Jentleson, “The Western Alliance and East-West Energy Trade,” in Gary K.
Bertsch, ed., Controlling East-West Trade and Technology Transfer (Durham, N.C.: Duke University Press, 1988), p.
328; Michael Mastanduno, Economic Containment (Ithaca, N.Y.: Cornell University Press, 1992), pp. 146-7.
24
Ghoshal, “Going against the Grain,” pp. 183-4.
25
Falkenheim, “Post-Afghanistan Sanctions,” p. 118; Mastanduno, Economic Containment, pp. 224-226.

140
 Overall, trade between the two powers which reached 4,522 million dollars in 1979

plummeted to 2,000 million dollars in 1980.26 U.S. economic measures against the USSR,

adopted side-by-side with the competitive military policy, were intended to inflict significant

damage on the Soviet economy. The main objective of the grain embargo was to deprive the

Soviet Union of the goods that were needed for its livestock herds, as well as to damage its food

industry and the diet of the population.27 Stringent controls in high-technology exports aimed at

constraining Moscow’s access to the western technology that was believed to help the Soviets

save resources for technology development. These technology controls were planned to remain

effective even if the Soviet Union changed its short term behavior.28

U.S. Response to the Soviet Challenge, 1981-1982

The Reagan administration came to office committed to rebuilding U.S. military superiority and

containing and reversing the expansion of the Soviet Union.29 After becoming president, Reagan

acknowledged that the Soviet economy “was a basket case, partly because of massive spending

on armaments,” and suggested “I wondered how we as a nation could use these cracks in the

Soviet system to accelerate the process of collapse.”30 The first Reagan directive on national

strategy, delivered in May 1982, explicitly stated that the U.S. would take serious efforts to force

“the USSR to bear the brunt of its economic shortcomings, and to encourage long-term

liberalizing and nationalist tendencies within the Soviet Union and allied countries.”31 Thus,

26
International Monetary Fund, Directions of Trade Statistics. Access http://elibrary-data.imf.org/.
27
Moyer and Mabry, “Export Controls as Instruments of Foreign Policy,” p. 33.
28
Mastanduno, Economic Containment, p. 224.
29
For the Reagan administration’s security strategy, see the White House, NSDD-32. Also see Caspar W.
Weinberger, “U.S. Defense Strategy,” Foreign Affairs, Vol. 64, No. 4 (Spring 1986), pp. 675-697.
30
Quoted in Gaddis, Strategies of Containment, p. 351.
31
See The White House, NSDD-32.

141
against the resurgent threat of Soviets aggression, the Reagan government not only accelerated

military buildup, but also envisioned cutting off economic ties with the Soviet Union. By doing

so, it intended to push the USSR to the breaking point.32

Still, when the Polish government, backed by the Soviet Union, cracked down on

Solidarity in late 1981, the U.S. shirked from severing trade with the USSR, although

Washington found a strong imperative to reinforce military countermeasures against Moscow.

Since the lifting of the grain embargo in April 1981, U.S. grain exports to the USSR were

restored to pre-Afghan sanctions levels, while in high-technology products the size of trade

remained miniscule and the Carter administration’s control measures remained effective.33

Reagan refused to re-impose the embargoes on grain even though it comprised the majority of

U.S. trade with the Soviet Union, contradicting his own security policy toward the USSR.

Similar to circumstances during the Carter era, U.S. industries during the Reagan

administration did not depend in any meaningful way on imports from the Soviet Union.

Reagan’s decision to maintain trade ties with the Soviet Union was mainly affected by the

presence of alternative trading partners for the USSR.

Existence of Alternative Trading Partners for the USSR

Reagan officials and the President himself were keenly aware that Carter’s post-Afghanistan

sanctions of 1980 turned out to be a failure. As Table 6-1 shows, between 1979 and 1980,

Britain, West Germany, France, Japan, and Italy’s exports to the Soviet Union increased while

32
Ibid; Louis J. Walinsky, “Coherent Defense Strategy: The Case for Economic Denial,” Foreign Affairs, Vol. 61,
No. 2 (Winter 1982), p. 272.
33
U.S. Congress, East-West Technology Transfer: A Congressional Dialog with the Reagan Administration
(Washington, D.C.: Government Printing Office, 1984), p. 21. In 1981, the US accounted for 3.3 percent of legal
exports of Western high technology to the USSR. See Bruce W. Jentleson, Pipeline Politics: The Complex Political
Economy of East-West Energy Trade (Ithaca, N.Y.: Cornell University Press, 1986), p. 179.

142
those of the U.S. decreased precipitously. The Soviet Union could easily find alternative trading

partners, and even U.S. allies were willing to take up for the absence of U.S. business. In short,

the U.S. in 1981 recognized that alternative trading partners existed for the Soviet Union.

Table 6-1. Western Exports to the Soviet Union, 1979-1982 (millions of dollars)

Country 1979 1980 1981 1982

Britain 891 1,058 871 620
FRG 3,619 4,373 3,394 3,870
France 2,005 2,465 1,865 1,559
Japan 2,443 2,796 3,253 3,893
Italy 1,222 1,267 1,285 1,499
U.S. 3,616 1,513 2,431 2,613
Source: IMF, Directions of Trade Yearbook, 1983, quoted in Mastanduno, Economic Containment, p. 233.

First, the Reagan administration was well aware that the U.S. could not effectively

control the flow of grains into the Soviet Union from other states. During the sanctions of 1980,

the Soviet Union took steps to reduce reliance on U.S. grain and diversify its grain imports. In

the 1979-1980 crop year, for example, Argentina exported 7.6 million tons of grain to the Soviet

Union and in July 1980 the two countries concluded an agreement to trade 4.5 million tons of

corn, sorghum and soybeans annually for the next five years. Brazil also increased grain sales to

the Soviet Union, signing a five-year agreement to provide soybeans, soya oil, and corn. Not

only the South American countries, but also Australia, Canada, and the European Community

countries withdrew or reconsidered their support of the grain embargo by late 1980.34 In May

1981, Ottawa went further and concluded an agreement with Moscow to sell a minimum of 25

million tons of grain over the next five years.35 Overall, according to one U.S. estimate, the

Soviet Union was able to import a total of 31 million tons of grain from alternative partners,

34
Congressional Research Service, An Assessment of the Afghanistan Sanction: Implications for Trade and
Diplomacy in the 1980s (Washington, D.C.: U.S. Government Printing Office, 1981), pp. 47-9.
35
Falkenheim, “Post-Afghanistan Sanctions,” pp. 113-115; Moyer and Mabry, “Export Controls,” pp. 44-5, 49-52;
Paarlberg, “Lessons of the Grain Embargo,” pp. 151-153.

143
which was only 2.5 million tons less than it had planned to import prior to the Carter

administration’s embargo.36

The U.S. found out that, as long as alternative partners existed for the Soviet Union,

grain embargoes would not only be ineffective but would also hurt the U.S. more than the Soviet

Union. Indeed, it was reported that Soviet diversification efforts resulted in the U.S. loss of the

Soviet market. During the eight years before the embargo of 1980, the U.S. supplied between 55

and 75 percent of Soviet grain imports, but since 1980 one third or less was provided by the

U.S.37 As President Reagan stated in early 1981, the grain embargo “was not having the desired

effect of seriously penalizing the USSR for its brutal invasion and occupation of Afghanistan.

Instead, alternative suppliers of this widely available commodity stepped in to make up for the

grain which would have been normally supplied by U.S. farmers.”38

Second, the Reagan administration also discovered that the USSR had alternative

partners in high-technology trade.39 Since coming to office, the new administration considered

technology control as an essential measure to weaken the Soviet Union. For instance, Secretary

of Defense Casper Weinberger noted that “without advanced technology from the West, the

Soviet leadership would be forced to choose between its military-industrial priorities and the

preservation of a tightly controlled political system. By allowing access to a wide range of

advanced technologies, we enable the Soviet leadership to evade that dilemma.”40 In this view,

denying Soviet access to advanced technologies would affect its military capability directly by

36
Paarlberg, “Lessons of the Grain Embargo,” p. 155; Moyer and Mabry, “Export Controls,” p. 50.
37
Falkenheim, “Post-Afghanistan Sanctions,” pp. 115-6
38
American Presidency Project, “Ronald Reagan: Statement on an Extension of the United States-Soviet Union
Grain Sales Agreement,” access http://www.presidency.ucsb.edu/ws/index.php?pid=42801#ixzz1r2tLQZQ8
39
Alexander M. Haig, Caveat: Realism, Reagan, and Foreign Policy (New York: Macmillan Publishing Company,
1984), p. 245; George P. Schultz, Turmoil and Triumph: Diplomacy, Power, and the Victory of the American Ideal
(New York: Scribner, 1995), p. 135, 138, 140; Vance, Hard Choices, p. 393.
40
Quoted in Mastanduno, Economic Containment, p. 238.

144
blocking it from achieving technological breakthroughs, and indirectly by rendering it more

costly to invest in the military. Given that multiple advanced economies emerged in the 1970s,

U.S. measures to limit technology transfer to the Soviet Union had to be reciprocated by others,

especially Western Europe and Japan.41

However, cooperation from allies was extremely difficult to attain, and U.S. companies

were losing due to unilateral controls. For instance, James Giffen, president of Armco

International, testified that in 1979 Armco and the Nippon Steel Corporation lost a 353 million

dollar contract to build a specialty steel mill in the USSR to a French competitor after the Carter

administration’s Afghanistan sanctions. Caterpillar Tractor Company also lost a 90 million dollar

contract to a foreign firm.42 As it was pointed out in the Senate, many high-technology products

were “readily and competitively available from other places in the world,” and by restricting

export of those goods, “we were depriving American manufacturers from having access to those

markets.”43 Different views on the geopolitical competition with the Soviet Union and the

security implications of East-West trade, and the increasing economic power of Western Europe

as a unit were suggested as the causes of disagreement between the U.S. and its allies.44

The problem of alternative partners in high-technology trade was further compounded

by Western Europe’s decision to participate in the pipelines project to purchase Soviet natural

gas. While the U.S. was against exporting pipeline equipment that could have spillover effects on

41
Jentleson, Pipeline Politics, p. 175; Jentleson, “The Western Alliance and East-West Energy Trade,” p. 315.
42
Philip J. Funigiello, American-Soviet Trade in the Cold War (Chapel Hill, N.C.: The University of North Carolina
Press, 1988), p. 198.
43
U.S. Congress, Senate, Subcommittee on International Economic Policy of the Committee on Foreign Relations,
East-West Economic Relations, Hearings, 97th Congress, 1st Session, September 16, 1981, p. 11.
44
U.S. Congress, House, the Subcommittee on Europe and the Middle East of the Committee on Foreign Affairs,
United States-West European Relations in 1980, Hearings, 96th Congress, 2nd Session, June 25, July 22, September
9, 15, and 22, 1980, pp. iv-vii. Also see Congressional Research Service, An Assessment of the Afghanistan
Sanction, p. 98; Haig Caveat, p. 245; Angela E. Stent, “East-West Economic Relations and the Western Alliance,”
in Bruce Parrott ed., Trade, Technology, and Soviet-American Relations (Bloomington, I.N.: Indiana University
Press, 1985), 283-323.

145
the Soviet Union’s military production, the Western European states were determined to proceed

with the project as planned. The U.S. had only limited leverage in affecting the development of

the project because, as the Office of Technology Assessment pointed out, “with few exceptions,

adequate quantities of the energy equipment sought by the USSR are produced and available

outside the United States, and the quality of these foreign goods is generally comparable to that

of their U.S. counterparts.”45 Still, pressuring its allies with negative incentives was not an

attractive option, since that policy could induce more losses for the U.S. by introducing frictions

among the NATO countries. Indeed, when the U.S. imposed extraterritorial pipeline sanctions on

the affiliates of U.S. firms in Western Europe, British, French, and German leaders were

infuriated and the EC formally protested the U.S. decision as “unacceptable interference in its

sovereign affairs.”46

Outcome: Maintenance of Extant Trade Ties

Despite its promulgation of competitive military policies against the Soviet Union, the Reagan

administration did not sever trade ties with the Soviet Union once it discovered that alternative

trading partners existed for the USSR. In grains trade, the Reagan administration refused to re-

impose embargoes and decided to continue existing export policy. On July 30, 1982, the U.S.

extended the 1975 Grain Agreement with the Soviet Union for one year, and in October 1982,

Reagan announced that the Soviets would be allowed to purchase up to 23 million tons of

grain.47 Even though limiting food supplies could be the most effective economic tool that the

45
Quoted in Jentleson, “The Western Alliance and East-West Energy Trade,” p. 315.
46
Jentleson, Pipeline Politics, p. 195.
47
Moyer and Mobly, “Export Controls,” p. 76; Michel Tatu, “U.S.-Soviet Relations: A Turning Point?” Foreign
Affairs, Vol. 61, No. 3 (1982), pp. 600-601; U.S. Congress, East-West Technology Transfer: A Congressional Dialog
with the Reagan Administration (Washington, D.C.: Government Printing Office, 1984), p. 14.

146
U.S. could wield to weaken the Soviet Union, the presence of alternative grain suppliers

constrained Reagan’s economic options.

In high-technology trade, the U.S. contemplated strengthening domestic and

international control schemes, but it soon encountered difficulties because of strong resistance

from other advanced economies. Even though the U.S. first expected that it could force allies to

stop supplying important equipment and know-how to the Soviet Union, especially those for the

ongoing pipeline project, it soon turned out that the Western European countries would choose to

openly blame the U.S. rather than conceding. Those countries also criticized the U.S. for refusing

to pay its own price by continuing grain trade.48 Consequently, as Martin Feldstein, Chairman of

the Council of Economic Advisors, pointed out, by pressuring other advanced economies to

adopt more stringent control measures “We were hurting the allies and ourselves.”49 Observing

that embargoes on high-technology pipeline equipment resulted in U.S. losses and controversies

within NATO, on November 13, 1982, President Reagan lifted the sanctions against U.S. allies.

Even though the Reagan administration took technology control very seriously, the U.S. had no

choice but to maintain extant policy arrangements when the Soviet Union could easily find

alternative partners.

Alternative Explanations

In contrast to my theory, the two alternative theories are not well supported empirically. In

particular, their causal mechanisms are not well corroborated by evidence. One alternative

explanation suggests that commercial interest groups that benefited from trade with the Soviet

48
David A. Baldwin, Economic Statecraft (Princeton, N.J.: Princeton University Press, 1985), p. 280; Martin,
Coercive Cooperation, p. 222.
49
Quoted in Funigiello, American-Soviet Trade in the Cold War, p. 207.

147
Union should have tried to defend their economic interests by pressuring the government.

Maintenance or severance of trade ties with the Soviet Union should reflect the success or failure

of those commercial interests in influencing governmental decisions, as well as their competition

with other societal groups. This view, however, is not convincing.

For the Carter administration, domestic economic interests were largely irrelevant in the

decision to impose sanctions against the USSR.50 In particular, commercial groups that traded

heavily with the Soviet Union did not actively defend their interests. During the campaign for his

second term, President Carter was prepared to accept losing some electoral support from farm

states by adopting grain embargoes. Still, a rising patriotic tide made farm lobby groups endorse

rather than protest the president’s economic measures.51 For instance, major farmers’

organizations, including the Farmers Union and the Farm Bureau Federation, announced their

tentative support of the embargo, confirming the “rally around the president” effect during

international crisis.52 Also, as one congressman from a farm state suggested, the loss of profit

from foreign sales could be easily offset by setting the price more realistically at home. The grain

embargo and the profit of farm states were not necessarily mutually exclusive.53

In lifting the grain embargo, the Reagan administration justified the decision by arguing

that only American farmers were losing without penalizing the USSR.54 Of course, Reagan

promised to remove the grain embargo during the presidential campaign in order to garner

support from farm states, and this promise constrained Reagan’s decision when he came to

office. Still, it needs to be noted that Reagan was at first reluctant to lift the grain embargo

50
Mastanduno, Economic Containment, p. 264.
51
Paarlberg, “Lessons of the Grain Embargo,” p. 146.
52
U.S. Congress, U.S. Embargo of food and Technology to the Soviet Union, pp. 24-5.
53
Ibid, p. 10.
54
American Presidency Project, “Ronald Reagan: Statement on an Extension of the United States-Soviet Union
Grain Sales Agreement,” access http://www.presidency.ucsb.edu/ws/index.php?pid=42801#ixzz1r2tLQZQ8

148
around March 1981. He was well aware that such a decision would disappoint large political

groups and supporters who wanted the U.S. to become more assertive against the Soviets,

especially after the brutal suppression of protesters in Poland.55 Further, it is not difficult to

conceive that relaxing export controls directly contradicted Reagan’s own agenda in the security

realm. Hence, Reagan officials sometimes appealed to an ostensible logic that selling grains

would drain the Soviet Union’s hard currency reserve.

The presence of alternative trading partners for the Soviet Union was a crucial fact that

enabled the Reagan administration to solve the dilemma between its military and economic

policies toward the USSR. At the same time, the claim that only U.S. farmers were losing from

grain embargoes allowed Reagan to avoid the criticism that he was captured by parochial

domestic interests. In other words, even though the farm interests might have played some role in

Reagan’s decision to maintain grain exports, the logic I set forth was embraced by the Reagan

administration when it actually made decisions over commerce with the USSR. Thus, the theory

I advance can subsume the domestic interest explanation in this particular case.

The other alternative explanation, which emphasizes the use of economic inducements to

change the challenger’s behavior, is also not convincing. Regarding post-Afghanistan sanctions,

the Carter administration did not even expect that the U.S. could coerce the Soviets to leave

Afghanistan through economic measures.56 Thus, it is difficult to view the post-Afghanistan

sanctions as deliberate acts to affect the challenger’s behavior. Reagan officials also did not

justify continuing the grain trade on the basis of its utility in dissuading the Soviet Union from

taking aggressive actions around the globe. Indeed, the difficulty of shaping the Kremlin’s

behavior was a rationale underlying Reagan’s military buildup against the USSR.

55
Funigiello, American-Soviet Trade in the Cold War, pp. 194-5.
56
Brzezinski, Power and Principle, p. 430.

149
Conclusion

This chapter compared U.S. responses to the re-emerging Soviet threat during the Carter and

Reagan administrations. This period presents an opportunity to observe how U.S. economic

strategies toward the USSR changed as one factor—the presence of alternative partner for the

challenger—varied, while the other key variable—the leading industries’ dependence on the

challenger’s economic inputs—remained fixed. Comparing the Carter and Reagan

administrations’ choices during a short period of time also allowed this analysis to control for the

effect of diverse confounding factors.

As my theory predicts, the Reagan administration did not sever trade ties with the Soviet

Union when it recognized that Moscow could easily replace imports from the U.S. with goods

from other countries. This approach contrasts sharply with the Carter administration’s decision to

impose embargoes against Moscow after the Soviet Union’s invasion of Afghanistan. For Carter

and his officials, it was expected that the Brezhnev regime would face significant economic

problems when the U.S. cut off grain exports. No foreign country seemed capable of or willing

to replace the U.S. in the trade of grains. As such, variation in the presence of alternative trading

partner constrained U.S. options and resulted in different outcomes in decisions over commerce

with the Soviet Union.

150
 CHAPTER 7

U.S. ECONOMIC RESPONSE TO THE CHINESE

CHALLENGE, 2008-

Throughout the 2000s, the U.S. clearly recognized China as its strategic competitor.1 In part as a

response to China’s growing military clout, the U.S. has maintained a large military presence in

Asia, while diminishing its forces in other regions of the world. More recently, with the Obama

administration’s declaration of “pivot to Asia,” many of the most capable U.S. military units

concentrated in the Middle East or mobilized for the War on Terror were redeployed to East

Asia. The U.S. has also increased investments in its ability to project forces across the Pacific.2

Moreover, Washington has made careful efforts to revamp its alliance system in Asia, while

building foundations for closer security cooperation even with its former adversaries such as

Vietnam.3 These developments might be interpreted as an incipient form of military containment

1
For instance, see Condoleezza Rice, “Promoting the National Interest,” Foreign Affairs, Vol. 79, No. 1
(January/February 2000), pp. 45-62; According to President Obama, “China’s both an adversary but also a potential
partner in the international community if it’s following the rules.” See “Transcript and Audio: Third Presidential
Debate,” NPR, October 22, 2012, http://www.npr.org/2012/10/22/163436694/transcript-3rd-obama-romney-
presidential-debate. Also see Aaron L. Friedberg, A Contest for Supremacy (New York: W. W. Norton, 2011).
2
For instance, see Department of Defense, Sustaining U.S. Global Leadership: Priorities for 21 st Century Defense,
January 2012, http://www.defense.gov/news/defense_strategic_guidance.pdf; Department of Defense, Quadrennial
Defense Review 2014, http://www.defense.gov/pubs/2014_Quadrennial_Defense_Review.pdf; Ministry of Defense,
Defense of Japan, 2011-2014, http://www.mod.go.jp/e/publ/w_paper/; Raymond T. Odierno, “The U.S. Army in a
Time of Transition,” Foreign Affairs, Vol. 91, No. 3 (2012), pp. 7-11; Kirk Spitzer, “U.S. Army to Asia: “We’re
Back,” Time, December 7, 2012. Also see Carnes Lord and Andrew S. Erickson ed., Rebalancing U.S. Forces:
Basing and Forward Presence in the Asia-Pacific (Annapolis, M.D.: Naval Institute Press, 2014).
3
Department of State, “U.S.-Vietnam Comprehensive Partnership,” December 16, 2013,
http://www.state.gov/r/pa/prs/ps/2013/218734.htm; “A Deepening Partnership with Vietnam,” The New York Times,
October 24, 2014; “Philippines Offers U.S. Forces Access to Military Bases,” Reuters, March 14, 2014. Also see
Committee on Foreign Relations, 113th Congress, Re-Balancing the Rebalance: Resourcing U.S. Diplomatic
Strategy in the Asia-Pacific Region (Washington, D.C.: U.S. Government Printing Office, 2014).

151
of China, although it is still unclear whether Washington would take more dramatic military

actions against Beijing.4

Meanwhile, the U.S. has become China’s major trade partner and has actively supported

China’s participation in the global economy. The U.S. backed China’s accession to the World

Trade Organization in 2001, and hence trade between the two countries (in goods) skyrocketed

from 121 billion dollars in 2001 to 562 billion dollars in 2013.5 Moreover, the U.S. has actively

endorsed China’s ascendance at the center of international processing trade. Indeed, China has

become one of the most trade dependent powers in the world, with an average 53.2 percent trade-

to-GDP ratio between 2010 and 2012, as well as becoming the world’s largest exporter and

second largest importer of merchandise.6 Analysts suggest that expanding exports has directly

contributed to China’s growth by increasing income and rationalizing production, and, indirectly,

by stimulating domestic consumption, investment, and government spending. The central role

occupied by Chinese firms in the global processing trade and imports from advanced economies

have also aided China by enhancing productivity and advancing technology development.7

These two contradictory developments in the U.S.’ military and economic policies

toward China reflect a dilemma in Washington’s strategy vis-à-vis Beijing. Economic

ascendance based on extensive commercial exchanges with the U.S. has fueled China’s military

4
Moreover, since the U.S. military has undergone a reduction of its overall size and experienced severe budgetary
constraints, an increase of U.S. forces in Asia, although not massive, suggests that Washington is taking the Chinese
military challenge very seriously.
5
U.S. Census, “Trade in Goods with China,” http://www.census.gov/foreign-trade/balance/c5700.html.
6
World Trade Organization (WTO), Trade Profiles 2013 (Geneva: WTO, 2013), p. 43.
7
Depending on the model used for estimation, the exact size of the effect of trade on China’s GDP growth diverges.
However, few doubt that international trade has contributed to China’s economic growth. For instance, see Yilmaz
Akyüz, “Export Dependence and Sustainability of Growth in China,” China and World Economy, Vol. 19, No. 1
(2011), pp. 1-23; “How Fit Is the Panda?,” The Economist, September 27, 2007; John Knight and Sai Ding, China’s
Remarkable Economic Growth (Oxford: Oxford University Press, 2012); Justin Yifu Lin, Demystifying the Chinese
Economic (New York: Cambridge University Press, 2012); Xiaohui Liu, Peter Burridge, and P. J. N. Sinclair,
“Relationship between Economic Growth, Foreign Direct Investment, and Trade: Evidence from China,” Applied
Economics, Vol. 34, No. 11 (2002), pp. 1433-1440; and Dani Rodrick, “What’s So Special about China’s Exports?”
China and World Economy, Vol. 14, No. 5 (September 2006), pp. 1-19.

152
buildup, which in turn has forced the U.S. to bolster its military presence in Asia.8 Contrary to

expectations that economic benefits would tempt China to conform to rules set by the U.S.—or

even become a “responsible stakeholder” of the U.S.-led international system—China has

strengthened its voice against the U.S. dominance in East Asia and around the globe, while

becoming more assertive in territorial disputes with U.S. allies in the West Pacific.9 Furthermore,

the dramatic increase of China’s gross domestic product has introduced waves of debates on

global power shifts and consequent systemic instability.10

This chapter examines whether the U.S. would be able to resolve this incongruity

between military and economic policies toward China—and if the U.S. would be able to

complement military containment of a more aggressive China by restricting bilateral trade—

applying the theory I developed and tested in previous chapters. I focus on the U.S. response to

the Chinese challenge since the late 2000s because, only in this period did China become the

world’s second largest economy and the U.S. reinforced its major combat units against China. In

8
Friedberg, A Contest for Supremacy, p. 109.
9
For the argument on “responsible stakeholder,” see Robert B. Zoellick, “Whither China: From Membership to
Responsibility?” Remarks to National Committee on U.S.-China Relations, September 21, 2005, access http://2001-
2009.state.gov/s/d/former/zoellick/rem/53682.htm. For the tension between China and U.S. allies in Asia, see
“Could Asia Really Go to War over These?” The Economist, September 22, 2012; Elizabeth Economy, “The Game
Changer: Coping with China’s Foreign Policy Revolution,” Foreign Affairs, Vol. 89, No. 6 (November/December
2010), pp. 149-150; Mark Landler, “Offering to Aid Talks, U.S. Challenges China on Disputed Islands,” New York
Times, July 23, 2010.
10
For instance, see Paul Kennedy, “American Power Is on the Wane,” Wall Street Journal, January 14, 2009;
Christopher Layne, “The Global Power Shift from West to East,” National Interest, No. 119 (May/June 2012), pp.
21-31; John J. Mearsheimer, “The Gathering Storm: China’s Challenge to U.S. Power in Asia,” The Chinese Journal
of International Politics, Vol. 3, No. 4 (Winter 2010), pp. 381-396; National Intelligence Council, Global Trends
2025: A Transformed World (Washington, D.C.: NIC, 2008); Robert A. Pape, “Empire Falls,” National Interest, No.
99 (January/February 2009), pp. 21-34; Gideon Rachman, “American Decline: This Time It’s for Real,” Foreign
Policy, No. 184 (January/February 2011), pp. 59–65; Arvind Subramanian, “The Inevitable Superpower,” Foreign
Affairs, Vol. 90, No. 5 (September/October 2011), pp. 66-78; Stephen M. Walt, “The End of the American Era,”
National Interest, No. 116 (November/December 2011), pp. 6-16; and Fareed Zakaria, The Post-American World
(New York: W.W. Norton, 2008). China’s GDP (ppp) was 13,395 billion dollars in 2013, while the U.S. GDP was
16,244 billion dollars. In terms of current prices, China’s GDP reached 9181 billion dollars in 2013. IMF, “World
Economic Outlook Database,” http://www.imf.org/external/pubs/ft/weo/2014/01/weodata/index.aspx.

153
other words, the U.S.’ relations with China before 2008 do not satisfy the scope condition of my

theory.

It needs to be noted that an assessment of the U.S. ability to manipulate commerce with

China is bound to be truncated. Today’s international commerce and Sino-U.S. economic ties are

extremely complex.11 Moreover, much of the data that could help test my argument against the

U.S. experience vis-à-vis China are the proprietary information of private companies.12 It might

also be needed to run economic simulations in order to accurately calculate the expected loss of

the U.S. from restricting trade with China, but a reliable simulation model is not publicly

available yet.13 Furthermore, primary sources on U.S. leaders’ actual belief, debate, and decision

making processes in dealing with China will remain classified for the next several decades.14

Accordingly, this chapter has modest goals. It examines government reports, academic

writings, and data and indices that are widely used by economic analysts in order to assess if the

U.S.’ leading industries depend heavily on Chinese economic inputs and whether China would

11
In the real world, diverse economic exchanges between China and the U.S., including production, trade, finance,
and investment are intimately linked with one another. Therefore, one might suggest that examining only
commercial relations is meaningless. Against this perspective, I explicitly focus on trade because there is no
theoretical framework allowing one to account for all important dimensions of bilateral economic exchanges. In the
economics literature, finance, production, trade, and investment are different sub-disciplines that build on different
theoretical framework. Different actors, interests, and institutions are involved in each of those economic activities.
In this situation, projecting one theoretical perspective across different realms of international economic exchanges
is likely to entail the danger of extrapolation. A different research project is needed to study the developments in
each of these issue areas.
12
For instance, the Department of Commerce gathers information on how much each U.S. firm trades with foreign
entities, and the Internal Revenue Service compiles reports from U.S. companies on their specific business activities
around the world for tax purposes. These firm level data, however, are not released for public view.
13
The optimal economic simulation for this purpose would require extensive firm-specific data, but those data are
confidential information. A different way of calculating the U.S.’ expected loss would be using simulation models
currently being used by U.S. governmental agencies that report to the White House and Congress (for instance, the
United States International Trade Commission (USITC)’s USAGE model). However, even such models build on
strong assumptions that might not correctly represent the Sino-U.S. relationship. Moreover, focusing on examining
the aggregate impact of certain policy decisions, they would not be able to predict outcomes in one specific bilateral
relationship. For an application of the simulation models, see USITC, China’s Agricultural Trade: Competitive
Conditions and Effects on U.S. Exports (Washington, D.C.: USITC, 2011), Appendix F.
14
Of course, there are official statements from U.S. leaders and writings by current and former officials who discuss
relations with China in their private capacities. Still, these are not undisputable primary sources showing the
underlying thinking and processes through which U.S. decision toward China are made.

154
be able to find alternative trading partners. Then, I explore how these two conditions can be

linked to the continuing U.S. refusal to impose any serious restrictions on trade with China.

My analysis suggests that the U.S. is not in the position that allows the reigning power to

restrict trade with the challenging power—leading industries’ low dependence on the

challenger’s economic inputs and absence of alternative trading partners for the challenging

power—although it is difficult to pinpoint where exactly the U.S. stands with regard to the two

explanatory factors. Thus, it might be better for the U.S. to maintain extant trade ties with China

and sustain the trajectory of current policies. Even if the U.S. decides to counterbalance China

more actively, commercial measures that undermine China’s further growth may not be a viable

or productive option for the U.S.

U.S. Leading Industries’ Dependence on Chinese Economic Inputs

In inter-industry trade (trade between states that have different industrial compositions, such as

the trade between China and the U.S.), a large portion of bilateral commerce in effect entails

exchanges of factors of production or tasks.15 From the mainstream trade economists’

perspective, when U.S. manufacturers trade intermediate or final goods with their Chinese

subsidiaries or subcontractors, that transaction entails importing Chinese labor or tasks.16

15
See Donald R. Davis, “Intra-Industry Trade: A Heckscher-Ohlin-Ricardo Approach,” Journal of International
Economics, Vol. 39, No. 3 (November 1995), pp. 201-226; Ronald R. Davis and David E. Weinstein, “An Account
of Global Factor Trade,” American Economic Review, Vol. 91, No. 5 (December 2001), pp. 1423-1453; Paul R.
Krugman, Maurice Obstfeld, and Marc J. Melitz, International Economics: Theory and Policy, ninth edition (New
York: Addison-Wesley, 2012); John Romalis, “Factor Proportions and the Structure of Commodity Trade,”
American Economic Review, Vol. 94, No. 1 (March 2004), pp. 67-97. Also, as I show below, many of the U.S.
imports from China are goods produced by U.S. firms in China, not simple final goods made by Chinese firms.
16
These economic transactions are often called offshoring or outsourcing. Still, they can be taken into account
within the framework of foreign trade through the concept of trade in tasks. See William Milberg and Deborah
Winkler, Outsourcing Economics: Global Value Chains in Capitalist Development (New York: Cambridge
University Press, 2013), chapter 1. Also see Gene M. Grossman and Esteban Rossi-Hansberg, “Trading Tasks: A
Simple Theory of Offshoring,” American Economic Review, Vol. 98, No. 5, (December 2008), pp. 1978-97.

155
Similarly, when the U.S. obtains Chinese final consumer goods for wholesale and retail, the U.S.

in effect is purchasing Chinese factors of production or tasks.17 Considering major U.S.

manufacturing and retail/wholesale industries’ massive purchase of Chinese economic inputs—

and their productivity and competitiveness gains vis-à-vis powerful foreign competitors—the

U.S. is likely to encounter a large loss in terms of overall economic performance were it to

restrict trade with China abruptly.18

Which Leading U.S. Industries?

Although the U.S. stands out among the great powers of modern history for its economic

diversity and reliance on the vast home market, there are certain industries that generate a huge

portion of U.S. GDP by engaging deeply in international trade.19 In terms of the value-added to

GDP, as Table 7-1 shows, there are several U.S. industries that are led by American

multinational corporations. While many U.S. companies are not engaged in foreign trade, MNCs,

by definition, are very active players in international commerce. Moreover, while most, if not all,

international trade occurs between or within firms, much trade is conducted by MNCs today.20

Moreover, as Gregory Mankiw points out, from the theoretical perspective “outsourcing is just a new way of doing
international trade.” “Why ‘Outsourcing’ May Lose Its Power as a Scare Word,” The New York Times, August 13,
2006.
17
Many consumer goods entail the cost of labor. In this case, U.S. retail/wholesale purchase from China rather than
from American firms because Chinese goods entail lower labor costs. In effect, purchasing from China involves
paying for Chinese labor, which proved to be cheaper than U.S. labor. Standard trade theories focus on what is
entailed in consumer goods trade. For mainstream trade theories, see Cletus Coughlin, “The Controversy over Free
Trade,” Federal Reserve Bank of St. Louis Review, Vol. 84, No. 1 (Jan./Feb. 2002), pp. 1-22; Elhanan Helpman,
“The Structure of Foreign Trade,” Journal of Economic Perspectives, Vol. 13, No. 2 (Spring 1999), pp. 121-144; and
Krugman, Obstfeld, and Melitz, International Economics.
18
To be clear, this does not mean that the U.S. economy would be paralyzed without trade with China.
19
For a recent work on the uniqueness of the U.S. economy, see Carla Norrlof, America’s Global Advantage: U.S.
Hegemony and International Cooperation (Cambridge: Cambridge University Press, 2010).
20
For instance, see Andrew B. Bernard, J. Bradford Jensen, Stephen J. Redding, and Peter K. Schott, “Firms in
International Trade,” Journal of Economic Perspectives, Vol. 21, No. 3 (Summer 2007), pp. 105-130; James R.
Markusen, “The Boundaries of Multinational Enterprises and the Theory of International Trade,” Journal of
Economic Perspectives, Vol. 9, No. 2 (Spring 1995), pp. 169-189; Krugman, Obstfeld, and Melitz, International
Economics. Also see Pol Antràs and Stephen R.Yeaple, “Multinational Firms and the Structure of International
Trade,” NBER Working Paper No. 18775, February, 2013.

156
Those MNCs have a particularly strong presence in the manufacturing industries and contribute

significantly to the U.S. GDP. Retail, wholesale, and mining industries are other areas where

MNCs play important roles.21 Table 7-2 further illustrates that U.S. MNCs, especially those in

manufacturing industries, are deeply engaged in global business and obtains enormous wealth

through their activities in foreign countries.

Table 7-1. U.S. MNCs (Parent Companies) Value Added to U.S. GDP (in billions of dollars)

2009 2010 2011 2012

All Industries Total 2595.78 2948.66 3160.86 3246.33
Mining 76.14 74.86 94.28 90.92
Manufacturing 1034.14 1147.23 1278.57 1271.61
Wholesale trade 124.43 142.6 160.46 164.00
Retail trade 238.58 257.16 265.38 270.18
Information22 287.63 333.15 351.74 377.74
Finance and insurance 260.12 356.98 356.92 393.82
Professional, scientific,
and technical services 177.55 196.29 198.09 204.4
Other industries23 397.18 440.38 455.43 473.67
Source: Bureau of Economic Analysis

Table 7-2. U.S. MNCs (Parent Companies) Total Sales in the World (in billions of dollars)

2009 2010 2011 2012

All Industries Total 9208.8 9774.34 10593.2 10926.35
Mining 108.03 125.24 160.7 168.88
Manufacturing 3656.72 4035.64 4569.69 4677.02
Wholesale trade 1109.79 1121.75 1233.88 1219.27
Retail trade 930.57 943.36 987.97 1051.95
Information 708.96 741.45 812.54 911.69
Finance and insurance 1509.37 1591.29 1545.82 1602.65
Professional, scientific,
307.77 310.09 322.68 334.34
and technical services
Other industries 877.58 905.5 959.92 960.54
Source: Bureau of Economic Analysis

21
The service industries—including the finance sector—that clearly do not obtain any significant inputs from China
are excluded from the analysis in this chapter
22
“Information” include Publishing industries, Motion picture and sound recording industries, Broadcasting (except
internet) and telecommunications, Broadcasting (except internet), Telecommunications, Data processing, hosting,
and related services, and Other information services
23
“Other industries” include Agriculture, forestry, fishing, and hunting, Construction, Utilities, Transportation and
warehousing, Real estate and rental and leasing, Management of nonbank companies and enterprises,
Administration, support, and waste management, Health care and social assistance, Accommodation and food
services, and Miscellaneous services.

157
 Accordingly, in this chapter, I focus on the manufacturing industries and retail/wholesale

industries. These industries’ performance is likely to be affected by, or benefit from, exchanges

with foreign countries since they are led by American MNCs. After examining whether the

manufacturing and retail/wholesale industries depend on economic inputs from China, this

chapter suggests that those industries would encounter significant economic loss when extant

commercial linkages with China are restricted.

Inputs from China: Chinese Labor/Tasks and Their Implications for the U.S.
U.S. MANUFACTURING INDUSTRIES’ USE OF CHINESE INPUTS

Since the entry of China’s massive labor force into the global economy, the U.S. manufacturing

sector has purchased heavily Chinese economic inputs in the forms of labor and tasks performed

by China’s large industrial clusters. Between 1990 and 2011, while the proportion of U.S.

manufactured imports from the Pacific Rim countries in its overall manufactured imports

changed only slightly from 47.1 percent to 46.1 percent, China’s share in this trade increased

from 3.6 percent to 25.3 percent.24 A large portion of these increased imports from China

entailed the U.S. manufacturing industries obtaining important labor and tasks from China.

Analysts point out that the U.S.’ purchase of Chinese inputs started from low value-added

consumer goods such as apparel, cloths, and other miscellaneous manufactured commodities, but

these were soon overtaken by advanced technology products, most notably communication

equipment, computers, and other electronics.25 By concentrating final or intermediate assembly

24
Wayne M. Morrison, “China-U.S. Trade Issues,” CRS Report to Congress, May 21, 2012, p. 10.
25
See USITC, Journal of International Commerce and Economics, Vol. 3, No. 1 (May 2011). Also see Wayne M.
Morrison, “China-U.S. Trade Issues,” CRS Report to Congress, September 30, 2011, p. 9.

158
to low- and semi-skilled labor rich China, the U.S. manufacturing industry could elaborate

competitive advantage and contribute to the overall economic efficiency of its home country.26

Table 7-3. Related Party Share of Major U.S. Imports from China27

2009 2011 2013

% of Related % of Related % of Related
Imports Party Imports Party Imports Party
Computer Equipment 14.6% 64.0% 16.4% 58.2% 14.8% 53.5%
Communication Equipment 7.8% 48.6% 9.5% 44.5% 12.7% 46.8%
Women's Apparel 5.3% 2.3% 4.6% 3.7% 4.5% 5.2%
Semiconductors/Electric Components 4.2% 44.4% 5.0% 46.1% 4.4% 49.0%
Footwear 4.5% 2.1% 4.1% 2.2% 3.8% 2.2%
Toys 6.2% 48.1% 4.1% 29.8% 3.4% 28.9%
Audio and Video Equipment 6.1% 40.4% 4.0% 41.2% 3.1% 39.7%
Furniture 3.1% 7.0% 2.8% 8.6% 2.9% 10.6%
Plastic Products 1.9% 6.8% 1.9% 7.1% 2.0% 7.1%
Small Electrical Appliances 2.0% 15.7% 1.9% 16.5% 1.9% 10.7%
Leather Products 1.8% 3.2% 1.8% 3.8% 1.8% 3.8%
Other Manufactured Commodities 1.8% 7.2% 1.7% 8.0% 1.7% 9.8%
Men's Apparel 1.9% 3.5% 1.8% 4.6% 1.6% 4.1%
Lighting Fixtures 1.1% 5.8% 1.2% 6.8% 1.4% 11.4%
General Purpose Machinery 1.3% 35.1% 1.3% 37.2% 1.4% 36.3%
Navigational, Measuring, Medical,
1.2% 41.1% 1.2% 48.8% 1.4% 46.6%
Control Instruments
Basic Organic Chemicals 1.0% 28.6% 1.2% 24.8% 1.3% 26.7%
Curtains and Linens 1.4% 3.6% 1.3% 3.8% 1.3% 5.2%
Fabricated Metal Products 1.1% 9.3% 1.2% 12.8% 1.2% 11.0%
Motor Vehicle Parts 0.7% 15.7% 1.0% 16.6% 1.2% 22.5%
Electric Equipment 0.9% 31.2% 1.0% 33.7% 1.1% 37.2%
Major Appliances 0.9% 15.5% 0.8% 13.5% 1.1% 31.6%
Sporting and Athletic Goods 1.2% 8.6% 1.1% 8.2% 1.0% 8.5%
Metal Valves 0.8% 20.8% 1.0% 22.1% 1.0% 21.1%
Jewelry and Silverware 0.9% 7.2% 1.0% 9.1% 1.0% 12.3%
Source: U.S. Census

26
Judith M. Dean, “Testimony before the U.S.-China Economic and Security Review Commission,” Hearing on the
Evolving U.S.-China Trade and Investment Relationship, June 14, 2012, access
http://www.uscc.gov/hearings/2012hearings/written_testimonies/12_6_14/Dean.pdf; Theresa M. Greaney and Mary
E. Lovely, “China, Japan, and the United States: Deeper Economic Integration,” Journal of Asian Economic, Vol.
20, No. 6 (November 2009), pp. 593-595; USITC, The Economic Effect of Significant U.S. Import Restraints,
seventh update (Washington, D.C.:USITC, 2011).
27
Items that comprise one percent or more of U.S. imports from China are listed in this table (five digit end-use
code).

159
 An assessment of available quantitative and qualitative data reinforces the view that the

U.S. manufacturing industries’ massive purchase of Chinese labor and tasks is a central feature

of bilateral commerce during recent years. Table 7-3 summarizes major goods imported from

China, the percentage share of those goods in all U.S. imports from China, and what portion of

those items were produced by U.S. firms’ partners or subsidiaries in China between 2009 and

2013. An important pattern is observed in this data: advanced technology products comprise the

largest portion of U.S. imports from China, but many of those products are goods made by U.S.

firms in China. Indeed, it can be suggested that, the more technologically advanced the imported

products are, the more likely it is that they are produced by U.S. firms’ initiatives in China.

Moreover, on average, more than 90 percent of U.S. manufacturing industries that imported from

China produced goods through their subsidiaries or partners in China between 2008 and 2013.28

As such, the related party data on U.S. imports from China suggests that U.S. firms in the

manufacturing sector extensively utilize Chinese economic inputs.29

This trend is also confirmed by the fact that processing or value-added trade has

constituted a significant portion of the commerce between the two countries.30 In 2005, the

United States was the largest destination for China’s processing exports, accounting for

approximately 31 percent of its total value-added exports.31 One estimate suggests that, in 2007,

28
Author’s calculation based on data from U.S. Census (NAICS 6 digit), http://sasweb.ssd.census.gov/relatedparty/.
29
For more specific discussions of bilateral trade, see USITC, The Year in Trade 2013 (Washington, D.C.: USITC,
2014).
30
According to one estimate, “About 58% of China’s VA exports are final goods. Only 23% are intermediates used
in final goods by the direct importer, and about 19% are intermediates further processed by the direct importer and
then exported. These results suggest that China is indeed near the end of many global supply chains.” Dean,
“Testimony,” p. 11.
31
In the same year, processing exports comprised 54.7 percent of China’s entire exports. Alyson C. Ma, Ari Van
Assche, and Chang Hong, “Global Production Network and China’s Processing Trade,” Journal of Asian
Economics, Vol. 20, No. 6 (November 2009), p. 647. Also see Prema-Chandra Athukorala, “Production Networks
and Trade Patterns in East Asia: Regionalization of Globalization?,” Asian Economic Papers, Vol. 10, No. 1 (2011),
pp. 65-95.

160
62.5 percent of China’s exports to the U.S. were processing exports.32 From this information, it

can be presumed that a significant portion of Chinese processing exports was comprised of

products made for U.S. firms, although company-specific proprietary data might be needed to

know exactly how much China has produced for American corporations.

Table 7-4. Examples of Major U.S. Industries’ Gains by Purchasing from China

Chinese Contributions
Industry China’s Role in the Supply Chain (Supply Industries) to the Performance of
the Industry
Circuit board & electronic component; Computer;
Aerospace Cost reduction
Engine & turbine; Semiconductor & circuit
Agriculture,
Engine & turbine; Power tools & other general purpose
construction, &
machinery; Wind turbine; Tire; Ferrous metal foundry Stable supplier; Cost reduction
mining machinery
products
manufacturing
Computer &
Semiconductor & circuit; Wire & cable; Semiconductor Cost reduction; Major
peripheral equipment
machinery production base
manufacturing
Semiconductor &
other electronic Cost reduction; Major
Aluminum manufacturing
component production base
manufacturing
Communications Circuit board & electronic component; Computer;
Cost reduction; Major
equipment Computer peripherals; Semiconductor & circuit;
production base
manufacturing Telecommunication networking equipment
Motor vehicle Automobile brakes; Automobile electronics;
Cost reduction; Stable supplier
manufacturing Automobile interior
Aluminum; Nut & bolt; Textile mills; Circuit board &
Motor vehicle parts electronic component; Lighting & bulb; Power
Cost reduction; Stable supplier
manufacturing conversion equipment; Semiconductor & circuit; Wire &
cable; Leather good & luggage; Synthetic fiber; Ball bearing
Navigational,
measuring,
electromedical, & Electric equipment; Glass product; Hose & belt Stable supplier
control instruments
manufacturing
Engine, turbine, and
power transmission Ball bearing; Metalworking machinery; Screw, nut & Reduce cost; Avoid
equipment bolt environmental regulations
manufacturing
Source: IBIS World; Orbis

32
This estimation builds on the data provided by China Customs Statistics and Chinese Ministry of Commerce. See
Judith M. Dean, Mary E. Lovely, and Jesse Mora, “Decomposing China-Japan-U.S. Trade: Vertical Specialization,
Ownership, and Organizational Form,” Journal of Asian Economics, Vol. 20, No. 6 (November 2009), p. 599. Also
see Robert Koopman, Zhi Wang, and Shang-jin Wei, “How Much of Chinese Exports Is Really Made in China?
Assessing Foreign and Domestic Value-Added in Gross Exports,” Office of Economics Working Paper, No. 2008-
03-B, USITC, March 2008. Moreover, value-added trade measures reveal approximately 40 percent smaller deficit
for the U.S. than using conventional trade statistics. See Dean, “Testimony.”

161
 Table 7-4 compiles specific examples of major U.S. manufacturing industries’ purchase

of Chinese economic inputs and the contributions of those inputs to their overall performance.

Usually, a supply chain or production relationship is involved in those industries’ trade with

China: U.S. firms purchased supplies ranging from nuts and bolts to semiconductors and

computers in order to make final goods at lower costs. On many other occasions, China

functioned as a production base for American companies, an activity often called offshoring of

production. In this trade with China, U.S. firms, in effect, imported Chinese labor or tasks in

order to reduce costs and enhance competitiveness.33

Meanwhile, a number of the U.S.’ leading industries have imported Chinese labor and

tasks not only to consolidate their position in home market, but also to enhance their

performance in the global market. Many U.S. firms have created majority-owned affiliates

around the world in order to more effectively utilize local economic inputs and expand sales in

certain foreign markets.34 Those affiliates not only produce goods that can be sent to their mother

companies, but also sell their products in local and foreign markets. In other words, to more

effectively purchase labor and tasks from China, U.S. firms set up affiliates in that country, and

export to the world through those local subsidiaries. Table 7-5 shows that U.S. MNCs’ exports to

unaffiliated foreign and local destinations are far larger than their exports to the home market or

other affiliated parties. It also illustrates that a significant part of major U.S. industries’

commercial performance is dependent on sales through affiliates in China.

33
Thus, economists agree that offshoring is “simply a new form of international trade.” See Gregory N. Mankiw and
Phillip Swagel, “The Politics and Economics of Offshore Outsourcing,” AEI Working Paper Series, July 2006.
34
Bernard, Jensen, Redding, and Schott, “Firms in International Trade”; Markusen, “The Boundaries”; Stephen D.
Cohen, Multilateral Corporations and Foreign Direct Investment (New York: Oxford University Press, 2007);
Robert Feenstra. “Integration of Trade and Disintegration of Production in the Global Economy,” Journal of
Economic Perspectives 12, No. 4 (Fall 1998), pp. 31–50; Geoffrey Jones, Multinationals and Global Capitalism
(New York: Oxford University Press, 2005); Milberg and Winkler, Outsourcing Economics.

162
 Table 7-5. Goods Supplied by Majority-Owned U.S. Affiliates in China (in millions of dollars)

2009 2010 2011 2012

To affiliated persons 29051 36304 47464 48192
To unaffiliated persons 88821 101690 125584 143415
To U.S. parents 8397 9047 13295 12266
To unaffiliated U.S. persons 1686 1672 2150 2282
To other foreign affiliates 13688 19229 20291 20466
To unaffiliated foreign persons 8990 10852 13672 14186
To other local foreign affiliates 6966 8027 13878 15460
To unaffiliated local persons 78145 89166 109763 126947
Source: Bureau of Economic Analysis

It needs to be noted that major U.S. industries also purchase Chinese labor and tasks

through exchanges with non-majority owned suppliers and sub-contractors in China. However,

while the data in Table 7-5 only capture business activities conducted by U.S. affiliates in China,

U.S. MNCs activities through non-affiliated companies in China are not known. For instance,

while Apple Inc. produces extensively in China through contracts with foreign companies, how

much Apple sells to the world through those contractors is not known to outside observers. When

non-majority owned suppliers and sub-contractors in China are taken into account, the extent to

which U.S. leading industries purchase from China would increase significantly. Moreover, their

gains from the exchanges with China would dramatically expand.

WHY CHINESE INPUTS MATTER: SEVERE INTERNATIONAL COMPETITION

For major U.S. manufacturing industries, Chinese economic inputs are important because

they are exposed to severe international competition. Considering the fact that powerful foreign

competitors exist in almost all manufacturing industries, even a small decrease in

competitiveness is likely to result in a decrease in the U.S. manufacturing firms’ overall

performance and revenue. Table 7-6 presents examples of foreign competitors in major

manufacturing industries. In this Table, “U.S. MNCs” are major American firms that lead U.S.

163
manufacturing industries (see Table 7-4), and obtain important economic inputs from China

within the context of supply chains or through production activities in China. Table 7-6 shows

that, while U.S. manufacturing industries (and manufacturing MNCs) are concentrated in areas

where technology and economies of scale are important, there are foreign firms that possess

equivalent, if not better, technology and size.35 These U.S. and foreign firms compete with each

other over market share, and try to utilize diverse resources from around the world in order to

achieve greater competitiveness. Indeed, the presence of severe international competition is one

of the most important reasons why U.S. industries have established relationships with Chinese

economic inputs in the first place.36 In this situation, it is evident that the loss of access to

Chinese economic inputs would only weaken U.S. firms’ position vis-à-vis their foreign

competitors.

Table 7-6. Foreign Competitors of Major U.S. MNCs

Industry U.S. MNCs Foreign Competitors

EADS, Bombardier, BAE Systems, Embraer,
Boeing, United Technologies, Lockheed
Aerospace Rolls-Royce, Turbomecanica, Mitsubishi,
Martin, Textron, Spirit Aerosystems
Kawasaki, GKN, Dassault
Agriculture, Komatsu, Kubota, AB Volvo, Doosan Infracore,
Caterpillar, Deere & Co, Baker Hughes,
construction, & MAN SE, Atlas Copco, Siemens, Aker
AGCO, Cameron International, FMC
mining machinery Solutions,
manufacturing Technologies, Joy Global
Mitsubishi, Hitachi, CNH Global
Apple, Hewlett-Packard, Dell, EMC,
Computer &
Western Digital, Seagate Technology, SCI Acer, Lenovo, Toshiba, Canon, Fujitsu,
peripheral equipment
manufacturing
Systems, Samsung, Hitachi, Sony
Netapp, Sandisc
Semiconductor & Intel, Jabil Circuit, Texas Instruments,
Samsung, Renesas, STMicroelectronics, NXP,
other electronic Micron Technology, Tyco Electronics,
Infineon, Denso, Sumitomo, Asahi Glass, Shin-
component Corning, Broadcom, Sanmina, Advanced
manufacturing Etsu, Heraeus, Prysmian, OC Oerlikon
Micro Devices
Communications VIA Technologies, Ericsson, Fujitsu, Mediatek,
Cisco, Qualcomm, L-3 Communications,
equipment Renesas, Samsung, Spreadtrum, Panasonic, A
manufacturing
Ratheon, Motorola, Harris
lcatel Lucent, Datalogic, Sepura, EADS, Thales

35
In the grocery industry, competition is mainly observed between U.S. companies. Still, once imports from China
are restricted, the price of goods sold by the U.S. grocery sector will rise, leading to a decrease of overall sales and
profit. Also, U.S. consumers’ real income would diminish since they would need to pay more to purchase similar
goods.
36
For instance, see Bernard, Jensen, Redding, and Schott, “Firms in International Trade”; Markusen, “The
Boundaries”; Cohen, Multilateral Corporations; Feenstra. “Integration of Trade”; Jones, Multinationals and Global
Capitalism; Milberg and Winkler, Outsourcing Economics.

164
 Table 7-6 (continued)

Industry U.S. MNCs Foreign Competitors

Motor vehicle General Motors, Ford, Chrysler, Paccar, Daimler, Toyota, Honda, Volkswagen,
manufacturing Navistar Mitsubishi, Hyundai
Johnson Controls, Lear Corp, Autoliv, Daikin, GS Yuasa, Siemens, Robert Bosch,
Motor vehicle parts
Tenneco, Dana, Borgwarner, Visteon, Schneider Electronic, Faurecia, Toyota
manufacturing
Federal-Mogul, Delphi Boshoku, Magna, Leoni,
Honeywell, General Dynamics, Northrop
Navigational, Grumman, Emerson Electric, Raytheon, Mitsui & Co, IHI, Daikin, Teijin, Tosoh,
measuring,
Danaher, Medtronic, Thermo Fisher Yokogawa, Akebono, Siemens, Basf, Olympus,
electromedical, &
control instruments
Scientific, Terumo, Koninklijke Philips, Getinge, Bruker,
manufacturing Boston Scientific, Agilent, Rockwell, Exelis, Shimadzu, Anritsu
St. Jude Medical
Engine, turbine, and
Siemens, Hitachi, Toshiba, Mitsubishi, Denso,
power transmission General Electric, Cummins, United
Hino, AB Volvo, Robert Bosch, Weichai,
equipment Technologies
manufacturing MAN, Gutenberg Group
Source: Orbis

In sum, U.S. manufacturing industries successfully reduce the cost of production through

bilateral trade with China. By doing so, they can more effectively compete with other foreign

companies, in particular those from other advanced economies. Moreover, China has also

functioned as a “stable” supplier to U.S. industries. With the rising importance of the global

supply chain, establishing relationships with foreign suppliers that can provide diverse items at

needed quantity and standardized quality have become very important for leading manufacturing

industries around the world.37 Supply chain relationships with China have proven to be

particularly advantageous in reducing risks related to the globalization of production.

RETAIL/WHOLESALE INDUSTRY

Another sector of the U.S. economy that purchases large quantities of Chinese economic

inputs—in the forms of labor and tasks—is the retail/wholesale industries. As economic theories

suggest, importing final consumer goods from a foreign state entails the purchase of that

37
For the importance of maintaining stable global supply chain, see Deloitte Development LLC, “The Ripple Effect:
How Manufacturing and Retail Executives View the Growing Challenge of Supply Chain Risk,”
http://www.deloitte.com/assets/Dcom-
UnitedStates/Local%20Assets/Documents/Consulting/us_consulting_therippleeffect_041213.pdf.

165
country’s labor or tasks.38 In this regard, when the U.S. purchases final consumer goods from

China, it is in effect purchasing cheap Chinese labor and tasks.

As it is often criticized by U.S. non-governmental organizations, U.S. retail/wholesale

industries, led by giant firms such as Walmart, purchase a large amount of tasks performed by

Chinese labor in the form of final consumer goods.39 For instance, by 2004, Walmart had

established supply relationships with more than 5,000 Chinese companies; and about 70 percent

of the goods it sold in the U.S. were made in China.40 Moreover, Walmart alone accounted for

about 9.2 percent of all U.S. imports of merchandise from China in 2006.41 Although specific

data on how much U.S. retail/wholesale companies buy from China today remains proprietary

information, it can be reasonably expected that the quantity and extent of those purchases are still

very large.

By purchasing a large quantity and variety of final goods from China, all else being

equal, the U.S. retail/wholesale business can expand their sales and profit. As their business

prosper, the retail/wholesale industry contributes more to the overall U.S. economic clout.

Moreover, the purchase of cheap Chinese final goods increases the real income of the U.S.

because American consumers can buy more goods with less money. Furthermore, by purchasing

the labor and tasks entailed in Chinese final goods, the U.S. can reallocate its resources to more

productive areas, further rationalizing its economy.42

38
Milberg and Winkler, Outsourcing Economics; Grossman and Rossi-Hansberg, “Trading Tasks.”
39
For instance, see Anita Chan ed., Walmart in China (Ithaca, N.Y.: Cornell University Press, 2011); Robert E.
Scott, “The Wal-Mart Effect: Its Chinese Imports Have Displaced Nearly 200,000 U.S. Jobs,” Economic Policy
Institute Issue Brief, No. 235, June 26, 2007.
40
Jingjing Jiang, “Wal-Mart’s China Inventory to Hit U.S.$18b This Year,” China Daily, November 29, 2004,
http://www.chinadaily.com.cn/english/doc/2004-11/29/content_395728.htm.
41
Scott, “The Wal-Mart Effect.”
42
This assessment is based on economic theories of international trade, which agree that inter-industry trade
enhances a state’s overall economic capacity. Still, such trade might create winners and losers. Scholars disagree
about the distributional consequences of trade, although they agree that trade contributes to the economy as a whole.
For instance, see Alan S. Blinder, “Offshoring: The Next Industrial Revolution?” Foreign Affairs, Vol. 85, No. 2

166
Low Substitutability of Chinese Economic Inputs
While leading U.S. industries in the manufacturing and retail/wholesale sectors extensively

purchase Chinese labor and tasks, other states are unlikely to be able to fully replace China as the

supplier of those inputs. Some might claim that the rising cost of Chinese labor and the

emergence of other labor-rich countries in the global economy have weakened China’s position

as the provider of labor and tasks for the U.S.43 They might further argue that Chinese inputs can

be easily substituted with inputs from other countries if need be. Nonetheless, there are reasons

to doubt the optimism on the substitutability of Chinese economic inputs.

Table 7-7. Revealed Comparative Advantage Based on Domestic Value Added Embodied in
Gross Exports of Manufacturing Goods (2009)

Wood,
Textiles, Chemicals Basic
Food paper,
textile and metals Machinery Electrical
products, paper Manufactu-
products, non- and and and Transport
beverages products, ring nec;
leather metallic fabricated equipment, optical equipment
and printing recycling
and mineral metal nec equipment
tobacco and
footwear products products
publishing
China 0.3445 2.9657 0.4726 0.4874 0.8386 0.7762 1.7693 0.3392 1.7631
Brazil 3.5196 0.5182 1.2894 0.8678 1.5995 0.5363 0.2838 0.9959 0.2452
India 0.6808 2.0925 0.3544 0.8047 0.9458 0.4212 0.9902 0.5252 4.7253
Indonesia 2.762 1.6041 1.3709 1.3045 0.7429 0.4357 0.5319 0.3243 0.9076
Malaysia 0.8579 0.4928 1.5659 1.5439 0.336 1.1953 1.5606 0.0948 0.1947
Mexico 0.8621 0.6701 0.3126 0.7473 1.1836 0.3968 1.2036 1.9552 1.1352
Thailand 2.5857 2.0131 0.4423 0.7237 0.5176 0.1954 1.5185 0.278 1.5578
Source: OECD-WTO Trade in Value Added

Table 7-7 summarizes the revealed comparative advantages of several labor-rich

countries. It shows that China has a clear advantage to other countries in textiles, textile

products, leather and footwear, machinery and equipment, electrical and optical equipment, and

(Mar.-Apr. 2006), pp. 113-128. Also see Gene M. Grossman and Elhanan Helpman, “Protection for Sale,” The
American Economic Review, Vol. 84, No. 4 (September 1994), pp. 833-850; Matthew J. Slaughter, “Globalization
and Wages: A Tale of Two Perspectives,” World Economy, Vol. 22 (1999), pp. 609-629.
43
Kevin Brown, “Rising Chinese Wages Pose Relocation Risk,” The Financial Times, February 15, 2011.

167
the manufacturing of diverse unspecifiable products. Other labor-rich states that might serve as

the U.S.’ production base do not possess as much comparative advantage as China in those

industries. China’s leadership in these industries is consistent with the composition of bilateral

trade between the U.S. and China, where diverse electronic products and textiles/apparels

comprise the majority of U.S. imports from China. Considering that a country’s comparative

advantage in certain industries does not change rapidly, China’s leadership in the

abovementioned industries is likely to endure for the near future.

Economic analysts agree that other potential production bases around the world are still

incapable of replacing China as the provider of labor and important tasks. Although other labor-

rich countries might exist, there are entry barriers to the tasks that are currently performed by

China. Simply put, other labor abundant countries are not ready to do much of what China does

for major U.S. industries.44 Such a barrier would not exist at the low end of the global production

chain.45 However, the ability to create scale economies and the possession of sufficient

technology, as well as the reliability as the supplier, are very important as a state moves up the

value chain (and do the job China performs today). Other labor-rich countries do not possess that

ability and reliability. Further, over one hundred industrial clusters have endowed China with a

unique advantage in the global processing trade compared with other potential manufacturing

centers. Each of these clusters specializes in producing certain goods and provides foreign firms

with governmental support, sophisticated supply chains, knowledge of the production process,

44
Accenture, “Wage Increase in China: Should Multinationals Rethink Their Manufacturing and Sourcing
Strategies?,” 2011, access
http://www.accenture.com/sitecollectiondocuments/pdf/accenture_wage_increases_in_china.pdf; Deloitte, “2013
Global Manufacturing Competitiveness Index,” 2012, access http://www.deloitte.com/assets/Dcom-
UnitedStates/Local%20Assets/Documents/us_pip_GMCI_11292012.pdf.
45
For instance, Vietnam easily observed low value add activities from China. See “Plus One Economy,” The
Economist, September 2, 2010.

168
and the flexibility to rapidly adjust to changing product specifications.46 Indeed, low wages have

not been the sole reason for U.S. producers to locate their production bases in China since the

1990s.47 In this regard, China is a “strong first-tier supplier” for manufacturing industries that

focus on more advanced technologies, while other developing countries such as India, Indonesia,

Malaysia, and Thailand are not.48 In fact, it would be more accurate to suggest that the tasks

Southeast and South Asian countries perform are different from what China does for the U.S.49

Moreover, business analysts suggest that China offers unique profit advantages to major

U.S. MNCs.50 Although rising labor costs in China have led many firms to consider the “China

plus one strategy”—adding a production base in a Southeast Asian state in addition to a base in

coastal China—utilizing Chinese economic inputs has at least four advantages that are not

available in other countries: (1) access to the booming Chinese domestic market, (2) increasing

Chinese labor productivity that offsets increasing Chinese wages, (3) a pool of labor that is large

and flexible enough to accommodate rapidly changing market demands, and (4) a reliable and

46
Li and Fung Research Centre, “Industrial Cluster Series,” No. 6, June 2010, access
http://www.funggroup.com/eng/knowledge/research/LFIndustrial6.pdf. Also see Douglas Zhihua Zeng, ed., Building
Engines for Growth and Competitiveness in China: Experience with Special Economic Zones and Industrial
Clusters (Washington, D.C.: The World Bank, 2010).
47
For instance, see U.S. Government Accountability Office, “Offshoring: U.S. Semiconductor and Software
Industries Increasingly Produce in China and India,” Report to the Committee on Foreign Affairs, GAO-06-423,
September 2006, pp. 13-20.
48
Milberg and Winkler, Outsourcing Economics, pp. 123-128. For evidence that the Southeast Asian states are
unlikely to be able to substitute China, USITC, ASEAN: Regional Trends in Economic Integration, Export
Competitiveness, and Inbound Investment for Selected Industries (Washington, D.C.: USITC, 2010).
49
Thus, despite the rising wage, China’s exports continued to thrive, and China remained the world’s production
center. Keith Bradsher, “Even as Wages Rise, China Exports Grow,” The New York Times, January 9, 2014; Tom
Orlik, “Rising Wages Pose Dilemma for China,” The Wall Street Journal, May 17, 2012.
50
An industry’s decision to use foreign economic inputs is determined by the prospects of profit, not calculation of
cost—including the cost of labor—per se. In this context, the dependence on Chinese economic inputs is eventually
determined by whether countries other than China can allow leading U.S. industries to attain their current level of
profit. Unless other countries could provide labor and tasks at levels comparable to current Chinese quality and
reliability—not simply at current cost—major U.S. industries’ profits would diminish. If China plays a unique role
with regard to U.S. industries’ profit, other countries are unable to replace China’s role.

169
flexible supply chain that could minimize risk.51 Others suggest that the undervalued renminbi

makes it profitable to purchase Chinese labor and tasks and sell goods in the world market

through China.52 These attributes of Chinese economic inputs help U.S. industries obtain more

profit, and are not available in other countries. Accordingly, although a number of U.S. firms

have “re-shored” some portion of their manufacturing activities from China to the U.S., they are

limited to certain high value-added and automated production, and those companies continue to

rely on Chinese inputs to remain competitive.53

In sum, for the U.S., the risk of “not being in China” is likely to be larger than the risk of

“being in China.”54 All else being equal, if the U.S. restricts trade with China, major U.S.

manufacturing industries (and to some extent, the wholesale/retail industry) are likely to become

less competitive, and lose revenues to foreign firms and obtain significantly less profit, thus

generating less material clout for the U.S. as a whole.55

The Availability of Alternative Trading Partners for China

In the current international economic structure, the U.S. is unlikely to be able to deny alternative

trading partners to China in all important aspects of foreign commerce. While the most important

51
“The Boomerang effect: As Chinese Wages Rise, Some Production Is Moving Back to the Rich World,” The
Economist, April 21, 2012; “The End of Cheap China: What Do Soaring Chinese Wages Mean for Global
Manufacturing?,” The Economist, March 10, 2012.
52
Ralph E. Gomory, “Testimony,” in U.S.-China Economic and Security Review Commission, Hearing on China’s
Industrial Policy and its Impact on U.S. Companies, Workers, and the American Economy, March 24, 2009. Low
wage, unfair labor standard, and lax enforcement of environmental protection laws also make China attractive for
U.S. manufacturers. See U.S.-China Economic and Security Review Commission, 2009 Report to Congress, 111th
Congress, 1st Session (Washington, D.C.: Government Printing Office, 2009), pp. 67-69.
53
“In Shift of Jobs, Apple Will Make Some Macs in U.S.,” New York Times, December 6, 2012.
54
For similar views, see Martin N. Bailey, “Adjusting to China: A Challenge to the U.S. Manufacturing Sector.”
Brookings Policy Brief, No. 179, January 2011; Robert Lawrence and Lawrence Edwards, Rising Tide: Is Growth in
Emerging Economies Good for the United States? (Washington, D.C.: Peterson Institute, 2011).
55
This view is in line with the USITC, The Economic Effect of Significant U.S. Import Restraints.

170
economic inputs China obtains from the U.S. are comprised of advanced technology products,

food, and services, there are other advanced economies and food producers around the world that

would be willing to take over U.S. sales to China. Moreover, under certain circumstances, China

might be able to divert a significant portion of its exports away from the U.S. Meanwhile,

Washington is likely to experience frictions with China’s alternative trading partners.

Alternative Partners with Regard to Imports from the U.S.

As Table 7-8 shows, China purchases a wide array of goods from the U.S. Between 2009 and

2013, the largest Chinese imports from the U.S. were oil seeds, oil nuts, and oil kernels. China

also imported a large quantity of raw materials from the U.S., including metal scraps, cotton,

hides and skins, coal, coke, and briquettes. Still, the majority of China’s imports from the U.S.

were manufactured industrial products, especially electronic products, machinery, transportation

equipment, chemicals, and equipment for diverse industrial and other purposes.

Table 7-8. Major U.S. Merchandise Exports to China (in millions of dollars)

2009 2010 2011 2012 2013

Total 69,571 91,872 103,715 110,584 121,440
Oil seeds, oil nuts and oil kernels 9,230.4 10,853.7 10,485.6 15,001.6 13,392.3
Other electrical machinery and apparatus 6,452.7 8,251.3 6,705.0 6,393.3 7,498.5
Special transactions not classd.accord.to kind 5,918.1 7,057.5 7,268.0 9,195.8 13,569.9
Plastic materials, regenerd. cellulose & resins 4,019.7 4,349.0 4,598.0 4,198.2 4,243.5
Machinery and appliances non electrical parts 3,965.4 5,989.8 6,474.8 5,746.3 6,409.8
Non ferrous metal scrap 2,661.1 4,505.6 6,320.2 5,439.0 5,147.9
Scientific,medical,optical,meas./contr.instrum. 2,583.9 3,346.4 3,549.5 4,039.8 4,062.8
Pulp & waste paper 2,497.6 3,047.2 3,998.0 3,818.9 3,610.4
Iron and steel scrap 2,478.0 1,772.9 2,290.5 1,325.1 1,172.3
Organic chemicals 2,363.4 2,976.3 3,475.5 3,185.1 2,877.8
Office machines 2,032.8 2,283.9 2,044.7 1,897.1 1,928.9
Road motor vehicles 1,842.0 4,366.0 6,612.2 6,909.9 10,201.2
Telecommunications apparatus 1,495.2 1,609.4 1,771.6 2,038.5 2,647.7
Electric power machinery and switchgear 1,455.2 1,776.3 1,896.3 1,956.8 2,228.7
Chemical materials and products, nes 1,161.3 1,588.6 1,759.1 1,931.1 2,276.2

171
 Table 7-8 (continued)

Machines for special industries 957.5 1,077.0 1,288.4 1,317.1 1,125.4

Power generating machinery, other than
899.7 1,216.0 1,583.5 1,416.0 1,709.6
electric
Cotton 867.9 2,217.7 2,634.4 3,441.0 2,202.0
Inorg.chemicals elems.,oxides,halogen salts 727.2 1,222.4 1,022.9 972.5 584.8
Ores & concentrates of non ferrous base
721.2 1,161.6 1,149.8 1,142.3 940.1
metals
Elec.apparatus for medic.purp.,radio. ap. 646.3 816.3 988.4 1,168.1 1,261.9
Petroleum products 416.0 720.7 1,157.6 1,234.7 1,663.0
Wood in the rough or roughly squared 244.1 643.0 1,092.2 816.4 1,153.7
Medicinal & pharmaceutical products 532.8 686.1 1,057.0 1,177.0 1,361.0
Hides & skins, exc.fur skins undressed 576.3 818.5 1,049.4 1,213.2 1,470.7
Maize (corn), unmilled 52.5 287.9 850.0 1,319.4 1,255.2
Coal, coke & briquettes 121.9 620.6 835.1 1,257.2 906.8
Source: UN Comtrade

While Beijing has pursued “indigenous innovation” as an important national objective

and tried to transform itself into an “innovation society,” these economic inputs from the U.S.

had important ramifications for China.56 In particular, as many U.S. officials argued, the U.S.

export of diverse ATPs helped China nurture its own advanced technology sector.57 Thus, were

the U.S. cut off bilateral trade, China might encounter significant economic loss if it could not

find alternative suppliers of its current imports from the U.S.

China, nonetheless, is likely to be able to find alternative trading partners to obtain

important industrial goods and raw materials. Most notably, there are several advanced

56
USITC, China: Effects of Intellectual Property Infringement and Indigenous Innovation Policies on the U.S.
Economy (Washington, D.C.: USITC, 2011); U.S.-China Economic and Security Review Commission, Assessing
China’s Efforts to Become an “Innovation Society”- A Progress Report (Washington, D.C.: U.S.-China Economic
and Security Review Commission, 2012).
57
In turn, China would advance its military related technologies. See Bureau of Industry and Security, U.S. Dual-
Use Export Controls for China Need to Be Strengthened, Final Report, No. IPE-17500, March 2006; Ian F.
Fergusson, “The Export Administration Act: Evolution, Provisions, and Debate,” CRS Report to Congress
(RL31832), July 2009; Ian F. Fergusson and Paul K. Kerr, “The U.S. Export Control System and the President’s
Reform Initiative,” CRS Report to Congress (R41916), July 2011; Susan V. Lawrence and David MacDonald, “U.S.-
China Relations: Policy Issues,” CRS Report for Congress (R41108), August 2012. Indeed, the U.S.’ advanced
technology product (ATP) exports to China have outpaced U.S. ATP exports to other parts of the world. See
Alexander Hammer, Robert Koopman, and Andrew Martinez, “Overview of U.S.-China Trade in Advanced
Technology Products,” United States International Trade Commission Journal of International Commerce and
Economics, Vol. 3, No. 1 (May 2011), pp. 5-12.

172
economies around the world that produce goods similar to the U.S. and compete with American

manufacturers on the market. For the firms in those advanced economies, U.S. restrictions on its

own exports to China would be a wonderful opportunity to expand their market share and

advance their competitive advantage. Especially, the advanced economies that are not threatened

by China in security relations would be particularly eager to take over U.S. exports to China.58

Today, the European Union states can be such countries.

Table 7-9. EU-28’s Major Merchandise Exports to China (in millions of dollars)

2009 2010 2011 2012 2013

Total 112,794 148,986 171,215 184,232 195,728
Machinery and appliances non electrical parts 17,338.4 22,872.9 25,725.4 22,623.1 24,676.1
Road motor vehicles 11,372.3 23,168.2 30,196.7 35,279.1 37,714.5
Electric power machinery and switchgear 7,276.5 8,916.0 8,769.2 8,523.7 9,112.9
Other electrical machinery and apparatus 5,158.2 6,185.9 6,554.1 6,902.0 7,992.6
Power generating machinery, other than
5,142.5 6,115.0 6,332.3 7,054.3 7,148.8
electric
Aircraft 4,640.1 6,518.5 6,833.0 8,553.6 8,371.8
Plastic materials, regenerd. cellulose & resins 3,856.1 4,329.3 4,077.6 4,435.6 4,608.3
Scientific medical,optical,meas./contr.instrum. 3,807.7 5,119.8 5,930.5 7,004.6 7,692.9
Machines for special industries 3,562.2 4,548.4 4,820.7 4,096.2 3,856.4
Metalworking machinery 3,506.8 3,728.5 4,381.7 4,869.3 4,342.0
Special transactions not classd.accord.to kind 3,479.0 3,968.3 4,075.4 4,531.6 4,642.9
Organic chemicals 3,049.1 3,160.9 3,347.7 3,717.2 3,374.4
Medicinal & pharmaceutical products 3,018.6 3,697.8 4,761.1 6,283.7 7,057.7
Non ferrous metal scrap 2,916.7 3,865.9 4,315.3 4,258.8 3,656.9
Copper 2,139.4 1,959.4 2,769.7 3,639.1 2,880.9
Telecommunications apparatus 1,897.2 2,106.7 2,193.7 2,477.4 2,661.9
Pulp & waste paper 1,504.5 1,893.4 2,557.4 2,544.5 2,423.0
Office machines 1,470.1 1,354.5 1,382.2 1,386.8 1,340.2
Chemical materials and products,nes 1,332.0 1,721.2 2,119.0 2,177.0 2,539.9
Textile and leather machinery 1,298.2 2,030.8 2,325.7 2,076.7 1,990.1
Tubes, pipes and fittings of iron or steel 1,166.8 674.0 764.3 637.0 952.9
Manufactures of metal, nes 1,023.3 1,314.9 1,437.8 1,543.9 1,736.9

58
Of course, other advanced economies are concerned about the economic impact of technology transfer and weak
intellectual property right protection in China, as well as the problem of undervalued yuan. Still, all else being equal,
they would be inclined to expand their sales to China if the U.S. restricts its exports. For the EU’s concerns about
trade with China, see http://ec.europa.eu/trade/policy/countries-and-regions/countries/china/.

173
 Table 7-9 (continued)

Universals plates and sheets of iron or steel 1,019.0 1,138.3 1,398.9 1,289.0 1,311.9
Petroleum products 491.4 969.0 1,416.3 1,768.5 1,904.9
Elec apparatus for medic.purp.,radio. ap. 785.2 986.9 1,259.1 1,454.7 1,716.2
Source: UN Comtrade

Table 7-9 suggests that the EU states can be alternative suppliers of important

commodities for China. Except for certain raw materials, the EU exports to China the same

categories of goods as the U.S. The similarity of the EU and the U.S.’ exports to China is

particularly notable in ATPs including electronics, machinery, and equipment. This similarity

suggests that the EU and the U.S. are competitors in the Chinese market; and it is likely that

European companies would readily expand their sales to China if American firms cut off their

exports for political reasons.

Indeed, during the 2000s, on average 65 percent of the EU’s exports to China were

machinery, equipment, transport, and electronics, in which the Europeans transferred technology

to meet the requirements of the Chinese government.59 Although the Western European states

sometimes could not fully compete with cutting-edge U.S. technology, the EU possessed many

advanced technologies that were nearly equivalent to those of the U.S.60 According to the

Chinese Ministry of Commerce, the EU became China’s principal source of technology imports

in 2009, accounting for about 30 percent of all technology imports.61

China’s ability to find alternative trading partners—in particular the ability to obtain

diverse ATPs from the EU—has been recognized by U.S. practitioners as well. As former

59
Nicola Casarini, Remaking Global Order: The Evolution of Europe-China Relations and Its Implication for East
Asia and the United States (New York: Oxford University Press, 2009), pp. 44-5, 81-139; May Britt U. Stunbaum,
“Risky Business? The EU, China and Dual-Use Technology,” Occasional Paper, No. 80, European Union Institute
for Security Studies, October 2009, pp. 14-15.
60
Mitchel B. Wallerstein, “Losing Controls,” Foreign Affairs, Vol. 88, No. 6 (November/December 2009), pp. 17-
18.
61
Oliver Bräuner, “China’s Rise as a Global S&T Power and China-EU Cooperation,” SITC Policy Brief, No. 29,
September 2011, p. 90.

174
National Security Advisor Brent Scowcroft observes, “the United States has competition in most

areas of advanced research and development, including military-related science and technology.

The number of access points to advanced science and technology has grown considerably and

perhaps more to the point, outside the control of the United States… the alliance has lost its Cold

War consensus.”62

Table 7-10. Alternative Suppliers of Certain Raw Materials for China (in millions of dollars)

Oil Seeds, Oil Nuts, and Oil Kernels Coal, Coke, and Briquettes
Argentina Brazil Canada Australia Canada Indonesia Russia
2009 1,203.6 6,343.0 1,371.1 2009 4,434.9 576.3 2,079.5 649.6
2010 4,120.1 7,133.4 819.3 2010 4,653.9 977.0 4,393.9 933.6
2011 4,393.7 10,957.3 925.4 2011 4,693.8 829.2 7,570.2 933.9
2012 2,725.9 11,880.2 2,461.0 2012 7,020.0 1,534.6 7,314.7 2,082.4
2013 3,220.9 17,145.7 2,259.6 2013 8,779.6 1,406.3 6,894.0 2,272.3
Source: UN Comtrade Source: UN Comtrade

Meanwhile, if the U.S. were to restrict its export of raw materials and agricultural

products, China would be able to find alternative suppliers. As shown in Table 7-8, oil seeds, oil

nuts, and oil kernels were some of the largest U.S. exports to China in value. Much of these

grains was soybeans that were used as animal feed or processed into cooking oil for human

62
Committee on Science and Technology, House of Representatives, Impact of U.S. Export Control Policies on
Science and Technology Activities and Competitiveness, Hearings, 111th Congress, First Session, 2009, p. 30. Also
see Committee on Science, Security, and Prosperity, Committee on Scientific Communication and National
Security, and National Research Council, Beyond ‘Fortress America’: National Security Controls on Science and
Technology in a Globalized World (Washington, D.C.: The National Academies Press, 2009); and Committee on
Science, Engineering, and Public Policy, Rising Above the Gathering Storm: Energizing and Employing America for
a Brighter Economic Future (Washington, D.C.: The National Academies Press, 2007); May-Britt Stumbaum, The
Security and Technology Relationship between Europe and China (La Jolla, C.A.: June 24, 2010); May-Brit U.
Stumbaum, “Testimony before the U.S.-China Economic and Security Review Commission,” in U.S.-China
Economic and Security Review Commission, Hearings on China-Europe Relationship and Transatlantic
Implications, 112th Congress, 2nd Session, April 19, 2012, pp. 81-91; Ø ystein Tunsjø, “Testimony before the U.S.-
China Economic and Security Review Commission,” in U.S.-China Economic and Security Review Commission,
Hearings on China-Europe Relationship and Transatlantic Implications, 112th Congress, 2nd Session, April 19,
2012; Gundran Wacker, “Testimony before the U.S.-China Economic and Security Review Commission,” in U.S.-
China Economic and Security Review Commission, Hearings on China-Europe Relationship and Transatlantic
Implications, 112th Congress, 2nd Session, April 19, 2012.

175
consumption.63 Moreover, the U.S. sells a large quantity of natural resources and materials to

China that are further processed by Chinese factories to make diverse merchandise.

Nonetheless, there are several grain producing states and raw material rich countries that

would willingly take up U.S. sales to China.64 As Table 7-10 shows, with regard to oil seeds, oil

nuts, and oil kernels, Argentina, Brazil, and Canada already export a significant quantity to

China. Especially, Brazil is already the largest exporter of those grains to China. In this situation,

if the U.S. restricts its export of feed grains to China, just as it did against the USSR during the

Carter administration, Brazil might repeat the history of becoming an alternative supplier for the

U.S.’ adversary. In addition to the three non-U.S. grain exporters in Table 7-10, European states

would be able to expand their grain production and sales to China, although their current

agricultural exports to that country are dwarfed by sales of manufactured goods. Australia would

be another source from which China would be able to obtain diverse grains.

With regard to the U.S. export of coal, coke, and briquettes—materials used as fuels for

industrial purposes or in households—Australia, Canada, Indonesia, and Russia can be effective

alternative trading partners.65 As shown in Table 7-10, these countries are already competing

with the U.S. in the market. In the export of hides and skins to China, Australia and Canada can

63
Foreign Agricultural Service, “People’s Republic of China-Oilseeds and Products Annual,” March 2014,
http://gain.fas.usda.gov/Recent%20GAIN%20Publications/Oilseeds%20and%20Products%20Annual_Beijing_Chin
a%20-%20Peoples%20Republic%20of_2-28-2014.pdf. Except for certain feed grains, China produces much of its
food needs domestically. See U.S.-China Economic and Security Review Commission, 2013 Report to Congress,
113th Congress, 1st Session (Washington, D.C.: U.S. Government Printing Office, 2013), pp. 5-6.
64
For data on China’s agricultural trade, USITC, China’s Agricultural Trade: Competitive Conditions and Effects on
U.S. Exports (Washington, D.C.: USITC, 2011). Also see United States Department of Agriculture, “World
Agricultural Supply and Demand Estimate Report,” at http://www.usda.gov/oce/commodity/wasde/.
65
China also buys a large quantity of U.S. scraps, smelting and refining them into pure forms of non-ferrous metals
(mainly aluminum and copper) to sell on domestic and international markets. Still, using scraps is only one method
of China’s non-ferrous metal production. Also, other suppliers of scraps are available to China on the market. For
instance, see Alexander Hammer and Lin Jones, “China’s Dominance as a Global Consumer and Producer of
Copper,” USITC Executive Briefings on Trade, August 2012.

176
be alternative suppliers, and Australia, Canada, and Russia would be able to replace the U.S. as

the source of “wood in the rough or roughly squared.”66

Different from historical adversaries of the U.S., China is a very large market that is

actively engaged in foreign trade, and at the same time has immense foreign currency reserves.

Simply put, China has large purchasing power, and can pay cash for foreign goods. This means

that other countries would actively seek opportunities to expand their business with China if the

U.S. were to impose restrictions on its own trade.67

Alternative Partners with Regard to Exports to the U.S.

The U.S. is one of the largest export destinations for China. In 2013, China’s exports to the U.S.

exceeded 369 billion dollars, accounting for 16.7 percent of all Chinese merchandise exports to

the world.68 The enormity of Chinese goods sold in the U.S. might suggest that, if Washington

decides to restrict trade with China, Beijing would not be able to divert exports away from the

U.S. Thus, one might argue that the position as the world’s second largest market (and the largest

national market) has endowed the U.S. with a unique advantage in dealing with its contenders.69

Nonetheless, there are reasons to expect that China can minimize the loss caused by

restricted exports to the U.S., and might even be able to find countries to absorb its current

exports to the U.S. First, the contribution of exports—specifically, exports destined for the

U.S.—to China’s GDP is considerably low in the first place when processing trade is taken into

66
See UNComtrade, http://comtrade.un.org/data/.
67
Furthermore, China will be able to find alternative providers of business services as well. International business
services, including entrepreneurial skills, IT solutions, logistics, financial skills, and other sales know-how, are very
important for organizing, maintaining, and upgrading diverse production activities. While China strives to advance
its economic organization and structure, these services can be provided not only by the U.S., but also by firms from
other advanced economies around the world, including Europe. For the role of international business services and
discussions on the competitors of U.S. service providers, see USITC, Effect of Restraint on Imports, chapter 3.
68
See UNComtrade.
69
Stephen G. Brooks and William C. Wohlforth, World Out of Balance (Princeton, N.J.: Princeton University Press,
2008), chapter 4; Norrlof, America’s Global Advantage.

177
account.70 Functioning as the production base of many MNCs, China is situated at the very end

of the international production network. Much of China’s manufacturing is organized around

purchasing parts, technologies, and raw materials from other countries, assembling them in its

industrial clusters, and selling the final manufactured goods on the world market. In this process,

what China actually gains through exports is the compensation for assembly. Although China

sells an enormous quantity of goods to foreign buyers, a large portion of payments from buyers

are eventually transferred to countries from which China purchased parts, materials, or

technology. Accordingly, after exporting to the U.S., what is left as value-added to China’s GDP,

or China’s GDP gains, is small.

This implies that, if the U.S. stops importing from China, China would lose much less

than is anticipated by arguments that build on reported (ordinary) trade statistics. One estimate

suggests that, in 2007, 62.5 percent of China’s exports to the United States were processing

exports.71 According to the United States International Trade Commission, the U.S.’ bilateral

trade deficit with China in 2004 was about 40 percent smaller when value added trade measures

are used instead of conventional statistics. A different value-added trade measure suggests that

the U.S. deficit was 53 percent smaller in 2005 and 42 percent smaller in 2008.72 These estimates

suggest that China’s gains from exports to the U.S. are significantly smaller than what appears in

reported statistics. Thus, China has much less to lose from restricted access to the U.S. market.

70
See Kemal Derviş, Joshua Meltzer and Karim Foda, “Value-Added Trade and Its Implications for International
Trade Policy,” Brookings Opinion, April 2, 2013, http://www.brookings.edu/research/opinions/2013/04/02-
implications-international-trade-policy-dervis-meltzer; and John B. Benedetto, “Implications and Interpretations of
Value-Added Trade Balances,” Journal of International Commerce and Economics, Vol. 4, No. 2 (November 2012),
pp. 39-61.
71
This estimate builds on the data provided by China Customs Statistics and Chinese Ministry of Commerce. Dean,
Lovely, and Mora, “Decomposing China-Japan-U.S. Trade.” Also see Koopman, Wang, and Wei, “How Much of
Chinese Exports Is Really Made in China?.” Moreover, value-added trade measures reveal approximately 40 percent
smaller deficit for the U.S. than using conventional trade statistics. See Dean, “Testimony before the U.S.-China
Economic and Security Review Commission.”
72
USITC, Economic Effects of Significant U.S. Import Restraints, p. 3-20.

178
 Second, there are other major markets in which China can potentially expand the sales of

its goods. Today, the EU, not the U.S., is the largest market in the world and the largest export

destination for China. On average between 2008 and 2013, the twenty eight EU states absorbed

21.8 percent of China’s all merchandise exports to the world.73 Moreover, the EU has been a

larger export destination than the U.S. for China over the past decade. Although economic crises

in several member states have constrained the growth of the EU’s commerce with China, the EU

still remains China’s largest trade partner. The enormous size of exports to the EU suggests that

China might be able to attain benefits related with the economies of scale even if the U.S. cuts

off imports from China. Moreover, considering its size as a market, the EU has a good potential

to expand its purchase of Chinese products.

More importantly, if the U.S. restricts importing from China, the EU states would

advance their competitive advantage vis-à-vis the U.S., and, consequently, absorb China’s

exports. As discussed above, several leading U.S. manufacturing industries obtain economic

inputs from China such as labor and tasks in order to ensure their competitiveness in the market.

Moreover, it was shown that the American MNCs that lead those manufacturing industries

compete with foreign companies based in Europe or other advanced economies and produce

similar goods. Meanwhile, similar to the U.S.-China trade, commerce between the EU and China

was built on comparative advantages.74 In 2011, 29.4 percent of all the EU’s manufactured

imports from China were produced by the European firms’ partners in China, but in advanced

technology products, which comprised the majority of the EU’s imports from China, this

73
UN Comtrade Data.
74
For instance, in 2007 approximately 51.9 percent of China’s exports to the EU consisted of processing exports.
Dean, Lovely, and Mora, “Decomposing China-Japan-U.S. Trade,” p. 606.

179
proportion was much higher, up 55.5 percent.75 In short, the U.S. and the EU are competitors in

many manufacturing industries and both heavily utilize Chinese economic inputs.

In this condition, U.S. restrictions on its own trade with China would provide an

opportunity for rival European firms to enhance their advantage and expand market share. In this

case, as they lose access to Chinese economic inputs that are entailed in imports from China,

U.S. firms would become less competitive in the market. In contrast, by continuing to do

business with China, European firms would be able to maintain their current level of

competitiveness. Accordingly, European companies would achieve significant competitiveness

gains vis-à-vis U.S. firms, and, all else being equal, European firms would effectively increase

their market share and also encroach on the U.S. market.

As European advanced economies triumph over the U.S., China’s current exports to the

U.S. might be absorbed by European economies. Those countries will purchase more economic

inputs from China in order to expand the production of goods for which they now have a

competitive advantage (vis-à-vis the U.S.). Thus, China’s current export of labor and tasks to the

U.S. can be diverted to Europe. Moreover, the European states will also purchase more Chinese

final products in order to further concentrate on making certain goods for which they enjoy

competitive advantage and that allow them to obtain the largest profit, while importing others

from China. As European countries expand specialized commercial relationship with China,

China’s current exports to the U.S. might be diverted to Europe.

Third, China has the potential to diversify its export destinations to countries other than

the EU and the U.S. As Figure 7-1 illustrates, China’s exports were concentrated in about ten

75
European Commission, “EU Bilateral Trade and Trade with the World: China,” access
http://trade.ec.europa.eu/doclib/docs/2006/september/tradoc_113366.pdf.

180
partners during the past decade.76 Moreover, the quantity of China’s exports to those ten

destinations have increased dramatically, from about 532 billion dollars in 2004 to 1,594 billion

dollars in 2014. Nonetheless, as the “EU&US Share” in Figure 7-1 shows, the portion of China’s

exports to the EU and the U.S. in its overall exports continuously decreased. In 2004, about 48

percent of China’s exports headed to the twenty eight EU states or the U.S. In 2013, this portion

diminished to 33.5 percent, revealing that China’s dependence on the world’s two largest

markets has decreased significantly. Furthermore, the proportion of China’s exports to its top 10

export destinations has decreased, from 89.7 percent of total exports in 2004 to 72.2 in 2013.

These developments suggest that, while China’s export concentration to certain markets has

decreased over time, China has expanded its market presence in diverse parts of the world. Thus,

since China has nurtured significant potential to sell its goods to markets outside of the U.S.,

Washington’s restrictions against Chinese imports might have limited impact on China.77

Figure 7-1. China’s Major Export Destinations

1800 100
1600 90
1400 80
70
1200
60
1000
50
800
40
600
30
400 20
200 10
0 0
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Top 10 Volume ($bn) Top 10 Share EU&US Share

Source: UN Comtrade

76
China’s top 10 export destinations during the past decade include the EU, the U.S., Hong Kong, Japan, South
Korea, Russia, India, Malaysia, Singapore, and Australia.
77
Indeed, Chinese leaders have been aware of the problem of export concentration to certain markets and tried to
diversify China’s export destinations. For instance, see “China Issue First White Paper on Foreign Trade, Explaining
surplus,” Xinhua, December 2011, http://mt.china-embassy.org/eng/zyxwdt/t885476.htm.

181
 Fourth, once the U.S. imposes restrictions against imports from China, Chinese final

consumer or industrial goods might be able to enter the U.S. market in roundabout ways. China’s

growing industrial clout and the global spread of bilateral/regional trade agreements would give

China opportunities to relocate its production facilities to places that are not affected by U.S.

restrictions but have good access to the U.S. market. Goods made in those new production sites

would at least partly use Chinese materials, parts, and technologies, yet the final product would

be considered non-Chinese.78 For instance, when the U.S. imposed duties on Chinese solar cells

in 2012, China revealed the ability to relocate its manufacturing facilities to Canada.79 The

Chinese solar panels assembled in Canada would enter the U.S. market free of duties, and be

sold as Canadian products in the U.S. In this case, China might have easily circumvented U.S.

import barriers by exploiting the commercial network of NAFTA. Considering there are

numerous preferential trade agreements in place and more extensive open trade arrangements are

under way, it can be expected that China would be able to sell a wide variety of its goods in the

U.S. through third countries.

As such, extensive U.S. restrictions on imports from China would not result in a dramatic

loss of China’s benefits related to current exports to the U.S. I do not mean, however, that China

can effectively divert all of its exports away from the U.S. I also do not suggest that the Chinese

economy is unlikely to be affected by restricted access to U.S. market. Nonetheless, there are

reasons to expect that China would be able to find alternative export destinations and ways to sell

its goods in the U.S. if Washington were to impose extensive trade restrictions against Beijing.

78
In a similar vein, a Japanese automobile produced in U.S. facilities is often considered as an American product
rather than a Japanese. “Honda Exports More U.S. Cars than It Imports,” USA Today, January 28, 2014.
79
Keith Bradsher and Diane Cardwell, “U.S. Slaps High Tariffs on Chinese Solar Panels,” The New York Times,
May 17, 2012.

182
China’s losses accruing from restricted access to the U.S. market might not be as large as some

observers anticipate.

Potential Loss from Frictions with Other States

While China would be able to find alternative trading partners for many aspects of its foreign

trade, the U.S. needs to be concerned about the loss that might rise from interactions with third

countries. U.S. policies designed to diminish imports from and exports to China would disrupt

the overall flow of goods, services, and other economic factors around the globe, and thereby

affect the economic performance of all major economies. Especially, considering the spread of

the globalization of production and China’s position at the end of the global production network,

U.S. restrictions on trade with China would almost automatically lead to the economic loss of

other major states. For instance, the U.S. might sell China certain ATPs to be further processed

in China and sold to the EU. Similarly, the EU states might export goods to China to be further

processed and sold to the U.S. Then, the U.S. trade restrictions against China in effect mean

denying the EU’s access to important Chinese goods that entail U.S. technology, or the U.S.

imposing barriers against European goods. Thus, U.S. trade measures against China could

introduce tensions between Washington and third countries. The losses accruing from such

tensions are the U.S.’ relative loss vis-à-vis China.

Indeed, the EU has demonstrated some possibility of standing at odds with the U.S. in

defense of its own economic interest.80 Although it was not fully substantiated, the Sino-EU

“strategic partnership” signed in 2003 suggested that China and the EU could be natural partners

in both economic and political realms.81 The controversy between the U.S. and the Europeans

80
Michael D. Swaine, America’s Challenge: Engaging a Rising China in the Twentieth-First Century (Washington,
D.C.: Carnegie Endowment for International Peace, 2011), p. 186.
81
David Shambaugh, “The New Strategic Triangle: U.S. and European Reactions to China’s Rise,” The Washington

183
over the lifting of the arms embargo on China between 2004 and 2005 revealed that it would be

very hard for the U.S. to persuade the EU states to forgo their economic interests in China in

support of U.S. security interests.82 If an issue concerning arms exports induced such severe

disagreements, U.S. efforts to control an inflow of goods and technologies that have indirect

military application to China would spur even more controversies. Considering ongoing

economic difficulties, European companies would have strong incentives to expand technology

cooperation with Beijing, while trying to find new business opportunities in China. Further, not

only the EU but also other countries that maintain close trade ties with China, most notably

Japan, Taiwan, and South Korea, would also collide with U.S. restrictions on trade.83

Distinct from the Cold War era, the current global political context would make it

difficult for Washington to coerce or persuade other advanced economies to impose similar

economic restrictions against Beijing. Many developed countries are not militarily threatened by

China in any meaningful way, and therefore have few security imperatives to replicate U.S.

policies against China.84 For instance, when the U.S. sees security issues in the export of ATPs to

China, the EU finds only economic issues.85 Having no serious security concerns with China,

Europe might choose “splendid isolation” rather than supporting the U.S. in Asian affairs.86 The

Quarterly, Vol. 28, No. 3 (Summer 2005), pp. 7–25.

82
Kristin Archick, Richard F. Grimmett, and Shirley Kan, “European Union’s Arms Embargo on China: Implications
and Options for U.S. Policy,” CRS Report for Congress, May 27, 2005.
83
These countries are top three sources of China’s processing imports. A large portion of China’s exports, indeed,
reflects its role as the workshop of the “Asian production network.” For instance, see Yuqing Xing, “Processing
Trade, Exchange Rates, and China’s Bilateral Trade Balances,” GRIPS Discussion Paper 10-30, National graduate
Institute for Policy Studies (Japan), January 2011; and Judith M. Dean, K. C. Fung, and Zhi Wang, “Measuring
Vertical Specialization: The Case of China,” Review of International Economics, Vol. 19, No. 4 (September 2011),
pp. 609-625.
84
Even when they had similar security concerns, the developed countries could not easily agree on coordinated trade
restrictions against the common adversary. For instance, see See Bruce W. Jentleson, Pipeline Politics: The Complex
Political Economy of East-West Energy Trade (Ithaca, N.Y.: Cornell University Press, 1986); Michael Mastanduno,
Economic Containment (Ithaca, N.Y.: Cornell University Press, 1992).
85
Stunbaum, “Risky Business? The EU, China and Dual-Use Technology.”
86
Ø ystein Tunsjø, “Testimony before the U.S.-China Economic and Security Review Commission,” p. 94.

184
EU states might even actively punish the U.S. for imposing economic restrictions against China,

since such policies could adversely affect their own economic growth.

Outcome: Maintenance of Extant Trade Ties with China

An assessment of available data shows that some of the U.S.’ leading industries are significantly

dependent on Chinese economic inputs and China would be able to find alternative trading

partners in many important dimensions of its foreign trade. According to my theory, the U.S. is

not in a position to restrict trade ties with China in order to supplement military balancing against

that country. Adopting policies designed to diminish trade with China would not only be

ineffective but also has the potential to inflict greater harm on the U.S.

Recent U.S. behavior over trade with China is consistent with my argument. Although

there were strong voices within the U.S. favoring restrictive trade policies, the tensions over

trade with China did not translate into actual policies.87 Specifically, four serious restrictive

measures against China, proposed by influential figures including members of Congress and

presidential candidates, were avoided in fear of more U.S. loss.88

First, repeated efforts to designate China as a “currency manipulator” were refuted by

U.S. administrations that were concerned about negative repercussions to the U.S. economy.

87
For instance, during U.S. presidential campaigns since the early 2000s, China’s unfair practices have been
repeatedly addressed as sources of trade imbalances between the two countries. However, after its presidential
elections, the U.S. has not actively revised existing policy arrangements over trade with China, neither imposing
heavy import barriers nor strengthening export control schemes. For instance, see David D. Hale and Lyric Hale,
“Reconsidering Revaluation,” Foreign Affairs, Vol. 87, No. 1 (January/February 2008), pp. 57-66. For a summary of
different positions in U.S. trade policy, see Daniel W. Drezner, U.S. Trade Strategy: Free versus Fair (New York:
Council on Foreign Relations, 2006).
88
For the danger of the U.S. facing more loss than gains, see Richard N. Cooper, “Is Economic Power a Useful and
Operational Concept?” Discussion draft, September 2003. Richard N. Cooper, “Living with Global Imbalances: A
Contrarian View,” Policy Briefs, PB05-3, November 2005, Peterson Institute for International Economics; Aaditya
Mattoo and Avrind Subramanian, “Leave China Out of a Trade Pact at Your Peril,” The Financial Times, December
8, 2011.

185
Since Senators Charles Schumer and Lindsey Graham’s request for a formal declaration of China

as a currency manipulator in 2005, many in the U.S. Congress and leading political figures such

as Mitt Romney advocated the need to punish China’s deliberate undervaluing of its currency. 89

They pointed out that fixing China’s exchange rate would restore the bilateral trade balance to be

in favor of the U.S., and, to some extent, reverse the increasing American reliance on Chinese

manufactured goods.

Nonetheless, there were “deeper structural reasons” preventing serious actions against

China’s foreign trade, including the designation of that country as a currency manipulator. On

many occasions, U.S. firms utilizing Chinese economic inputs were actually benefitting (in terms

of profit) from the undervalued renminbi, and they were vulnerable to Chinese retaliation.90

Moreover, designating China as a currency manipulator would lead to an increase in the price of

Chinese goods in the U.S., which in turn would diminish the real income of American citizens.91

Although large imbalances in the balance of payments existed, it was unclear whether adjusting

the exchange rate would really help the U.S. economy. The voices clamoring to punish China’s

currency-related trade policy foundered against economic reality.

Second, the protectionist pressures made salient during an economic recession were

effectively subdued. A state is likely to have strong incentives to adopt restrictive trade measures

during economic downturns. In the U.S. case, “the Great Recession” of 2007 might have led

89
For instance, see Charles E. Schumer and Lindsey O. Graham, “Will It Take a Tariff to Free the Yuan?,” The New
York Times, June 8, 2005; C. Fred Bergsten, “Correcting the Chinese Exchange Rate,” Testimony before the Hearing
on China’s Exchange Rate Policy, Committee on Ways and Means, U.S. House of Representatives, September 15,
2010. For Mitt Romney’s emphasis on designating China as currency manipulator, see “Transcript and Audio:
Second Presidential Debate," NPR, October 16, 2012, http://www.npr.org/2012/10/16/163050988/transcript-obama-
romney-2nd-presidential-debate.
90
For instance, see Arvind Subramanian, “Preserving the Open Global Economic System: A Strategic Blueprint for
China and the United States,” Policy Brief, PB13-16, June 2013, Peterson Institute for International Economics.
91
Nick Carey and James B. Kelleher, “Special Report: Does Corporate America Kowtow to China?” Reuters, April
27, 2011.

186
Washington to adhere to laws and legal procedures seeking to diminish imports from China.92

Nonetheless, in the midst of the recession, the Obama administration intended to boost the U.S.

economy and reduce its deficit by bolstering exports rather than restricting imports. In January

2010, President Obama proposed the National Export Initiative, which aspired to double U.S.

exports in the next five years and created the Export Promotion Cabinet and the President's

Export Council to support that plan.93 In the administrations’ overall trade policy, it was

repeatedly stated that U.S. economic interests and prosperity could be best served by remaining

committed to existing rules, while more aggressively seeking access to foreign markets.94

Protectionist policies were adopted over a few, less important items such as tires and solar

panels, but their effectiveness was doubted. Indeed, many expected that such measures would

adversely affect the U.S. economy.95 Moreover, criticisms of the increasing trade deficit and

pressures from Congress to adopt new and more stringent policy measures were often countered

by evidence that they failed to recognize the processing trade that is conducted through China.96

Maintaining trade ties with China was viewed as the best option for U.S. economic performance

even during a recession.

92
For discussions of these U.S. laws and legal procedures, see USITC, The Year in Trade 2013, chapter 2.
93
The White House, “State of the Union Address,” January 2010, access http://www.whitehouse.gov/the-press-
office/remarks-president-state-union-address; The White House, “Remarks by the President at the Export-Import
Bank's Annual Conference,” March 11, 2010, access http://www.whitehouse.gov/the-press-office/remarks-
president-export-import-banks-annual-conference
94
See The President's Trade Policy Agenda, 2009-2011, access http://www.ustr.gov/2010-trade-policy-agenda.
95
Gary Clyde Hufbauer and Sean Lowry, “U.S. Tire Tariffs: Saving Few Jobs at High Cost,” Policy Brief, PB12-9,
April 2012, Pearson Institute for International Economics. Also see John Bussey, “Get Tough Policy on Chinese
Tires Falls Flat,” The Wall Street Journal, January 20, 2012; “U.S. Adds Tariffs on Chinese Tires,” The New York
Times, September 11, 2009; “Solar Tariff Upheld, but May Not Help in U.S.,” The New York Times, November 7,
2012.
96
For examples of widely cited counterevidence, see Michael J. Ferrantino, Robert B. Koopman, Zhi Wang, and
Falan Yinug, “The Nature of U.S.-China Trade in Advanced Technology Products,” Comparative Economic Studies,
Vol. 52, No. 2 (2010), pp. 207-224; and USITC, The Economic Effect of Significant U.S. Import Restraints. Also see
Neil C. Hughes, “A Trade War with China?,” Foreign Affairs, Vol. 84, No. 4 (Jul./Aug. 2005), pp. 94-106; Henry M.
Paulson, “A Strategic Economic Engagement,” Foreign Affairs, Vol. 87, No. 5 (Sep./Oct. 2008), pp. 59-77.

187
 Third, despite the strategic importance of denying China’s access to cutting edge

technologies, the U.S. has not strengthened its export restrictions.97 Even on goods with

significant military relevance, the U.S. has not actively strengthened existing control regimes.98

Despite the Obama administration’s pledge to revamp its export control system, the dual-use

nature of important modern technologies, the need to rely on Chinese production facilities for

competitive advantage, and the existence of alternative foreign suppliers have restricted the

effectiveness of existing control schemes and delayed the development of a new framework.99

Through the debate in Congress and the administration, it was revealed that unilateral controls

would not be effective since China can simply obtain the technology from other countries. In

many cases, stringent controls on U.S. firms would only harm the U.S. economy.100 Moreover,

while U.S. dominance over cutting-edge technology can no longer be assumed, multilateral

control regimes such as the Wassenaar Arrangement, the descendent of the COCOM, have

become ineffective in the post Cold War context.101 Consequently, instead of strengthening the

97
Many have argued that the U.S. should strengthen and return home the R&D, and stop further outsourcing of
important technological products (which require the outflow of U.S. technology). For instance, see Gary P. Pisano
and Willy C. Shih, “Restoring American Competitiveness,” Harvard Business Review (July-August, 2009).
98
In particular, controlling inflow of high and dual-use technology to China was deemed critical given the likely
scenario of military confrontation between the two powers. U.S.-China Economic and Security Review
Commission, 2011 Report to Congress (Washington, D.C.: U.S. Government Printing Office, 2011), pp. 7-8;
Bureau of Industry and Security, U.S. Dual-Use Export Controls for China Need to Be Strengthened.
99
Jim Garamone, “Gates Proposes Revamp of Export System,” American Forces Press Service, April 20, 2010,
access http://www.defense.gov/news/newsarticle.aspx?id=58830.
100
Wallerstein, “Losing Controls.” Also see Center for Strategic and International Studies, Briefing of the Working
Group on the Health of the U.S. Space Industrial Base and the Impact of Export Controls, February 2008,
http://csis.org/files/media/csis/pubs/021908_csis_spaceindustryitar_final.pdf; Committee on Science, Security, and
Prosperity, Committee on Scientific Communication and National Security, and National Research Council, Beyond
‘Fortress America’; Committee on Science, Engineering, and Public Policy, Rising Above the Gathering Storm; and
Committee on Science and Technology, House of the Representatives, 111th Congress, 1st Session, Impacts of U.S.
Export Control Policies on Science and Technology Activities and Competitiveness (Washington, D.C.: U.S.
Government Printing Office, 2009).
101
U.S. Government Accountability Office, “Export Controls: Challenges with Commerce’s Validated End-User
Program May Limit Its Ability to Ensure that Semiconductor Equipment Exported to China Is Used as Intended,”
Report to the Committee on Foreign Affairs, GAO-08-1095, September 2008; Committee on Science and
Technology, Impact of U.S. Export Control Policies, p. 30.

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existing export control system, the U.S. government has adopted or considered policy measures

that can facilitate U.S. high technology exports to China.102

Fourth, the ambitious goal of creating a trade bloc exclusive of China has not progressed.

A number of U.S. leaders suggested that the Trans Pacific Partnership (TPP), a U.S.-led

multilateral preferential trade arrangement, would help restore Washington’s commercial

leadership in the Asia-Pacific, as well as creating enormous wealth for the U.S.103 It was also

suggested that, through this agreement, the U.S.’ economic dependence on China would diminish

and Washington would be able to exercise more pressure on Beijing. Moreover, several

practitioners and scholars in and outside of the U.S. have suggested that the TPP has the potential

to become an instrument for “economic containment” of China.104

However, it was illustrated that a trade agreement excluding China would not make any

significant contribution to the U.S.’ relative economic performance. Even if the TPP were in

place, Beijing could simply refuse to follow the rules set by Washington. In this case, it is

uncertain whether the U.S. and other members of the TPP can take effective collective actions

against China. Moreover, China can establish its own free trade agreements with East Asian

states in order to compete with the U.S.-led economic bloc, as well as collaborating with EU

102
The Validated End User (VEU) program, introduced by the Department of Commerce in June 2007, aimed to
make it easier for American firms to export dual-use items to China. Also, the President’s reform initiative has not
stated to expand the list of controlled items. Christopher F. Corr and Jason T. Hungerford, “The Struggles of
Shipping Dual-Use Goods to China,” China Business Review, January-February 2010; Fergusson and Kerr, “The
U.S. Export Control System and the President’s Reform Initiative.”
103
For a general overview of the TPP, see Ian F. Fergusson, William H. Cooper, Remy Jurenas, and Brock R.
Williams, “The Trans-Pacific Partnership (TPP) Negotiations and Issues for Congress,” CRS Report (R42694),
December 2013.
104
Shao Binhong ed., China and the World: Balance, Imbalance, and Rebalance (Leiden: Koninklijke Brill NV,
2013); Jay Newton-Small, “Why Trying to Hurt China in the Trade Game Could Backfire,” Time, January 14, 2014;
Amitendu Palit, The Trans-Pacific Partnership, China and India: Economic and Political Implications (New York:
Routledge, 2014); David Pilling, “It Won’t Be Easy to Build an ‘Anyone but China’ Club,” The Financial Times,
May 22, 2013.

189
states.105 Thus, it would be very difficult for the U.S. to advance its economic position vis-à-vis

China through a series of exclusive trade agreements.

Recent developments in these four important and popularized agendas over trade with

China suggest that Washington could not impose any serious commercial restrictions against

Beijing because doing so would not do any good to the U.S.’ economic clout. On the contrary, it

was often plausible that the U.S. would lose more than China. This, of course, does not mean that

clear causal relationships could be established between the two conditions I examined and the

U.S. decision over bilateral commerce with China.106 Nevertheless, while my theory suggests

that the U.S. is not in a position to restrict trade ties with China, recent U.S. behaviors on trade

with China are consistent with the overall proposition of my argument.

Alternative Explanations

In contrast to my theory, there are several reasons to doubt the validity of the two alternative

explanations. To be clear, both the use of economic inducements and the influence of domestic

economic interests have been observed in the U.S.’ foreign policy toward China. Nonetheless, it

is difficult to argue that the need to use economic statecraft or domestic interest group politics

105
Aaditya Mattoo and Avrind Subramanian, “Leave China Out of a Trade Pact at Your Peril,” The Financial Times,
December 8, 2011; Arvind Subramanian, “Preserving the Open Global Economic System: A Strategic Blueprint for
China and the United States,” Policy Brief, PB13-16, June 2013, Peterson Institute for International Economics.
Furthermore, U.S.’ material gains through the TPP would not be large. According to one estimate, U.S. gains from
TPP by 2025 would be about 0.4 percent of GDP, and about three quarters of this increase is accounted for by
Japan’s liberalizing its service sector. See Peter Petri and Michael Plummer, “The Trans-Pacific Partnership and
Asia-Pacific Integration: Policy Implication,” Policy Brief, 12-16, 2012, Peterson Institute for International
Economics. Also see Sander M. Levin (Ranking Member of Committee on Ways and Means, U.S. House of
Representatives), “The Challenges and Opportunities of International Trade: Past, Present, and Future,” Peterson
Institute for International Economics, Tuesday, July 23, 2013.
106
In order to confirm if the causal mechanism I propose is working, more detailed and direct data is necessary. For
instance, I need to know how U.S. leaders’ actually assessed their country and China’s economic positions. Such
data, however, is currently unavailable, and is unlikely to be available in the next few decades.

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played a decisive role and made the U.S. avoid any serious commercial restrictions against

China. Moreover, even if some evidence in support of an alternative explanation is available, a

close look reveals that my theory could potentially trump that alternative explanation.

Furthermore, the two alternative explanations are particularly difficult to explain the U.S.’

decisions over bilateral commerce after Washington strengthened military presence in East Asia

in the late 2000s.

One alternative theory suggests that the U.S. might have not imposed any serious

restriction on trade with China in order to shape China’s behavior through the promise of

economic gains. In this view, China’s large absolute gains from the U.S.-led international trade

system should have given Washington significant leverage vis-à-vis Beijing, and the U.S. could

utilize the prospects of continuing economic benefits to affect the trajectory of China’s rise. If

successful, China would become what Robert Zoellick called a “responsible stakeholder” of the

U.S.-led international order rather than a challenger.107 Indeed, the George W. Bush

administration advocated economic engagement toward China as a means of enhancing U.S.

strategic interests in Asia.108

Nonetheless, many of these ideas became invisible around 2008, when China actually

became the world’s second largest national economy and the U.S. indeed strengthened its

military presence in the Asia-Pacific. After 2008, officials who previously advocated shaping the

trajectory of China’s rise through the promise of economic gains, including Robert Zoellick

himself, argued that the U.S. should explore ways to establish “a new type of great power

relationship” rather than pushing China to behave properly.109 President Barack Obama also

107
Zoellick, “Whither China: From Membership to Responsibility?”
108
Friedberg, A Contest for Supremacy, chapter 4. Also see Paulson, “A Strategic Engagement”; and Rice,
“Promoting the National Interest.”
109
Robert B. Zoellick, “The Great Powers’ Relationship Hinges on the Pacific,” The Financial Times, June 4, 2013;

191
stressed the need for cooperation between the two states for global economic growth and

emphasized trade without protectionism, rather than setting forth the need to shape China’s

behavior.110 Moreover, while economic recessions hit the U.S., the need to punish China’s

economic wrongdoing, not the promise of economic gains to shape Chinese behavior, became a

popular rhetoric.111 In short, when the scope condition of my theory was satisfied, evidence in

support of this alternative explanation became weak.

According to the other alternative explanation, continuing U.S. commercial engagement

toward China reflects the interest of powerful domestic economic groups. In particular, lobbying

efforts of diverse commercial groups that have different stakes in trade with China and the

competition between those interest groups to influence national decisions need to be observed in

order to confirm whether this theory’s causal mechanism works. Leaders’ policy decisions on

trade with China should reflect the competitive domestic political processes.

One major problem with regard to this alternative explanation is that the competition

between the winners and losers of trade with China has been difficult to observe in the U.S.’

formal political processes.112 Instead, there seems to be bipartisan support when criticizing

China’s trade policy and advocating U.S. countermeasures. China’s “unfair” practices over trade

with the U.S. have been a very popular topic in Washington. In presidential debates and

discussions in Congress, few leaders actively argued that the U.S. should take no measures on

Robert B. Zoellick, “U.S., China, and Thucydides,” The National Interest, (July-August 2013). Also see Amitai
Etzioni, “Is China a Responsible Stakeholder?” International Affairs, Vol. 87, No. 3 (2011), pp. 539-553.
110
See The President's Trade Policy Agenda, 2009-2011, http://www.ustr.gov/2010-trade-policy-agenda; “America,
China, and Protectionism: Wearing Thin,” The Economist, September 14, 2009.
111
Gary Clyde Hufbauer, Jacob Funk Kirkegaard, Woan Foong Wong, and Jared Woollacott, U.S. Protectionist
Impulses in the Wake of the Great Recession: Report to the International Chamber of Commerce Research
Foundation (Washington, D.C.: Peterson Institute for International Economics, 2010); Wayne M. Morrison, “China-
U.S. Trade Issues,” CRS Report (RL33536), July 2014.
112
Arvind Subramanian, “The Curious Case of the Protectionist Dog that Has Not Barked,” The Financial Times,
July 10, 2013.

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trade with China. While American workers were viewed as losers from the increasing trade with

China, a voice that proclaimed the need to utilize more foreign inputs, including Chinese,

induced furor from both sides of the aisle.113 Accordingly, the assumption of the domestic

politics based explanation—competition between domestic interests—has been problematic in

the first place.

A related problem is the gap between what U.S. leaders criticize of the trade with China

and actual U.S. trade policy toward China. Throughout the 2000s, there were strong forces that

wanted to push China to revalue its currency, impose import barriers against that country, erect

more stringent controls over U.S. exports, and establish new trade arrangements in the Asia-

Pacific. Advancing these policy initiatives would have corresponded well with the anger

Congress showed over China’s unfair trade practices and related U.S. losses. Nonetheless, even

without serious lobbying by pro-trade groups, the U.S. did not adopt any policy that might

significantly diminish trade with China. In recent years, except for tires and solar panels (items

without any serious impact on the U.S. economy), there was no good case that could be

interpreted as a restrictive trade measure against China that represented the widespread U.S.

dissatisfaction.114 The continuing absence of serious U.S. countermeasures, despite Congress and

leading political figure’s thorough criticism of China’s foreign trade behavior, suggests that the

influence of economic interest groups might not be the decisive force driving U.S. decisions on

trade with China.

113
Daniel W. Drezner, “The Outsourcing Bogeyman,” Foreign Affairs, Vol. 83, No. 3 (May-Jun. 2004), pp. 22-34;
Linda Levine, “Offshoring (of Offshore Outsourcing) and Job Loss among U.S. Workers,” CRS Report for Congress
(RL32292), December 2012; Michael Spence, “The Impact of Globalization on Income and Employment,” Foreign
Affairs, Vol. 90, No. 4 (Jul.-Aug. 2011), pp. 28-41.
114
For a list of U.S. economic measures on trade with China, USITC, The Year in Trade 2013.

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 Finally, the domestic interest based explanation is problematic because the role of

lobbying—the hallmark of this theory’s causal mechanism—is murky. Within the U.S., an

accurate description of major U.S. firms’ lobbying behavior over trade with China would be that

they lobby neither for nor against China.115 Moreover, even if certain U.S. industries lobbied the

government in order to expand business opportunities in China, my theory can potentially trump

the domestic interest based explanation. For instance, the U.S. satellite industry has exerted

pressures on Washington to expand trade with China, but the logic this industry brought forth

was that alternative trading partners were widely available for China in space technologies.116 In

this case, it can be argued that one of my theory’s explanatory factors is the driving force behind

the U.S. industries’ decision to pressure Washington.

In sum, there are reasons to doubt the ability of these two alternative theories to explain

U.S. behavior over trade with China. However, there is still not enough evidence to reject the

alternative explanations in the U.S. case. The problem of limited data looms large in the testing

of alternative explanations, as well as in my theory.

Conclusion

This chapter examined whether the U.S. would be able to complement military balancing against

China by restricting bilateral trade, applying the theory that was developed and tested in the

previous chapters. Although there are still severe limits in data, available evidence suggests that

115
It might be suggested that U.S. MNCs do not want to antagonize either American or Chinese consumers by
lobbying for one position. Still, this proposition requires further systemic investigation.
116
For instance, see Bureau of Industry and Security, U.S. Space Industry “Deep Dive” Assessment: Impact of U.S.
Export Controls on the Space Industrial Base (Washington, D.C.: BIS, 2014); Committee on Science, Security, and
Prosperity, Committee on Scientific Communication and National Security, and National Research Council, Beyond
‘Fortress America.’

194
the U.S. is not in a position to counter the Chinese challenge using both military and commercial

means. Several leading U.S. industries depend on Chinese economic inputs in order to ensure

competitiveness in the markets. At the same time, China would be able to find alternative trading

partners in many important dimensions of its trade with the U.S. Thus, it is unclear whether the

U.S. would be able to inflict significant relative loss on China by restricting bilateral trade.

Accordingly, maintaining extant trade ties with Beijing would be a better and more productive

option for Washington. U.S. leaders’ refusal to impose any serious restrictions on trade with

China is consistent with the predictions of my theory.

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 CHAPTER 8

CONCLUSION

Ever since the United States became the dominant power of the international system, a country

identified as an adversary of the U.S. encountered both military and economic countermeasures

organized by Washington. Especially, manipulating international trade has been a pillar of the

U.S. strategy in dealing with the challengers to its security interests. Imperial Japan, Nazi

Germany, the Soviet Union, China (before the 1970s), North Korea, North Vietnam, Cuba,

Nicaragua, Libya, Iran, and Iraq all found themselves in an unfavorable international economic

environment when they were militarily at odds with the U.S.1 If China grows more aggressive

and openly challenges the U.S.-led international order, and if the U.S. decides to strengthen

military containment of China, Washington might need to make a hard choice whether to

reiterate its strategic tradition of utilizing both military and economic means against a security

challenger.

In order to understand this choice, a theory explaining the conditions under which a

reigning power can reinforce its military countermeasures with economic policy is needed. In

extant international relations scholarship, however, economic options that can be wielded by the

reigning power in conjunction with military force remain largely underexplored. In particular,

many experts of military strategy have explicitly focused on how the U.S. should employ its

1
Robert J. Art, A Grand Strategy for America (Ithaca, N.Y.: Cornell University Press, 2003), p.113-120; David L.
Asher, Victor D. Comras and Patrick M. Cronin, Pressure: Coercive Economic Statecraft and U.S. National Security
(Washington, D.C.: Center for New American Security, 2011); Alan P. Dobson, U.S. Economic Statecraft for
Survival 1933-1991(New York: Routledge, 2002); Richard N. Haass ed., Economic Sanctions and American
Diplomacy (New York: Council on Foreign Relations, 1998); Richard N. Haass and Meghan L. O’Sullivan, Honey
and Vinegar: Incentives, Sanctions, and Foreign Policy (Washington, D.C.: Brookings Institute Press, 2000).

196
military power to protect important national interests.2 Nonetheless, few security scholars and

practitioners of military strategy would disagree that military power works better when it is

reinforced by appropriate economic means. For instance, unless the changing balance of

economic capabilities is dealt with, it might be difficult for the U.S. to attain important national

security interests—i.e. preventing the emergence of a dominant power in an important region of

the world. Moreover, challenges to the U.S. relative power position cannot be effectively

countered unless the U.S. improves its overall relative material capacities.

This dissertation sought to address this discrepancy in extant international relations

literature. Below I summarize my theory and findings. Then, I discuss the theoretical and policy

contributions of the dissertation. Finally, I introduce directions for future research.

Summary of the Argument and Findings

I argue that two factors together determine a reigning state’s decision whether or not to restrict

trade with a military challenger. The first determinant of the reigning state’s decision is its major

industries’ dependence on economic inputs originating from the challenging state. Before

restricting extant trade with the challenger, the reigning state needs to assess the impact of the

security diseconomy on its own material capacity. If its own economic performance were to be

pervasively undermined by the trade restrictions against the adversary, the reigning state’s

2
Art, A Grand Strategy for America, p. 1; Richard K. Betts, American Force (New York: Columbia University
Press, 2012), pp. 24-28; Barry R. Posen and Andrew L. Ross, “Competing Visions for U.S. Grand Strategy,”
International Security, Vol. 21, No. 3 (Winter, 1996/97), p. 5; John J. Mearsheimer, “Imperial by Design,” The
National Interest, No. 111 (January/February 2010), pp. 16-34. Even the scholars who view that grand strategy is
about using diverse military and non-military resources have indeed focused on explaining appropriate ways to
employ U.S. military force. For instance, see Joseph S. Nye, Jr. “The Case for Deep Engagement,” Foreign Affairs,
Vol. 74, No. 4 (July/August 1995), pp. 90-102; and Stephen G. Brooks, G. John Ikenberry, and William C.
Wohlforth, “Don’t Come Home America: The Case against Retrenchment,” International Security, Vol. 37, No. 3
(Winter 2012/13), pp. 7–51.

197
decision would be potentially constrained by the fear of a large cost. I suggest that the extent to

which the reigning state’s major economic sectors rely on the inputs from the challenging state,

including merchandise, technology, services, factors of production, or what some economists call

“tasks,” can account for this calculation.3

This dependence is considered high when two conditions are met: (1) the reigning state’s

major industries rely on certain economic inputs from the challenger to ensure efficiency and

competitiveness (as well as profit), and (2) the inputs from the challenging state are difficult to

substitute with inputs from a different foreign country. When these two conditions are present,

manipulating economic exchanges involves significant costs on the reigning state itself. If at

least one of these two conditions is absent, the reigning state’s dependence on economic inputs

from the challenging state can be considered low.

The second determinant of the reigning power’s decision is the presence of alternative

trading partners for the challenger, defined as states that could replace the reigning state’s role in

the challenging state’s foreign trade. The impact of the reigning state’s trade restrictions would

be maximized when it holds a monopolistic position in all important dimensions of international

trade. If so, the reigning power’s restrictions on bilateral trade would affect the challenging

power’s economic capacity with certainty. In contrast, when multiple powerful economic actors

exist in all areas of commerce, the reigning state’s ability to influence the challenger’s economic

performance would be sharply limited. In this case, were the reigning state to sever bilateral

trade, the challenging state can simply trade with others, thus diminishing the negative

repercussions of the reigning state’s economic manipulation. In other words, the international

elasticity of the reigning state’s role (in the challenger’s foreign trade) constrains the reigning

3
For the contents of trade, see William Milberg and Deborah Winkler, Outsourcing Economics: Global Value
Chains in Capitalist Development (New York: Cambridge University Press, 2013).

198
power’s ability to affect the challenging power’s economic performance through trade

restrictions.4

These two factors jointly shape the reigning state’s net assessment of the outcome of

trade restriction against the challenging state, which in turn tells the reigning state whether it

should maintain or abandon trade ties with the challenging state. For the reigning state to

improve the balance of power vis-à-vis the challenging state through a security diseconomy, two

conditions need to be met: its major economic sectors do not depend heavily on economic inputs

from the adversary, and the challenging power cannot find alternative trading partners that could

replace the reigning state. If these two conditions are present, the reigning state would be able to

impose more losses on the adversary since its own economic performance would be largely

unaffected while the challenger would lose certain economic gains that are related with trade

with the reigning power.5

When at least one of these two conditions is absent, the reigning power would not choose

to restrict trade with the challenging power because it is difficult to inflict relative loss on the

challenger. Under certain conditions, cutting off bilateral trade would inflict greater harm on the

reigning power. First, if the challenger can find alternative trading partners while the reigning

state’s leading industries depend on economic inputs from the challenging state, the reigning

state is likely to face more economic loss without bilateral trade. Thus, in order to preserve its

own relative power, the reigning state would maintain trade ties with the challenger. Second, if

4
This factor also accounts for the reigning state’s gains related to exports to the challenging state, as well as the
reigning state’s loss arising from tensions with other states.
5
Here, the size of the adversary’s current gains does not matter. If it gains a lot, it would lose a lot. If it gains little, it
would lose little. The point here is “who would lose more,” and the two factors determine conditions for the
adversary’s relative loss. Meanwhile, it could be assumed that the reigning state in general has a more robust
economy than a challenging power because, being the world’s largest economy for a protracted period of time, the
reigning state is likely to possess a more optimized economy. Thus, if the reigning state obtains only small economic
inputs from the challenging state, manipulating bilateral economic exchanges would have no serious economic
repercussions.

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the reigning power’s leading industries depend on economic inputs from the challenging power

and the latter state also cannot find alternative trading partners, the reigning state cannot be

certain who would lose more without bilateral trade. In this case, the reigning state is likely to

maintain trade ties with the challenging state in order to minimize risks. Third, if the reigning

state’s major industries depend on inputs from the challenging state and the challenger can find

alternative trading partners, the reigning power would maintain trade ties with the challenging

power because it cannot inflict any significant loss on that country. In this case, only the reigning

state is likely to lose certain economic gains that are related with exports to the challenger, while

the challenging state can sustain its economic activities through trade with others.

This argument is tested against case studies of reigning powers’ responses to challenging

powers since the late nineteenth century. I examined all cases where a reigning state

strengthened military countermeasures against a challenging state, and found a need and

opportunity to reconsider extant trade ties with the challenger. The cases that satisfied these

scope conditions were Britain’s response to the German challenge during the years leading up to

World War I, the U.S.’ response to the Japanese challenge before the Pacific War, the U.S.’

response to the Soviet challenge during the early Cold War, and two U.S. administrations’

responses to the resurgent Soviet threat at the beginning of the “Second Cold War.”

I find that historical evidence is largely consistent with the predictions of my theory.

Britain did not restrict trade with a rising Germany in order to preserve its own relative power

position. While its leading industries depended heavily on economic inputs from Germany,

Germany could find alternative partners with which to trade, and Britain discovered that its

material capacities would diminish more than Germany’s if bilateral trade were restricted. In

contrast, the U.S. abandoned trade with Japan in order to weaken that country’s capacity to

200
pursue regional hegemony in Asia. Its leading industries’ low dependence on Japanese economic

inputs and the absence of alternative trading partners for Japan endowed Washington with a

significant freedom of action in manipulating trade with Tokyo. Similarly, the U.S. severed trade

ties with the Soviet Union in order to slow down the USSR's industrial growth and military

buildup. Absence of alternative trading partners for the Soviet Union in the immediate aftermath

of World War II and its leading industries’ low dependence on economic inputs from the USSR

enabled the U.S. to inflict a relative loss on the Soviet Union by restricting trade. Finally, by

comparing the Carter and Reagan administrations’ economic responses to Soviet aggressions in

Afghanistan and Poland, respectively, I examined how the variations in one explanatory factor—

existence of alternative trading partners—affected the outcome (the other independent variable,

leading industries’ dependence on challenger’s products, is fixed). It is found that the existence

of alternative trading partners led the U.S. to continue trading with the USSR despite intensifying

military tensions.

In contrast to my argument, I find the two alternative explanations wanting. One

alternative theory suggests that the reigning power would choose to maintain current trade policy

toward the challenger in response to domestic interest groups that want to sustain trade ties with

the challenging state. The hallmark of this approach is a bottom-up process whereby domestic

groups mobilize themselves to protect commercial stakes and their interactions with other

societal groups and national leaders, mainly through lobbying and activities related to elections.

The other alternative explanation suggests that the reigning state might continue trading with the

challenger in order to utilize economic gains as positive inducements for shaping the challenging

state’s behavior (together with military countermeasures). If the reigning state decides to use

negative economic sanctions, bilateral trade would be restricted. From this perspective, the

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reigning power can employ multiple means to prompt desired actions from the challenging

power. Although logically consistent, these two alternative explanations are not well

corroborated historically.

In sum, the reigning state’s decisions over trade ties with the military challenger can best

be understood as a choice that aims to maximize its own relative power position. The reigning

power keeps trading with the challenging state if restricting trade would inflict greater harm on

itself. It severs bilateral trade only when it can improve its relative power by imposing a security

diseconomy. This theory best describes the evidence for the reigning state’s decisions in dealing

with the challenging state since the late nineteenth century.

Theoretical Contributions

This dissertation makes several theoretical contributions. First, this project examines economic

complements to military balancing strategies, a topic that has been dismissed by many security

scholars. For most theorists of international security, military balancing is the central way of

responding to challenges to the status quo. Nonetheless, manipulating economic exchanges

should be taken more seriously precisely because it is linked to the distribution of material

capacities. The international balance of power reflects the distribution of relative economic

capacities, as well as the distribution of military power. Indeed, changes in the distribution of

economic resources herald the onset of intense geopolitical competition.6 Therefore, simply

balancing against or containing a challenging power militarily is often not enough. Unless

6
Robert Gilpin, “The Theory of Hegemonic War,” Journal of Interdisciplinary History, Vol. 18, No. 4 (Spring
1988), pp. 591-613; John J. Mearsheimer, The Tragedy of Great Power Politics (New York: W. W. Norton, 2001);
Kenneth N. Waltz, “Structural Realism after the Cold War,” International Security, Vol. 25, No. 1 (Summer 2000),
pp. 32-39.

202
changes in the balance of economic capabilities, which is the root cause of the changes in the

overall balance of power, is properly handled, it might be difficult for a state to attain important

security interests. In this context, this dissertation introduces one way of tailoring commercial

exchanges into the scholarship on balancing strategies.

Second, this dissertation addresses an information gap in studies on the linkage between

security and economy in international politics. On the one hand, the scholarship on economic

statecraft tends to focus on identifying the independent effect of economic tools in advancing

strategic goals, often without taking seriously the military dimension of a state’s foreign relations

or the complementary role of economic policies.7 On the other hand, although a number of

scholars have explored the implications of economic exchanges to national security, they

confined attention to strategic raw materials or dual-use technologies.8 Meanwhile, many

scholars have studied the relationship between military competition and economic exchanges.9 In

7
David A. Baldwin, Economic Statecraft (Princeton, N.J.: Princeton University Press, 1985); Daniel W. Drezner,
The Sanctions Paradox: Economic Statecraft and International Relations (New York: Cambridge University Press,
1999);, Gary Clyde Hufbauer, Jeffrey J. Schott, Kimberly Ann Elliott, and Barbara Oegg, Economic Sanctions
Reconsidered. 3rd edition (Washington, D.C.: Peterson Institute for International Economics, 2007); Richard
Rosecrance, The Rise of the Trading State (New York: Basic Books, 1986). Also see Robert A. Pape, “Why
Economic Sanctions Do Not Work,” International Security, Vol. 22, No. 2 (Fall 1997), pp. 90-136. A notable
exception is Mastanduno, Economic Containment, which focuses on the complementary role of economic
manipulation within the context of military containment. Meanwhile, some scholars address the economic benefits
of military engagement with the world. Still, they do not discuss how economic policies could complement military
strategy. For instance, see Eugene Gholz and Daryl G. Press, “The Effects of Wars on Neutral Countries: Why It
Doesn't Pay to Preserve the Peace,” Security Studies, Vol. 10, No. 4 ((2001), pp. 1-57; Daniel W. Drezner, “Military
Primacy Doesn’t Pay (Nearly As Much As You Think),” International Security, Vol. 38, No. 1 (Summer 2013), pp.
52-79; Richard W. Maass, Carla Norrlof, and Daniel W. Drezner, “Correspondence: The Profitability of Primacy,”
International Security, Vol. 38, No. 4 (Spring 2014), pp. 188-205.
8
Stephen D. Krasner, Defending the National Interest: Raw Materials Investments and U.S. Foreign Policy
(Princeton, N.J.: Princeton University Press, 1978); Gordon H. McCormick and Richard E. Bissell, eds., Strategic
Dimensions of Economic Behavior (New York: Praeger, 1984); Nicholas J. Spykman, America's Strategy in World
Politics: The United States and the Balance of Power (Hamden, C.T.: Archon Books, 1970), p. 273. Also see Dick
K. Nanto, “Economics and National Security: Issues and Implications for U.S. Policy,” CRS Report (R41589),
January 2011.
9
For a recent study on the pacifying effect of commerce, see Gerald Schneider and Nils Petter Gleditsch, eds.,
Assessing the Capitalist Peace (New York: Routledge, 2012). Also see Edward D. Mansfield and Brian M. Pollins,
eds., Economic Interdependence and International Conflict: New Perspectives on an Enduring Debate (Ann Arbor:
The University of Michigan Press, 2003); and Patrick J. McDonald, The Invisible Hand of Peace: Capitalism, the
War Machine, and International Relations Theory (New York: Cambridge University Press, 2009).

203
this research program, theories on the security externalities of trade suggest that an adversarial

relationship generally leads to a decrease of trade.10 Conversely, some theorists suggest that the

magnitude of economic ties or the economic orientation of a country affect its military reaction

against a security challenger.11 Other scholars who emphasize economic side payments argue

that some states might provide economic benefits to its allies in order to strengthen or constrain

them, while still others argue that economic inducements could be used to shape the behavior

and interests of a security challenger.12

These theories, nonetheless, did not address the inconsistency between the reigning

state’s military and economic policies in dealing with a challenging state. For them, it is

commonly viewed that a correlation exists between the severity of military competition and the

magnitude of economic cooperation. They also dismissed the possibility that the reigning state

has good reason to use military and economic strategies simultaneously. Moreover, they do not

take into account the U.S.’ position in the international system and the specific economic

contexts in which the U.S. pursues its interests. This dissertation accounts for these discrepancies

in the extant international relations literature.

10
Joanne Gowa, Allies, Adversaries, and International Trade (Princeton, N.J.: Princeton University Press, 1994);
Joanne Gowa and Edward D. Mansfield, “Alliances, Imperfect Markets, and Major-Power Trade,” International
Organization, Vol. 58, No. 4 (Autumn 2004), pp. 775-805; Edward D. Mansfield, Power, Trade, and War (Princeton,
N.J.: University Press, 1994).
11
Steven E. Lobell, The Challenge of Hegemony: Grand Strategy, Trade, and Domestic Politics (Ann Arbor: The
University of Michigan Press, 2003); Paul A. Papayoanou, “Interdependence, Institutions, and the Balance of Power:
Britain, Germany, and World War I,” International Security, Vol. 20, No. 4 (Spring, 1996), pp. 42-76; David M.
Rowe, “World Economic Expansion and National Security in Pre-World War I Europe,” International Organization,
Vol. 53, No. 2 (Spring 1999), pp. 195-231. Also see Kevin Narizny, The Political Economy of Grand Strategy
(Ithaca, N.Y.: Cornell University Press, 2007).
12
Christina L. Davis, “Linkage Diplomacy: Economic and Security Bargaining in the Anglo-Japanese Alliance,
1902-23,” International Security, Vol. 33, No. 3 (Winter 2008/9), pp. 143-179; Steven E. Lobell, “Second Face of
Security Strategies: Anglo-German and Anglo-Japanese Trade Concessions During the 1930s,” Security Studies, Vol.
17, No. 3 (2008), pp. 438-467; Lars S. Skålnes, “Grand Strategy and Foreign Economic Policy: British Grand
Strategy in the 1930s,” World Politics, Vol. 50, No. 4 (Jul., 1998), pp. 582-616.

204
 Third, this dissertation marries balance of power logic with insights of mainstream trade

economists. For balance of power theorists who take material capacities seriously, foreign

commerce is important when it can alter states’ material power.13 Missing in this approach is a

good understanding of how commerce actually contributes to material power. Modern economic

theories of international trade provide useful insights to fill this loophole.14 Trade theories

commonly suggest that international trade increases overall national wealth not simply through

profits obtained by selling goods in foreign markets, but more importantly by elaborating on the

productive and allocative efficiency and overall performance of the economy.

By taking into account the efficiency-enhancing effect of trade, systemic international

relations theories would be able to present a more comprehensive and realistic assessment of the

interaction between reigning and challenging powers. For instance, while extant realist view

tends to focus implicitly on the simple wealth that is obtained by selling goods in foreign

markets—and the surplus or deficit in the balance of payments—this perspective has not been

consistent with the prevalent economic approach to international trade. Expansion of processing

trade and the large share of intra-firm trade in today’s commerce between the great powers

further necessitate an understanding of the efficiency-enhancing dimension of trade. In other

words, this dissertation “updates” realist understanding of international trade, and thus the

implication of economic exchanges to the balance of power. In reconsidering ongoing trade with

its security competitor, a state would carefully gauge how its own and the competitor’s overall

13
For a treatise of this issue, see Klaus Knorr, The War Potential of Nations (Princeton, N.J.: Princeton University
Press, 1956).
14
For useful overview of the trade theories, see Cletus Coughlin, “The Controversy over Free Trade,” Federal
Reserve Bank of St. Louis Review, Vol. 84, No. 1 (Jan./Feb. 2002), pp. 1-22; Elhanan Helpman, “The Structure of
Foreign Trade,” Journal of Economic Perspectives, Vol. 13, No. 2 (Spring 1999), pp. 121-144; Paul R. Krugman,
Maurice Obstfeld, and Marc J. Melitz, International Economics: Theory and Policy, ninth edition (New York:
Addison-Wesley, 2012).

205
economic performance would be affected, and the impact of those economic changes on the

balance of material capacities.

Finally, the argument of this dissertation extends the scope of studies on international

interdependence. Within the context of the literature on interdependence, it can be argued that a

reigning state utilizes economic means to complement military power when a challenging state is

asymmetrically dependent on it—defined as a situation where the adversary would lose more

once the reigning state manipulates extant economic exchanges.15 Such asymmetry enables the

reigning state to improve its relative power position vis-à-vis the challenging state through

economic means. The interplay of the two factors introduced by my theory determines whether

or not the challenging state is asymmetrically dependent on the reigning state. Still, I differ from

extant literature on interdependence in showing that asymmetric dependence in economic

relations matters because it affects states’ calculation of relative material capacity. Put

differently, balance of power theorists have good reason to embrace the liberal theorists’

emphasis on the role of asymmetric dependence because it can affect states’ relative power

calculations.

Policy Implications

This project also has important policy implications. Since the mid-nineteenth century, the U.S.

has not experienced serious security competition with a close economic partner.16 Moreover, the

15
Asymmetric dependence is the description of a situation, not a theoretical proposition pertaining to certain
theoretical tradition. For the realist view on interdependence, see Waltz, Theory of International Politics, pp. 104-
107. Here, I focus on vulnerability interdependence, which means “an actor’s liability to suffer costs imposed by
external events even after policies have been altered,” because “vulnerability interdependence includes the strategic
dimension that sensitivity interdependence omits.” Robert O. Keohane and Joseph S. Nye, Power and
Interdependence, third edition (New York: Longman, 2001), pp. 11-14.
16
Although the U.S. experienced the Venezuelan Crisis with Britain in the late nineteenth century, that dispute is

206
U.S. could effectively adopt military counterbalancing and restrictive economic measures

simultaneously when it encountered an adversary. In short, the U.S. remained exempt from the

dilemma of pursuing incongruent military and economic policies in dealing with a challenging

power.

Nonetheless, Washington is no longer in a position to utilize trade restrictions freely

together with military countermeasures. The U.S. would encounter significant costs if it adopts

serious economic restrictions against China because many of its major industries depend on

Chinese economic inputs and Washington might encounter intense frictions with almost all

major economies around the world. In contrast, China might be able to find alternative partners

in certain dimensions of its foreign trade. In this condition, it is difficult to ensure that the U.S.

could be better off than China by cutting off bilateral trade.

Then, would the U.S. be able to take deliberate policy measures in order to minimize its

leading industries’ dependence on Chinese economic inputs and strengthen cooperation among

major economies against trade with China? A powerful reigning state such as the U.S. would

certainly be able to invest heavily in its major industries’ independence from foreign inputs and

pressure other countries to replicate its policy against the adversary. Nonetheless, it is dubious

whether such investment and pressure would prove effective in today’s international system.

There are multiple foreign economic actors competing with and trying to outperform American

firms, and readily capitalize on U.S. policies that decrease its own firms’ market

competitiveness. Thus, deliberately diminishing the use of foreign economic inputs would

involve large risk and potential loss for U.S. companies. Moreover, although the U.S. might be

the world’s largest market as a single country, there is a larger integrated market, the EU, as well

difficult to be considered as a serious security competition.

207
as several other large markets around the globe. It is unlikely that those big markets can be

pressured by Washington to restrict trade with the Chinese market. Some might suggest that the

U.S. can exercise pressure on other countries by utilizing its position as their security provider.17

However, there is abundant historical evidence which shows that such a method did not work.

Even when all major economies relied heavily on the U.S. to ensure their security, Washington’s

overt pressure on its allies to cut off economic exchanges with the common adversary either

failed or put the U.S. in an awkward situation.18

This does not mean that the U.S. would never be in a position to adopt trade restrictions

against the Chinese threat. I do suggest, however, that a favorable situation to impose a security

diseconomy would not be created by the U.S.’ deliberate domestic and international policy

measures alone. Changes in market conditions—for instance, the introduction of innovative

technologies by U.S. firms, dramatic developments in preferential trade agreements among the

world’s major markets, and a universal decision among all the advanced economies to severely

punish China’s violation of intellectual property rights and currency policy—are prerequisites to

effective economic countermeasures against China. Nonetheless, the bottom line is that, while

the U.S.’ political decisions do not necessarily determine international economic conditions and

17
Brooks, Ikenberry, and Wohlforth, “Don’t Come Home America.”
18
For instance, see Gunnar Adler-Karlsson, Western Economic Warfare 1947-1967 (Stockholm: Almqvist and
Wiksell, 1968); Philip J. Funigiello, American-Soviet Trade in the Cold War (Chapel Hill, N.C.: The University of
North Carolina Press, 1988); Ian Jackson, The Economic Cold War: America, Britain and East-West Trade, 1948-63
(New York: Palgrave, 2001); Bruce W. Jentleson, Pipeline Politics: The Complex Political Economy of East-West
Energy Trade (Ithaca, N.Y.: Cornell University Press, 1986); Mastanduno, Economic Containment. It is also dubious
if the U.S. would be able to exercise such pressure on the West European states in order to control their economic
activities with China. For potential protest from Europe, see Nicola Casarini, Remaking Global Order: The
Evolution of Europe-China Relations and Its Implication for East Asia and the United States (New York: Oxford
University Press, 2009); May-Brit U. Stumbaum, “Testimony before the U.S.-China Economic and Security Review
Commission,” in U.S.-China Economic and Security Review Commission, Hearings on China-Europe Relationship
and Transatlantic Implications, 112th Congress, 2nd Session, April 19, 2012, pp. 81-91; Øystein Tunsjø,
“Testimony before the U.S.-China Economic and Security Review Commission,” in U.S.-China Economic and
Security Review Commission, Hearings on China-Europe Relationship and Transatlantic Implications, 112th
Congress, 2nd Session, April 19, 2012.

208
structure, deliberately creating the economic circumstances for a security diseconomy against

China might be beyond Washington’s ability.

In this situation, rather than imposing self-defeating restrictions on trade with China,

Washington would need to wait and see if China indeed continues its growth to become a “peer

competitor” of the U.S. There are two different views that predict starkly different trajectories of

the rising power’s economic ascendance.19 One widely recognized scenario suggests that China

is likely to continue its astounding economic growth, although at a lower growth rate, eventually

exceeding the U.S. material capacity. Leading economic institutions predict that the U.S. GDP

will be surpassed by China between 2016 and 2028.20 If China comes to possess the world’s

largest economy and successfully becomes an advanced economy, the U.S. might be pressured to

commit itself to an economic order led by China.

In contrast, a different scenario suggests that China’s growth would eventually slow

down and the U.S. would be able to retain its position as the leading great power both in the

economic and military realms. In this view, it is very difficult to sustain a high economic growth

rate as a state’s economy develops and becomes more sophisticated. Moreover, the leap from a

19
Different theories undergird two different scenarios. For the late developer advantage or the advantage of
backwardness approach, see Elise S. Brezis, Paul R. Krugman, and Daniel Tsiddon, “Leapfrogging in International
Competition: A Theory of Cycles in National Technological Leadership,” American Economic Review, Vol. 83, No.
5 (Dec., 1993), pp. 1211-1219; Alexander Gerschenkron, Economic Backwardness in Historical Perspective
(Cambridge, M.A.: Belknap Press, 1962) Gene Grossman and Elhanan Helpman, Innovation and Growth in the
Global Economy (Cambridge, M.A.: MIT Press, 1991); Robert Lucas, “On the Mechanics of Economic
Development,” Journal of Monetary Economics, Vol. 22, No. 1 (July 1988), pp. 3-42; Paul Romer, “Endogenous
Technological Change,” Journal of Political Economy, Vol. 98, No. 5 (October 1990), pp. S71-S102. For the first
mover or early mover advantage, see Roger A. Kerin, P. Rajan Varadarajan, and Robert A. Peterson, “First-Mover
Advantage: A Synthesis, Conceptual Framework, and Research Propositions,” Journal of Marketing, Vol. 56, No. 4,
(Oct., 1992), pp. 33-52; Marvin B. Lieberman and David B. Montgomery, “First-Mover Advantages,” Strategic
Management Journal, Vol. 9, No. S1 (Summer 1988), pp. pp. 41-58; Richard Makadok, “Can First-Mover and
Early-Mover Advantages Be Sustained in an Industry with Low Barriers to Entry/Imitation?” Strategic Management
Journal, Vol. 19, No. 7 (July 1998), pp. 683-696; R. Preston McAfee, Hugo M. Mialon and Michael A. Williams,
“What Is a Barrier to Entry?,” The American Economic Review, Vol. 94, No. 2, (May, 2004), pp. 461-465. For an
overview of the factors that allowed China's growth and the prospects of its future growth, see Justin Yifu Lin,
“China and the Global Economy,” China Economic Journal, Vol. 4, No. 1 (2011), pp. 1-14.
20
Christopher Layne, “This Time It’s Real: The End of Unipolarity and the Pax Americana,” International Studies
Quarterly, Vol. 56, No. 1 (March 2012), p. 206.

209
developing economy to an advanced economy requires more than simple growth in the size of

the economy. Further, a country such as China would need to solve enormous domestic

problems, including redistribution issues that accumulated during decades of unprecedented

economic growth.21 Unless those domestic reforms are properly implemented, China’s growth is

likely to slow down.22 Accordingly, the likelihood of China becoming a giant Hong Kong is a

remote possibility.23 If this scenario proves to be more prescient, the U.S. would maintain its

position as the reigning power, and the fear of rising China would become the latest addition to

the “declinist” literature in the U.S.

Which view is correct still remains unanswered. Nonetheless, it seems that the U.S.

would be unable to take active measures over trade with China in order to affect that country’s

economic growth. This situation distinguishes the U.S. response to the Chinese challenge from

Washington’s relations with other countries that emerged as the U.S.’ security threat.

Directions for Future Research

This dissertation sought to offer a simple theory on a specific dimension of economic exchanges

in a specific context of great power competition. Therefore, the finding of this dissertation can be

better considered a building block for a more sophisticated theorization of states’ balancing

behavior, and of the economic aspects of the competition between the international system’s

leading great powers. As directions for future research, three substantive issues can be suggested.

21
For instance, see Minxin Pei, China's Trapped Transition: The Limits of Developmental Autocracy (Cambridge,
M.A.: Harvard University Press, 2008); Susan L. Shirk, China: Fragile Superpower (New York: Oxford University
Press, 2007).
22
Bob Davis, “IMF Warns of Slower China Growth Unless Beijing Speeds Up Reforms,” The Wall Street Journal,
July 30, 2014.
23
For this view, see Richard Cooper, “Is ‘Economic Power’ a Useful and Operational Concept?” Discussion Draft,
September 2003.

210
 First, while this dissertation explains the reigning state’s decision on trade with the

challenging state, this does not mean that trade is the only economic exchange that matters in

great power competition. On the contrary, other economic interactions, including finance and

investment, can affect the reigning state’s relative power position vis-à-vis the challenging state.

Nonetheless, I did not try to explain the reigning state’s decision on other dimensions of

economic exchanges with the challenger in order to avoid extrapolating my theory. Theorizing

the reigning power’s behavior over finance or investment requires accounting for different

actors, agendas, and interests. Furthermore, finance and investment affect the overall material

capacity of a country in different ways. Therefore, developing a theory that accounts for all

important dimensions of economic exchanges is unfeasible or unnecessary. Instead, examining

other important aspects of the reigning state’s economic relations with the challenging state is

reserved for different projects.

Second, focusing on the options for the reigning state, my theory did not address

equilibrium outcomes from the interaction between the reigning and challenging states. In order

to explain this, a theory that accounts for the challenging state’s behavior is needed. The

challenging power is in a different relative power position compared with the reigning state, and

has different concerns and interests in pursuing its security. For instance, if the reigning state

only needs to care about the challenging state, the challenger is worried about the competition

with all other major states in its neighborhood. Moreover, the challenging state can be in a

different stage of economic development compared to the reigning state, and thus have different

economic considerations. Thus, the challenging state’s calculation over trade with the reigning

state would be driven by factors that are not considered in my theory. Once we have a good

211
understanding of the challenging state’s behavior over trade with the reigning power, then the

outcome of the interaction between the reigning and challenging powers can be better theorized.

Third, certain components of my theory—assumptions, causal mechanisms, or the

explanatory factors—can be further elaborated to explain how all major states, not just the

reigning state, economically deal with their security competitors. All states would have

incentives to utilize both military and economic means in countering challenges to their security.

Moreover, an inconsistency between an “ordinary” state’s military and economic policies toward

a threatening state is puzzling from the theoretical perspective, and reflects a dilemma in that

country’s foreign policy. Thus, it would be both theoretically and practically reasonable to

pursue a more general theory on a state’s use of economic restrictions in dealing with a security

competitor. This dissertation can be a useful starting point for that study.

212
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