Macrostrategy versus “Grand Macro Strategy”

In February, the Atlantic Council noted, “Today, the frequency and potency with which governments deploy “economic statecraft” -which includes sanctions, export controls, tariffs, investment restrictions, and price caps, among other tools- has never been higher.” The re-election of Donald Trump is obviously set to refocus market thinking in this area.

Crucially, economists discuss these policy developments while being unfamiliar with the “economic statecraft” under which they more traditionally sit. This knowledge gap means economic analysis lacks a conceptual framework for how or why policy choices are made. As a result, analysts may wrongly ascribe the underlying motivation to the introduction of these policies, or fail to understand what policy may logically flow on.

This report explains the key differences between economic policy and economic statecraft; the related term “grand strategy” and its schools of thought; and the statecraft policy toolkit, and its dynamics. It then looks at how late-2024 US and EU economic statecraft compare versus their historical contexts, drawing specific examples as an indication of what may lie ahead in some scenarios.

The conclusion is that markets should be prepared to supplement purely economics-focused macro strategy with a fusion geopolitical “grand strategy-plus-economics” lens, which we dub “Grand Macro Strategy.” A more geopolitical world, by its very definition, should arguably preclude a reliance solely on business-as-usual economic thinking.

For markets, the recent, rude interjection of national security is “new.” However, the link between the economy and foreign policy has been recognized as important since the times of Thucydides, Plato, and later by Marx and Keynes.

We can define the distinction between economic policy and the different but related concept of economic statecraft where:

The key difference is akin to that between asking, “What is GDP growth?” versus “What is GDP growth for?” The latter might involve a GDP growth target, but it’s not the actual target. This brings us to the next key definition:

So, economic statecraft is just one leg of a three-legged grand strategy stool of ways to achieve national security ends within given national means. As Von Clausewitz infamously argued, “war is a mere continuation of policy by other means.” By extension, economic statecraft is a mere continuation of a political and military policy by other means.

Importantly, both idealists and realists can be either hawks or doves. European idealists today are in favor of soft-power, free-trade andpacifism. The idealist US neoconservative hawks behind the 2003 Iraq War believed they could spread liberal democracy by force. Likewise, statecraft realists can be doves who don’t see a war as being in their national interests, or irridentist hawks who see that war brings them rewards.

The economic statecraft toolkit contains both carrots and sticksthat individually or collectively persuade, or force, other states to adopt certain actions. They fall into three broad categories: trade, capital, and other, which often all sit under the umbrella of industrial policy.

Trade

For idealists, free-trade agreements (FTAs) build security through interdependence. Realists think they allow monopoly exporters or monopsony importers to coercetrade partners due to their dependence. Idealists oppose tariffs andnon-tariff barriers (NTBs) but will use them to defend their ideals. Realists see trade as a supply side response for key goods and as national security, where tariffs produce revenues that can be used to lower domestic taxes or fund national projects. and. Subsidies, the inverse of tariffs, are viewed the same way, and are often used by realists. in tandem with tariffs.

Boycotts of firms/goods allow idealists to police their system or over national security; for realists, they create opportunities that their domestic firms can exploit. A parallel path is export controls to retain key technologies, or to block strategic imports by a rival economy’s military. However, statecraft’s ‘strategic materials fallacy’ argues that such measures are inadequate because civilian items are dual use. This can then lead to trade embargoes, which are accepted by idealists to uphold their principles and by realists for reasons of national security or self-interest.

Third-party neutral rights to trade with both sides through a blockade are overruled on principle by idealists, i.e., sides must be taken. Realists back their own neutral rights to trade, but oppose those of others when embargoing someone.

Capital

Foreign aid is a key statecraft tool, but comes with strings attached, i.e., provisions to only buy goods from donor-country firms, or with policy quid pro quos. The same holds for official loans, even for idealists. Capital controls can be used to keep money in or out of a certain sector domestically or internationally, for national security reasons. Idealists will use such tools selectively, realists as and when they suit them.

Idealists use primary sanctions and secondary sanctions to police the liberal system. Realists would like to use sanctions but generally do not have the network effect to do so (though China just sanctioned a US firm supplying drones to Ukraine over its sales to Taiwan, with huge implications for supply chains given China’s trade dominance). Realists try to evade sanctions; idealists must then choose between enforcement (risking geopolitical tensions), or displaying a lack of teeth.

Other

Economic statecraft can include other areas with one caveat: if they have a national security goal.

Monetary policy can be statecraft. The Bank of England was established in the 17^th century to fight France via low state-borrowing costs, providing the template for other central banks. The first and second world wars shaped the Federal Reserve System created in 1913. In both conflicts, the Fed focused on war finance, not inflation. Outside war, central banks historically helped governments with national economic development via seignorage: the BOJ, ECB, BOE, and Federal Reserve have all used major balance-sheet expansions during recent financial crises and the Covid pandemic.

Fiscal policy is always statecraft: it’s just a question of what the money is spent on - and of how much the fiscal deficit can expand (and be financed) in a geopolitical crisis.

FX policy can be statecraft. Idealists may let markets set FX rates, but realists consider export competitiveness, stability (versus others’ instability), and power, e.g., the dollar as reserve currency makes US rates, sanctions, and Fed swap lines statecraft tools.

Infrastructure has always been statecraft: for idealists Roman roads linked Europe, which its legions marched down for realists; today, we see China’s Belt and Road Initiative or the EU Gateway Programme. On energy, idealists cooperate on the green transition, but realists see a zero-sum game of limited green resources, technology, and good green jobs. Food can either be produced cooperatively, for idealists, or weaponized, for realists. All key commodities can either see their prices pushed higher when supply is choked off or, inversely for exporters reliant on commodity income, see prices pushed far lower by various tools to undermine their macro stability.

Industrial policy

An overarching term used for many of the above policies in combination is industrial policy, or government assistance to businesses to boost or reshape specific economic activities that markets cannot address on their own. Today, industrial policy is back in fashion in the west, and is spreading through the hyper globalised world economy: indeed, as Michael Pettis recently summarized it: ‘Which Country Should Design US Industrial Policy?’ – the US, or China?

Table 1 summarizes the key policy tools in the toolkit and shows how each is either carrot (🥕) or stick (🦯) depending on how it is used. As a heatmap, green shows that a particular tool is used freely, and red shows that it is not. Additional notes on how or why the policy is used, and its particular effects and /risks are also included. It also points to the policy dynamics, where one policy tool often leads to the use of another, either flowing downwards towards escalation (↓) or being mirrored back at the originating party (↔) in contagion.

Let’s now look at how the economic statecraft toolkit might be used if the hypothetical liberal state of Examplonia wants to prevent Antagon from prosecuting a war against its neighbor Protagon.

Table 2 shows the history and current status of US economic statecraft on a qualitative heatmap where green is laissez-faire and red is not: this is necessarily only indicative for the purposes of this report.While we rank the US as more idealist in 2024 than in 2020 (given that the Biden White House displayed realism versus China and Russia, whereas Trump applied it globally), US economic statecraft currently resembles the two world war periods in its breadth, and its ‘heat’ is closer to the period of 1970’s Cold War détente, with some areas even hotter.

Clearly, the US has swung between realist (isolationist) and idealist (internationalist) phases. When it feels its survival is threatened, it reacts with strong economic statecraft. Indeed, a war-phobic US must logically rely more on economic and political statecraft in lieu of military power.

The pattern economic statecraft in Europe (including the UK) is clear. It was home to Machiavelli, Von Clausewitz, Palmerstone, and Bismarck; realpolitik is German; Europe was realist until WW1, then sharply idealist after WW2 and the end of the Cold War. However, recent shocks have started Europe on a path to a more realist grand strategy of “open strategic autonomy”, which will necessitate the use of economic statecraft over economic policy.

European Union(?)

One of the key challenges Europe faces is that it remains politically divided. Part of Europe is prepared to move to a more realist world view. However, there is still a lot of support for not completely ditching idealism. Moreover, some EU governments are more realist than idealist- but in a pro-Russia direction. So the key question remains whether the “slow agony” Draghi threatened for an unreformed Europe will suffice to speed up its shift to a more realist use of economic statecraft. The experience from recent decades is that it may well require a common enemy and a crisis to get things moving.

On that note, some senior EU diplomats (anonymously) take the view that “The return of Trump would be a beneficial shock that will enable the EU to move forward, like the pandemic or the energy crisis following the war in Ukraine.”

For markets, this implies the need to look beyond macro strategy based on purely economic assumptions to a broader methodology involving economic statecraft, which we dub ’Grand Macro Strategy’.