Joint Seminar Finance - Macro: A Theory of Economic Coercion and Fragmentation

Abstract

Hegemonic powers exert influence on other countries by threatening the alteration of financial and trade relationships. Mechanisms that generate gains from integration, such as external economies of scale and specialization, also increase the hegemon’s power because in equilibrium they make other relationships poor substitutes for the hegemon’s. Other countries implement economic security policies to insulate themselves from hegemonic pressure, but in doing so can inefficiently fragment the global economy. A hegemon can benefit from committing to limit coercion to attract participation in its economic network and preserve its power. We estimate that U.S. geoeconomic power relies on financial services, while Chinese power relies on manufacturing. Since power is nonlinear, much economic security could be achieved with little overall fragmentation.

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