Memo

22. Jan. 2024

Germany Needs an Economic Security Strategy that Prioritizes the Mitigation of Import-Related Vulnerabilities

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Given the increasing weaponization of economic interdependence, Germany should prioritize the mitigation of import-related vulnerabilities as part of a broader economic security strategy. Import-related vulnerabilities have significant potential for systemic disruption, and they lend themselves to cost-effective geoeconomic coercion by adversaries. They can, however, be effectively mitigated through stockpiling, diversification, reshoring, innovative substitution, and deterrence – or a combination of them.

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Economic interdependence and the increasing politicization of international economic relations give rise to economic and geoeconomic vulnerabilities. Germany and the EU have responded by launching many initiatives and policies aimed at mitigating these vulnerabilities, including the creation of an anti-coercion tool, greater coordination of inward foreign direct investment, export control policies, and policies aimed at mitigating the EU’s dependence on crucial imported technologies and critical raw materials. Individual policies are also gradually being integrated in the context of Germany’s national security and China strategies.

While mitigating economic risk is essential, it is costly. Moreover, not all risks need to be maximally minimized. It is therefore important to identify the most critical risks and prioritize their mitigation in the context of a broader, multi-pronged economic security strategy at the German and EU level. Critical vulnerabilities should be reduced to the maximally acceptable level, while non-critical vulnerabilities can be managed through less costly policies, such as deterrence.

The greatest economic risk is related to imports that are essential to the functioning of the economy and its critical sectors, like defense or health. Lack of access to critical imports, including intermediate inputs, can cause massive damage in the case of a major international systemic economic disruption such as war. The immediate example that springs to mind here is Russia’s attempt to weaponize its energy exports to its geopolitical adversaries after its large-scale invasion of Ukraine. Yet even if the absence of an open conflict, other geoeconomically motivated export restrictions by an adversary can prove extremely disruptive. The importance of critical intermediate inputs, such as semiconductors, is often much more significant than what is implied by the value or volume of their imports. Consequently, Germany and the EU should prioritize the mitigation of these critical vulnerabilities.

Economic Risks Related to Cross-Border Trade and Finance
  Vulnerability Geoeconomic Deterrent Short-Term Defense Medium-Term Defense
Import-Related Vulnerabilities

Export controls that lead to a loss of access to critical imports with cascading negative effects throughout the economy, including in key sectors such as defense and health

Target coercer’s own critical vulnerabilities Stockpiling

Diversification

Innovative substitution

Reshoring

Export-Related Vulnerabilities

Import restrictions that lead to reduced exports, economic efficiency, and growth Leverage the size of the EU market by threatening to impose import restrictions Create fiscal space to buffer the impact of negative demand Negotiate and deepen free trade agreements
Vulnerabilities Related to Cross-Border Financial Claims and Flows

Seizure and expropriation that lead to financial losses

Currency sanctions that lead to a reduced ability to engage in international trade and finance

Germany and the EU hold financial “collateral” in the form of foreign investment in the EU Rebalancing, i.e., diversifying foreign financial claims

Strengthen country risk management at the level of individual firms

Strengthen the Economic and Monetary Union

Advance the capital markets union to make the euro more attractive

Vulnerabilities Related to Foreign Direct Investment

Financial losses

Risks related to supply chains and imports

Technology leakage

National security risks related to the foreign ownership of critical infrastructure

Germany and the EU hold financial “collateral” in the form of foreign investment in the EU

Tighten the oversight of companies operating in critical sectors, including their outbound investments

Tighten restrictions on foreign investment in critical sectors

Force foreign owners to divest critical companies

Diversification

Tighten restrictions in sectors relevant to technology/national security

Tighten the regulation and supervision of critical sectors and companies supplying critical goods

Strengthen capabilities in counterespionage and cyber defense

Source: Author’s own compilation

Policies for Mitigating Import-Related Vulnerabilities

Different risk mitigation policies come with different economic costs and different levels of effective risk mitigation. There is no one-size-fits-all approach. Policymakers need to determine the maximum acceptable risk threshold and then decide on the most cost-effective way of reducing import-related risks, including by combining various risk mitigation policies. Here is an overview of the mitigation policies that can be used.

Stockpiling

Stockpiling critical inputs helps to buffer the impact of supply shocks. It also reduces the ability of geoeconomic adversaries to exploit import-related dependencies by buying the time to take mitigating actions. A government can provide financial incentives or set mandatory targets. Governments could get more closely involved in the purchase and storage of critical commodities like energy. Germany and the EU could, for example, impose mandatory minimum reserves for such goods.

Diversification

Import diversification reduces the risk of economic disruption and curtails the ability of a geoeconomic adversary to exploit import-related dependencies. While diversification should primarily be led by the private sector, the German government should actively support it by providing financial incentives. In addition, the EU should negotiate enhanced international trade and investment agreements that provide German and European companies with enhanced access to critical goods. Further, Germany could pursue government-to-government supply deals and even impose minimum mandatory diversification thresholds in critical economic sectors.

Reshoring

Reshoring seeks to reduce risks by producing critical goods domestically. This is generally costly, and it may increase the risk of other types of domestic disruption – particularly if production is concentrated geographically. The German government should, however, consider reshoring, especially in critical sectors such as defense or health in which a failure to source critical goods can have disastrous consequences.

Innovative Substitution

Innovative substitution seeks to produce substitutes for critical imports through the development of alternatives. The German government could provide subsidies to the private sector to incentivize it to engage in research and development in this area. In some cases, new technologies that allow critical commodities to be reused or recycled can also help reduce import dependence.

Deterrence

Deterrence seeks to dissuade politically motivated attempts to disrupt imports rather than mitigate the impact of global systemic disruptions. It should be politically well calibrated to target the most salient economic vulnerabilities of potential geoeconomic coercers – including their import-related vulnerabilities. Targeting import-related vulnerabilities is generally more cost-effective than opting for broader retaliatory measures.

Recommendations for the German Government

Governments have an important role to play in ensuring national economic security. To paraphrase the late French statesman Georges Clemenceau: economic security is too important to be left to the markets. Managing firm-level risks does not always translate into low risk at the systemic level. Therefore, the German government should establish a framework to identify, evaluate, and mitigate risk that includes the identification, evaluation, and mitigation of critical import-related vulnerabilities.

  • Identify: In close consultation with the private sector, the German government needs to gather the data necessary to identify which imports are most critical to the functioning of the country’s overall economy and its strategically important sectors, e.g., defense and health.
  • Evaluate: The German government must then evaluate which import-related vulnerabilities should be prioritized and which of the mitigation options (or combination thereof) is best suited to reach the desired cost-benefit trade-off. Those critical vulnerabilities that are deemed to not lend themselves to either deterrence or diversification may require more costly mitigation policies such as stockpiling in the short term, reshoring in the medium term, and innovative substitution in the long term.
  • Mitigate: The German government then needs to decide how best to support effective risk mitigation. Where the private sector is unable or unwilling to mitigate systemic risk, the government should intervene by providing economic and financial incentives. If necessary, the German government could also impose mandatory risk mitigation policies like obligatory stockpiling. It could also get directly involved in risk mitigation, for example through the purchase of critical goods.

The German government should seek to manage import-related risks at the EU level through measures that include EU deterrence policies, critical raw materials policy, and inbound and outbound investment policies. Yet where European cooperation proves difficult or insufficient, Germany’s government must not hesitate to pursue mitigation policies at the national level – especially because of Germany’s greater international trade integration and its large industrial sector that is more dependent on critical foreign inputs.

 

Bibliografische Angaben

Jaeger, Markus. “Germany Needs an Economic Security Strategy that Prioritizes the Mitigation of Import-Related Vulnerabilities.” January 2024.

This DGAP Memo was originally published online on January 23, 2024.

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