The first is simply the ability to “buy more might” in order to build up one’s military power. Throughout much of pre-modern history, rulers saw wealth primarily as a means to achieving military superiority. The Bank of England was granted its Royal Charter in 1694 so that it could sell bonds to wealthy London merchants in order to finance William III’s military campaigns on the Continent. More recently, the economic drain imposed on the Soviet economy by the Soviet-US military arms race was certainly one factor in its eventual collapse. In the case of modern peacetime democracies, however, the ability to “buy more might” is generally less constrained by the economics of national wealth than by the politics of voters who prefer lower taxes or social programs to a military build-up. It is in this sense that Peter Peterson argued in an October 2004 Foreign Affairs article that the United States faces a long-term trade-off between economic security and national security: meeting the demands of an aging society may conflict with financing a multi-decade war on terrorism.

The second type of economic power can be termed “carrots and sticks,” or the ability to achieve foreign policy objectives through the deployment of national economic resources. In the 1950s, the US-funded Marshall Plan was a very big carrot to speed up European economic recovery and thereby hold at bay the attractions of local Communist parties. The 1978 Camp David Agreement between Israel and Egypt was laced with substantial increases in foreign aid from the United States to both governments. Sticks have typically been less successful. The US economic boycott of Cuba has been in place for four decades without notable effects on Castro’s policies. The tariffs on steel imports imposed by the United States in 2003 were ruled illegal under the rules of the World Trade Organization (WTO) in 2004.

The United States is certainly wealthy enough to offer some tasty carrots in support of its foreign policy objectives. But there are two major difficulties in turning economic bribes into effective instruments of foreign policy. First, US taxpayers may decline to foot the bill. The budget allocations for the war in Iraq and its aftermath already exceed US$150 billion. With a federal deficit in excess of US$500 billion per year, the US government is not in a position to distribute many more carrots. Second, the ability of donor nations to dictate the actions of recipient nations has surely declined since the end of the Cold War. Governments of democratic recipients, such as Israel, have been voted out of office for following unpopular policies agreed on with external donors. Meanwhile, economic sticks such as tariffs are limited by WTO rules and by their tendency to backfire on domestic firms by raising their input costs. Thus the “carrot and stick” power of the United States is low and probably shrinking as economic integration proceeds and the political sophistication of recipient countries grows.

A third type of economic power is the ability to bend the rules of economic engagement in ways that favor one’s domestic firms or consumers; that is, to “tilt the playing field.” This includes attempts to hold one’s currency artificially low in order to benefit exporters or to insist that US rules for accounting standards or intellectual property protection be used by foreign firms who wish to operate on an equal footing with domestic firms in the large and attractive US market.

By virtue of its sheer economic size, the United States has an effective veto over most international rule changes with which it disagrees. Its rejection of the Kyoto Protocol—on the grounds that it would hamper the competitiveness of US firms—has effectively prevented those countries that have signed it from achieving their global objectives. But the United States rarely has sufficient economic power to impose its own preferred standards on others. The competitive structure of global markets and the importance of foreign firms in them effectively limit the ability of US firms, or the US government, to set international standards based on its own rules. Foreign exchange markets prevent long-term competitive devaluations by any major country. Prior commitments at the WTO constrain US attempts to “tilt” trade rules, just as they protect US firms from such attempts by other governments. Provided the WTO retains its authority, this type of economic power will remain weak.

A fourth category is hyper-competitiveness. While this is difficult to define, many business people and politicians believe that, like pornography, they “know it when they see it.” A hyper-competitive country would have such a favorable economic climate that its firms would gain dominant positions in key industries or innovative areas so that firms from other countries could not catch up or compete successfully. Although this has been a recurrent fear, it is hard to find sustainable examples. The stock market bubble of the late 1990s created huge wealth in the information technology and telecommunications industries, where US firms were in the lead. But much of that evaporated in the subsequent stock market falls. In the 1950s and 1960s, US firms dominated the auto industry, mostly because of the voracious appetite for autos by US families. But by the 1980s, Japanese car companies were gaining market share in the United States. A famous benchmarking study at the Massachusetts Institute of Technology in 1990 showed how Toyota, Nissan, and Honda had achieved productivity levels higher than those of GM, Ford, or Chrysler. That era passed, and by the late 1990s Nissan had fallen into what looked like terminal decline. It was rescued by the French firm, Renault, who moved Carlos Ghosht, its brilliant Brazilian manager, from Paris to Tokyo to lead the turnaround. He was so successful that he was subsequently voted Japan’s Most Admired Businessman.

This story demonstrates an important aspect of today’s competitive markets which effectively limits the ability of the United States—or any other country—to build hyper-competitive power. In many industries, the marketplace is now global for inputs as well as outputs. If labor is cheaper in China than in the United States or Germany, then auto firms from both countries can set up production plants in China. An exceptional manager from Brazil may choose to work in Paris or Tokyo as easily as Detroit or Sao Paulo.