National security and economic prosperity are two sides of the same coin
11 Nov 2022|

The recent release of the US national defence strategy identifying China as the ‘pacing challenge’ and most consequential strategic competitor for decades to come further reinforces the need for thinking that clearly articulates Australia’s strategic positioning. The decoupling in key technology sectors currently occurring between the US and China, however, will require Australia to re-evaluate the costs associated with meeting national security needs through market economics.

The scarcity and importance of rare-earth elements have made them desirable because they are used in vital parts of consumer goods like electric vehicles and military equipment such as the F-35 fighter jet. China is the global rare-earths superpower, a role it has used to its own advantage in the past and will likely continue to. In 2010, for example, it stopped exports to Japan over territorial disputes. The general consensus in Australia, the US and other like-minded countries is that for strategic reasons building rare-earth processing capacity outside China must be prioritised.

But diversifying rare-earth supply chains is about more than mining; it requires a complete alternative value chain that extends from processing to manufacturing. Historically, the costs associated with mining and processing rare earths, combined with China’s lax environmental policies, were the basis for their consolidation in China. Growing the rare earths supply chain in Australia will therefore require substantial financial incentives and policy mechanisms to make it economically attractive.

There’s also a pressing need to prioritise semiconductor production because of supply shortages. Semiconductors are also integral to F-35s and electric vehicles, as well as smart phones and other devices. Over the past couple of decades, the Taiwan Semiconductor Manufacturing Company has become the nanoscale semiconductor export superpower. The large amount of capital required to set up and operate a semiconductor fabrication makes it financially unattractive for many corporations.

Taiwan’s proximity to China and the continued threat of an aggressive Chinese takeover of the island, have prompted US President Joe Biden’s administration to invest large sums of money to regrow the American semiconductor industry and increase the number of US suppliers. Ramping up the US’s industrial-scale manufacturing capacity, though, will take many years and a lot of capital. Whether it can be done in a competitive manner with the incentives under the new CHIPS Act is an open question.

It’s not just semiconductors and rare-earth elements that are under the microscope. The list runs from munitions to medical supplies and includes anything that may affect the functioning of a nation and its critical systems. The ongoing calls to rectify shortcomings in secure supplies of these items and the drive to prioritise newer sectors, though, are cast against the years of relative stability during which globalisation created unprecedented wealth in Australia—albeit on an unequal basis.

The dominance of a pro-market, globalised mindset led to the undermining of the vital notion that market economics and national security are intertwined. Events like the war in Ukraine and its impact on Europe’s energy needs have shown once again that markets can be significantly affected by geopolitics and that an assessment of potential national security risks should always be part of the calculations made by both governments and businesses.

This is not to say that Australia needs to go back to the uncompetitive price controls and government interventions that started to be unwound in the 1960s. The Covid-19 pandemic, however, exacerbated existing tensions and demonstrated that a completely hands-off approach by government in sectors such as the energy market can create havoc when they’re affected by global events. The government has shown its ability to mobilise emergency spending in some circumstances, but in others, such as ensuring sufficient supplies of Covid-19 vaccines, hasn’t been able to resolve shortages in the short term because of limited domestic manufacturing capacity.

Capacity constraints are particularly pertinent for Australia’s defence organisation, and highlight the problem with simply calling for the defence budget to be increased to match the times. It’s one thing to increase the budget to boost the number of desired capabilities or platforms, but it’s not possible to offer quick returns if the handful of options for production are already at capacity. It’s hard to respond effectively to strategic circumstances that are deteriorating now if there’s little else to do but wait for years before the expected capabilities can enter service.

The government may also choose to increase how much it’s willing to pay for a specific product to jump ahead of others in the queue. But even for simple things like surgical masks such actions can create tensions between allies and partners, an outcome that can have its own ramifications in the context of Australia’s approach to national security.

Looking into the near future, Australia will need to contend with multiple macro risks that are surrounded by deep uncertainty, such as dealing with the effects of climate change, the potential for nuclear war in Europe and a possible major-power conflict in the Indo-Pacific. These risks are intertwined, creating a compounding effect that limits the government’s ability to deal with any one of them discretely.

After decades of operating in a world with globalised supply chains for a range of vital products, the government is faced with having to navigate the challenges associated with distributed production because of the potential national security risks that come with relying on supply chains with single points of failure. It’s a difficult knot to untangle and the costs will likely be significant, but the risks to both national security and future economic prosperity are too high not to attempt to do so.