Strategic Hedging Theory

[Santi Dubrova]

Strategichedging is a form of behavior used by states wanting to improve their competitiveness while at the same time avoiding direct confrontation with main contenders. It is an appealing option for states facing uncertainty due to structural changes in the international system such as the present unipolarity giving way to a process of power diffusion. Under such conditions, strategic hedging becomes an attractive alternative for other strategies like balancing, bandwagoning, and buckpassing. Especially for second-tier states, it becomes a behavior of choice vis--vis the system leader.

The index comprises three core dimensions (economic capability, military power and decision-making capability), which are broken down into six sub-indicators: gross domestic product (GDP), foreign exchange and gold reserves, government debt, military expenditure, growth of military arsenal, and democracy. Because second-tier states in the international system are likely to have the greatest incentives to engage in strategic hedging, the composite index developed in this study is applied to a sample of seven leading second-tier states in a comparative case study.

The results indicate that for states to score high on strategic hedging capability, they need to score high on all core dimensions. Negligence of one of the components leads to a significant decline in total hedging capacity. Such results show why China tops the strategic hedging capability index and scores significantly higher than the other second-tier states.

Foreign exchange reserves are assets held by central banks and monetary authorities. They usually consist of gold and various global currencies such as US dollar, euro, pound sterling, and yen. Central banks attempt to preserve the liquidity of foreign exchange reserves to meet payments in foreign currency and to confront financial crises (Zhang et al. 2013: 138). Importantly, foreign exchange reserve plays a significant role in hedging overall macroeconomic risks (Li et al. 2012: 1524). High volume of foreign exchange reserve and gold makes the hedging state ready to accept domestic and international costs in the short-term as part of hedging behavior. Consequently, foreign exchange reserve is used as a positive indicator to measure strategic hedging capability.

Military power has a dual and contradictory effect from the standpoint of hedging behavior. While strategic hedging involves upgrading of military capabilities, it seeks to avoid provoking the system leader either through increasing its military arsenal provocatively or through entering into an alliance against the latter (Tessman and Wolfe 2011; Tessman 2012; Salman and Geeraerts 2015). For these reasons, we chose two indicators, one positive and the other negative to measure the impact of military power on strategic hedging.

The financial management of the entire military sector is essential to protect the state and its population against internal and external threats. Military spending in the strategic hedging framework is somewhat similar to the arms race dynamic. Both of them occur in peacetime and involve a gradual increase in armaments resulting from conflicting purposes and/or mutual fears under conditions of uncertainty (Huntington 1958; Tessman and Wolfe 2011). Importantly, increases in the military expenditure lead to improvement of the competitive military ability of the hedging state. The size of military spending, therefore, is a positive indicator of the level of hedging.Footnote 3

While improving competitive military ability is essential to strategic hedging, the hedging state should avoid an extensive arms buildup that might disturb the system leader and lead to a dispute, a crisis, or a military confrontation (Tessman 2012; Salman et al. 2015). Moreover, there is a negative causal relationship between military spending and economic growth, especially when military expenditure leads to negative economic growth (Chang et al. 2011). In this context, military spending relative to GDP is used as a negative critical indicator for measuring strategic hedging capability.

Implementation of sovereign decision is a basic pillar of hedging behavior. Rich nations do not routinely become great powers; they need a strong central government to harness the economic and military power for the purposes of foreign policy, which explains why the United States was a minor power in the late nineteenth century although it was the richest country in the world, including military, economic, political, and diplomatic factors (Zakaria 1998). Therefore, it is mandatory to allocate at least one indicator to measure central authority.

All data have been taken for the year 2013. The leading seven second-tier states (China, France, Germany, India, Japan, Russia, and UK) have been selected on the basis of their being the largest economic and/or military powers in the world (except the United States as a system leader) and are used for a comparative case study. The study uses six different datasets that help to measure the components of strategic hedging (gross domestic product, reserve of foreign exchange, government debt of GDP, military expenditure, military expenditure of GDP, and democracy). Table 1 illustrates the sources of these data.

Finally, Chinese decision-making, also in the realm national security, is a centrally coordinated process that is heavily influenced by the expectations and beliefs of key decision makers in the Party, the state, and the Central Military Commission (Huiyun 2009). All in all, China has adopted a correct track for successful hedging: it focuses primarily on economic development, and in doing so tries to create a balance between economic and military capabilities while centrally coordinating its policies at the highest levels of government. Given these reasons, China constitutes a perfect example of a strategic hedging state, and tops the strategic hedging index with a score that is significantly higher than Russia, which occupies the second place (Fig. 3).

Arguably, most EU countries have entered into an unbalanced partnership with Washington, and have relied heavily on subsidies provided by the system leader, especially military aid, resulting in losing several competitive abilities. Moreover, belonging to a joint union and high levels of democracy affect their political and economic decision-making capabilities. Consequently, Germany, France, and UK occupy modest positions in the strategic hedging index, with substantial convergence in competitiveness (Figs. 8, 9, 10).

There are other indicators to measure military power such as global militarization index (GMI), the number of military personnel, and the level of military equipment. However, due to the lack of accurate figures we only use a military spending index.

Exercise Malabar is an annual bilateral naval exercise between the United States and India (some years to include Japan, Australia and/or Singapore). The exercises take place every year since 1992 until 2014 (except for a brief interregnum, 3 years, after the 1998 Pokhran II nuclear tests) (Pandit 2014).

The study will be carried out based on a theoretical framework drawn from strategic hedging theory, a new structural theory in international relations, to examine the shifts in UAE policy towards Iran. Previous literature suggests that small states prefer hedging over balancing or bandwagoning. The authors also undertake a descriptive analysis and deploy a longitudinal within-case method to investigate changes in UAE policy towards Iran and identify the causal mechanisms behind these changes. That method allows investigating the impact of a particular event on a case by comparing the same case before and after that event occurred.

The main finding of this study is that the UAE hedging strategy towards Iran allowed maximizing the political and economic returns from the cooperation with Iran and mitigating the long-range national security risks without breaking up the consistent and beneficial ties with other regional and global powers. Hedging achieved the desired outcome, which is preventing direct military confrontation with Iran. Hard balancing, adopted by Abu Dhabi after the 2011 Arab Spring, has proved to have some negative effects, most importantly provoking Tehran. Some recent indicators suggest, though that the UAE may revert back to its long-established hedging policy towards Iran.

Since its foundation in 1971, the UAE pursued a strategic hedging based policy towards Iran. The UAE hedging towards Iran involved:Soft balancing, which mostly comprises stimulating participation in multilateral organizations, as well as developing relations with regional and major powers to thwart or undermine Iranian policies and impede its attempts to impose hegemony over the region;

Hard balancing, which includes developing UAE military capabilities to discourage Iran from aggressive actions, and forming alliances with major and regional powers, most importantly the USA and Saudi Arabia, to act as counterbalances to Iranian regional influence and/or give them a stake in a stable regional order.

In doing so, the UAE, which considers Iran as its largest regional threat, extended its commercial and diplomatic relations with Tehran, as well as maintaining its own military and security alliances with Saudi Arabia and the USA. More importantly, the UAE did its best to prevent an outright falling-out or open confrontation with Iran.

This paper attempts to explain why the UAE has restructured its policy towards Iran in the aftermath of the Arab Revolutions and explore whether it may revert back to its long-established hedging policy.

Strategic hedging is a mixed strategy of cooperation and conflict, relying on both soft and hard power tools. It is a combination of policies that, on one hand, stress engagement and integration mechanisms and, on the other, emphasize realist-style balancing. Hedging state cooperates with the powerful threatening state (PTS) to avoid threats or/and getting involved in unequal conflicts (soft balance). At the same time, elements of hard balancing are being taken against the PTS, such as engaging in alliances with the competing forces of PTS and increasing military and non-military capabilities (Gindarsah, 2019).

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