Part 2: Risks in Focus:
2.2 Instabilities in an Increasingly Multipolar World
Already, states are prioritizing short-term or proximate concerns over long-term or more global issues.3 Not only may a resulting global leadership vacuum fuel geopolitical instability in the years to come, it may also exacerbate global governance challenges and have undesirable consequences for the long-term development of systemically important sectors such as energy, financial services and healthcare.
Demographic and economic changes, such as growing middle classes in most emerging-market countries, ageing populations in Europe, China and Japan, and fast-expanding populations across much of North Africa, the Middle East and India, are transforming societal expectations and shaping national political priorities. In parallel, ever more extensive trading relationships, international travel, migration and technological advances are increasing the speed at which ideas, information, people, capital, goods and services cross borders.
Against this backdrop, key geopolitical variables will influence global development over the next decade. These include the ability of key emerging markets to successfully deliver on substantial economic and political reforms, and the willingness of leading powers to cooperate economically and on global governance issues. Thus, across the world, tension between the domestic imperatives of growth and stability is setting the mood for international relations.
The Risk Landscape of the Future
With a five-to-ten year lens, four potential threats can be identified in light of current trends: emerging-market uncertainties, commercial and political frictions between countries, the proliferation of low-level conflict, and slow progress on global challenges.
Emerging Market Uncertainties
The four BRIC nations now rank among the 10 largest economies worldwide and China is predicted to top the table on a purchasing power parity basis within the next three to eight years.4 But emerging markets in general are by no means a unified group, and in the coming years their economic performance is likely to diverge. Arguably, these countries are reaching an inflection point in their development where the growth model of their economies cannot continue to support the creation of wealth.5
Existing undertones of social unrest may be aggravated by externally driven economic shocks and the unsatisfactory implementation of far-reaching domestic reforms, even more so where political succession planning is unclear. While increased global trade and the faster movement of capital in a more integrated global economy generally support economic growth, they can expose countries to volatility induced by hot money flows, the fragility of traditional trading partners and a prolonged ebb in the commodity super-cycle, resulting in financial system fragilities. Additional challenges will arise as countries allocate a more prominent role to market forces and extend welfare frameworks, especially where this rubs up against institutional inertia and vested interests in society.
As Figure 2.1 shows, popular discontent with the status quo is already apparent among rising middle classes, digitally connected youth populations and marginalized groups (for example, ethnic minorities and the new urban poor). Collectively, they want better services (such as healthcare), infrastructure, employment and working conditions. They also want greater accountability of public officials, better protected civil liberties and more equitable judicial systems. The misuse of power, official complacency and greater public awareness of widespread corruption have sharpened popular complaints.
Figure 2.1: Countries with Social Unrest in 2013 (selected)
Source: Eurasia Group, Oliver Wyman, websites.
Note: Excludes military conflicts in Syria, Mali, Democratic Republic of Congo, Central African Republic, etc.
Interstate Frictions – Commercial and Political
Domestic economic goals will increase pressure on international commercial partnerships. While global trade deals might be harder to come by, notwithstanding the success of the World Trade Ministerial Conference in Bali in December 2013, deals that involve smaller groups of countries are on the rise, with several extensive frameworks currently under negotiation (for example, the Trans-Pacific Partnership, TPP, and Transatlantic Trade and Investment Partnership, TTIP, – see Figure 2.2). These aim for greater economic harmonization on standards and regulations, in addition to tariff reductions. For some governments, a significant political price will have to be paid for being on the inside, such as the opening up of protected industries, while others may face choices that will position their allegiances for years to come.
Some countries may use trade and investment relationships as a means of projecting geopolitical power and achieving strategic advantage. At the same time, pursuing geopolitical interests may damage economic confidence, notably in South-East Asia, where rising nationalist expectations and growing pressure on leaders for success is already affecting trade relations in key markets.6 Given the large number of potential flashpoints, political missteps may reduce trust and have lasting economic consequences.
Proliferation of Low-level Conflict
Growing opportunities for asymmetrical warfare heighten the risk of national security crises. The risks for developed states posed by traditional forms of terrorism have proved less potent in recent years. At the same time, the number of attacks in the “south” has grown quite quickly and alarmingly. The risk is that terrorist activities in weak or fragile states can undermine states, cause unrest and then spill over into neighbouring countries, causing regional instability.
Technology-based aggressions from state and non-state actors are on the rise.7 In the world of cyber warfare, strategic advantage will remain for the foreseeable future with aggressors – barring radical changes to the structure of the Internet (see Part 2.4) – with multiple incidents in every region of the world. Similarly, the inevitable spread of drone technology will create new hard-to-address capabilities for rogue actors – highlighted by the ability of a camera drone to get within three metres of German Chancellor Angela Merkel in September 2013. Multilateral agreements in these low-level conflict areas would help to manage the associated risks, if not eliminate them.
Moreover, in a world where fiscal constraints, legitimacy concerns and domestic demands compete for attention, established powers will be more reluctant to accept new responsibilities abroad. As a result, conflicts within and between states may more easily deteriorate into crises. Potential nuclear proliferation in the Middle East will continue to draw high-level political attention in Washington and in Europe. But the capacity to resolve problems elsewhere will likely depend on the creation of regional coalitions of the willing, able and like-minded, given regular impasses in the UN Security Council. This challenge may become especially complex in East and South-East Asia, a region that lacks a viable regional security framework and contains nations that still depend strongly on the US security “umbrella”.
Slow Progress on Global Challenges
Adding to the factors that will weigh on growth, the greater role of regional forums and tendencies towards de-globalization may complicate progress towards sustainable global development. Cross-cutting, slow-burn, systemic challenges, such as climate change, widespread illicit trade, the management of the oceans (including a more accessible Arctic), Internet governance, international cooperation on space missions, and the enhancement of human rights, may prove more intractable when the prioritization of domestic economic and social concerns undermines the ability of states to coordinate and implement policy remedies.
The persistent deadlock and declining expectations regarding international agreements on greenhouse gas emissions exemplify the difficulty in securing collective national self-sacrifice on topics that are not immediately pressing for all and subject to commonly held values. But policy uncertainty surely undermines the global investment environment and deepens scepticism about the ability and willingness of leaders to solve pressing transnational problems.
The growing scale and assertiveness of leading emerging market countries will increasingly challenge the legitimacy, relevance and efficacy of incumbent global multilateral organizations or groupings. Some already face accusations that they reflect an outdated post-Second World War balance of global power, while others are so large, ideologically diverse or financially constrained that decision-making and implementation is hard to achieve. Re-energizing their mandates and encouraging convergence on key goals would be a helpful counterpoint to topics that might best be handled at the regional level.
Implications for Systemically Important Sectors
Geopolitical risks will not only affect the interaction between countries but will also affect, and be affected by, developments in three sectors that are critical to the well-being of the global economy: energy, financial services and healthcare. Box 2.1 shows how key themes from the previous section play out in these areas.
Box 2.1: Geopolitical Implications for Systemically Important Sectors
Geopolitical and energy sector dynamics will remain deeply intertwined over the next decade as a number of key countries strive for greater energy independence, supply chain control and/or supply diversification. Over the coming decade, the US is likely to become the world’s top oil producer and a net exporter of natural gas (see Figure A).1 China is likely to extend its multiple strategic investments in energy assets across the Middle East, Africa and the Americas, and deepen its energy relationship with the Russian Federation. Many European nations, intent on diversifying by fuel type and supply countries, will strengthen their commitment to locally produced renewable energy and also the construction of liquefied natural gas (LNG) terminals.
Figure A: Oil and Gas Production – US Focus (2010-2025)
The implications for international relations are far-reaching. US energy self-sufficiency and lower feedstock prices are likely to encourage further onshoring of energy-intensive manufacturing. Reduced US dependency on the Middle East may shape perceptions of the region’s vulnerability to security crises, with other countries obliged to play greater roles. New unconventional oil supplies, along with financial pressures in emerging-market countries to boost production, will further limit the ability of the Organization of the Petroleum Exporting Countries (OPEC) to set prices. More widely available LNG supplies could undermine the Russian Federation’s negotiating leverage with consumers in Europe and Asia. Washington may use LNG exports to achieve foreign policy goals – for example, to encourage the key energy growth markets of Asia to accept US terms for admission into the Trans-Pacific Partnership.
National oil companies are likely to expand their international reach (especially into Africa), using the financial and political backing of their governments to outbid international oil companies (IOCs) on assets, although IOCs will be better positioned for (joint) ventures, such as shale gas, where the latest technologies are required – provided the risks of intellectual property loss and potentially escalating royalties can be managed. In some parts of the world, domestic concerns about local content, employment and energy prices may delay or derail the market reforms needed to facilitate energy sector collaborations and investment in infrastructure. In Europe, policy uncertainty resulting from the desire to balance price objectives and environmental commitments may result in inefficient energy systems featuring stranded assets, continued subsidization, investment delays and higher levels of government interference.
Stability will be a key objective in this sector. Advanced economies will focus on implementing major reforms designed to improve market resilience. The application of reform principles is already politicized, with domestically drafted regulations (e.g. Dodd-Frank) set up to protect national financial systems at the expense of extraterritorial institutions.2 The drive towards regional harmonization by the European Union (EU) is set to continue, generating political friction as members seek to protect their national interests, an example being the negotiation of safeguards in the EU banking union and market legislation by the United Kingdom (UK).
The complex interplay between layers of regulation and the differences between regimes and philosophies – for example, the UK’s values-based approach versus the US’s rules-based approach – will increase friction and costs related to compliance, transactions and reporting. This may encourage institutions to reconsider the scope and footprint of their operations. Likewise, the deleveraging of the regulated financial system, via higher capital requirements, might force increasing amounts of financial activity outside the regulatory parameter into the shadow banking system in the pursuit of higher returns.
In emerging-market countries, the extent of financial sector liberalization will be shaped by three factors: recognition of the importance of the financial sector as a strategic area of growth; the country’s ability to deliver substantial structural economic reform without significant domestic instability; and the strength of domestic financial lobbies. Countries that do open up are likely to set a relatively higher bar to entry for foreign institutions, both to prevent distortions and to protect domestic incumbents.
While some measures – such as the establishment of wholly-owned subsidiaries with local capital and governance – should limit systemic risk impacts, other measures may inhibit innovation that could support economic growth. A measured approach to liberalization may help some countries avoid stop-start policies, as seen in Brazil’s insurance market, as well as reduce the risk of the unwelcome macroeconomic consequences that come with hot money and incorrectly sequenced reforms, notably inflationary pressures, exchange rate appreciation and asset-price bubbles.3
Leading emerging markets may increasingly seek to position themselves as regional financial centres and reduce their vulnerability to volatile foreign capital flows while increasing their domestic investor base. To attract talent and capital, regional hubs – existing (such as Hong Kong SAR and Singapore) and aspiring (including Istanbul, Shanghai, Moscow, Johannesburg and Dubai) – will need to strategically identify the areas in which they will specialize to better understand the opportunities and risks presented by partners and competitors.
Due to slower economic growth, healthcare funding will be a defining challenge for all countries over the next 10 years. Ageing populations and the persistent rise in chronic and lifestyle diseases (see Figure B) will force both developed and emerging economies to transform provisions and how they are paid for.
Figure B: Projected Increase in Number of People with Diabetes Aged 20-79 (2013 vs 2035)
In emerging markets, any failure to create sustainable universal healthcare systems – a constitutional obligation in Brazil and Turkey, and a stated ambition in India, Indonesia and South Africa – may arouse social unrest. In developed markets, a failure to transform care would threaten the implied social contract with citizens and imperil countries’ abilities to finance other public priorities, such as foreign policy. Future cost pressures are likely to fall increasingly on employers and insurance programmes, with an increasing role for the financial sector in all countries.
Necessary reforms in the health sector could have geopolitical implications. A shortage of qualified physicians could increase poaching between countries. Inefficient, localized models of care may give way to consolidated structures. Increasing cost pressures are likely to broaden the supply and demand of health tourism, with the potential for large cost savings. Innovations in care delivery models, such as more radically separating acute specialist care from more remote monitoring / telemedicine could further open up provision of healthcare.4 A sharper policy focus on lifestyle improvements could affect the global food production industry, among others.
It is likely that emerging markets will pragmatically open up investment opportunities for foreign firms in healthcare and pharmaceutical provision, albeit sometimes in partnership arrangements. Foreign involvement will probably be blocked in areas that are easily managed domestically, such as the production of simple generic drugs, though more complex areas, such as biologics, may well remain open. Requirements for technology transfer and assistance for local research and development (R&D) are likely to intensify, however – as is apparent in the Russian Federation’s Pharma 2020 strategy.5
Cost pressures in these countries are likely to lead to the increasing use of compulsory licences, harder scrutiny of pharmaceutical patents and demands for transparency on pricing, as well as controversial pricing mechanisms to lower drug costs. India has already implemented such measures, and similar approaches are anticipated in Brazil, South Africa and possibly China. Rather than taking a blanket protectionist stance, it is likely that governments will target the drugs that cost them the most money, such as those for oncology. This pressure, already echoed in such developed countries as Germany, asks big questions about the feasibility of large-scale research and development work and thus the ability to meet future healthcare needs.
1 IEA 2013; and US Energy Information Administration 2013, Annual Energy Outlook. Available at http://www.eia.gov/forecasts/aeo/pdf/0383(2013).pdf.
2 Oliver Wyman 2012a.
3 University of Pennsylvania: The Wharton School 2013b.
4 Oliver Wyman 2012b.
5 The strategy can be found at http://pharma2020.ru/. For an appraisal in English, see the Analytical Summary from the Swiss Embassy at http://www.s-ge.com/de/filefield-private/files/25703/field_blog_public_files/5244
Navigating through a fractured and potentially volatile geopolitical environment will require foresight, flexibility and fresh thinking for countries, companies and multilateral organizations alike. In the face of potential surprises and reversals, the agile and the adaptable are most likely to thrive.
Given the potential for reversals and unwelcome surprises, strategic diversification will be critical. Just as governments should avoid relying on individual security, trade and investment partnerships, so companies should take a portfolio view of their risk exposures to particular markets and seek natural hedges against them.
Successful risk mitigation for all participants will also involve a constant challenge to engage and communicate more deeply. Legitimacy will be increasingly important for multilateral organizations, accountability for governments and transparency for companies. When these aspects are not adequately addressed, loss of trust will have significant political and economic consequences.
Broad-based coalitions, where they are not overly ambitious, may help to overcome new barriers that could emerge from the focus on domestic priorities. Multistakeholder initiatives may increasingly prove key to building consensus, unlocking capital and developing innovative solutions to national, regional and global challenges. It will often be important to nurture relations with all useful partners, regardless of political differences. But careful alignment in areas of mutual benefit will enable participants to harness a wide range of future opportunities.