Part 2: Risks in Focus:
2.2 Global Risks Arising from the Accelerated Interplay between Geopolitics and Economics
Geopolitics traditionally focuses on military might, resources and demographics as measures of national influence, while economics focuses on growth, productivity and prosperity. However, geopolitics and economics have been intertwined through history – for example in the rise of British political power on the back of the “economic” Industrial Revolution, the era of British and French colonialism, or the Cold War, when a deep geopolitical divide separated economies. When the Cold War ended, an era of common norms ushered in a global economy; now, more than 25 years after the fall of the Berlin Wall, strategic competition is returning. The world is grappling with a seemingly accelerating dynamic between geopolitics and economics. Today’s realpolitik is not ideologically driven, includes new players and takes place in the context of deep economic integration.
Will the global economy, the efficiency of the international system and the win-win logic of commerce be undermined by geopolitics? How will economic decisions and spheres of influence impact the global balance of power? What global risks could emerge when countries use economic rather than military tools to advance their ends? These questions have been brought into focus by trends including the recent heightened tensions in East Asia, the acceleration of regional integration in South-East Asia and the rise of preferential and regional trade agreements more generally, the shale gas and oil revolution in the United States, turbulence in the Middle East and Ukraine, competing integration mechanisms in Latin America, China’s assertion of leadership in the global economy, and acts of terrorism and violent strife that are redrawing borders and sending economies backwards.
Global interconnectedness and the rising speed of information transmission have reinforced the interdependence between geopolitics and economics, with cyberspace representing an important new front in the geopolitical equation as cyber attacks have the growing potential to inflict economic damage. This makes it difficult for decision-makers to predict the development of such situations as sanctions and other instruments of economic coercion, thus raising the risk of unintended consequences. The interplay between geopolitics and economics can create, reinforce and alter the nature of the interconnections between global risks, affecting many areas of public policy and international cooperation.
Governments and businesses alike need to conduct “geopolitical due diligence” to not be caught off guard. The focus below is on three areas where direct effects are likely – disruptions to international trade, and threats to political cooperation and the international rules-based system.
How Is this Situation Manifested?
In a retreat from the prevailing logic of globalization that characterized the 1990s and early 2000s, today’s international environment is in large part marked by self-interested nation states trying to gain relative power over others, even at the expense of economic considerations. Rising unemployment and more difficult fiscal situations are contributing to the more inward orientation of economies. The growth of trade along global value chains and intensifying financial linkages have increased the economic cost of rising protectionist policies, such as tariffs, sanctions and trade wars, as described in Box 2.1.
As states turn inwards, their international economic policies tend to focus on collaboration with smaller groups of like-minded countries that would allow them to better pursue their economic goals. Countries have always sought to achieve both geopolitical and economic aims through regional economic integration – the European Economic Community, for example, was established to stabilize relations and raise the stakes in case of war as well as to increase market size and economic opportunities. Many regional groupings are established as they allow countries to gain relative power over others. This type of thinking is currently why the Association of Southeast Asian Nations (ASEAN) is seeking to create a unified market by 2015 and pursuing an agreement on a Regional Comprehensive Economic Partnership (RCEP). It is also one of the drivers of the United States’ efforts to pursue discussions on two major free trade and investment agreements – the Transatlantic Trade and Investment Partnership (TTIP) and the Trans-Pacific Partnership (TPP).
However, in some cases competing integration agreements are creating strategic competition: in Latin America, the Pacific Alliance and Mercosur provide different models of integration; in Ukraine, the country was torn between the European Union and the Eurasian Economic Union; and Asian countries need to assess the US-led TPP and the ASEAN-led RCEP. As illustrated by Table 2.1, the current situation is a complex mix of overlapping and competing regional negotiations.
A driver of the intensifying interplay between economics and geopolitics is the growing direct role of the state in the world economy, which is affecting traditional trade and investment flows and potentially enabling countries to exert geopolitical influence through economic dependency. This trend is manifested in increasing state-led investments in other countries’ infrastructure, such as in the case of Chinese investment in Africa or Latin America; strategic investments by sovereign wealth funds and state-owned enterprises in land and businesses in other countries, as seen in the case of Gulf economies’ investments in Africa, and government purchases of other governments’ debt. In August 2014, China and Japan held 7.2% and 7% of US debt, respectively.
To strengthen their geopolitical position, countries have also reverted to measures that control access to economically important national resources or the prices of commodities over which they exert monopoly power to undermine other economies’ performance. These potential ways to leverage power over other countries through economic links are increasingly becoming an explicit part of foreign policy thinking.
In today’s interdependent global economy, whenever countries focus on their domestic market – even if the decisions are taken by central banks rather than politicians – there is potential for unintended effects on other countries to spill over into the geopolitical sphere. For instance, one side effect of Japan’s expansionary monetary policies to restart its domestic economy has been the devaluation of the yen by about 50% in recent years, much to the detriment of its neighbours, while quantitative easing in the United States has impacted international capital flows into emerging markets.
Global Risks Emerging from the Interplay between Geopolitics and Economics
Opinion polls show that the public in countries such as Japan, Germany and the United States are increasingly sceptical about the benefits of trade and foreign investment, even as their governments push for increased liberalization. Despite progress on the trade facilitation agreement, the larger Doha Round of trade negotiations has stalled, costing an estimated $180 billion per year at the global level. Negotiations of regional agreements are also being questioned (one example is TTIP in Germany). Although growing again, global flows of foreign direct investment remain down by more than a quarter from their 2007 peak, and international trade growth has slowed since 2012. It has yet to be determined, however, whether this is merely a cyclical or structural phenomenon heralding a phase of de-globalization in which globalized markets give way to regional groupings and to a rise in protectionist measures.2
When confronted with political and economic volatility at home, countries often revert to protectionism under the guise of policies to reduce risk. A recent OECD report shows that despite their professed commitment to free trade, G20 economies have increasingly reverted to protective measures since growth slowed in 2012 in the wake of the global financial crisis.3 Protectionism can take different forms. It can be related, for example, to the protection of strategic sectors, local content requirements in the case of external investment, or state bailouts.
Economic sanctions are another type of punitive geo-economic measure, such as the tit-for-tat engaged in by Russia and the West, which indicates that some countries are ready to countenance a long period of economic hardship and diplomatic woe to achieve their political goals. The risk is thus significant that if the use of punitive geo-economic measures becomes more widespread, a growing number of countries may revert to protecting national producers and supply chains, which could considerably impact global trade flows. The economic effects of sanctions can include slow growth, unemployment and fiscal pressures. Taken together, the slowdown in globalization, the rise in protectionism and the increasing prevalence of sanctions could give rise to a scenario of slower growth in advanced and emerging economies. Slower growth in emerging economies could translate into social unrest and political instability if the aspirations of large portions of the population cannot be met.
The Increasing Risk to the Architecture of Global Governance
Much of the interplay between economic and geopolitical interests plays out not in the trade arena but in the Bretton Woods institutions. Countries’ inability to agree on an institutionalized, closer coordination of macroeconomic policies to reduce global imbalances provides an interesting example. Some observers see the failure to mitigate these imbalances, combined with the return of strategic competition in an era defined by an erosion of trust, as raising a tail-risk possibility of undermining the Bretton Woods institutions themselves and the international rule-based system more generally.
These developments are reflected in the recent alternative structures being established by selected countries. Brazil, Russia, India and China in 2014 set up the New Development Bank, the so-called BRICs Bank, which is intended to lend up to $34 billion globally, particularly for infrastructure projects. In the same year, together with 20 other countries, China created the Asian Infrastructure Investment Bank for the Asia-Pacific region. Much as a retreat from global multilateralism is worrisome, stronger regional multilateralism is not necessarily a bad thing, as regional solutions to regional problems can be consistent with global governance structures. As already noted, although economic integration is not often explicitly targeted, it binds nations more closely together politically. Some observers see the current push for RCEP as a means to restore trust in Asia, stabilize security situations and find solutions at a regional level to other ongoing problems.
Some observers also see the TPP and TTIP as the last chance for the United States and Europe to bring many developing countries into alignment with a liberal economic institutional framework by creating a domestic market big enough to be able to set the rules in the global economy – an implicit recognition that current global governance institutions are no longer functioning effectively enough to achieve this goal. Yet, increasingly, negotiating countries question the benefits of these mega regional agreements.
Any weakening of global governance could weaken collective resilience to global risks, which respect no national borders and require multilateral responses. These include climate change, where an inability to agree on carbon reductions could result in rising sea levels, more frequent storms and stress to water supplies; migration flows, where pressures on societies and resources could result in conflict; and Internet governance, where a tendency towards fragmentation can already be observed through some large economies’ efforts to put into place measures to protect their national networks. Should a global governance solution to the Internet not be found, further fragmentation could significantly reduce the benefits of communication and information networks that the world has come to take for granted.
What Can Be Done?
At a time of highly interconnected challenges that can only be addressed through global cooperation, reducing the barriers to international collaboration is crucial, as no collaboration is the worst possible outcome. What can stakeholders do to strengthen international collaboration and to reduce the risk of negative effects of geo-economic measures?
Many of the challenges related to international collaboration reflect a lack of trust among the key players. Strengthening trust among leaders and populations in global economies is therefore key to ensuring effective collaboration at a time when strategic competition dominates international relations. Without trust, no decisions at the international level will be taken. However, the responsibility extends beyond the political level: multinational companies and consumers also have a role to play to strengthen the argument in favour of global collaboration in the face of growing pressures to prioritize national economic self-interest.
Faced with competing strategic pivots and governments’ growing tendency to look inwards and prioritize their domestic producers and economies, and with an increased reliance on economic levers as a means to gain geopolitical influence, the coming years could see competitive relationships between the major powers develop into trade and currency wars, requiring economic diplomacy.
While regional institutions and alternative structures have a role, global institutions must respond to pressure to better reflect the rising wealth and power of emerging economies. They remain the most promising means for competing powers to build strategic trust, which could minimize the detrimental effects of geo-economic competition on growth and prosperity.
Box 2.1: Global supply chains – too lean?
With the opening of markets worldwide and the reduction of barriers to the flow of goods and capital, the creation of value has become a complex process spanning countries and continents. The far-reaching global supply chains set up by multinational corporations are more efficient, but the complexity and fragility of their interlinkages make them vulnerable to systemic risks, causing major disruptions. These comprise natural disasters, including those related to climate change; global or regional pandemics; geopolitical instability, such as conflicts, disruptions of critical sea lines of communication and other trade routes; terrorism; large-scale failures in logistics; unstable energy prices and supply; and surges in protectionism leading to export/import restrictions.
Recent specific examples of threats to the smooth functioning of global supply chains include the Ebola outbreak in West Africa, tensions in the Middle East and the dispute between Ukraine and the Russian Federation. The latter has caused disruptions in the supply of gas to European countries, while sanctions imposed by the European Union and the Russian Federation have restricted access to specific sets of goods and forced some companies to review the architecture of their supply chains. One effect is Germany’s exports to Russia were reduced by 26.1% in comparison to the year before, as reported in August 2014.
Box 2.2: The World Economic Forum’s work on geo-economics
The World Economic Forum is developing a clearer understanding of the interaction between geopolitics and economics with the support of its Network of Global Agenda Councils. The Global Agenda Council on Geo-economics aims to become the world’s leading network of thinkers on the impact of geopolitics on the global economy and vice versa – launching a vital global discussion that links leaders from the worlds of politics, economics and business in a debate about the major trends that are changing the world. The Council will publish an annual brief identifying the main geo-economic issues on the horizon and delve into the implications of emerging developments, such as the use of sanctions or low oil prices for different regions, actors and sectors. Issues that will be examined in more depth include the next phase of economic warfare, the next wave of state capitalism (including the rise of central banks as drivers of geo-economics and the rise of strategic sectors), the idea of gated globalization, the role of infrastructure in building alliances, and the weakening of peripheral countries by regional agreements. The Forum’s work will also include an assessment of impact on selected industries. It will be developed over the coming years and the findings will be integrated into the work of the Forum and its communities.