Two years into the biggest pandemic in a century, the world of risk looks eerily familiar — and is possibly even more interlinked.
The precarious interconnectedness of our globalised world has been laid bare by a once-in-a- generation black swan event, and the geopolitical fault lines are more fractured than ever. The pandemic recovery has revealed trade supply chain weaknesses and exposed developing countries to new financial stresses just when they are also being asked to start bearing some of the burden of carbon emission cuts. The Morrison government’s criticism of Chinese transparency around COVID-19 dealt a major blow to Australia’s relationship with its biggest trading partner, making nuclear submarines and a war to defend Taiwan suddenly seem more possible. These are a few “known unknowns” that lie ahead.
1. Chinese puzzle
While fears about Chinese external military action get more attention, President Xi Jinping’s internal campaign against technology giants and billionaires creates more immediate risks around China’s trajectory to being the world’s biggest economy by the end of this decade. More than a third of the audience at a Fitch Solutions 2022 outlook webinar thought this was the most underpriced political risk worldwide.
This campaign started as a quest for self-reliance in a less-globalised world and a more consumption- driven economy. But it has morphed into a bigger push to reduce corporate oligopoly, exert control over the private sector and increase “common prosperity”. After starting with fintech giant Alibaba, it has spread to private education, the big tech sector, property development and the media — both increasing the power of state-owned enterprises and reducing foreign influence through channels like offshore listings.
Former International Monetary Fund (IMF) chief economist and Reserve Bank of India governor Raghuram Rajan says: “While parallels to Mao’s Cultural Revolution are probably overblown, fears the new crackdown will prove counterproductive are not... it will deter innovation and private-sector risk-taking, while imposing excessively conservative party preferences on the activities that are being encouraged.”
2. After Biden
US presidents often lose congressional seats in their first midterm elections, but go on to win a second term as president. But Joe Biden is in an unusual position at the 8 November elections due to the questions over whether his age will limit another presidential run and because former president Donald Trump has not gone away, despite his own advanced age. Biden has used the skills from 50 years in politics to push ahead with economic and foreign policy election promises, but the deep divisions ahead were underlined by the difficulty implementing voting rights reforms less than one year into his time in office. Former Republican foreign policy adviser Robert Kagan, now at the Brookings Institution, argues: “The US is heading into its greatest political and constitutional crisis since the Civil War, with a reasonable chance over the next three to four years of incidents of mass violence, a breakdown of federal authority and the division of the country into warring red and blue enclaves.” While many disagree, these views are likely to gain more attention if midterm losses for Biden encourage the Trump Republicans to embark on more aggressive disruption.
3. Delta plus
From the BlackRock Investment Institute to the IMF to the Australian Global Health Alliance (AGHA), there is unity on one global risk: that the world has little time to increase COVID-19 vaccinations in poor countries before new variants undermine global vaccination progress. The IMF World Economic Outlook (WEO) notes “a dangerous divergence” in the world due to differences in vaccine access and economic support threatening inflation breakouts, food shortages and social unrest. The Shot of Hope report from AGHA and others, found two thirds of epidemiologists surveyed in 28 countries thought a mutant virus would render first-generation vaccination ineffective in less than a year. The report estimates it would cost $68b–$82b to vaccinate the entire world by the end of 2022. By contrast, the IMF estimates that if COVID-19 is allowed to have “a prolonged impact into the medium term” it would reduce global GDP by US$5.3 trillion over the next five years.
4. The big split
Last September, the BlackRock Investment Institute listed technology decoupling between the US and China at the top of its 10 geopolitical risks by likelihood, giving it a high chance of occurring and an acceleration in its scale and scope. “Ongoing strategic competition between the US and China is driving global fragmentation as both countries are focused on reducing vulnerabilities and a managed decoupling of their tech sectors,” it said. Bain & Company estimates that technology-related foreign direct investment between the two countries dropped by 96 per cent in 2016–20 and says both sides are pushing for technology supply chain independence with massive domestic investments in this sector. But the WEO sees this reversal of high- tech integration between such major economies as undermining the value of increased investment in scientific research which, it says, should be a key part of any long-term pathway out of COVID-19. For example, it estimates that a full scientific decoupling between the two countries — measured by scientific citation intensity — would reduce world productivity by at least 0.8 per cent at a time when average labour productivity in rich countries is only growing at less than two per cent a year.
2016–20 technology-related foreign direct investment between the US and China dropped
5. A new climate
The United Nations conference on climate change in Glasgow has set a new trajectory for carbon emission reduction over the next decade and on to mid-century. But in 2022, the real new pressure on business is likely to come from a trifecta of environmental regulation, which will disclose more information about the quality of existing business practices. These are the European Union green taxonomy, which sets out what constitutes environmentally sustainable economic activity; the International Financial Reporting Standards sustainability standard; and the EU sustainable financial disclosure regulation. Combined, these measures will produce more information on environmental practices, allow it to be compared and open up an informed debate about “greenwashing”.
“It challenges companies that are saying they are doing things, but perhaps are not,” says Fitch Ratings global head of ESG research Marina Petroleka. She adds that with the environmental and governance parts of ESG now well understood in business “we will see a lot more scope for the ‘S‘ to start rising”.
6. Breaking the chains
Logistics delays suddenly went from the shop floor to the top floor when US president Biden called a media conference last October to talk about “something called supply chains” and their impact on Christmas presents. Remarkably, a global boom in goods demand by cashed-up developed-world consumers in the second wave of the pandemic has revealed more supply chain weaknesses than the factory shutdown in the first wave in 2020. IHS Markit data shows manufacturing delivery times in advanced economies fell at the sharpest rate on record in late 2021. World Trade Organization director-general Ngozi Okonjo-Iweala warned this logjam would last well into 2022. While this is mostly due to sudden consumer demand, dislocation of containers and nearshoring of production, the IMF has warned it could lead to “unmooring” of inflationary expectations. The main geopolitical response has been endorsement of a system of supply chain stress testing — similar to that now used in banking — by the G7 leaders’ summit as part of a new focus on economic resilience.
British economist Diane Coyle CBE has argued: “A top priority is to have better data and better business intelligence in government. Even after 30 years of globalisation, there is astonishingly little detailed, publicly available information on product flows in global supply chains.” But the Productivity Commission’s reports on Australia’s supply chain risks have emphasised that that these “are best managed by those who have direct incentives to mitigate them, and typically this means firms” — rather than by government intervention.
7. United Europe
The French presidential election in April (and probably again in June for a second round) will be the first step towards answering one of the biggest short-term questions about the future of Europe — can President Emmanuel Macron fill the shoes of long-serving German Chancellor Angela Merkel?
It may also determine how Australia restores ties with France and the European Union after the AUKUS submarine row. Strong monetary and fiscal support has strengthened European political unity through the pandemic and post-Brexit thanks to Merkel’s ability to straddle deep economic and political divides. Macron wants to go further — by crafting a more independent Europe with an integrated foreign and defence policy. This could extend to more assertive use of the economic and financial standard setting powers the EU has in, for example, climate regulation. But first, Macron must fend off more insular opponents in the French election and then find a like-minded integrationist partner elsewhere in Europe to replace Merkel.
8. Taiwan ambiguity
From the business crackdown at home to the battle for technological supremacy abroad, China is now the constant factor in all geopolitical risk assessments. But the greatest absolute uncertainty surrounds its attitude to regaining control of what it regards as a “renegade province” in Taiwan. Fears of a military clash, which would draw in the US and probably Australia (after the AUKUS submarine deal) have grown. This is due to the assessment that China is close to having the capacity for a successful invasion and possibly a window of opportunity until the US brings on new weapons later in the decade.
Meanwhile, as China has stepped up rhetoric about an invasion, the Biden administration has given mixed signals about changing the longstanding US policy of “strategic ambiguity” as to what it would do if China attacked Taiwan. One innovative attempt to use big data to forecast military conflict (by Coolabah Capital Investments) found that the probability of a low-intensity Chinese military conflict with Taiwan in 2020 was 75.4 per cent — up from 69.8 per cent in 2000. The probability of a low-intensity military conflict between the US and China was actually down slightly — from 46.9 per cent to 46.1 per cent over the same time. Strategic ambiguity, indeed.
9. Out of the crypt
While the rise of decentralised finance and crypto assets has divided investment markets, they have now been elevated to the top ranks of geopolitical risk alongside COVID-19 recovery and climate change by the IMF in its latest Global Financial Stability Report. It says that financial stability risks are not yet systemic, but should be monitored due to “inadequate operational and regulatory frameworks in most jurisdictions”. But the report specifically focuses on the way cryptoisation in less well-regulated emerging markets could circumvent exchange and capital controls leading in some emerging markets is outpacing richer economies — driven by dissatisfaction over inefficient payment systems and poor economic management — risking de facto dollarisation of those economies.
The IMF says a sound regulatory framework for crypto assets “must be a priority on the global policy agenda” covering reform of payments, tax and banking systems in emerging markets. The US Treasury has also expressed concern that cryptoisation will undermine the viability of economic sanctions.
10. Polling places
While the voting in the US and France stands out for risks it poses to the Biden administration and European unity, there will also be elections closer to home just as Australians also go to the polls.
South Korea chooses a new president in March amid dissatisfaction with the way outgoing left- leaning incumbent Moon Jae-in has managed both economic and pandemic issues. A conservative victory could cause increased tension with North Korea, while another left-wing president would probably add to existing tensions with Japan over historical issues.
The Philippines chooses a new president in May, with controversial populist Rodrigo Duterte prevented from running again. In the past, the Philippines has tended to alternate between populist and technocratic leaders. However, in these elections, populists again appear to be in front again — including Ferdinand “Bongbong” Marcos Jr, son of the ousted 1980s dictator, and world boxing champion Manny Pacquiao.
An election is also likely in Malaysia in the second half of the year. This follows four years of political turmoil in which the country’s once dominant United Malays National Organisation (UMNO) has fractured into warring factions or separate parties. The battle to define Malaysian democracy has come at the cost of poorer management of the economy and the COVID-19 pandemic.
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