Future developments boil down to this: As long as it is possible to avoid direct hot wars between major powers that have emerged in the emerging geopolitical landscape, the main battlegrounds for geopolitical competition will be economics and technology.
Today, all major world powers have started using protectionist measures that were rare during the era of globalization. That seems to be the end of that liberal mantra that democracies that trade with each other do not go to war, as Benjamin Constant put it in the 19th century.
The Biden administration continued and tightened export controls and investment barriers initiated by the Trump administration.
The strategy, code-named “small yard, tall fence,” aims to slow China’s technological advances in areas where the United States feels more vulnerable than its main competitor (notably semiconductors in the critical field of artificial intelligence).
The Americans and their allies in Asia and Europe are wary of the catastrophic consequences of full economic decoupling from China, but have aligned themselves with a risk-averse strategy to reduce unilateral dependencies.
Essentially, the US realized in the age of COVID that they can’t possibly not make surgical masks… because it’s cheaper to import them from China – and put the military factories into operation with wartime decrees!
In response, China imposed restrictions on rare earth exports, put up barriers to imports and generally made it more difficult for Western companies to operate in its market. The trend is clear: geopolitical competition leads to geoeconomic upheaval.
After the Russian invasion of Ukraine, Europe and Russia have largely decoupled their economies. The West has used its dominance of the financial sector to impose sanctions on Russia and threaten secondary sanctions against those who do not comply. This in turn accelerated important developments. In response, Russia has turned to China and other neighboring countries to circumvent Western export bans.
The new alliances of the same camp
The BRICS group has boosted the use of local currencies in bilateral trade to protect its members’ economies from Western sanctions.
After the upheaval during the pandemic and the boost in productivity through digital automation, industrialized economies have begun to emphasize their resilience and have been led to rearrange their supply chains.
Now, geopolitical competition is accelerating these trends and promoting “cooperation between friends” based on shared values.
The trend is clear: geopolitical competition causes geoeconomic turmoil.
Taken together, these trends are changing the way the global economy works.
The dominant economic paradigm is shifting from efficiency to resilience in the face of an environment of structural change.
The new trade blocs and the return of the nation-state
Globalization shows reversal tendencies. The result may not be full de-globalization, but rather “regionalization,” potentially characterized by emerging trade blocs.
The interests of the market no longer dominate, but in politics, other considerations besides efficiency are strengthened. After a brief hiatus, the primacy of national security interests returned.
The state, long on the sidelines, is reasserting its control over politics. Companies are rapidly adapting to this new environment. The neoliberal model is officially in decline.
The upheavals in economic models
Beyond piecemeal measures, major economic powers have begun to change their growth models. China, aware of geopolitical headwinds in Western markets, is trying to shift to a “two-way” economy.
However, the shock from the Covid-19 measures and uncertainty about the future have led to a reduction in consumer spending. Sluggish domestic demand has exacerbated existing problems in the manufacturing sector and the real estate market, contributing to a latent crisis in the banking sector.
Efforts by local governments to manage this situation could further exacerbate the debt problems facing both private companies and the state, and could eventually lead to the same stagflation that has characterized Japan’s economy.
China is under pressure to focus more on exports to channel excess production. This could lead to trade barriers from major economies such as those in the G7 group, potentially sparking a new round in the trade war.
China’s strategy to shield its economy from sanctions by becoming technologically self-sufficient could inadvertently exacerbate its overcapacity issue.
If China cannot boost consumer confidence through improved living standards and healthcare, its plan to balance export growth with increased domestic consumption is likely to fail. This would leave China’s growth vulnerable to the headwinds of geopolitical competition.
The data being overturned
Transitioning from a model focused on rapid GDP growth through government expansion of the productive base and infrastructure projects to a more balanced economy is challenging, especially when current incentives are fueled by the political imperative to maintain control over the financial sector.
Similarly, the Inflation Reduction Act marks the return of industrial policy in the United States and the end of a long period of deindustrialization. Like all major economies, the US is suffering from sluggish consumer demand.
No matter who occupies the White House next year, skepticism about free trade and the goal of creating jobs in the American hinterland will be at the center of economic policy. Similarly, security interests have now come to the fore in the economic outlook of all OECD economies.
This shift is altering the opportunity structures for growth worldwide. Of course, the impact of geo-economic disruptions will vary by geography, location, geopolitical vulnerabilities and position in the global value chain.
- For some commodity exporters, market politicization can prove beneficial.
- Others aim to take advantage of the windfalls of geopolitical competition and capitalize on opportunities to forge alliances.
- However, for those who rely on the historically successful model of cheap labor, export-led industrialization, the task of reversing the development process may become more difficult.
- The replacement of human labor by robots, algorithms and Artificial Intelligence in developed economies is eroding the comparative advantage of cheap labour.
Moreover, the fact that technology transfer and supply chains have become geopolitical weapons undermines the ability of developing countries to industrialize.
China’s dumping of excess production in local Asian markets could lead to regional deindustrialization, where domestic industries struggle to compete and may even collapse.
Navigating a global economy that is fragile, fragmented and prone to shocks challenges conventional economic models and makes debt crises even worse.
Cheap-labor, export-led industrialization will be difficult in a world plagued by geoeconomic disruption. This means there is an urgent need to adjust development models accordingly.
In preparation for this necessary strategic discussion, a thorough analysis of the potential impacts of geoeconomic disruptions and the capacity of both the public and private sectors to respond is required.
Equally important, any realistic proposal for a new development model must take into account the domestic political economy.
Changes in development paths create new winners and losers. Therefore, resistance to change from those who stand to lose is to be expected.
Given the influence of many status quo forces on the economy, this resistance can derail efforts to adapt to the new economic environment.
This explains why countries where elites have captured the state for their own benefit often lag behind in the development race.
Therefore, the search for a new development model should not be a purely academic exercise, but should also take into account the balance of social forces.
Guiding principles
Therefore, there is no one-size-fits-all solution and each country should develop a tailored approach that aligns with its particular circumstances.
However, a few guiding principles can help guide these discussions.
- Geopolitical competition presents opportunities.
- Western countries’ risk management and diversification strategies bring investment to states perceived as friendly.
- The “exit” strategy of Chinese private companies in the Asian market can also benefit the ecosystems of local economies.
- However, the choice of partner for infrastructure projects – whether in connectivity, telecommunications or energy – can affect investment opportunities, terms of trade and market access from other countries.
- Leaning too much to one side can also lead to being taken for granted.
Therefore, most countries in the Indo-Pacific region, with a few notable exceptions, adopt balancing strategies to avoid taking sides.
Actions, even if driven purely by business interests, are now viewed through a geopolitical lens. Rhetoric aimed at a domestic audience resonates differently with international investors.
Countries need to carefully assess their stance and formulate a coherent stance through their rhetoric.
Geopolitical alignments
The critical question is whether structural trends could force countries to choose sides against their economic interests.
Geopolitical events can significantly affect economic growth paths, and conversely, geoeconomic disruptions can push countries into geopolitical alignments.
In the event of a major regional conflict there could be intense pressure to align with one camp. Even countries not directly involved in territorial disputes or military conflicts will face disruptions to their supply chains and other indirect consequences.
In a new Cold War scenario, the technological divide could lead to significant costs and create dependencies, prompting countries to narrow their supply chains and infrastructure to align with one technological world over another.
For many debt-ridden developing countries, the need for bailout or restructuring programs could lead to political pressures to align with a bloc.
States with a clear stance on their foreign policy will be in a better position to avoid outside interference and deal with the complexities of geopolitical competition.
The emerging world order is unlikely to be as clear-cut as during the previous Cold War.
Today’s major economies are deeply interconnected and interdependent. Unless a major hot war occurs, the cost of complete economic decoupling would be prohibitive for all “players”.
For example, if a future US administration continues the “small yard, tall fences” strategy, large parts of the global economy will remain interconnected.
In addition, de-risking strategies based on digital automation at home and supply chain diversification abroad are inherently limited by the cost of moving from the cheap labor model.
The expected effects of long-term strategies such as de-dollarization may also play an important role.
However, the new global economy may become more fragmented and regional, with increased vulnerability to shocks and turbulence.
Countries must focus on strengthening their resilience and adapt quickly to this evolving landscape.
Achieving a better supply-side and demand-side balance between economies will help adapt to geoeconomic disruptions, while mutual understanding among all domestic stakeholders will facilitate survival in an environment of geopolitical competition.
