Convulsions will reflect much deeper forces in play
THE convulsions to come in 2017 are the political manifestations of much deeper forces in play. In much of the developed world, the trend of aging demographics and declining productivity is layered with technological innovation and the labor displacement that comes with it. China’s economic slowdown and its ongoing evolution compound this dynamic.
At the same time the world is trying to cope with reduced Chinese demand after decades of record growth, China is also slowly but surely moving its own economy up the value chain to produce and assemble many of the inputs it once imported, with the intent of increasingly selling to itself. All these forces combined will have a dramatic and enduring impact on the global economy and ultimately on the shape of the international system for decades to come.
These long-arching trends tend to quietly build over decades and then noisily surface as the politics catch up. The longer economic pain persists, the stronger the political response. That loud banging at the door is the force of nationalism greeting the world’s powers, particularly Europe and the United States, still the only superpower.
Only, the global superpower is not feeling all that super. In fact, it’s tired. It was roused in 2001 by a devastating attack on its soil, it overextended itself in wars in the Islamic world, and it now wants to get back to repairing things at home. Indeed, the main theme of US President-elect Donald Trump’s campaign was retrenchment, the idea that the United States will pull back from overseas obligations, get others to carry more of the weight of their own defense, and let the United States focus on boosting economic competitiveness.
Barack Obama already set this trend in motion, of course. Under his presidency, the United States exercised extreme restraint in the Middle East while trying to focus on longer-term challenges — a strategy that, at times, worked to Obama’s detriment, as evidenced by the rise of the Islamic State. The main difference between the Obama doctrine and the beginnings of the Trump doctrine is that Obama still believed in collective security and trade as mechanisms to maintain global order; Trump believes the institutions that govern international relations are at best flawed and at worst constrictive of US interests.
No matter the approach, retrenchment is easier said than done for a global superpower. As Woodrow Wilson said, “Americans are participants, like it or not, in the life of the world.” The words of America’s icon of idealism ring true even as realism is tightening its embrace on the world.
Revising trade relationships the way Washington intends to, for example, may have been feasible a couple decades ago. But that is no longer tenable in the current and evolving global order where technological advancements in manufacturing are proceeding apace and where economies, large and small, have been tightly interlocked in global supply chains. This means that the United States is not going to be able to make sweeping and sudden changes to the North American Free Trade Agreement. In fact, even if the trade deal is renegotiated, North America will still have tighter trade relations in the long term.
The United States will, however, have more space to selectively impose trade barriers with China, particularly in the metals sector. And the risk of a rising trade spat with Beijing will reverberate far and wide. Washington’s willingness to question the “One China” policy – something it did to extract trade concessions from China – will come at a cost: Beijing will pull its own trade and security levers that will inevitably draw the United States into the Pacific theater.
But the timing isn’t right for a trade dispute. Trump would rather focus on matters at home, and Chinese President Xi Jinping would rather focus on consolidating political power ahead of the 19th Party Congress. And so economic stability will take priority over reform and restructuring. This means Beijing will expand credit and state-led investment, even if those tools are growing duller and raising China’s corporate debt levels to dangerous heights.
Critical year for Europe
This will be a critical year for Europe. Elections in the pillars of the European Union — France and Germany — as well as potential elections in the third largest eurozone economy — Italy — will affect one another and threaten the very existence of the eurozone. As we have been writing for years, the European Union will eventually dissolve. The question for 2017 is to what degree these elections expedite its dissolution. Whether moderates or extremists claim victory in 2017, Europe will still be hurtling toward a breakup into regional blocs.
European divisions will present a golden opportunity for the Russians. Russia will be able to crack European unity on sanctions in 2017 and will have more room to consolidate influence in its borderlands. The Trump administration may also be more amenable to easing sanctions and to some cooperation in Syria as it tries to de-escalate the conflict with Moscow. But there will be limits to the reconciliation. Russia will continue to bolster its defenses and create leverage in multiple theaters, from cyberspace to the Middle East. The United States, for its part, will continue to try to contain Russian expansion.
As part of that strategy, Russia will continue to play spoiler and peacemaker in the Middle East to bargain with the West. While a Syrian peace settlement will remain elusive, Russia will keep close to Tehran as US-Iran relations deteriorate. The Iran nuclear deal will be challenged on a number of fronts as Iran enters an election year and as the incoming U.S. government takes a much more hard-line approach on Iran. Still, mutual interests will keep the framework of the deal in place and will discourage either side from clashing in places such as the Strait of Hormuz.
The competition between Iran and Turkey will meanwhile escalate in northern Syria and in northern Iraq. Turkey will focus on establishing its sphere of influence and containing Kurdish separatism while Iran tries to defend its own sphere of influence. As military operations degrade the Islamic State in 2017, the ensuing scramble for territory, resources and influence will intensify among the local and regional stakeholders. But as the Islamic State weakens militarily, it will employ insurgent and terrorist tactics and encourage resourceful grassroots attacks abroad.
The Islamic State is not the only jihadist group to be concerned about. With the spotlight on Islamic State, al Qaeda has also been quietly rebuilding itself in places such as North Africa and the Arabian Peninsula, and the group is likely to be more active in 2017.
Crude oil prices will recover modestly in 2017, thanks in part to the deal struck by most of the world’s oil producers. (Notably, no country will fully abide by the reduction requirements.) The pace of recovery for North American shale production will be the primary factor influencing Saudi Arabia’s policy on extending and increasing production cuts next year. And though it will take time for North American producers to respond to the price recovery and to raise production, Saudi Arabia knows that a substantial rise in oil prices is unlikely. This means Saudi Arabia will actively intervene in the markets in 2017 to keep the economy on course for a rebalance in supply, especially in light of its plan to sell 5 percent of Saudi Aramco shares in 2018.
Higher oil prices will be a welcome relief to the world’s producers, but it may be too little, too late for a country as troubled as Venezuela. The threat of default looms, and severe cuts to imports of basic goods to make debt payments will drive social unrest and expose already deep fault lines among the ruling party and armed forces.
Developed markets will also see a marked shift in 2017, a year in which inflation returns. This will cause central banks to abandon unconventional policies and employ measures of monetary tightening. The days of central banks flooding the markets with cash are coming to an end. The burden will now fall to officials who craft fiscal policy, and government spending will replace printing money as the primary engine of economic growth.
Tightening monetary policy in the United States and a strong US dollar will shake the global economy in the early part of 2017. The countries most affected will be those in the emerging markets with high dollar-denominated debt exposure. That list includes Venezuela, Turkey, South Africa, Nigeria, Egypt, Chile, Brazil, Colombia and Indonesia. Downward pressure on the yuan and steadily declining foreign exchange reserves will meanwhile compel China to increase controls over capital outflows.
Calm as markets have been recently, steadied as they were by ample liquidity and by muted responses to political upheaval, they will be much more volatile in 2017. With all the tumult in 2017, from the threats to the eurozone to escalating trade disputes, investors could react dramatically. Asset prices swung noticeably, albeit quickly, in the first two months of 2016. 2017 could easily see multiple such episodes.
The United States is pulling away from its global trade initiatives while the United Kingdom, a major free trade advocate, is losing influence in an increasingly protectionist Europe. Global trade growth will likely remain strained overall, but export-dependent countries such as China and Mexico will also be more motivated to protect their relationships with suppliers and seek out additional markets. Larger trade deals will continue to be replaced by smaller, less ambitious deals negotiated between countries and blocs. After all, the Transatlantic Trade and Investment Partnership and the Trans-Pacific Partnership were themselves fragments spun from the breakdown of the Doha Round of the World Trade Organization.
Economic frustration can manifest in many ways, not all of which are foreboding. In Japan, the government will be in a strong position in 2017 to try to implement critical reforms and adapt its aging population to shifting global conditions. In Brazil and India, efforts to expose and combat corruption will maintain their momentum. India has even taken the ambitious step of setting its economy down a path of demonetization. The path will be bumpy in 2017, but India will be a critical case study for other countries, developed and developing alike, enticed by the efficiencies and decriminalized benefits of a cashless economy and who increasingly have the technology at their disposal to entertain the possibility.