[Photo from Unsplash]
The Context
The world as we knew it after the 1991 fall of the Soviet Union has disappeared. Today, one can see three clear trends. Each is intertwined, yet distinct. Each poses its individual risk, but collectively they pose far greater systemic risks to economies and companies.
- There’s war in Europe between Russia and Ukraine. There’s another war between Israel and Hamas with significant regional consequences, and high risk global economic impacts. Iran’s proxies are directly involved in the conflict threatening both Israel and the Red Sea and directly affecting Suez Canal trade. The threat that Iran poses to Israel, with some level of direct aggression, remains high, and threatens the Persian Gulf, the vital Strait of Hormuz and, thereby, global oil and natural gas supply.
- China is flexing its muscles aggressively in the Indo-Pacific, not just over Taiwan but also against US allies like the Philippines, and Japan.
- Most crucially, beneath all this is the battle for hegemony between the US and China and the globe is dividing itself into blocs once again. There’s one bloc that’s US-inclined, another led by China & Russia, and a likely third that would ideally like to straddle these two blocs with countries like India, Vietnam and Brazil.
On December 11, 2023, while speaking at the 20th World congress of the International Economic Association, Gita Gopinath, the First Managing Deputy Director of the International Monetary Fund asked two vital questions:
- “Are we at a turning point?”
- “Are we on the brink of Cold War II?”
The State of Play
The world today is showing increasing, though gradual, signs of fragmentation argues Gopinath. Economic policy is being increasingly dictated by domestic politics and national security arguments. The US seeks to build fences to protect its economy and technology against China. There are global cries for “friend-shoring,” “de-risking,” and “self-reliance.” Nation-states are slowly being called upon to align with the emerging blocs. The drivers are both trade and geopolitics. As bloc-level frictions intensify, foreign policy could well play a significant role in foreign direct investment and trade agreement decisions.
In her talk, Gopinath raised two further questions about what Cold War II would mean for the global economy and how the gains from economic openness within a more fragmented world could be preserved. Gopinath also pointed out: “Over the past 5 years, threats to the free flow of capital and goods have intensified as geopolitical risks have grown. Some measures, including tariffs or export restrictions, directly target trade and investment. Other behind-the-border measures indirectly affect trade flows, such as fiscal and financial support to specific domestic sectors and local content requirements.”
Trade pacts, particularly specific Free Trade Agreements (FTAs) between nation states are emerging as a new normal. The trends point to trade blocs with a focus on industrial policies drawn on the basis of protectionism and national security. The US has indicated the path with its Infrastructure Investment and Jobs Act (IIJA), CHIPS Act, and the Inflation Reduction Act (IRA).
Why Does It Matter?
Today’s tensions, and the policies that are emerging, will have clear company-level consequences.
- Political concerns like the potential risk of sanctions, or war disruptions will now inescapably be a part of any corporate strategy, investment or operational calculus.
- Supply chains are being redrawn and the process will be dynamic and call for agility.
- The investment strategies of companies will perforce be reconsidered based on foreign policy alignments and/or geography.
- Cost structures, once based purely on competitive low-cost supply chains, will be affected by new strategies that are meant to build redundancies in the chain.
Then there are three geo-economic and geopolitical factors that are musts when corporate strategy is designed. It’s again important to note that these factors are dynamic and have systemic global effects:
- China is inevitably a part of all global economic equations, given its massive capacities and its overwhelming market shares in key categories, particularly across renewables, automobiles, steel, critical minerals, etc. Beijing’s equation with New Delhi is a dynamic that bears careful and constant scrutiny.
- The US and its allies will attempt to drive trade barriers and trade and political frictions will persist. The overhang of the US-China tensions will have a global impact on both nation-states and businesses. Legacy relationships, like the one India has with Russia, too will assume consequence.
- Asia, particularly South East Asia (largely the ASEAN countries) and India could gain, though China’s shadow looms large. Trade connectivity is fast expanding particularly with agreements like the Regional Comprehensive Economic Partnership (RCEP), Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) and the Indo-Pacific Economic Framework for Prosperity (IPEF), besides the web of free trade agreements across the region.
India, however, is not a part of either the RCEP or the CPTPP. It’s a part of the IPEF, though substantial trade gains are still not visible. India is still negotiating a deal with ASEAN, and the EU, and no trade agreement with the US is on the horizon. The speed at which India concludes trade agreements will matter much for both Indian companies and the country’s economy, especially when it comes to FDI and capital flows.
Dig Deeper
- [Read] Cold War II? Preserving Economic Cooperation Amid Geoeconomic Fragmentation: Plenary Speech by IMF First Managing Deputy Director Gita Gopinath at the 20th World Congress of the International Economic Association
- [Watch] Gita Gopinath on global economic fragmentation at the PIIE-IMF Rethinking economic policy conference
The next edition of the Masterclass Briefings will cover the geopolitics and geo-economics of the Indo-Pacific and examine India’s positioning and competitive advantages in the region
Click here to see the full package
