As we assess the geopolitical landscape in 2023, the Global Insights Center foresees the continued evolution of multiple power centers with countries increasingly seeking to maximize their self-interests. These events largely pre-date COVID-19. However, the pandemic and Russia-Ukraine War in many ways exacerbated this trend. So, our overall Geopolitical theme for 2023 is based on the fracturing world order as new power centers arise, many of whom seek to further their own interests.
To analyze this topic, we will focus on the following themes, which could affect the risk environment in the year ahead:
- Western-led security systems under challenge
- Rise of alternative financial systems
- Supply chain reshuffle
- Shift in industrial policy
Theme 1: Western-led Security Systems Under Challenge
The current world order was largely born after World War II, which some nations contest.
The North Atlantic Treaty Organization (NATO) was officiated shortly before the Soviet Union tested its first nuclear weapon. NATO was – and remains – a military alliance of mainly the U.S. and Western European powers. When it originated, its primary objective was to contain the expansion of the Soviet Union.
In addition to NATO, the U.S. was able to stitch together military alliances in Asia with Japan, South Korea, the Philippines and Thailand. And, of course, Australia and New Zealand were and remain two of America’s closest allies. Often, these military ties were coupled with economic and manufacturing linkages with U.S. economic policy favoring the offshoring of industries to allied nations.
Collectively, this meant that the economic and security framework was largely developed and led by the U.S. and Western Europe. The purpose was to instill peace while promoting western ideals. Moscow went the other way, creating the Soviet Union, largely by force.
For many other nations, the new order simply felt like a new form of colonialism and hegemony. They responded by creating the "non-aligned movement" (NAM)—a collective of nations that shunned the idea of alliances. These included India and large sections of Africa and Latin America. However, many of the NAM nations were economically and military inconsequential.
(While China was not part of NAM, it did not subscribe to the Western-led order. The country was also not a dominant economic or military power for much of the post-World War II environment).
Thus, many of these nations could not alter the economic or security architecture, which was increasingly dominated by the West and secondarily by the Soviet Union. Yet they had grievances over issues such as access to nuclear technology or the structure of the United Nations Security Council.
Economic prowess often correlates to security strength and a seat at the leadership table.
The very same economic principles that the West promoted (i.e., globalization, liberalized trade, free markets, open capital accounts, etc.) ended up working. In the end, this helped empower countries that questioned the Western-led order, first economically, then militarily.
And the improved economic standing is enabling these nations to flex their muscles in different manners. But most of them, in one way or another, are expressing a view that the Western-led framework be challenged and that they should have a seat at the table of major powers. They believe they should help shape a new framework, and that framework should ultimately further their own interests.
In the 1970s, the five largest economies were the U.S., Russia, Japan, Germany and France, with the U.K. not far behind. However, the U.S. dominated all other economies with a gross domestic product (GDP) almost four times the size of the Soviet Union's at USD 1.1 trillion compared with USD 300 billion. The U.S. was as large as the next six economies and effectively as large as all of Western Europe.
By the 1980s, the Soviet Union fell to fifth place while the U.S. economy was only two times as large as Japan's at USD 2.9 trillion compared to USD 1.1 trillion. Then, following three decades of globalization, China surged to second place just behind the U.S., with the ratio of dominance converging. The U.S. economy was USD 25.3 trillion in 2022 with China not far behind at USD 20.0 trillion. Meanwhile, India found itself moving up the ranks at USD 3.3 trillion.
China and India were not anywhere close to being the largest economies in 1970 and despite their best efforts, could not sway the formation of the global order even though they had issues with it. Over the next decade, China is expected to eclipse the U.S. while India is on track to become the third largest economy. This will enable both countries to parlay their economic strength into strategic capabilities, which is already starting to happen.
Looking ahead, economic gains could allow countries to project military and diplomatic strength.
From an economic lens, both India and China are ramping up their defense budgets, which can provide them the direct ability to project power. But beyond traditional kinetic power, both are also utilizing their growing economic heft to direct foreign policy towards their interest.
For example, India increased purchases of Russian oil at discounted prices in 2022 to ensure its current account deficit would not widen as overall energy prices rose. At first, the U.S. was upset. But the Treasury Secretary at the time, Janet Yellen, eventually declared that India could buy all the Russian oil it wanted. Why? Likely because allowing India to buy Russian oil would ensure global supply would not become constrained. Plus, the U.S. recognized that India could serve as a valuable emissary to Russia. Much of this arose due to the size of India's economy and its increasing economic footprint.
Another example is the fact that the G20 has largely replaced the G7. For years, the G7 served as the setting for the most powerful nations who helped determine global affairs and military matters. Now, as the world order fractures, that role is being delegated to new entrants, hence the rise of the G20.
In 2023, we anticipate these nations, plus others like Saudi Arabia, Turkey, Russia and to a lesser extent, the United Arab Emirates, will challenge the existing global world order. At a minimum, these nations do not want Western power to curtail their own goals and interests. They will utilize their economic and tangible military strengths as they seek a greater role in global affairs.
It's complicated, but all about self-interests, especially in a multi-polar world.
The world of security is not binary. For instance, India spearheaded the NAM movement, and even today refuses to join alliances. While it has voiced its concerns with the U.S.-led security framework, India concurrently forged a “strategic partnership" with the U.S. The two countries often conduct joint military drills. Their armies are semi-intertwined from an operational standpoint. And India can procure high-tech advanced U.S. military equipment.
At the same time, India has ties with the Russian army and buys their military equipment. I guess you could say that India largely has it both ways to maximize self-interest. During the Cold War, this put the U.S. and India at odds. But now, the U.S. and Russia accept India's position, which is a significant change in geopolitics. The fact that the U.S. has a strategic partnership with India while New Delhi maintains proximate ties with Moscow would have been unthinkable 30 years ago.
Turkey is somewhat similar. It is a member of NATO, yet buys advanced Russian weapons, like the S-400 missile system. As we look forward, traditional alliances will remain. But as the world fractures and becomes multi-polar, some of these alliances may shift as complex partnerships arise.
Theme 2: Rise of Alternative Financial Systems
Nations accelerate adoption of alternative financial systems to reduce U.S. dollar and financial system dependence.
Alongside the development of the security framework, the U.S. and its allies began to create a series of institutions after World War II that helped shape the current economic order. This included the creation of multi-lateral lenders, like the IMF and World Bank. Through both entities, the U.S. and Western Europe were able to direct money towards nations that needed assistance, while also promoting Western policies and values.
From there, a Western-led economic framework began to blossom, including the dominance of Western financial institutions and payment systems. Consider the fact that today you can use your credit card almost anywhere in the world. However, the settlement of that card (or rails as they are called) likely traverses a system owned by a U.S. financial institution or card company. This means that U.S. companies can monitor a significant portion of personal transactions. And if they want, they can also cut off individuals and countries from accessing that system.
Similarly, when two banks need to transact a payment, they need to use the SWIFT messaging network, which is a Belgium-based transaction system. SWIFT often relies on an actual settlement system, like Clearing House Interbank Payments System (CHIPS), which is owned by the U.S. For any dollar-based transactions, CHIPS is the go-to entity for clearing payments.
Granted, non-dollar transactions can move outside of CHIPS. However, most countries increasingly clear their counterparty payments via dollars and most commodity products are traded and settled in dollars. Thus, for most of the world, SWIFT and CHIPS became the go-to entity for settling payments. Similar to the credit card rails, Western countries can deny select parties access to SWIFT and CHIPS, thereby making it hard for them to settle payments.
The U.S. was able to leverage its dominance over these systems by restricting Russia's access after they invaded Ukraine, hindering their ability to repay creditors. While successful, it also sent a signal to other countries that they, too, could face restrictions. To many, it revealed the risk a Western-led economic framework poses to their national interests. Accordingly, many large and economically dominant countries that have a strong presence in international financial systems—like India and China—are looking to develop their own parallel financial architecture to immunize them from this risk.
Government led-financial networks are starting to take hold in many nations.
In 2012, India launched RuPay, a domestic settlement system to support Indian credit cards. At first, it was meant to help the government send cash benefits to citizens. It has since become an alternative to Western credit cards and payment systems. More importantly, it's a symbol of Prime Minister Narendra Modi's desire to create India's own financial architecture: one that inoculates India from geopolitical risks, including the ability of Western countries to potentially restrict India.
After all, it was over 20 years ago when India faced Western sanctions owing to its nuclear tests in 1998. Since then, the sanctions have been fully lifted, and Western countries have eagerly courted India. In fact, the U.S. has a strategic partnership with India and has forged a close relationship on the nuclear front, more than reversing the stigma India faced for its nuclear tests.
However, after Russia was cut off from SWIFT and two major U.S. credit card companies exited the market, India was again made aware again of the power of sanctions. Thus, the Indian government and central bank are promoting policies that indirectly give RuPay a competitive advantage. Now, RuPay has upwards of 600 million customers, enabling a significant portion of commercial activity within India to bypass Western networks altogether.
Russia and China have done the same with the Mir and UnionPay systems, respectively. In fact, Russia's Mir and India's RuPay are forming a link enabling financial transactions to take place between both countries. This could serve as an important link now that Russia has been cut off from the West and from Western credit cards. Both sides have toyed with the idea of settling commodity purchases via a direct currency exchange settlement, rather than converting to dollars first. However, the idea has not taken hold yet.
Furthermore, Brazil President-elect Luiz Inacio Lula da Silva (or Lula) is a proponent of establishing a single currency for Latin America, named the "sur." This would act as a wholesale central bank digital currency to unify regional currencies. This could lead to a future in which Latin America moves away from SWIFT to clear its payments.
While the dollar will remain dominant, de-dollarization is on the move.
The dollar's demise has been in discussion for years. But the dollar will likely remain dominant as most transactions and commodity trades are settled and indexed to the dollar. Furthermore, its reserve currency status makes it a desired asset.
However, aspects of de-dollarization are emerging. In fact, the dollar as a percentage of reserve currencies has declined from 70% to 60% over the past 20 years. Part of this is due to technological advancement and globalization, which has made other currencies easier to use. China's rise as a dominant trading partner for many countries has prompted the need for more renminbi-denominated assets. But part of it is on account of central banks looking to diversify their portfolios.
Another method of sanctioning Russia included the U.S. restricting Moscow's ability to access its dollar reserves held outside of the nation. Up until then, Russia assumed the dollar reserves the Central Bank of Russia accumulated over the years via energy exports would insulate it. However, that did not fully pan out. Accordingly, many other large holders of dollar reserves are likely wondering if they could face similar restrictions in the future.
The most immediate shift will likely be seen in the invoicing of trade flows. Following Russia's ostracization, Moscow began invoicing its exports in rubles, and Saudi Arabia allowed China to pay for oil in their own currency, renminbi. Other countries have made similar moves. In November 2022, Brazil and Argentina agreed to establish a bilateral payment system in local currencies for the sale and purchase of electricity. Thus, the potential economic costs of this shift should be considered within the context of the breakdown in the world order.
The broader theme is evident: Rising powers that resented the idea of being dependent on Western-created and managed financial systems and networks are in a position to build their own systems given their growing economic clout, and they are doing just that.
The gap between the U.S. economy and others has narrowed, enabling other nations to carve out a role for themselves in the financial architecture. This is in part because they feel they are economically consequential countries and therefore should have independence over their affairs. It's also to mitigate against future risks and ensure that other countries cannot use financial systems to hinder their own foreign policy objectives (i.e., cutting nations off from systems like SWIFT).
Regardless of what some may think about sanctioning Russia or removing it from SWIFT, these actions likely accelerated a decoupling of financial networks. Countries like India and China, as well as Saudi Arabia, are likely going to accelerate the process of building their own financial architecture.
This goes beyond settlement systems and includes financial diplomacy and the process of lending money. While China has historically been a major creditor to emerging markets seeking to build out their infrastructure, India is ramping up its own lending to win over new friends. This is likely on account of India seeking to compete with China for influence.
For 2023, we see this trend accelerating even further.
Theme 3: Supply Chain Reshuffle
The nexus between trade and geopolitics leads to a re-alignment of partnerships.
In the early 1990s, Saudi Arabia was exporting over 2.0 million barrels of oil per day to the U.S. By 2003, that number grew to nearly 2.2 million b/d. However, by the end of 2022, U.S. imports of oil from Saudi Arabia stand at less than 400,000 b/d. Meanwhile, Saudi Arabia currently exports 1.6 to 1.9 million b/d to China, and just under 900,000 b/d to India.
Accordingly, the flow of commodities trade has already re-shuffled, leading to foreign policy changes, too. It's no surprise that U.S.-Saudi Arabia ties are at their lowest levels ever. The commercial bonds between both nations have frayed. Thus, trade flows can affect geopolitics and vice versa.
Looking ahead, as partnerships realign and a multi-polar world rises, we can anticipate the movement of goods and services to reorient in kind.
New trade routes likely to open in the coming years, which could re-orient the flow of goods.
Egypt used to buy nearly 80% of its wheat from Russia and Ukraine. Following the war, wheat products were heavily disrupted, leading to potential food shortfalls and inflation. We know from history how this works. For example, the Arab Spring, a series of anti-government protest, started in Tunisia but quickly spread to Egypt and was largely driven by high food prices. Accordingly, Egypt quickly began to procure wheat from India, a market it barely tapped for agricultural products in the past.
Facing sanctions on Russian energy supplies, European nations scrambled to find new export markets. Africa was a prime destination. Italy was one of the most dependent on Russian natural gas, which accounted for over 40% of Italy's imports prior to the war. In response to the imposed sanctions, Italy aggressively sought to diversify its supplies by first turning to Algeria, which was Italy's second largest supplier with a 40-year relationship due to Eni's operations in the country. Italy and Algeria inked a deal to increase current import volumes by 40%.
Yet, the deal stoked concerns over Spain's access to Algerian gas. Years of underinvestment have made it more difficult for Algeria to ramp up production on such short notice, limiting how much gas it can export. Moreover, Algeria cannot divert its gas commitments away from Spain to Italy. While acting in self-interest, European relations were strained in the process, showing the vulnerability of regional alliances, like the European Union.
Equally consequential is the movement of tech products. With growing worries about China-Taiwan relations, New Delhi is actively courting semiconductor manufacturers to set up shop in India. If this materializes, we could start to see increased technology products trade between India and developed markets.
Looking ahead, we anticipate new trading partnerships to form. Globalization is not dead. But the geographic orientation of globalization is likely to change.
Theme 4: Shift in Industrial Policy
Governments and businesses will likely focus more on concentration risk and mitigation strategies.
A fractured world order gives rise to potential interstate conflict, and businesses understand that there are significant costs involved when their operations are concentrated in regions that could be affected. A business' viability could be questioned when just a few of their locations are taken offline.
The technology sector provides a good base case. Semiconductors are a critical technology required across a variety of products, such as cars, computers, consumer electronics and military equipment. The world's leading semiconductor manufacturers are primarily based in Taiwan, with additional facilities in Japan and South Korea. Beyond semiconductors, the final assembly of important products like phones are concentrated mainly in China. The pandemic created disruptions to semiconductor availability that showcased the economic impact of concentration risk.
Consider the auto sector: fewer chips available meant fewer vehicles were made and the subsequent shortage of vehicles on the market led to an increase in both new and used car inflation, which ultimately contributed to overall inflation.
More importantly, as China became more aggressive in its stance on Taiwan, concentration also presented national security implications. In the event that semiconductor production was down for a prolonged period, not only would technological advancement slow, but there would be a shortage of chips for critical products, like missiles and cyber defense.
Consequently, we will see companies seeking geographic diversification, and often this will be accompanied by governmental support. The U.S. has already passed legislation, including the CHIPS Act, to encourage production in the U.S. in order to shift the concentration from Taiwan. In breaking up supply chains, there will also be a rise in the concept of “friend shoring," in which countries seek to construct supply chains in countries with which they are friendly.
The term “friend shoring" is new, but the trend is not. For example, in the 1970s and 1980s, U.S. economic policy encouraged greater investment and ventures with manufacturers in Asia to help support nations like Japan economically. These engagements raised concerns about the U.S. supporting the rise of future competitors in Japan. At the same time, the U.S. was also helping China integrate into the global economy, fostering concern that the West had created a security threat as a result.
At its core, “friend shoring" involves companies moving towards new markets. In terms of manufacturing, countries in Asia, like Vietnam, Bangladesh and India are well-positioned to benefit. In fact, India has already announced production-linked incentives worth billions of U.S. dollars over the next two years to encourage investment in critical sectors to present a viable manufacturing alternative.
In the year ahead, we will likely see companies increasingly prepare to protect themselves from concentration risk and the fallout from potential stress points, like a war. They will likely move production to multiple facilities in new markets. This could raise the cost of production, but the net benefit is easing potential risk.
Globalization will not die. Instead, it will move to new geographies, which could benefit some markets in Asia.
Nationalism and industrial protection could rise further.
With a shift in industrial policy and the breakup of supply chains, countries will increasingly take a protectionist tact to capitalize on the potential gains of the movement, especially for their growth industries. In 2023, we will see countries seeking to boost their economies via policies that suit their interests.
India, as mentioned, has already taken steps to present itself as a viable destination outside of China. In Indonesia, President Joko Widodo (or Jokowi) imposed a ban on the export of nickel ore. This was a big move, considering Indonesia possesses the largest nickel reserves globally and it's a key component in electric vehicle production. This policy allows Jokowi to leverage the country's natural resources to attract foreign capital and grow its domestic electric vehicle industry.
Latin America has taken a protective stance on its resource wealth. A key commodity to watch is lithium, which is a crucial ingredient in rechargeable batteries for mobile phones, laptops and electric vehicles. For context, nearly 55% of the world's lithium deposits are located in the "Lithium Triangle" that spans the northern regions of Chile and Argentina and the southwest region of Bolivia. Chile is the largest regional player, producing 25% of the global supply in 2021, and the price of lithium carbonate equivalent (a lithium derivative) has increased close to 500% over the past two years. It is no surprise that regional leaders are voicing interest in creating national lithium companies, like President Boric in Chile. Further, Bolivia and Mexico have already formalized national lithium companies of their own. Nationalization gives the government direct control of the supply chain (and a larger share of the revenue).
We are witnessing a reversal of the post-war environment as open markets decay and countries seek to protect their industries. This will have strong implications within the breakdown of the world order.
Protectionism will become a growing theme within the context of the Green Transition.
Looking ahead, the broader shifts in industrial policy will define the evolution of the Green Transition. In particular, the value of commodities, especially rare earth minerals, could become heightened as trade flows shift. Latin America and Africa are rich in key ingredients sought for the transition to green energy, including lithium, copper, cobalt and nickel.
The need for investment presents an opportunity for the rising powers as both diplomatic partners and new investors. At the same time, it presents a lucrative revenue source for both Latin America and Africa. This is important when facing the fallout from COVID-19 and the Russia-Ukraine war.
Over the past year, constituencies have been acutely aware of income inequality, which was exacerbated during the pandemic. Governments borrowed more debt to fund relief programs while incorporating subsidies and tax cuts to ease the burden on citizens. Now, leaders face a mandate to continue and even increase the level of social spending, but this is constrained by their now weakened financial position as result of past policies.
Latin America presents a prime example. In the recent wave of elections over the last 18 months, citizens ousted incumbent candidates, instead choosing left-leaning leaders with a desire for wealth distribution. However, many of these leaders assumed office with a mandate to increase social spending while facing a high debt burden and slow growth. At the same time, as we've seen in Peru and Chile, these same leaders must contend with opposition-led congressional bodies. Commodity extraction presents win-win because it can unlock revenue quickly and garner widespread political support.
Protectionist policies could also mean a higher degree of scrutiny of foreign firms operating in certain jurisdictions. This year, Congo's state mining company, Gecamines, blocked exports from the Tenke Fungurume Mine (the second largest cobalt mine in the world). China's CMOC Group is a partial owner of the mine, holding an 80.0% stake versus Gecamines at 20.0%. Exports were blocked because CMOC was allegedly underreporting reserve levels to reduce the amount of royalties that it had to pay the government. Understanding the evolving importance of cobalt to the production of lithium-ion batteries, the government took a closer look at the royalty scheme to try and maximize their revenue. While the mine remains operational, it has not exported cobalt since the dispute was initiated.
Certainly, Latin America and Africa are in a position to court investment with their rich natural resources, which in turn will stimulate slowing growth. Plus, the additive revenue associated with mineral extraction can be applied to social spending. With this in mind, we anticipate countries in these regions will seek to take a larger revenue share, but it could come at the expense of a deteriorating operating environment for foreign firms.
Moving into 2023, we will likely see this focus manifested as changes to tax policy alongside tighter oversight of certain commodities. Leaders will seek trading relationships with those who provide the most economic benefit, adding to the complexity of partnerships in a multi-polar world.
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