Donald Trump’s win in the US presidential election on November 8th has, at a stroke, prompted a profound change in the geopolitical outlook. Mr Trump is a uniquely difficult figure for international leaders to respond to, for two reasons. First, his foreign policy agenda is extreme: trade tariffs on China and Mexico; renegotiating the North American Free-Trade Agreement (NAFTA) and the Iranian nuclear deal; reduced support for US allies; and greater co-operation with Russia. Mr Trump’s win means that the US will steer a new course in the world. His “America First” stance rejects the view of American exceptionalism—that the US has a responsibility to cement and uphold its values around the world. Instead, Mr Trump is an isolationist and a deal-maker who sees foreign relations as a zero-sum game. His agenda will be built around three principles: that America should stop working to solve the problems of others; that current trade agreements are damaging the US economy; and that immigrants do not pay their way. The Trump administration will reduce its international commitments, creating a space for other countries, like China, to step into. This will be evident even in areas where there is already a high level of risk, such as in the South China Sea and Syria. Japan and South Korea will have to shout louder for attention; Russia, Turkey and Egypt will find the US more co-operative.
Events may diverge from The Economist Intelligence Unit’s forecast in ways that affect global business operations. The main risks are represented by the following scenarios.
Very high risk = greater than 40% probability that the scenario will occur over the next two years; high = 31-40%; moderate = 21-30%; low = 11-20%; very low = 0-10%.
Very high impact = change to global annual GDP compared with the baseline forecast of 2% or more (increase in GDP for positive scenarios, decrease for negative scenarios); high = 1-1.9%; moderate = 0.5-0.9%; low = 0.2-0.5%; very low = 0-0.1%.
Risk intensity is a product of probability and impact, on a 25-point scale.
Negative scenario—China suffers a disorderly and prolonged economic slump
High risk; Very high impact; Risk intensity = 20
We currently expect China to experience a sharp economic slowdown in 2018, with growth slowing to 4.2%, from 6.2% in the previous year. The political reshuffle at the Chinese Communist Party Congress scheduled for late 2017 will enable the president, Xi Jinping, to alter economic policy in 2018. The primary focus of this shift will be an attempt to slow the rapid growth in credit that has been a feature of government policy since the global recession in 2008-09 and has caused the country’s debt stock to surge to over 200% of GDP. Despite the scale of the slowdown, we anticipate that it will be policy-induced and therefore easier for the authorities to manage (reflecting in part the state’s deep integration with China’s banking system). As a consequence, we do not expect it to result in a rise in unemployment and social unrest on a scale that would threaten the established order, and maintaining economic growth of above 4% should be sustainable in the following years. However, there are substantial risks to this outlook. The bursting of credit bubbles elsewhere has usually been associated with sharper decelerations in growth, and, if accompanied by a house-price slump, the government may struggle to maintain control of the economy. If the Chinese government is unable to prevent a disorderly downward economic spiral, it would lead to lower global commodity prices, particularly in metals. This would have a detrimental effect on Latin American, Middle Eastern and Sub-Saharan African economies that had benefited from the earlier Chinese-driven boom in commodity prices. In addition, given the growing dependence of Western manufacturers and retailers on demand in China and other emerging markets, a prolonged deceleration in Chinese growth would have a severe global impact—far more than would have been the case in earlier decades.
Negative scenario—”Grexit” is followed by a euro zone break-up
Moderate risk; Very high impact; Risk intensity = 15
Although an 11th-hour agreement between Greece and its euro zone creditors for a third bail-out in mid-2015 removed the immediate risk of “Grexit”, the country’s future within the euro zone remains at risk. The fragile Syriza-led governing coalition finally managed to agree a raft of pension and income tax measures imposed by its creditors in May 2016, but the reforms prompted violent protests. Despite pressure from the IMF, euro zone finance ministers delayed a decision on a debt-forgiveness deal until 2018—a situation that will lessen the already unpopular government’s appetite to implement the remainder of the bail-out programme’s economic reforms. In the event that Greece were to fail to abide by the terms of its bail-out, prompting a domestic bank run, the return of capital controls and ultimately its departure from the currency, the idea that membership of the euro zone is irrevocable would no longer hold and attention would turn to other highly indebted countries in the single-currency area. The Greek debacle has shown the fundamental difficulties associated with creating a single currency zone without a concurrent fiscal union. With the euro zone’s political and economic problems mounting, these inadequacies will return to the fore—especially if the Italian banking crisis were to escalate, dragging the government down with it. If Grexit led to other countries leaving the euro zone, this would destabilise the global economy. Countries leaving the zone under duress would suffer large currency devaluations and be unable to service euro-denominated debts. In turn, banks would suffer huge losses on their sovereign bond portfolios and the global economy would be plunged into recession.
Negative scenario—Beset by external and internal pressures, the EU begins to fracture
Moderate risk; Very high impact; Risk intensity = 15
The UK’s decision in June to become the first country (excluding Greenland) to leave the EU has raised concerns about the future viability of the EU. Although the UK has long had an ambivalent attitude towards Europe, the hostility of the UK Independence Party towards the EU is mirrored by other European “insurgent” parties, such as the Freedom Party in the Netherlands and Front National (FN) in France. With this in mind, there is a risk that the establishment parties in the EU will consider offering a referendum in order to siphon off support from populist parties. Among others, Marine Le Pen, the FN leader, has made such a referendum a key plank of her party’s manifesto. Although the UK’s fate may deter other European leaders from employing a similar tactic, in reality the arguments pushed by the Brexit campaigners—focused on immigration and loss of sovereignty—chime with much of Europe. The failure of the EU to agree a united response to the refugee crisis, which saw checks and barriers reappearing across Europe’s Schengen area, and the deep resentment in some Mediterranean countries towards the austerity measures imposed by the EU are indicative of the rise of national priorities among the region’s politicians. With no cogent roadmap in place for the future of the “European project”, there is a growing risk of an existential crisis in the EU that could culminate in its eventual fracturing. In the event that the EU were to begin to fracture and land borders were reimposed, trade flows and economic co operation would be hindered, weighing on growth in the world’s largest single trading bloc. More widely, the area’s slew of trade deals internationally would potentially need to be renegotiated as the bloc begins to disintegrate, while the probable fracturing of the euro zone would translate into enormous currency volatility globally (including a near-certain substantial strengthening of the US dollar).
Negative scenario—Currency depreciation and low commodity prices trigger an emerging-market corporate debt crisis
Moderate risk; High impact; Risk intensity = 12
With the Federal Reserve (the US central bank) expected to restart its tightening cycle in December 2016, and the anticipated Chinese hard landing in 2018 likely to be accompanied by renewed US-dollar strengthening, the potential remains for a renewed capital flight to safety. The countries most vulnerable to the shifting monetary cycle in the US are those with wide fiscal and current-account deficits; those viewed as lacking political and policy credibility; and those heavily reliant on commodity exports. (In the case of Venezuela, all three, combined with policy shortcomings, have raised the prospect of hyperinflation and default.) Those countries most exposed may be forced to raise their own policy interest rates in order to avoid destabilising capital outflows and currency depreciation. Also vulnerable are emerging-market corporates, especially in Asia, which in recent years have eagerly taken advantage of the hunt for yield. Since the global financial crisis in 2008, emerging-market corporate debt has risen from 50% of GDP to close to 75%, and Chinese private-sector credit is still growing at three times the rate of nominal GDP growth. This exposure to rising rates would be exacerbated if local currencies were to weaken, which would push up the cost of corporates’ foreign-currency borrowings. Any rolling emerging-market debt crisis would cause panic across the global capital markets and could require governments to step in to shield their banks from the fallout.
Negative scenario—The rising threat of jihadi terrorism destabilises the global economy
Moderate risk; High impact; Risk intensity = 12
The threat of jihadi terrorism has moved up the international policy agenda after a series of devastating attacks in Lebanon, Turkey, Egypt, France, Belgium and Indonesia. Despite losing considerable territory in Iraq and Syria, a jihadi group, Islamic State (IS), remains an especially challenging group to counter—first, because of its self-declared, albeit diminishing, “caliphate” in Syria and Iraq, which provides both an operational base and a propaganda tool, and second, because of the ease with which it can recruit and motivate attackers around the world. Taking advantage of its decentralised nature—which allows individuals to operate under its banner anywhere in the world without prior contact with the group—IS has been able to strike a wide variety of targets across multiple continents. Besides its ability to win new adherents, IS’s other success has been to garner the backing of internationally established jihadi organisations, such as Ansar Beit al Maqdis in Egypt and Boko Haram in Nigeria. The spread of IS and its influence poses a dilemma for global policymakers, who are under pressure to intervene militarily to suppress the group in its strongholds in the Middle East (especially now that hundreds of thousands of Syrian refugees are seeking sanctuary in Europe). However, they risk reprisals in their home countries by radicalised sympathisers of IS, which is increasingly seeking to retain influence—in the wake of its territorial losses in Iraq and Syria—via the stepping-up of terrorist attacks abroad. Should this spiral of attack and counter-reprisal escalate, it would begin to dent consumer and business confidence, which in turn could weigh on US and European stockmarkets.
Negative scenario—Chinese expansionism leads to a clash of arms in the South China Sea
Moderate risk; High impact; Risk intensity = 12
A ruling in July by the Permanent Court of Arbitration (PAC) in favour of the Philippines in its case against China’s claims in the South China Sea has cast the territorial tensions in the region in a new light. In recent years China has sought to exert its claimed historical rights to the sea areas demarcated by its so-called nine-dashed line, which encompasses around 85% of the South China Sea. Among other methods, this has included dredging work by Chinese vessels, focused on turning reefs, atolls and rocks in disputed parts of the South China Sea into artificial islands and, in some instances, military bases. This work has profound territorial implications. According to the UN Convention on the Law of the Sea, uninhabitable rocks have a 12 mile territorial zone, while habitable islands have 12 mile territorial waters and a 200 mile exclusive economic zone. However, in its ruling the PAC argued that there was “no legal basis” for China to claim historical rights within its nine-dashed line. China declared the verdict null and void, although the Ministry of Foreign Affairs did say that it was open to negotiations over resolving the dispute. However, the ministry’s role in driving policy over the South China Sea has usually been secondary to that of the military and the leadership of the Chinese Communist Party, neither of which has adjusted its tactics. Although China’s bilateral tensions with the Philippines have eased following the election of Rodrigo Duterte (who has sought to shift the Philippines away from its traditional alliance with the US and towards China), it is worth noting that China remains mired in multiple island disputes elsewhere, including with South Korea and Japan. As a result, there is a risk that the court setback will provoke China to re-emphasise its de facto control of the disputed region, such as by declaring a no-fly zone. Such an approach could lead to a military build-up in the region, which, in turn, would raise the danger of an accident or miscalculation that might lead to a wider military escalation. Any worsening of the row could undermine intra-regional economic ties, interrupt global trade flows and depress global economic sentiment more broadly.
Positive scenario—Global growth surges in 2017 as emerging markets rally
Low risk; Very high impact; Risk intensity = 10
The start of 2016 was fraught for global currency and commodity markets, with oil prices slumping towards US$25/barrel and a number of emerging-market currencies adversely affected by the start of US monetary tightening. The resulting dip in global equity markets was exacerbated by growing concerns over China’s economic slowdown and the depreciation of the renminbi. However, since February there has been a significant turnaround in investor sentiment, with global equity markets rallying to their pre-2016 highs and oil prices recovering. Indeed, financial markets even took the Brexit vote in their stride. As a consequence, capital inflows into emerging markets have resumed in 2016, following two years of outflows. The stage may now be set for a period of greater macroeconomic, currency and commodity stability, which could propel global growth, at market exchange rates, to 4% in 2017. This would be the highest level since 2010, when the global economy was awash with post-crisis stimulus. A broad-based acceleration in growth would not only provide welcome relief to slow-growing euro zone countries, which are heavily reliant on export demand, but could also assist in China’s economic rebalancing. An improvement in global demand would provide support for commodity prices, giving welcome relief to Latin American, Middle Eastern and African commodity exporters.
Negative scenario—Rising tide of political populism in the OECD results in a retreat from globalisation
Moderate risk; Moderate impact; Risk intensity = 9
The UK’s vote to depart from the EU was a setback for global economic and political integration, and will prompt major soul-searching among Western governments. As shown in the election of Donald Trump in the US and the growing influence of populist parties (both left and right) in, for example, Spain (Podemos), Italy (Five Star) and France (FN), there is a powerful backlash under way against the consequences of globalisation. This nativist sentiment is in some ways understandable. The benefits of trade liberalisation tend to be spread thinly across the vast bulk of the population, and thus often go little noticed; by contrast, the victims of globalisation, such as those living in areas heavily reliant on a dwindling manufacturing or industrial base, are often concentrated and disproportionately affected. This dichotomy has been exacerbated by a stagnation in living standards for many people across the OECD in the past decade. In the face of these challenges, it will prove difficult to ratify trade agreements. We expect negotiations on the Transatlantic Trade and Investment Partnership (TTIP; a proposed trade agreement between the EU and the US) and the Trans Pacific Partnership (TPP; between the US and 11 other countries) to fail. There is even a risk of a wholesale protectionist revival if, for example, the OECD were to go through another economic downturn. The impact of a protectionist wave would be felt around the world. In wealthy countries with dominant services sectors, rising trade tariffs would push up living costs and depress domestic demand, causing economic growth to slow. Among major low-cost exporters, such as those concentrated in East Asia, higher barriers would curb exports, investment and job creation.
Negative scenario—The UK government fails to prevent a “hard Brexit”
High risk; Low impact; Risk intensity = 8
Following the UK vote to leave the EU in June, the current government, led by Theresa May, is currently facing the thorny task of attempting to negotiate a departure from the EU that will concurrently not preclude its continued participation in the single market. Given the scale of the challenge, we anticipate that the two-year deadline to negotiate a deal (once Article 50 is triggered) will be extended. This would perhaps entail the UK joining the European Economic Area (EEA) for a transitional period, after which the UK agrees a final deal that includes the government compromising over its demand to take back full control of immigration in return for remaining part of the EU single market. However, there are significant downside risks to this forecast. In particular, securing at least some restrictions on immigration is likely to be a minimum requirement for Mrs May, and without this any EU trade deal will probably be politically unacceptable at home. If EU leaders do not agree to this, negotiations would break down and the UK would leave the EU without any arrangement in place. This would almost certainly result in an abrupt depreciation in the value of the pound and a sharp economic slowdown in the UK—still the fifth-biggest economy in the world—leaving the economy just over 3% smaller than under our baseline forecast. This slowdown would also harm the EU itself, given that the UK is one of the few relatively fast-growing economies in Europe and is an especially important trade partner for countries such as Spain (notably in tourism) and, in particular, Ireland.
Negative scenario—A collapse in investment in the oil sector prompts a future oil price shock
Very low risk; High impact; Risk intensity = 4
The response of the world’s oil companies to lower prices should raise concerns about the long-term impact on future energy supplies. Oil and gas projects worth up to an estimated US$1trn have been deferred or cancelled (a process that started before the decline in oil prices began), despite the fact that a global energy consultancy, Wood Mackenzie, estimates that over 20m barrels/day of new capacity needs to be brought on stream by 2025 to offset declining output in ageing fields and meet new demand. History provides repeated warnings of the long-term impact of oil-price slumps: the surge in oil prices to close to US$150/b in 2008, for example, can be traced back to the investment freeze across the industry in the wake of the oil-price collapse in 1998. In addition, the prospect of an OPEC (and possibly an accompanying non-OPEC) oil production cut from December would, if implemented, accelerate any market rebalancing and, in turn, exacerbate the impact of the investment downturn. Meanwhile, contrary to historical precedent, the oil market is still not taking into account geopolitical risks to supplies, ranging from war in the Middle East to political ructions in Venezuela and outages in Nigeria. Nevertheless, we believe that the risk of an oil price spike in 2017-21 remains low, reflecting the new output coming on stream from low-cost producers such as Iraq (and post-sanctions Iran), as well as the ability of US shale oil producers to revive drilling activity rapidly in the event of a price recovery.