In our latest look at the impact of the economic shock brought on by Covid-19, we focus on geopolitics. We think there will be long-lasting negative effects on regime stability, structural reform and relations with neighbours.
In the same way that hysteresis (the impact of shocks far outlasting the duration of those shocks) can impact individuals or segments of an individual economy, it can impact entire countries or blocs of countries. The effects of the global demand shock will likely outlast the shock itself:
Commodity exporters will see greater risks to government stability, particularly where citizen welfare expectations are high, such as in the GCC (where fiscal breakeven oil prices are far above current levels), political legitimacy was already at risk (eg Algeria, Iraq, Iran, Peru), or where Covid-19 responses are particularly poor (eg Brazil, Iran).
Countries in the midst – or in urgent need – of structural reform, likely find it politically much more difficult to implement this reform in a much tougher economic environment (eg France in developed markets, Brazil, India, Saudi, South Africa in the large emerging markets, or Argentina, Egypt, Indonesia, Pakistan, Philippines in smaller emerging markets).
It is possible, of course, that the current crisis may prompt some countries which have been reluctant to pursue structural reform historically to change course. There is no sign of this yet and there likely needs to be much more pain felt before the deep-seated vested interests, which have inhibited reform historically, acquiesce, eg Bangladesh, Indonesia, Nigeria, Thailand, or Zimbabwe could all be candidates for this.
In the same way that inequality is likely to increase between individuals within one country (the regressive impact of the economic shock), it is also likely to increase between countries in the same region. The results are also analogous: more spillover of insecurity, migration, strain on bilateral relations, appeal of nationalist politicians. Note the initially scornful response to the Covid-19 outbreak in Iran by some of its neighbours (and the US) and the subsequent blame directed at Iran when infections spread to those neighbouring countries, or the use of Covid-19 as a pretext for populist politicians in Europe to reinforce their message on refugees and immigration.
Source: WB, Tellimer Research
Source: UN, WB, Tellimer Research
Regional blocs, with incomplete integration, will fragment even quicker (EU, NATO, GCC)
Prior to the current crisis, strains were already evident in regional blocs and security alliances, such as the EU, NATO, and the GCC. (In this context, organisations like the African Union, ASEAN, or Mercosur should not be included, because they have hardly acted as coordinated, credible geopolitical actors in the past).
The absence of coordinated responses to Covid-19, in part because these blocs and alliances were not designed for cooperation during crisis so much as for cooperation during more orderly environments, may push some of these alliances towards breaking point.
- The EU was already struggling with the repercussion of the sovereign debt crisis (which dates back to 2009), Brexit negotiations, and the rise of authoritarian governments (eg Hungary, Poland, and, for a while, Romania). The perception that the EU (specifically its relatively richer northern states) has failed to provide urgent and adequate assistance to its struggling states is in plain sight in the rhetoric of political leaders in Italy and Serbia. Furthermore, the democratic norms included as a part of EU membership criteria were already under strain with the authoritarian shifts in Hungary and Poland (as well, for a while, Romania); these strains are likely to increase as some leaders impose and hold on to emergency executive powers for an indefinite period.
- NATO was already divided over issues such as allocation of defence budget needs, Iran, the Sahel region of Africa, and Turkey (in terms of its Russian arms purchases and incursion in Syria). Spillover of Covid-19 infection-related disruption in Syria to Turkey, or regime destabilisation in Iran because of US sanctions which inhibit the Covid-19 response, could test the coherence of the alliance.
- The GCC was already divided internally on the issue of Qatar and its relations with the Muslim Brotherhood, Turkey and Iran. In the early days of Covid-19, intra-regional travel was restricted but on a unilateral and ad hoc, rather coordinated and systematic, manner. In the event that the crisis brought about by Covid-19 and, more importantly, the oil war, puts intolerable strain on Oman (with its stretched sovereign balance sheet and high fiscal breakeven oil price, relative to other GCC members) from a social or currency perspective, it is not clear whether the richer GCC members will repeat the sort of assistance they provided after the “Arab Spring” in 2011-12.
The fragmentation of these blocs and alliances has major repercussions for the emerging markets, more widely.
- Further exits from the EU would reduce the utility of the EU trade deals negotiated by emerging market exporters and, more importantly, pit nearby emerging market exporters against competition from those exiting (eg Egypt, Morocco, and Romania might have to compete with an Italy or Spain which has exited the EU and effectively devalued its currency).
- Strains which saw Turkey exit NATO or Oman exit the GCC would allow for geopolitical rivals to the US and the EU, eg China, Russia or Iran, to expand their influence in these countries.
US-China friction will shift to a fuller-blown Cold War, dividing the world into two camps
The international Covid-19 response, both in healthcare protocol and economic stimulus terms, has been uncoordinated, at best, and characterised by suspicion and beggar-thy-neighbour, at worst. Given the scale of the disruption, it is unlikely that globalisation (or de-globalisation) continues the same trajectory that preceded the crisis.
Logically, there are two outcomes. Either there is a reversal of de-globalisation politics and a move to more coordination, strengthening of international bodies, and assertion of superpower leadership. Alternatively, the opposite occurs and there is acceleration towards isolationism and tribalism in international relations. A scenario positioned between these theoretical extremes may already be playing out: a more formalised cold war between the US and China.
Prior to the current crisis the US and China were already on opposing sides on many issues, for example:
- Trade access (tariffs, intellectual property protection), with the Phase 1 deal representing an incomplete and fragile agreement;
- Technology in 5G mobile networks;
- Territorial control in the South China Sea (from Vietnam to the Philippines);
- Belt and Road Initiative (BRI);
- North Korea;
- Hong Kong;
- Uighur Muslims;
Control and influence in a range of existing international bodies and agreements (eg UN, IMF, WB, WHO, WTO, IAEA, FATF) and the early stages of establishing rivals to these by China (eg AIIB in infrastructure finance, RCEP for regional trade).
The reactions on both sides to Covid-19 point in this direction, eg
- China’s triumphalist rhetoric on arresting the rise of reported infections (almost as a means to demonstrate the credibility of its flat-lining of infections);
- China’s very public show of sending doctors and medical equipment to the likes of Italy or Spain;
- The Trump administration’s pointed referral to the “Wuhan” or “Chinese” virus long after other political leaders or mainstream media had stopped using these terms;
- Hints from the Trump administration that China withheld timely information at the time of the Covid-19 outbreak; and
- Tit-for-tat effective expulsions of journalists.
The challenge for emerging and frontier market investors in a US-China cold war scenario will be to identify the countries able to occupy what might be a very narrow geopolitical space:
- Feed China’s consumption base directly with finished goods or (indirectly) with commodities;
- Benefit from China’s export of capital (BRI-type infrastructure investment deals with governments, as well as foreign direct investment into corporates);
- Benefit from US trade barriers on China which drives relocation of manufacturing to rival locations; and
- Avoid falling offside of US interests and risk the penalty of trade barriers and sanctions.
Source: Tellimer Research
Source: Twitter (@realDonaldTrump, @zlj517, Lijian Zhao, China MFA
Source: IISS, Tellimer Research. Includes procurement, R&D, maintenance.
You can read more on how Covid-19 is reshaping the world in our recently published report Waiting on the World to Change, in which we explore how the current crisis will result in new normals for politics, macroeconomics, business models, and finance.