Can 12 months shape the future? History suggests it can. The events of late 1978 and 1979 were to shape the following 30 years, until the Great Recession of 2009. We believe events of 2017 will prove similarly far-reaching.
In late 1978, Deng Xiaoping came to power in China, replacing the Gang of Four and immediately set about dismantling the worst excesses of Chairman Mao’s Cultural Revolution. The reforms he introduced have transformed China from a low-income, agricultural society to the second largest economy in the world and one moving rapidly up the export value chain. These reforms have led to the greatest development story in history, moving 500 million people out of poverty, and with it creating a new consumer class, industrial powerhouse, and directly changing the fortunes of many other emerging and frontier market countries. Its export policies would come to play a leading role in the build-up to the Great Recession.
Further West, four events re-defined the modern Middle East. In December 1978, Zia al-Huq, Chief of the General Staff of the Pakistani Army, became the first Islamist President of Pakistan since its founding in 1948. In January of 1979, one of the most significant revolutions in history occurred in Iran. In March of that year, Egypt signed a peace treaty with Israel. Lastly, in December 1979, the USSR invaded Afghanistan.
The peace treaty with Israel withdrew Egypt to the sidelines, having previously been the most influential country in the Arab world. The Islamic Revolution transformed Iran from a country with global pretentions to one with regional ambitions and ignited a Cold War with Saudi Arabia. Iran also switched sides in the Global Cold War to supporting the Soviet Union. The Soviet invasion of Afghanistan created a natural counter balance consisting of Pakistan, a long time adversary of Iran and deeply concerned by Iranian-Soviet designs on Afghanistan, Saudi Arabia and the United States. Arab Sunni extremists, including Osama bin Laden, were flown from Saudi Arabia to Pakistan, and then helped across the border to set up a base, or “Al Qaeda” in Arabic, in southern Afghanistan, trained and armed by the CIA. The subsequent war in Afghanistan, the growth of Al Qaeda, the Iraq-Iran war and the regional Saudi-Iran Cold War would lead to 9/11 and the US invasion of Afghanistan in 2002 and Iraq in 2003.
Further West yet, two elections were to cause a fundamental re-alignment in global politics. In May of 1979, Margaret Thatcher was elected Prime Minister of the United Kingdom, and one year later, her ideological soulmate, Ronald Reagan, was elected President of the United States. This was to usher in a neo-liberal alignment that was to define and dominate the Western political discourse until the Great Recession.
2016 gave witness to major geopolitical and geoeconomic shocks, not least Brexit and the election of President Trump. As global risks and uncertainties are continuing to spread relentlessly, political risk, once a preserve of emerging markets, has become normalised in developed markets too. We are at an inflection point in international affairs and we believe that, as in 1979, the events of 2017 will similarly come to define global politics and the global economy for the next 30 years.
Spire’s founders, Rebecca S. Bachmann and Matthew Hoffer Craig, list what they believe these defining events of 2017 will be.
The Beginning of History
In 1989, Francis Fukuyama wrote an essay called the “End of History”, arguing that the West’s victory in the Cold War meant liberal democracy had proved itself to be the end-point of humanity’s sociocultural evolution. Instead, The Great Recession of 2009 witnessed the beginning of the end of this 20 year “peace” and the perceived supremacy of Western liberal democracy. Today, the world is more multipolar than at anytime since WWI. Furthermore, the election of President Trump has come at a time when a number of countries, far from turning towards liberal democracy, are being led by dominant individuals asserting their personalities over nominally independent institutions, rolling back the recent advances of democracy. Concurrently, a rising tide of populism is sweeping across the West as people are questioning, more than any time since 1945, the ability of apolitical institutions and democratic government to deliver on jobs security and economic growth. We believe this new global multipolarity and the ability of liberals to combat populism in the West will define international affairs for the coming 30 years.
Forging new global economic growth models
Two features stand out in the global economy today: “secular stagnation” and low nominal interest rates in developed countries; and the need for emerging markets to build new growth models. A fierce debate has engulfed policy makers with respect to the former. On the one hand, central bankers and many economists believe that quantitative easing (QE) and asset purchases prevented The Great Recession from becoming a second Great Depression. The counter argument says that QE has distorted the price of financial assets and permanently decoupled these prices from the “real” economy. The result has been jobless growth and a permanently low inflationary environment. This distortion has led to what economists call a “liquidity trap”, where consumers refuse to spend and companies refuse to invest in the expectation that prices will fall even more, leading to further deflation. Japan offers an important lesson: what was considered a “lost decade” in the 1990s has now entered its third decade and still, Japan has been unable to reflate its economy. Prime Minister Abe’s “3 arrows” to tame deflation (QE, fiscal and structural reforms) have failed to hit their mark. To what extent has the West turned Japanese? This will become apparent once we better understand to what extent lack of inflation has been caused by macroeconomic and fiscal fundamentals, and to what extent they have been caused by other factors such as shifts in technology. The ability of the West, particularly Europe, to stimulate inflation and growth is critical given the plethora of structural issues it faces, such as ageing demographics, unfunded pension schemes, weak investment, low productivity, rising healthcare costs and rising household debt.
One Western country that has begun to raise short-term nominal rates is the United States, and this has brought emerging market growth models into scrutiny. Global emerging markets enjoyed a 10 year boom in the 2000s due to China’s economic growth and demand for natural resources. This boom is unlikely ever to be repeated.
The principle two factors affecting emerging market growth are US liquidity and Chinese commodity demand. The former is decreasing as US rates increase and the Fed ‘tapers’ QE, whilst the latter is also decreasing. This is making commodity exporters that also run current account deficits particularly vulnerable to the effects of capital outflows (e.g. Brazil, Indonesia). Current account deficit, manufacturing exporters (e.g. Turkey, Mexico) are also vulnerable; countries with a current account surplus are being forced to draw down currency reserves whilst changing their growth models (e.g. Saudi Arabia). All emerging and frontier market economies will be forced to diversify their economic development strategies, and the success with which they achieve this will be as divergent as these countries and regions are disparate to each other.
China will reshape Asia…and itself
Many column inches have been devoted to when China will become the next superpower. Often overlooked in this debate is the fact that China has never shown a desire to be a global power. It has, however, had designs on Asia and particularly so today. Its sense of historical grievance and need for development has created a dual policy of economic internationalism and foreign policy nationalism. With President Trump having already signed the order for America’s withdrawal from TPP, President Obama’s “Pivot to Asia” has been replaced by a US-centric trade policy, creating a void that will be filled by China. Indeed, China has already begun doing so through the implementation of 3 connected long-term strategic plans: the creation of the AIIB; “Belt & Road”; and Made in China 2025, designed to create globally dominant technology companies and high-value exports. Over the next decade, we can expect more countries historically hostile to China to move into its political sphere of orbit via engagement with one or more of these 3 strategic plans, as well as a thawing of relations with its historical rival India as both countries grasp the major benefits that cooperation can bring.
However, China is also facing unprecedented pressures for change domestically. Its economic model, which relies on exports and fixed asset investment spending (now at an unsustainable level of 80% of GDP), is under severe pressure. Private and business debt, particularly that of State Owned Enterprises, has soared, capital outflows are at record levels, and exports to America will weaken in light of rising US economic nationalism. China needs to rebalance its economy towards domestic consumption, but the falling value of the Renminbi is reducing the purchasing power of Chinese consumers. Something must give, and we expect the country’s leaders to pull out all the stops to reshape its economy to sustain its broader regional strategic objectives.
The United States to lead a new, more sustainable version of globalisation?
That President Trump will limit America’s role in deepening globalisation is not in doubt. To claim that this will create a wave of protectionism akin to the 1930s might be misleading, however. Harvard Professor Dani Rodrick, in The Globalization Paradox, claims that “level 3” globalisation, that practised globally by countries in the Bretton Woods era from 1945 until the 1970s, to be the most desirable form of globalisation. “Level 4” globalisation, characterised by large capital flows and practised mostly in the 1990s and 2000s, has proved unsustainable. Thus, there are many different shades of globalisation. The important question is whether President Trump will utilise American leadership to re-create a new Bretton Woods era which strikes a sustainable balance between national sovereignty and international trade, or whether his policies will cause countries to engage in outright protectionism, with similar consequences to the 1930s?
Bitcoin and Blockchain goes mainstream
As geopolitical and geoeconomic instability puts further pressure on global currencies, both private and institutional investors will seek out alternative investments to diversify their portfolios. 2017 could, therefore, be the year in which Bitcoin legitimises itself in the eyes of the public, completing its transformation from a “dark net” currency. With traditional banks and the financial services industry further diversifying into and supporting both Bitcoin and blockchain technology, we anticipate that other industry sectors will follow suit. Health care, telecommunications and supply chain management will enormously benefit if blockchain can be implemented to the point where the value derived from blockchain platforms is greater than the cost of running them.
We believe that 2017 may not (yet) be the year in which regulators finally give the green light for a wider adaptation and embrace of blockchain technology. However, continued efforts from private and public sector organisations will have an outsized impact educating the public about blockchain. It is clearly one of the key future technologies that will underpin industry.
Industrial vs Technology companies: The race to win Industrial IoT
Until recently a vertical in its own right, today the “Internet of Things” is itself defined by different segments, including in consumer goods, personal health, smart cities, retail, homes and offices. However, one of the most exciting corporate battle in history has started to take place around “Industrial IoT”, a cloud-based platform of applications constantly feeding back, and gathering, data from connected machines, creating analytical and predictive power for industrial products. The market is expected to be worth $300bn by 2020 and well over $1trn by 2030. The race to win this Industrial IoT centre-ground is being fought in one corner by major industrial companies, such as GE, Siemens, Mitsubishi and Rolls-Royce, who are pushing to develop their technological expertise, and by ‘large tech’, such as Google, Amazon, IBM, Oracle and SAP in the other corner, who are in turn developing their industrial capacities. Technology companies have won these races in the past…given their agility and ‘mindset’, we predict history will repeat itself.
The industries (and jobs!) of the future are already here
If we are to believe technologists, eight out of ten jobs of the future have not yet been invented. Ever deepening globalisation and unprecedented technological innovation are the largest disruption forces in the world today, and a backlash against these by “left-behinders” has caused economic nationalism to rise across the Western world. Concerned about technology automating jobs or globalisation outsourcing them, an increasing number of people voted for Brexit and Trump, voted against Italy’s reform package and support Le Pen in France. However, it is worth remembering that the First Industrial Revolution also displaced large numbers of rural workers, who then subsequently found work in factories. The main concern on the minds of most policy makers can be summed up as: “if we are to defeat this wave of populism, then the current industrial revolution will need to deliver on jobs pretty soon”.
In fact, we may not have long to wait. From education to healthcare, from infrastructure to energy, our world today is a relic of 20th century design. Installing a solar panel on the roof of every home in the West would spawn an ecosystem of engineers, mechanics, builders, managers and fitters creating millions of new, mostly manual jobs. Redesigning cities so they are more connected, building high-speed rail and new ‘smart’ highways would drastically improve infrastructure. Re-designing education and medicine to make them both personalised, would also create many new jobs. It is worth reminding ourselves that 1 billion people still lack access to flushing toilets while hundreds of millions of dollars are being invested in flying cars. Rather than straining to imagine the jobs of the future, we should instead better understand how current technology can be used to solve existing challenges. In short, upgrading existing physical and digital infrastructure from the 20th to the 21st century would create millions of jobs. We hope that policy makers, technologists and the private sector will (belatedly) come together at the global level to realise this opportunity.
The Middle East is being reshaped…and neither ISIS nor America will be at the heart of it
Since 1945, the United States has been the most powerful force shaping relations in the Middle East. Since June of 2014, ISIS has made the headlines as the region’s pre-eminent threat. Amid this noise, it is easy to overlook the fact that ISIS has been sustained beyond its core support by a sense of grievance by many of the region’s Sunnis. Substantial Iranian and Russian military support for Bashar al-Assad has turned the tide of the Civil War. By making the conflict about ISIS, they have enlisted the support of President Trump whilst keeping Assad in power. The Cold War with Iran and the new global energy context has forced Saudi Arabia into a much more aggressive and muscular foreign policy. The outcome will likely result in the defeat of ISIS, but also in the sidelining of America, which has ceded strategic ground to Russia. In its place, we can expect to find the Middle East further defined by the Iran – Saudi Cold War, with numerous smaller hot wars taking place. This will involve a plethora of forces including the Iraqi and Syrian Kurds, Turkey, Shia and Sunni militias and forces loyal to the Assad regime, with the United States having increasingly little sway over this wide array of actors. Against this backdrop, the MENA region will continue to struggle with the far greater challenge of job creation for its youth, economic diversification and private sector development.
Mexico to challenge Brazil for the leadership of Latin America
Brazil has lurched from one crisis to another over the past 5 years. Not long ago considered one of the world’s most important rising powers, the country’s economy has been hit by a perfect storm. Its public sector is unsustainably large: it spends money at the level of a developed country and its government has 59 ministries, more than any other country. Diversification of the economy has not been strong enough to counter-balance the collapse of its energy industry and concurrent energy revenues. Private household debt is one of the largest in the world. Its economy contracted by 4% in 2016, the worst recession of the BRICs, and GDP per capita has declined in real terms by 9% since 2014. Nonetheless, Brazil remains the unchallenged hegemon of Latin America. This could change over the coming decade. In its place may well step Mexico. It continues to make progress in its war against the Cartels and the economy is performing robustly and grew by more than 2% in 2016. If President Trump follows through with his policy aims, Mexico, with a population almost the size of Brazil, less reliant on commodity exports and with a diversified manufacturing base well equipped to move up the export value chain, may well decide the time has come itself to loosen its association with the United States and look southward to take up the reigns of leadership in Latin America.
Renewable Energy will continue to advance technologically… but oil will remain, king
The beginning of the end of oil has often been predicted, not least throughout 2016 as an oil glut caused prices to fall. It is also worth remembering that geopolitical tensions the like of which we are witnessing today would have caused large output disruptions in the past. It hasn’t happened this time primarily due to US shale and record Saudi output. The lack of a supply shock has maintained demand. Experts expect oil demand to peak only in 2040 due to future growth in China and particularly India, which will increase the size of the global middle class, raise living standards and create more demand for white goods, automobiles and other energy intensive goods. Technological advancements in drilling and exploration, as well as oil having the deepest and most secure supply and logistics chains of all fossil fuels, should soften the impact of future supply shocks. Renewables will continue to advance as alternative energy sources but will require a major technological breakthrough to impact oil, which few experts expect to happen before 2030.
Europe will no longer be able to find a messy muddle through the middle
The outcomes of the Dutch, French and German general elections this year will enable commentators to predict with greater accuracy where the European Union will be in 10 years from now. Although populism is undoubtedly on the rise, defenders of liberalism can take heart that Chancellor Merkel remains in a strong position and looks likely to win re-election. Most pressing in her in-tray will be to deal decisively with Europe’s debt crisis and leading Brexit negotiations once Britain has triggered Article 50. Also on the agenda for Europe’s leaders will be to increase its voice on the global stage, particularly in the face of a Trump presidency, and this must involve more clearly defining what the European Union stands for. If these hurdles can be overcome, we expect the European Union to thrive again in a re-defined, more close-knit community; if they cannot be overcome, the EU may find national populist backlashes increasingly harder to navigate. Global companies that had previously invested in Europe based on policy certainty and low levels of political risk might re-think these investment decisions.
