Political Issues to Watch in 2018
January 9, 2018

The business backstory for 2017 is that geopolitics did not seem to matter—at least not the way they have in recent years. Major political tremors have rattled the United States, Europe, the Middle East, and Northeast Asia; the geopolitical balance of power between China and the United States is shifting; fake news has become a buzzword in many countries; and political polarization and fragmentation seem to be on the rise globally. Despite of all of this, the world’s economic outlook is the rosiest in years and global markets are flying high. Loose monetary policies and record borrowing have helped paper over political risks.

While the economic outlook is better, the global political risk super-cycle will persist into 2018. The United States, the United Kingdom, Saudi Arabia, North Korea, Brazil, Mexico, and Venezuela will be notable hotspots. More global governance challenges such as inequality, populism and extremism, truth in media, cybersecurity, free trade, and climate change persist as well.

Here are seven key country-level issues that investors and business leaders will need to pay attention to in 2018 in dealing with politicians and policymakers, stakeholders in society, and local business partners and competitors.

Globalization: Made in China

Consumers worldwide have become accustomed to seeing "Made in China" labels on everything they buy. This ubiquity was achieved largely by China becoming the world’s order taker, but the government is undertaking several changes to turn the country into an order maker.

First, Beijing is investing in sunrise technologies such as the internet of things, artificial intelligence, robotics, aerospace, and new energy vehicles. Its "Made in China 2025" blueprint aims to promote domestic innovation and brands, setting out to have Chinese firms control 80 percent of the domestic market in these priority technology areas within eight years. This coordinated and well-funded drive pushes the limits of trade rules and presents a competitive threat to multinationals. For example, the rapid expansion of solar power generation around the world over the past decade is due in large part to China’s development incentives, easy access to capital, and innovation in manufacturing that have led to the country’s overcapacity and falling prices for panel making. Western manufacturers that pioneered solar technologies are getting crushed.

Beijing is repositioning itself as a superpower. President Xi Jinping no longer downplays the country’s global influence by asserting that China is a developing nation.

Second, China is exporting its prodigious engineering and construction capability across Asia and into Africa and Europe with its Belt and Road Initiative and the Asia Infrastructure Development Bank, with the intent of knitting its part of the world together and doing so on its terms. As such, Belt and Road should not be seen as market driven, but as an intensely political and geopolitical venture that has significant implications for multinational infrastructure and logistics firms, as well as changing the governance expectations of large infrastructure projects.

China’s reach into global commercial real estate is also expanding: Its outbound investment in massive real estate ventures is transforming the urban cores of cities such as Los Angeles, Vancouver, Brooklyn, and Sydney.

Finally, Beijing is repositioning itself as a superpower. President Xi Jinping no longer downplays the country’s global influence by asserting that China is a developing nation. At Davos in January 2017 and during the Communist Party congress in October, Xi presented China as a nation with strong, unified leadership and a well-defined plan for the future that will drive global growth and integration as well as play a more active role in multilateral institutions.

Brexit: Mind the gap

Brexit Day is March 29, 2019. London’s priority in 2018 will be to minimize disruption and downside for both sides—a tall order. The tight deadline severely limits how much and how quickly the U.K. can diverge from its current relationship with the EU and its other trading partners. Many issues will be deferred by hasty stop-gap measures that preserve much of the status quo ante for 3-5 years while permanent arrangements can be negotiated.

For example, setting up systems on both sides of the Channel to clear thousands of customs declarations per year will require hiring, training, and positioning thousands of inspectors—tasks officials have admitted will take several years to implement. In any event, the May government’s stumbles so far suggest that the coming year will continue to be punctuated by dire warnings from businesses and investors of gaps and impending trouble.

Although the British have asserted that they are not European, their political leaders have no clear vision for what they want their country to be in the future.

According to a recent RAND Corporation assessment, every post-EU relationship option for the U.K.—Canadian, Swiss, Norwegian, Turkish, or WTO—promises to depress Britain’s long-term economic outlook. But economic dislocation is not the only challenge Britain faces. There is a diversion risk as well: Policymakers will be preoccupied with the transition for at least five more years, crowding out other important issues such as healthcare, housing, education, inequality, and innovation.

The bigger picture is that although the British have asserted that they are not European, their political leaders have no clear vision for what they want their country to be in the future. Should the public become disenchanted with it all, the Tories will face an existential crisis and the business community may also have to contend with a hard-left Labour government on top of a costly Brexit in a few years’ time.

Europe: Pulling together

Europe in 2017 was marked by the specter of nationalism and fragmentation, but growth across the EU accelerated. While the far right progressed in Germany and Austria and had a strong showing in France, voters and politicians largely chose the path of pragmatic leadership. Going into 2018, policymakers want to get past Brexit as soon as possible so they can focus on their own grand projects to remake the continent.

Rather than expecting the EU to fall apart in 2018, expect it to pull together, which will support investor and business optimism. Angst voiced during the last few weeks over Chancellor Angela Merkel’s difficulties in forming a government has been overblown. Pragmatism and responsibility, not grandstanding and polarization, underpin Germany’s political culture. A key difference is that Merkel will be looking to cement her political legacy and the new government is likely to support closer Franco-German cooperation to address European challenges. Tighter eurozone integration will be on the 2018 agenda.

Rather than expecting the EU to fall apart in 2018, expect it to pull together, which will support investor and business optimism.

In contrast to the political division and inward preoccupation exhibited by the United States and the U.K., France offers a model of democratic political renewal. The May 2017 election of President Emmanuel Macron broke the old two-party hierarchy and ushered in a new generation of politicians, and the public and powerful unions largely have gone along with Macron’s efforts to make the economy more competitive. And Paris is seeking to use Brexit as an opportunity to challenge London as a center for entrepreneurship, creativity, and business, if not financial services.

Catalonia is a globalization success story, but its impetuous push for independence in 2017, combined with Madrid’s heavy-handed response, revived fears of a fragmenting Europe. The December 21 elections will return independence-minded parties to the regional parliament on promises to defend Catalan interests. But unionists will also be fired up, and independence activists will have to be more modulated and nuanced in their approach. A key issue to watch in 2018 is how Madrid responds: A clumsy hand will energize the resistance.

Saudi Arabia: Wait and see

Saudi Arabia has embarked on a far-reaching economic, political, and cultural transformation instigated by Crown Prince Mohammed bin Salman (MBS). Weak oil prices are the immediate driver of change, but prices have been down before. What’s different this time is that market experts are talking about the prospect of peaking oil demand, budget commitments are structurally higher than oil revenue expectations, and Iran has eclipsed Saudi Arabia as a regional geopolitical power.

The stunning announcement in October 2017 of a new anti-corruption committee and the arrest of dozens of prominent elites highlights the fast-paced, wide-ranging, high-stakes nature of MBS’s plans. The crown prince is taking a tool from the kits of Xi and Vladimir Putin: Fighting alleged corruption is his new hammer to realign economic interests and consolidate political control.

Saudi Arabia has been on the losing side of the civil war in Syria, pursued a destructive and losing war in Yemen that has also exposed Riyadh to missile attacks, and instigated the Qatar blockade that has exacerbated intra-Sunni tensions and pushed Qatar closer to Iran.

The message MBS is sending is that he can choose who he wants to prosecute, with no royal or business elite being untouchable. This will generate significant political risks for foreign banks and business partners in the year ahead, especially as billions of dollars of wealth is forfeited, repatriated, and reallocated.

Longer term, these moves are raising expectations among young, restive Saudis, and their frustrations will escalate if economic opportunities do not improve. This is especially pertinent given that MBS’s track record is not good. His country has been on the losing side of the civil war in Syria, he has pursued a destructive and losing war in Yemen that has also exposed Riyadh to missile attacks, and he instigated the Qatar blockade that has exacerbated intra-Sunni tensions and pushed Qatar closer to Iran.

North Korea: Nuclear winter redux?

There is a dominant line of thinking in political science and economics that political leaders are essentially predictable and rational. A corollary is that nations that gain nuclear weapons capability become more geopolitically risk averse because nukes are not good tools for coercion: Their use invites massive retaliation and annihilation.

Accordingly, Kim Jung-un, rather than being crazy, rationally views a nuclear capability and the capacity to deliver nuclear weapons to U.S. territory as the ultimate guarantor against external threats—something his country has faced since its founding. But Kim regards the United States as posing a significant threat and is taking actions—nuclear tests, missile tests, cyber-attacks—that risk provoking the United States.

A nuclear conflict involving North Korea has been treated as a very low risk, albeit a potentially high-impact black swan event. Whether one believes the relevant actors are rational, the notable differences in the stand-off in 2018 are that the chance of miscalculation is higher given Pyongyang’s accelerated testing program and Washington’s bellicose signals, such as the administration raising the specter of a preemptive attack and Trump’s assertion "we will take care of it" after North Korea launched a more advanced missile in November 2017.

A nuclear conflict in 2018 is still highly unlikely, but its probability has increased.

The United States’ demand that the North denuclearize is a nonstarter for Pyongyang (and its erstwhile allies in Beijing and Moscow), while Washington’s signals are confusing—with the secretary of state offering to negotiate while the While House bats down such offers. As in financial markets, rational decision-makers do miss and misinterpret signals and stumble into trouble.

A nuclear conflict in 2018 is still highly unlikely, but its probability has increased. Black swans are hard to predict and harder to plan for, and nobody wants to think about nuclear war and the potential for millions of human casualties. But being surprised by one is worse. Global markets are flying high, but conflict in Korea would ground them in a hurry.

Russia: More relevant geopolitically, more peripheral economically

Putin’s victory in the March 18 presidential election is preordained. However, elections are a weak knee in Russia’s body politic: The issue to watch in 2018 is how elegantly Putin’s team can pull off the win while achieving respectable turnout and without sparking a popular backlash. Otherwise, a political clampdown could ensue, harming economic sentiment and further distancing Russia from the West.

In any event, Russia is recovering from its two-year recession, and the IMF expects the economy to grow 1.8 percent in 2018 because of the firming of global oil prices and recovering domestic consumer demand. Interest from foreign investors and businesses is also up, but unlike China, Russia remains a price taker and its economic outlook remains heavily dependent on oil revenues. Putin has no plans to invigorate the economy, and other than selling natural resources to China, its business leaders and people are inward-looking and isolated from the global economy.

As Western headlines continue to focus on revelations of Russia’s fake news propaganda, election meddling, geopolitical power plays, and incriminations from the Mueller investigation, Putin’s stature will be burnished at home.

As Western headlines continue to focus on revelations of Russia’s fake news propaganda, election meddling, geopolitical power plays, and incriminations from the Mueller investigation, Putin’s stature will be burnished at home. But Russia’s long-term economic outlook is uninspiring. The perception of Russia’s strategic threat (combined with U.S. legislation adopted in August 2017) lock in sanctions for the foreseeable future, and this dramatically narrows the scope for constructive relations—something that all interested businesses and investors should take into account.

Latin America: Perennial underperformer?

Political developments in Latin America have largely been eclipsed by events around the world. Of note, the IMF expects the region to continue underperforming the global economy with a modest increase from 1.2 percent growth in 2017 to 1.9 percent in 2018. Latin America has experienced a tide against leftist-populist politics on the continent over the past couple of years—in Brazil, Argentina, Chile, and Venezuela. In 2018, presidential elections will be held in Mexico, Brazil, and Colombia, and the overarching issue for businesses and investors will be the prospect for populists and the left to regain ground.

Venezuela’s turmoil has been widely reported on. Given the contentious political situation and economic contraction—by one-quarter in the last two years, according to IMF estimates, with a further 6 percent contraction in 2018—it’s not clear whether President Nicolas Maduro can survive another year. Should there be regime change, a transition government will have the herculean task of stabilizing and reforming an impoverished, polarized, and armed country while placating bondholders abroad.

A U.S. withdrawal from NAFTA would inject the issue into Mexican election politics, providing sustenance to the most populist and nationalist of the three main presidential candidates.

NAFTA negotiations are not going well, and a U.S. exit announcement in early 2018 is most likely. While Washington is insisting on several "poison pill" changes, including minimum U.S. origin content requirements and the elimination of trilateral dispute resolution panels, Canada and Mexico have made it clear they will walk away if the United States maintains its hard line.

The headline issues in the Mexican election in July are all domestic: crime, corruption, and slow growth. A U.S. withdrawal would also inject NAFTA into election politics, providing sustenance to the most populist and nationalist of the three main presidential candidates, Andrés Manuel López Obrador. His victory would represent a historic shift to the left in Mexican politics. The broader U.S.-Mexico relationship would then be under pressure from both sides of the border, hurting not only trade and investment but also cooperation across a host of issues such as investor protection, drugs, and migration.

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DJ Peterson is a Pacific Council member and president of Longview Global Advisors.

A PDF version of this report can be downloaded at the Longview Global Advisors website.

The views and opinions expressed here are those of the author and do not necessarily reflect the official policy or position of the Pacific Council.

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