In the year ahead, we're likely to see companies increasingly prepare to protect themselves from concentration risk and the fallout from potential stress points like a war.
As 2023 gets underway, the continued evolution of multiple power centers will further dominate the geopolitical landscape as countries increasingly seek to maximize their self-interests. These events largely pre-date COVID-19. However, the pandemic and the Russia-Ukraine war have exacerbated this trend.
In addition, several unique themes could affect the risk environment in the year ahead, including challenges to Western-led security systems, alternative financial systems, revamped supply chains and shifts in industrial policy.
In the year ahead, we're likely to 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.
Here are four geopolitical risks to watch in 2023:
1) Challenges to Western-led Security Systems
The North Atlantic Treaty Organization (NATO) was—and remains—a military alliance of mainly the U.S. and Western European powers. For many other nations though, this new order simply felt like a new form of colonialism. During the Cold War, many nations responded by creating the Non-Aligned Movement (NAM), a collective of nations that shunned the idea of alliances. This included China, India and large sections of Africa and Latin America.
While the concept and functioning of NAM is less relevant today, the sentiment persists. Namely, a view that the Western-created and led security framework impinges on the interests of certain nations. These nations are now more economically relevant, enabling them to contest this framework.
For example, India and China have ramped up their defense budgets in tandem with their economic growth, which can provide them with the direct ability to project power. However, beyond traditional kinetic power, both are utilizing their growing economic heft to direct foreign policy toward their interest. For example, while India has voiced its concerns with the U.S.-led security framework of NATO, it has concurrently forged a strategic partnership with the U.S. At the same time, India has ties with the Russian army and buys their military equipment.
In 2023, it is anticipated that India, and others like Saudi Arabia, Turkey, Russia and, to a lesser extent, the United Arab Emirates, may challenge the existing global world order. At a minimum, these nations do not want Western power to curtail their own goals and interests.
Concurrently, many like India will still seek greater cooperation with the West on the defense and economic front to further their interests. They will utilize their economic and tangible military strengths as they seek a greater role in global affairs. While traditional alliances will remain, the world is becoming fractured and multi-polar, and this could cause some alliances to shift giving rise to complex partnerships.
2) The Rise of Alternative Financial Systems
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 such as the International Money Fund (IMF) and World Bank. Through both entities, the U.S. and Western Europe were able to direct money toward 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.
The U.S. was able to leverage its dominance over these systems by restricting Russia's access after it invaded Ukraine, hindering its 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.
Rising powers that resented the idea of being dependent on Western-created and managed financial systems are now able to build their own systems. 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 and could accelerate further in 2023.
3) Supply Chain Reshuffle
The flow of commodities trade has already started to shift, leading to foreign policy adjustments. As partnerships have realigned and a multi-polar world has developed, it is anticipated that the movement of goods and services will continue to reorient.
For example, Egypt used to buy nearly 80% of its wheat from Russia and Ukraine, according to Reuters. Following the war, wheat production was heavily disrupted, leading to potential food shortfalls and inflation. If history is any indication, Egypt will be sure to pivot for future wheat purchases as it did during the Arab Spring, a series of anti-government protest that was largely driven by high food prices, when it quickly began to procure wheat from India, a market it barely tapped for agricultural products in the past.
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, increased technology products could start to be traded between India and developed markets, resulting in new trading partnerships. It is anticipated that these changes to the geographic orientation of globalization will continue in 2023.
4) Shift in Industrial Policy
A fractured world order could also give rise to potential interstate conflict. There are significant costs involved for businesses when their operations are concentrated in regions that could be affected.
For example, 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 is concentrated mainly in China. The pandemic created disruptions to semiconductor availability that showcased the economic impact of concentration risk.
Countries will also take a protectionist tack to capitalize on the potential gains of their growth industries. 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. A key commodity to watch is lithium, which is a crucial ingredient in rechargeable batteries for mobile phones, laptops and electric vehicles.
Shailesh Kumar is head of The Hartford's Global Specialty Insights Center. He is an economist with deep expertise in economic, credit and geopolitical matters. He was formerly with the U.S. Department of the Treasury.
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