End of Empire – 1: World of divides and why India may adapt to a more closed economy better

The combination of stresses identified in this column have set up feedback loops which will reshape the current economic and power relationships.
PM Narendra Modi seen with US President Biden and Canadian PM Trudeau at the G-7 summit. Modi might have more reasons to laugh than Biden or Trudeau in a closed economy. (AFP)
PM Narendra Modi seen with US President Biden and Canadian PM Trudeau at the G-7 summit. Modi might have more reasons to laugh than Biden or Trudeau in a closed economy. (AFP)

This three-part piece examines the re-arrangement of global economic and power structures underway. This part examines the current great geopolitical divisions. The second part can be read here and the third part here.

Points of Difference

"There are decades where nothing happens, and there are weeks where decades happen". Lenin’s phrase – there are doubts as to the attribution - describes periods when established economic, power and social relationships are challenged and sometimes overturned, often violently. The question is whether this is one of those times.

Today, there is a sharp division between the 'West' -- the USA and its Anglosphere acolytes (Canada, Australia, New Zealand) supported unenthusiastically by Europe and Japan --- and the rest of the world. Positions on the Ukraine conflict highlight the schism. Support for Ukraine is primarily Western, representing less than 20 per cent of global population. The vast majority of nations have refused to condemn Russia's actions or profess neutrality on the matter. China professes cautious support of Russian grievances.

While couched in bromides about shared values and unity, European and Japanese support of the Anglosphere is self-serving. Both have benefitted from American military protection and lower defence spending which has been diverted to more productive activities. It reflects the reality of geographic proximity to Russia and China as well as greater economic connections.

The non-Western position reflects caution about great power conflicts, economic factors, often complicated colonial pasts and experience of Western hypocrisy and self-interest. There are legitimate questions about the support for Ukraine, especially the provision of generous financial and humanitarian aid. The favoured treatment of white, Christian refugees relative to victims of conflicts and disasters in the Middle East, Asia and Africa has not gone unnoticed.

This division threatens the current global order overseen by America.

A Sea of Troubles

The avoidable Ukraine conflict, with its unnecessary destruction and human suffering on all sides, is only a catalyst. Whatever the length, dimensions and outcome of the proxy war between the US and Russia, the West's response -- trade restrictions, sanctions and asset seizures -- will outlive the military actions and prove highly damaging.

The 'weaponization' of trade and finance, a modernisation of gunboat diplomacy, has a long lineage. Sanctions and blockades were used in World War 1 and influenced Japan's entry into World War 2. Since 1979, the US has sought to isolate the Islamic Republic of Iran after the Shah, installed by an American coup d’état,was overthrown by a popular revolution. Measures against Russia actually commenced in 2014. The US has imposed progressively more stringent restrictions on China since 2017 to preserve its economic hegemony.

In the short term, the measures have affected Covid-19-disrupted supply chains, aggravating shortages and price inflation, especially in food, energy and raw materials. In the longer term, the interaction with other stresses may prove more significant.

The effects of climate change-driven extreme weather -- droughts, floods, storms, wildfires -- on food production and transportation links are accelerating. Resource scarcity -- water, food, raw materials especially fossil fuels -- is simultaneously rising due to natural limits.

Alongside disruptions to food production, major producers are increasingly stockpiling or banning foreign sales to ensure domestic supply and control local costs. As of mid-2022, 34 countries had imposed restrictive export measures on food and fertilizers contributing to price surges of key staples.

Energy shortages are not purely the result of sanctions on Russian oil and gas exports. They reflect under-investment in traditional sources due to Environment Sustainability Governance investors withholding funding from these industries. The energy transition is likely to be slow due to the challenges of building capacity, reconfiguring electricity systems and converting industry and heavy transportation to non-fossil fuels. Shortages of critical metals and minerals, many of which are non-recyclable, will retard progress.

Given the West's high energy needs, availability and cost will remain a major issue. Progress on controlling climate change will simultaneously stall with reversion to higher CO2 emission fuels to lower energy prices and the cost of living compounding the underlying problem.

The reversal of globalisation, which previously drove global growth, is another factor. Despite its benefits, greater economic integration had drawbacks. It reduced national sovereignty. Benefits and costs were not shared equally. It was financed by large financial imbalances (China-US and intra-Europe). The post-2008 Great Recession beggar-thy-neighbour monetary, fiscal and currency policies of advanced economies were destabilising. In parallel, successive events -- the 2011 Thai floods, the Tohoku earthquake and tsunami that caused the Fukushima nuclear plant disaster, multiple episodes of extreme weather and finally the Covid-19 pandemic -- illustrated the fragility of just-in-time production and tightly coupled global supply chains.

Changes in the electoral dynamic reinforced the shift. Financial crises, economic stagnation, shortages, war and pestilence have created a persistent atmosphere of anxiety and fear. Politicians have rushed to exploit the instability. Lacking tractable solutions, they parade nationalist credentials and strong leadership, targeting elites (Davos Man), foreigners and immigrants. The Ukraine conflict is merely the latest chapter in this history.

While these pressures are unlikely to abate, complete deglobalisation and a retreat to autarky are unlikely due to intricate connections and more importantly the effects on availability and cost of products. Instead, increased re-, near- or friend-shoring may separate the world into trading blocs reinforcing divisions.

The combination of the identified stresses has set up feedback loops which will reshape the current economic and power relationships.

Winners and Losers

All nations are affected by these changes but not equally. A drift to more closed economies may not favour the West.

Functioning as an isolated entity or bloc requires a sizeable population, resources (food; water; energy; raw materials) self-sufficiency, necessary technologies and skills and the ability to defend your interests. Alternatively, you must be able to access these elements from within your trading bloc or from partners.

One reason that trade restrictions and sanctions have had less effect to date than expected is that Russia possesses many of these characteristics. In addition, absence of universal compliance reduces the effectiveness of these measures. Non-West countries, such as China and India, benefit from sanctions, being able to purchase oil and gas at significant discounts. Attempts at enforcement, such as a proposed oil price cap, may not be successful without excluding violators from global payments, insurance or sanctions which would widen the divisions substantially.

China lacks self-sufficiency, especially in food and raw materials, such as iron ore and energy, which they have tried to creatively overcome through strategic overseas investments, the Brick and Roads Initiative and leasing farmland. Interestingly, Russia can supply a significant part of the Middle Kingdom's food, energy and mineral needs although this would require some reconfiguration of infrastructure.

Countries like Russia, China and India are not fully integrated into the global market system and had been relatively isolated until the 1990s. Their essential structures are capable of adapting to a more closed economy. In recent years, China and India have increasingly redirected policies and investments towards their home markets, abandoning reflexive globalism. The objective is to attain the greatest possible independence in or control over strategic sectors and essential products.

The West is more reliant on global commerce, although individual positions differ.

The US is substantially self-sufficient in food and energy. However, it has outsourced large components of its manufacturing and would have to re-skill its workforce to re-shore activities. It also requires export markets for its advanced products -- 40 per cent of S&P 500 companies’ revenue originates outside the US.

Canada, the UK, Australia and New Zealand enjoy varying degrees of food and resource self-sufficiency. Canada, Australia and New Zealand are major exporters of food or raw materials. The UK is a significant exporter of services. All are dependent on imports of manufactured goods.

Europe and Japan are oriented to manufacturing but reliant on imported raw materials, especially energy. Japan also has a growing reliance on imported foodstuffs. They are large exporters, with significant reliance like the Anglosphere on the Chinese market.

The West is disadvantaged by high-cost structures, which have been offset in recent decades by imported cheap labour and raw materials. Europe, especially Germany, has tied its economic fortunes to the availability of low-cost Russian gas. If forward prices prove correct, then Europe’s gas and electricity costs would reach nearly €2 trillion (equivalent to around 15 per cent of GDP). The high operating leverage to cheap energy cost in the case of Germany equates to around $2 trillion of value-added production from $20 billion of imported Russian gas.

Changes in the existing global economic structure threaten Western living standards. The disruption of global trade and mobility during the Covid-19 pandemic and resulting shortages provided a window into these susceptibilities.

Satyajit Das is a former banker and author of numerous works on derivatives and several general titles: Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives (2006 and 2010), Extreme Money: The Masters of the Universe and the Cult of Risk (2011), A Banquet of Consequences RELOADED (2021) and Fortune’s Fool: Australia’s Choices (2022). His columns have appeared in the Financial Times, Bloomberg, WSJ Marketwatch, The Guardian. The Independent, Nikkei Asia, and other publications.

This is part of the web-only series of columns on newindianexpress.com.

© 2022 Satyajit Das All Rights Reserved

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