Think geopolitics doesn’t impact the economy? Think again.

08-OCT-2022

High school students in the year 2052 will likely have an entire chapter in their Social Studies curriculum about the events in the year 2022 – the year that the global political order was re-written and events started to spiral into situations unthinkable in the late 20th century.

Of course the geopolitical events we are watching unfold at the moment – the Russian invasion of Ukraine, the posturing of China around Taiwan, the revolution in Iran, Saudi Arabia’s cozying up to Russia – had their origins long before 2022. But this is the year that many of these events are starting to have major consequences.

Yet it would be a mistake to think that the impacts of these events will be confined to politics. The impacts are also economic. There are three primary ways in which the geo-political events of 2022 will nudge the global economy closer to what seems like an inevitable recession in 2023.

The first is simply the negative effects that war – and indeed even threats of war – have on consumer sentiment. Developed economies in North America and the EU are heavily driven by consumers. And with the 24-hour news cycle bombarding us with dire reports from Ukraine, China, Iran, etc., it weighs on the enthusiasm to spend. Coupled with inflation, rising interest rates and slumping stock markets, consumer optimism is being beat down even lower with every geopolitical news update.

The second impact is on trade disruption. The global economy of the second half of the 20th century was built largely on vastly expanded trade. From the origins of the GATT after World War II (which became the World Trade Organization), to the creation of major trading agreements such as NAFTA, the EU and the Comprehensive and Progressive Agreement for Trans-Pacific Partnership, our global economy is based on trade.

But who’s talking about trade deals today? Almost no one. It’s hard enough to get a G8 nation (Russia) to play nicely in the sandbox, never mind come together as nations to cooperate on trade deals. Global trade is certainly not over, but it may be diminishing as the 21st century looks to be more about conflict than cooperation. And that will cost every trading country through lost export markets, higher import costs and less efficient production.

The third way that geopolitical conflict will erode the economy is through displaced public spending: more tax dollars spent on tanks, missiles and aircraft carriers, and less spent on more productive things like education, transportation infrastructure and medical research. NATO members are expected to pay 2% of their GDP on their military. Hardly any member country meets that expectation. But if geopolitics worsen over the coming years, members will have no choice but to increase military spending. In Canada, for example, the Parliamentary Budget Office estimates Ottawa would have to spend an additional $75 billion by the year 2027 to meet NATO requirements. That’s relative to a total budget of around $400 billion, so it is a considerable increase in public spending. That would have to be financed either through higher taxes, reduced spending elsewhere, or additional public debt.

Worsening consumer sentiment, disruptions to global trade, and higher public spending on the military are all likely if global geopolitical developments continue on the path set in 2022. There’s no certainty, however, that this will be the case. We don’t know Putin’s next move, or that of Xi Jinping either. Things may calm down and reasonable actions carry the day.

But is anyone taking that bet? Companies, industries, countries and even individuals need to prepare for what could be prolonged geopolitical conflict and the economic disruption they will bring. The second blog in this series will outline some practical actions that can be taken to mitigate these economic threats.