The Global Economy in an Era of Geopolitical Tensions and Uncertainty

October 15, 2024

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Introduction

From a rational perspective, the interconnected nature of today's global economy means that no nation is an island. Nonetheless, as geopolitical tensions escalate and economic integration faces unprecedented challenges, the global economic landscape appears increasingly brittle and uncertain. The fundamental reason for this boils down to the exacerbating distrust among nations, organizations, and peoples, manifested in rising political ethnocentrism, nationalism, and populism, making global stability susceptible to the pressures of beggar-thy-neighbor diplomacy, unpredictable economic policies, and blunt impulses over rapid technological advancements. This article explores the complexities of the global economy amidst these tense times, offering an analysis of current economic conditions, potential future scenarios, and strategic responses to mitigate risks.

Geopolitical Tensions and Economic Fragility

The rise in geopolitical tensions—be it through ideological differences, territorial conflicts, or trade disputes—has led to a more fragmented global landscape. Alarmingly, military expenditures among major countries have outpaced their economic growth rates. This fragmentation poses significant threats to global supply chains that are crucial for the smooth operation of the global economy. In response, countries have stepped up the relocation or duplication of supply chains to avoid geopolitical hot-spots and unreliable partners, a move that could lead to increased costs and reduced efficiency. International direct flights are considerably reduced as airlines suffer significant losses due to Russia's airspace restrictions. A container ship traveling round trip from Shanghai to Rotterdam now incurs an additional cost of up to one million USD by navigating via the Cape of Good Hope as the Red Sea is under frequent attack, which has also caused a drain on Egypt's coffer, heavily reliant on the income from the Suez Canal.

The current geopolitical climate suggests a shift toward economic nationalism and reduced globalization. Countries prioritize domestic industries and manufacturing to decrease dependency on volatile global markets. New laws with protectionist components, such as the US 2021 Bipartisan Infrastructure Law, the 2022 CHIPS and Science Act, and the 2022 Inflation Reduction Act, are designed to lure and push companies to reinvent their supply chain strategies. Onshoring, reshoring, and nearshoring have become buzzwords in executive meetings. Walmart pledged in 2021 to spend an additional 350 billion USD through 2030 on items made, grown, or assembled in the US.

Even worse, tariffs and other policy instruments are being politicized in favor of allies and weaponized to target geopolitical adversaries. In response, Chinese companies are incentivized to invest in developing countries to circumvent US punitive tariffs. To avoid the countervailing duties on Chinese e-vehicles, some Chinese automakers may reconsider investing in EU countries. As the EU Cross Border Adjustment Mechanism (CBAM) is ready to be implemented, a host of exports, especially from developing countries, will incur extra costs due to their carbon footprints. Ironically, the Global North's pledge to offer 100 billion USD to assist green transitions in the Global South has never been fulfilled.

The resilience of global supply chains is under scrutiny as countries reassess their economic strategies in response to increased risks from ideological and geopolitical tensions. Trade disputes are a primary driver of current economic uncertainty. These disputes often lead to tariffs and trade barriers, impacting global markets and economic stability. For instance, the US-China trade war has had wide-reaching effects on the global supply of electronics and agricultural products, influencing everything from production costs to consumer prices.

Since the World Trade Organization (WTO) as a multilateral trade platform is drydocked in an impasse, despite cries for reform, countries have resorted to regional trade agreements as buffers against global disruptions. However, in the absence of a dispute settlement mechanism comparable to the WTO appellate body, compliance with these agreements hinges on the cooperation of the parties involved. Companies are diversifying their supply sources, shifting from a focus on efficiency to security—from the traditional "low cost" to the refreshed "best cost" strategy.

Under the ostentatious pretext of shifting from free trade to fair trade, these maneuvers serve to distort the proper functioning of market mechanisms, worsen the trade conditions for developing countries, fracture supply chains realized over decades of globalization, and slow trade growth, forcing a reevaluation of economic partnerships.

The global economy is navigating through a tumultuous period marked by geopolitical tensions and economic uncertainties. By understanding the intricate interconnections and potential risks, nations and businesses can devise strategies to navigate this complex landscape effectively. Building resilient supply chains, regulating emerging technologies, and fostering international cooperation are pivotal in shaping a stable and prosperous global economic future.

The Real Economy Versus High Finance

Financial markets often react more to investor sentiment, speculative activities, and future expectations than the state of the real economy. For instance, stock prices can rise despite high unemployment rates if investors believe future profits will remain strong or if monetary policies favor investment returns. Over the past two decades, there has been a trend toward financialization, which refers to the increasing dominance of financial actors, motives, institutions, and markets in the economy. This shift has diverted focus from real economy to Wall Street, sidestepping traditional economic activities like production and trade. When priority is placed on short-term gains and speculative profits for the sake of artificial prosperity over long-term economic stability and growth, a disconnect grows between the real economy—the production and delivery of actual goods and services—and speculative high finance, characterized by stock markets and a dazzling array of financial products.

Financial markets exert a significant influence on economic policy. Governments and central banks often adjust interest rates or provide bailouts for financial institutions to appease stock markets and investors, with the belief that strong financial markets equate to a healthy economy. This approach can neglect the real economy, driving capital to flow into financial products rather than sectors that contribute most to real economic growth and societal needs, such as job creation, wage growth, infrastructure investment, public health, and education that yield long-term benefits to people's livelihood. As a result, the economy becomes more susceptible to financial crises, as seen in the 2008 global financial crisis, where the collapse of financial markets had severe repercussions for the real economy worldwide, leading to recessions, job losses, and decreased public spending on essential services. When investors harvest windfall gains with speculative capital, workers and consumers see fewer benefits from economic growth.

The discussion around the real economy versus high finance is integral in shaping policies that truly reflect and support broader economic well-being, rather than just the financial sectors. This alignment is crucial for achieving sustainable growth and equitable economic development.

The Specter of an AI Bubble

Investors are rushing to the shore in artificial intelligence (AI) lest they miss a big win amid the revolutionary changes, which are expected to influence industrial operations and consumption patterns. Capital is piling up for companies working on AI, machine learning, and related technologies, hoping to get ahead during this major technological shift. However, it must be cautioned that AI technology is often subject to hype, with media and industry leaders sometimes portraying it as a panacea to a wide array of problems. This can lead to unrealistic expectations about what AI can achieve, at least in the short run before investment patience is worn out.

While the influx of funds and interest can accelerate AI research and development, it can also lead to a misallocation of resources, with too much capital going into less viable projects while potentially more impactful innovations are overlooked. In addition to the technological challenges and fierce competition that will wash out a large number of players, the monetization of AI technologies remains uncertain, and ethical debate and regulatory discrepancies loom large, creating challenges for investors and policymakers. With so much capital chasing a limited number of opportunities, valuations of AI companies may reach unsustainable levels, creating a bubble-like scenario where prices are driven by speculation rather than economic value. Cases of fraud have time and again popped up as a result of venture capital and government subsidy.

One thing is certain, as in any major technological advancement, the divide between rich and poor countries, between open and isolated societies will be further widened. While the application of AI may proliferate around the world, the rule setting will be centralized in the hands of the few. It is worth ringing the alarm that, unlike the previous industrial revolutions that freed people from their manual toil, this round of AI revolution, if poorly governed, shall be leveraged to penetrate people's mind frames that are exposed to manipulation by a handful of oligarchs and hegemons.

Like other bubbles, if the growth in investment and valuations is not supported by corresponding advancements and practical implementations that generate expected earnings from the market, there could be a risk of a market correction. This would affect not only individual companies but potentially the broader technology sector. Should this bubble burst, it could lead to significant economic fallout which will not only impact economies heavily invested in this technology, but the entire world, who will pay the price as the fallout morphs into a global financial contagion.

Understanding and identifying an AI bubble requires careful analysis of investment trends, technological advancements, market valuations, and the broader economic landscape. It's important for investors and stakeholders to critically assess the capabilities and limitations of AI technologies and to align their expectations and strategies accordingly. Robust regulatory frameworks are needed to mitigate risks associated with AI development and deployment, ensuring ethical guidelines and preventing monopolistic behaviors while fostering a healthy AI ecosystem that contributes to economic growth without exacerbating inequalities.

Future Outlook and Proposed Solutions

The global economic outlook remains uncertain, but strategic policies and cooperative international relations could help stabilize the global market. To shape resilient and sustainable supply chains, the function of market mechanism needs to be re-envisioned within a global landscape where the division of labor, based on comparative advantages, contributes to a prospect of shared prosperity through open-minded cooperation. For this common goal, trust needs to be rebuilt around the overarching theme of peace and development. Cognitive biases have to be eliminated among national and corporate leaders who remain fetish about a zero-sum game where temporary military or technological prowess brings unfair gains. Instead of engulfing sovereign territories or controlling other regimes by might, nations can secure their futures through international cooperation and fair competition. True national security can only be enhanced by national strength via fair play on the global stage.

No moment in history has required more responsible leadership and stewardship apace with the times than today. Since many have expressed discontent with the existing global order, new international institutions and agreements resting on equitable grounds must be established to manage economic policies and resolve disputes effectively. Investment needs to be directed toward green technologies, public health, and education to foster long-term financial integrity and economic resilience. Any technological breakthrough is a double-edged sword, and AI is no exception. This breakthrough must be kept in the hands of people, and cater to the needs of human advancement. How AI can be adapted to enlighten people around the world and to prepare workforces for future economic conditions is a daunting task for investors, leaders, and academics to engage multiple stakeholders to work on in a transparent, accountable, and sustainable manner.

 

 

Please note: The above contents only represent the views of the author, and do not necessarily represent the views or positions of Taihe Institute.

 

This article is from the September issue of TI Observer (TIO), which explores the current turbulence in the global economy, analyzing the effects of geopolitical tensions, supply chain fragmentation, development of financialization, hollowing out of the real economy, in order to shed light on future economic transformations. If you are interested in knowing more about the August issue, please click here:

http://en.taiheinstitute.org/UpLoadFile/files/2024/9/30/1810401645ddb395e-0.pdf

 

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