By David Skilling*
The disruptive events over the past three years – from the pandemic to the invasion of Ukraine and the structural shift of the global economy onto a wartime footing – have placed deep pressure on countries around the world.
War and other shocks illuminate the strengths and weaknesses of political systems in ways that are not apparent during normal, less turbulent conditions. Ukraine, for example, has performed remarkably under unimaginable pressure.
So at the start of the year, this note discusses how different countries have been affected by this acute stress; and how well placed they are for the economic and political regime change underway.
United States
Political polarisation in the US has weakened social cohesion and institutions, and caused decision-making gridlock. The US has been in a close race between its macro dysfunction and its micro-level innovation and dynamism.
Indeed, the US had a bad pandemic – with poor health outcomes – largely due to this political context. But over the past two years, there has been some stabilisation even if political risks remain (note this week’s chaotic House Speaker elections).
The US is now moving in a broadly bipartisan way in terms of the strategic competition with China, with big investments in industrial policy, R&D, and infrastructure to strengthen the US economy as well as a tougher military and diplomatic posture. And it has led the West’s response to Russia’s invasion of Ukraine, providing significant military and financial aid.
The US does better facing external competition than domestic challenges. Indeed, the shared purpose due to the external rivalry may moderate domestic political tensions. Whereas the pandemic exposed weaknesses, strategic competition plays to US strengths. I am becoming more structurally bullish on the US, with its financial and technological leadership positions.
However, some of these recent policies (such as the Inflation Reduction Act) interact with protectionist tendencies in the US, due to its mismanagement of international trade over the past few decades. The US will need to remain open and engaged, with strong partnerships, to compete effectively.
Europe/UK
After a characteristically slow start, the EU responded relatively well to the pandemic; high vaccination rates supported good economic and health outcomes in many countries. But the Russian invasion of Ukraine highlighted the deep complacency across much (not all) of Europe on strategic economic, political, and security exposures.
There has been an encouraging response, with European governments implementing tough sanctions on Russia and committing to invest more in areas from military capability to strategic autonomy. And this experience has reinforced a toughening stance on China (although with variation: note Germany).
However, European institutions move gradually, and Europe’s deeper integration into the global economy (compared to the US) means that decoupling comes at a high cost. Europe has a long way to go to position its economy for a wartime footing, with substantial investments and policy innovation required to build resilience and competitive strength.
In the UK, the pandemic and the economic spillovers from Russia’s invasion have put further strain on a structurally weak UK economy. The UK has under-performed its peers since the global financial crisis. Indeed, the UK had the worst economic performance of any G7 country through the pandemic – as well as poor health outcomes – and has a weak economic outlook.
These external shocks have revealed policy and political deficiencies. Without significant policy change, notably around Brexit, economic improvement is unlikely. The political chaos has reduced but the UK’s ability to make the investments required to perform in a changing global context is uncertain.
China
The pandemic has highlighted the strengths and weaknesses of China’s autocratic decision-making. The rapid lockdowns constrained the costs, but zero Covid was unsustainable. And the abrupt shift to open up, with apparently little/no preparation, will generate substantial near-term economic and health costs.
China’s highly personalised decision-making process creates real risks for China – and the world; for example, on decision-making with respect to Taiwan. Some of China’s recent rhetoric and decision-making seems to have reweighted diplomacy and economics over ideology, but this could easily change.
China’s massive market gives it options in building strategic autonomy, and influencing economies and firms to support it. But it remains deeply reliant on technology and other expertise from the US, Europe, and elsewhere.
China’s economic prospects are challenged, with a contracting working age population, weak productivity performance, and structural distortions across its economy. My assessment is that its political environment will constrain China’s ability to develop as an innovative, dynamic economy. It is not clear that China will be able to overtake the US as the world’s largest economy – particularly given the tougher strategic posture of the US and Europe.
China remains a formidable competitor, but it is a much more challenging external environment for China. For example, this week China reduced its commitment to local semiconductor firms because of the absence of results from its massive support to date.
One asset is that an enfeebled Russia is becoming a client state of China, giving China readier access to energy and other commodities. This transactional relationship will skew increasingly in China’s favour.
Middle powers
Another important group of countries are the ‘middle powers’, from India and Indonesia to Saudi Arabia and Turkey. These G20 economies (and others) are acting to carve out strategic space in a more contested global environment – not aligning with the West (on issues like Ukraine) and pursuing their national interest. They do not want to choose sides.
Many of these countries have deep domestic challenges, but are taking advantage of a more fluid global environment to restructure external networks. The rebalancing in the Middle East towards China on energy and financial flows is just one example. The shift of the global economy to a wartime footing has accelerated realignments, as countries reassess the value of existing relationships. Expect these countries to become more forceful in capturing economic value, in areas from energy and commodities to global value chains, and shaping the global system.
Small advanced economies
Small economies have performed well over the past few years despite (or more likely because of) their deep exposure to the global economy. They generated strong GDP growth as well as good health outcomes through Covid. And they are effectively navigating economic shocks from higher energy prices and changing patterns of globalisation.
Small advanced economies have a series of valuable assets: effective governments, social cohesion, strong skills and innovation capabilities, as well as an external orientation. There are not economies of scale in navigating regime change: as shown in the discussion above, large economies have no intrinsic advantage.
If anything, small advanced economies may out-perform as they position for this new environment rapidly and creatively. From Singapore’s strategic positioning, to the aggressive economic strategy revealed by Dubai this week, to the green energy initiatives pursued by small economies around the North Sea, there is an intensity of action.
Creative destruction
A wartime global economy is a time for serious countries. Significant, sustained changes in strategic policy settings will be required, from industrial and innovation policy to foreign policy and security.
This means that we should expect an accelerated process of creative destruction. Periods of pressure from disruptive change produce a broader distribution of outcomes; some countries (and firms) will perform, and others will struggle. The ongoing global stress tests may generate surprising results.
*David Skilling ((@dskilling) is director at economic advisory firm Landfall Strategy Group. The original is here. You can subscribe to receive David Skilling’s notes by email here.
**Get in touch (by reply email or at [email protected]) if you would like to access the full paper referred to in the article above.
