A turning tide

As we look to this weekend’s G20 meetings in Argentina (with low expectations), it is increasingly clear that the international order is fragmenting.  There is growing strategic competition between the US and China: evident in the US/China tariffs, the failure to agree a communique at the APEC meetings, as well as ongoing geopolitical rivalry.  Singapore Prime Minister Lee warned recently of the risk that countries in ASEAN may be forced to choose between the US and China, exactly the binary choice that countries in the region have been seeking to avoid.  And this international fragmentation can be seen in many other domains: the contested vote for the chair of Interpol, Russian provocation, as well as discussions about possible alternatives to the USD.

Around the world, economic institutions and norms are weakening under stress from structural changes in big power relativities and domestic political preferences.  These institutional dynamics are the backstory to the daily melodrama of trade wars, and will increasingly shape the behaviour and performance of the global economy. 

Many of the institutions established over the past several decades have contributed to growth and globalisation.  But institutions are context-specific, being established to respond to particular priorities: such as the need to support an open trading system (WTO), international economic policy coordination (G7, G20), regional economic integration (EU), as well as domestic policy institutions such as central bank independence and fiscal rules. 

To work, economic institutions need to reflect an underlying intellectual or policy consensus, a political and social consensus, as well as to be consistent with the international balance of power.  Post-war institutions that promoted a relatively open, rules-based system were supported by US hegemony, an intellectual consensus on the benefits of openness, and a view that establishing these institutional constraints on national decision-making was a satisfactory trade-off for securing better outcomes.

But things can change quickly when this underlying consensus weakens or reverses.  The growing big power rivalry between the US and China threatens the open, liberal international system. And pressures from globalisation and technology on labour markets have eroded support for regional integration and other domestic policy institutions.  The existing institutions are increasingly inconsistent with the preferences of big powers and electorates in many countries.  There is a growing demand to ‘take back control’.

From the WTO to the G20, institutions that worked satisfactorily during over the past few decades are struggling to function in a different environment.  Globalisation will continue, but we are moving into a more fragmented, multi-polar world and with a much heavier degree of political influence.  Economic instruments are increasingly being weaponised to advance strategic interests, notably by China and the US. 

This international fragmentation will create economic costs, as strategic political dynamics shape trade and investment flows.  This is particularly clear in the technology sector, where barriers to market access and to investment are being imposed.  This week, New Zealand was the latest country to ban Huawei from participating in the 5G roll-out on security concerns.

These institutional pressures are also evident within countries and regions, from debates on the balance of national sovereignty against regional integration (from the ongoing Brexit process, where realities are being confronted, to the small country-led Hanseatic League in Europe to develop new views on EU reform).  And there are pressures on central bank independence, in the US and elsewhere.

In addition to the array of specific risks that cloud the economic outlook, these dynamics create a pervasive general uncertainty as existing institutional arrangements are adjusted or abandoned – and new arrangements are built.  These are structural forces, not just temporary noise, and will be a central theme in the global economy over the coming years.  These stresses are not easily resolved. 

Although it is not one-way traffic (note last week’s Swiss referendum that rejected a proposition to allow Swiss law to override international treaties), and inertia can be a powerful force, changes in the political environment create an unusually uncertain and fluid situation. From the Eurozone, the rules guiding international trade and investment, and global exchange rate arrangements, to macro policy institutions and the regulation of the digital economy, significant change is possible.  Events regarded as tail risks may be moving closer to the centre of the probability distribution.

A transition to new institutional arrangements is likely to involve substantial economic disruption, as was the case from the 1970s as institutions adapted to new realities: the collapse of the Bretton Woods exchange rate arrangements, the establishment of OPEC, and the need for new economic policy approaches.  For much of the developed world, the 1970s was a period of sluggish growth and economic volatility.  An unwinding of existing institutions could cause similar disruption for a period.

I don’t yet see anything too alarming in the global economic outlook.  Economic activity is moderating, but my bellwether group of small advanced economies are demonstrating a measure of resilience. However, changes to the rules of the game would generate a fundamental shock to the global economy: governments, firms, and investors should be building resilience against this uncertainty.  And creative thinking will be needed to craft new institutions and policies that fit this new context.  Small countries, deeply exposed to these uncertainties, are in the vanguard of this process.

The past century of history shows that we should not over-estimate the permanence of economic institutions.  Institutions are constructed, not states of nature, and only last as long as they remain consistent with the surrounding environment.  As economist Herb Stein once said, ‘If something can’t go on forever, it won’t’.  Good advice.

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Dr David Skilling

Director, Landfall Strategy Group



David Skilling