The world has entered a geopolitical recession – a prolonged erosion of international cooperation. In addition, the global economy is being reshaped by climate, demographics, and artificial intelligence, which brings both economic opportunities and new geopolitical risks.
  |   Econs

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‘It is very difficult to predict anything, especially the future’ – an aphorism most often attributed to the Danish theoretical physicist Niels Bohr. ‘Predicting the future is indeed difficult, but we shall try,’ said Alexei Zabotkin, Deputy Governor of the Bank of Russia and moderator of the session of the Bank of Russia’s Financial Congress devoted to the global economy, to the participants.

The two main factors currently shaping the diverging forecast scenarios for both the global economy and the economies of individual countries are geopolitics and artificial intelligence. While geopolitical upheavals are viewed as a negative factor, the development of AI technologies is often associated with great hopes. Zabotkin proposed discussing the impact of these and other key factors on the economy. Econs provides excerpts from the discussion.

The Cyclical Nature of Geopolitics

Vuk Jeremić, President of the Centre for International Relations and Sustainable Development, Visiting Professor at Sciences Po, the Paris School of International Relations, former Minister for Foreign Affairs of Serbia and former President of the UN General Assembly:

– By analogy with economic cycles – periods of economic boom and bust – there are geopolitical cycles. These are long periods characterised either by cooperation and trust between the major powers, or by confrontation.

Currently, the world is in a phase of geopolitical recession. Its characteristics include: a decline in cooperation and trust between the major players (the US, China, Europe, and Russia); more frequent extreme events (conflicts, sanctions); and a ‘stagnation’ within international organisations. In global governance, the old rules cease to work, and the new ones have not yet been formed.

In economics, recessions are usually short-term GDP declines followed by recovery, and the transition from one phase of the economic cycle to another can be predicted. In geopolitics, a recession is a prolonged erosion of order that lasts for decades. It is much harder to emerge from this than from an economic downturn, and it is impossible to predict when it will happen.

During an economic recession, the main thing is to prevent an economic depression. In geopolitics, the transition from recession to depression would mean nothing less than war: ‘I very much hope that a geopolitical depression can be avoided.’

AI could become a factor that exacerbates the geopolitical recession. In response to the question of whether AI could become the ‘nuclear weapon’ of the 21st century: AI could be used for cyberattacks, disinformation, or the synthesis of biological toxins. Unlike nuclear weapons, ‘AI proliferation’ cannot be controlled.

Emerging from the geopolitical recession will require immense political will and further institutional changes. Perhaps, as in the situation with the Cuban Missile Crisis of 1962, only proximity to catastrophe will force the leaders – the US and China – to sit at the negotiating table. For Russia and Europe, the main risk is the prolongation of the conflict, which could escalate into a ‘geopolitical depression’: ‘I am a European. I grew up in Serbia, teach in Paris, and often visit Russia, which I love very much. What really keeps me awake at night is what is happening now between Russia and Europe.’

All this does not mean that the planning horizon is zero. Planning is necessary and possible. It must be multi-scenario – with probabilities assigned to different scenarios – as well as flexible and adaptable – plans must be reviewed as circumstances change. An example is China, which uses five-year plans but allows for adjustments every year. A counterexample is the US, whose policy has become so unpredictable that it is forcing businesses to shorten their planning horizons to a few days.

Ksenia Yudaeva, Executive Director for Russia at the IMF:

– There are four main drivers that will shape the state of the global economy in the medium term:

  • Geo-economic fragmentation – unlike ad hoc conflicts (such as that in the Strait of Hormuz), this trend is long-term in nature.
  • Climate change – this issue is sometimes underestimated in Russia, but climate shocks are able to destroy a country’s macroeconomic stability in one season. Example: a country that, two years ago, was regarded as a model of sound fiscal policy, with falling debt and high growth rates, has become a country with unsustainable debt in need of restructuring, facing major problems with economic growth – all it took was a single hurricane.
  • Demographic trend – the aging of the workforce and the changes to its structure are exerting direct pressure on public finance and potential growth.
  • Artificial intelligence – unlike the previous trends, this is the only one whose impact may be positive. However, the question remains whether AI can outweigh the negative impact of the other three trends.

A paradoxical situation is emerging with real interest rates. Usually, slowdowns in economic growth should lead to lower rates, but the opposite is happening now. The reason is a sharp increase in investments in several areas:

  • AI requires colossal investments in data centres and the energy sector. Unlike the internet boom of the 2000s, technology companies are now among the leading investors.
  • Geo-economic fragmentation is forcing countries to replicate previously global systems (such as navigation, social media, and payment infrastructures) within their own bounds or within blocs.
  • Climate change requires investment both in disaster prevention and in the reconstruction of damaged infrastructure.
  • Uncertainty is also pushing up interest rates, as investors are factoring in higher risk premiums.

The cost of geo-economic fragmentation is always economic losses. Brexit is a vivid example. Immediately after the 2016 referendum, the predictions of catastrophic consequences proved unfounded: the pound fell, but the volatility quickly subsided, and economic growth actually accelerated. However, ten years later, the UK’s GDP is 8% lower than it could have been without Brexit. This illustrates that the economic losses from isolation manifest with a delay, but they are quite significant.

Unprecedented Uncertainty as the New Norm

Rami Abulnaga, Deputy Governor of the Central Bank of Egypt:

– The current level of uncertainty is unprecedented. The traditional forecasting models relied upon by central banks have become practically useless because:

  • it is impossible to interpret the dynamics of events with the usual logic;
  • risks are shifting from being ‘rare’ to ‘constantly present’;
  • even extreme scenarios with low probabilities require immediate consideration.

For central banks, this means having to be very creative and constantly assuming that any risk may materialise at any moment.

The consequences of the crisis in the Strait of Hormuz – rising energy prices – are just the tip of the iceberg. It has revealed a new reality for exporters: while it was previously thought that a surge in commodity prices was to their advantage, it has now become apparent that, even if an exporter has the goods, they may be physically unable to export or insure them. Firms and states now need to consider not only the price but also the physical possibility of delivery, adding new variables to the equations.

Sergey Ulatov, Chief Economist of the Eurasian Fund for Stabilisation and Development:

– Representatives of stabilisation funds suffer from a ‘professional bias’: they initially assess any new shock as catastrophic and are then surprised that countries manage to cope with it. Three years ago, geo-economic fragmentation was named the main threat, a year later, it was stablecoins, another year later, it was the climate crisis, and this year, it is the energy crisis and the situation in the Middle East. Each time, analysts predicted a strong negative effect. And economies showed ‘remarkable resilience’ – surprising resilience.

The main reason for this resilience is the flexibility of the private sector, which is able to rapidly restructure supply chains, adjust the structure of value added, and find new resources even in the face of uncertainty.

Alexander Isakov, Senior Managing Director and Head of Sber’s Centre for Macroeconomic Research:

– Over the past 20 years, economists have become accustomed to the idea that all shocks are typically demand shocks. And, for example, weak business activity has led to a fall in inflation. However, the last five years have been dominated by supply shocks, and weak business activity has been accompanied by rising prices. This means that the economy is close to its production capacity limit, and any new shock should, by default, be interpreted as a supply shock until proven otherwise.

The second important change is that the old quantitative rules no longer apply. For example, previously, budget analysts needed to know only the price of oil and the ruble-to-dollar exchange rate, while all other parameters (volumes of oil production, the ratio between domestic consumption and exports, the price ratios for different types of petroleum products and gas, etc.) remained constant for years. Now, all variables change so quickly that rigid rules become useless. This applies not only to the budget but also to many sectors of the real economy.

The ‘remarkable resilience’ of economies to shocks is a consequence of companies and states being forced to create backup systems, and while this process is ongoing, it creates growth inertia. This is short-term growth. The key to genuine sustainable growth lies in increasing labour productivity, redistributing resources more efficiently, and developing technology.