The rise in attention given to geopolitics by leaders in the world’s most advanced economies is directly correlated with the breakdown of a world order that, for decades, provided a relatively stable economic environment. In this environment, both politicians and business leaders could depend on a set of rules that helped govern state and business interactions.
Politically, we have moved from a bipolar world in the 1980s, split between the US-led West and the Soviet-led East (when China was still on the global sidelines) into the US-led hegemonic period of the 1990s. That US-dominated world has evolved into what today can only be classified as a multipolar world, with major poles including the US, China, Europe, Russia, and India.
This fragmented world order has resulted in competing interests for dominance both politically and economically. Politically, the stability of historical alliances is being tested. Whereas, in the past, blocs tended to stick together regardless of the topic, now they are oftentimes reconfigured issue by issue, thus promoting greater volatility. At the heart of this restructuring is the uncompromising rise of national self-interest at the expense of bloc or alliance interest, thus making those groupings much more fragile.
As a result, the economic rules of the game set up by international (though Westerndominated) institutions in the 1980s and 1990s are under fundamental threat. The irony is that their demise is being pushed by some of the very players who were their architects. The principles of neoliberal economics and market fundamentalism, the foundations of what was called the Washington Consensus, are all but dead. While free markets may have never truly existed in the
purest sense, the current environment has seen the rise of activist industrial policies in the West as we have not seen in decades.
In doing so, though, they pushed the balance of payments equation from the level of the nation-state to the level of the firm.
While geopolitical risks lead to lower investment levels and, by extension, reduced innovation and stock market returns, volatility always creates winners and losers, both at the nation-state and firm levels. Whereas, in March, Mexico and Canada were the target of tariff threats, and governments and firms alike were scrambling to react, by April those tariff threats paled in comparison to those faced by other countries. All of a sudden, Canada and Mexico were in a “relatively” privileged position. As such, what is more important? That I get the tariff eliminated, or that it is less than that imposed on my competing neighbor? Assuming there is some degree of inelasticity in demand, relativity becomes the name of the game.
Likewise, if positioned correctly, volatility creates the opportunity for firms to benefit. In the 2010s, Argentina, a country identified as the poster child of turbulence, introduced a policy that required firms to balance the foreign currency required for their imports with an equal value of exports. The aim was to eliminate any strain on the country’s dwindling monetary reserves. In doing so, though, they pushed the balance of payments equation from the level of the nation-state to the level of the firm. Given that importers are rarely also exporters, a secondary market developed for “export bills.” These bills allowed importers to access the hard currency reserves needed to finance their imports. Nothing comes for free, though, so the going rate settled at roughly 5% face value of the bill. While this was an amount that auto and technology importers could afford to pay as they could pass it on to a captive market, the impact on the selling firms, or exporters, was much more significant. The largest exporters from Argentina traded in global commodity markets where margins would hover around 1-2%. Overnight, these firms were able to reap profits of 6-7%, and over the four years of the policy, they accumulated between 14 and 24 years of profits.
Not all firms took advantage of this opportunity presented by the Argentine government. Some sat on the sidelines, thinking that there was something “fishy” or illegal in what was going on, whereas in fact, everything was above board. So long as the government did not have to erode its hard currency reserves, it was happy.
So, what separated those who leveraged this market imperfection from those who didn’t? It all begins with mindset. When dealing with volatile environments, one needs to view them not as threats but as opportunities to separate oneself from the rest. Stock traders view volatility as a way to increase their profits, as stable markets mean less potential for arbitrage. As Thomas Jefferson said, “Nothing can help the one with the wrong mental attitude.” Mindset can be
influenced both in the selection of people as well as in the development of those people. People learn from the policies designed and behaviors exhibited by those they report to. As such, the view senior management takes towards volatility will influence the way the rest of the corporation behaves.
Mindset is not enough, however. Companies must have the entrenched abilities and organizational structure needed to allow individuals further down the organization to make time-dependent critical choices. Very centralized hierarchical structures tend to have slow response times, and in volatile environments speed becomes essential.
So, how does one delegate more while maintaining control? The key boils down to management through values. Organizations with strong values-based cultures can use pre-emptive behavioral controls including training programs and role-modeling, instead of more traditional and backward-looking output-based controls such as performance reports, to influence decision-making at the local level. This does imply, though, increased trust from top management on the frontline. To develop that trust and cultivate a basic understanding of the environment they are facing, it is important that senior leaders leave their headquarters and get out into the field. Despite the wealth of information on the internet, ChatGPT, or Zoom, nothing can replace face-to-face engagement when it comes to developing local understanding and building trust.
Today, a Chinese or Russian corporate passport is much more advantageous.
There are winners and losers as a result of geopolitical disruption: not all firms are impacted equally. Sometimes this is based on elements out of the control of the firm such as nationality or industry, but in other cases, it is rooted in factors that the firm can influence.
TABLE 1 – Factors impacting risk exposure
As has been evident in the recent round of tariff threats by the US, nationality and industry do make a difference: where you come from and the relative positioning and power of your home government can affect how you are impacted positively or negatively. Venezuela is a case in point. Prior to Chavez/Maduro, American and European firms enjoyed a privileged position based on the economic and political ties between the regions. Today, a Chinese or Russian corporate passport is much more advantageous.
Whether your ownership structure involves local private or government interests can also impact your local positioning. Likewise, your industry may or may not be the target of geopolitical actions depending on variables including strategic importance, local substitutes, and impact on the economy.
While firms cannot do much about those variables, others are more easily influenced. Geographical footprint, for instance, and the organization of your operations may have a dramatic impact on risk exposure. What are you producing, and where? Where is the value added being produced? Is it concentrated in one country or spread across many? This may not only have tariff implications. In countries where property rights may be threatened and depending on the answers to those questions, there may be a risk of nationalization or expropriation because simple assembly plants are of little value in such scenarios compared to fully integrated ones. Likewise, these approaches are less useful for governments where local entities are heavily indebted versus those financed with firm capital, as countries are much more hesitant to alienate global capital markets than one specific firm. Finally, the ability of the firm to influence local policymakers and key stakeholders can also impact the kind of treatment it receives from governments.
With both of these techniques, it’s less about predicting the future accurately and more about understanding what your moves would be if different futures came to pass.
There are a variety of tools available to help both analyze and mitigate these risks. These include scenario planning which allows a firm to assess the impact of environmental uncertainties on possible future scenarios and then assess what the implications are for the firm’s decision making today. For instance, in today’s world, two critical uncertainties for a European-based firm could be US tariff rates and the US dollar/Euro exchange rate. By crossing these two variables, the worst-case scenario would be where tariff rates for European exports are raised to 50% and, at the same time, the US dollar depreciates. At the same time, three other scenarios come from the simultaneous evaluation of these variables. The key is for the firm to understand what each of these four scenarios would mean and what it would need to do to be prepared for each outcome. Many other uncertainties could be assessed in this manner, such as commodity prices, inflation, and the like.
Horizon scanning is a similar tool that allows firms to identify trends that may have a fundamental impact through a systematic assessment of the environment. If you see the occurrence of a phenomenon increasing in a hockey-stick style of growth, there is a good chance it is a trend. Oftentimes trends start slowly and then, at a certain point, they accelerate exponentially. We saw this with COVID-19 as well as AI adoption. The ideal outcome is to identify the trend before its acceleration phase so that you can not only be prepared but, in some cases, influence its evolution.
With both of these techniques, it’s less about predicting the future accurately and more about understanding what your moves would be if different futures came to pass.
There is no excuse for not being prepared. As Condoleezza Rice and Amy Zegart state in their 2018 book Political Risk, “No one can foresee precisely how history will unfold. But managing political risk does not need to be pure guesswork. You do not have to know exactly where the risk will come from to be prepared for it.”
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