The top risks for 2009

Today, Eurasia Group announces one of our most important annual research reports — Top Risks for 2009 — and so I think it’s only fitting that I kick off this blog with a look ahead at the biggest sources of political risk for the coming year.

It’s not hard to paint a negative outlook for the coming year, given the political instabilities that such a serious global economic downturn inevitably creates. But beneath the market turbulence that will dominate the headlines in coming months will be two very important structural factors: around the world, we’ll see more state intervention in the global economy, and much of that intervention will be reactive and badly coordinated. In part, that’s because many policymakers driving this trend will be worrying more about local politics than about the global economy as they make key decisions. That’s why politics (and not market-savvy cost-benefit analysis) will drive the global economy more directly (and less inefficiently) in 2009 than at any point since the end of World War II. 

In fact, our top risk comes directly from the U.S. Congress. Political risks have historically been far more important for market outcomes in developing states. That’s not so this year. The current financial crisis has created unprecedented opportunities for government interference in economic affairs within rich states, and nowhere is that more true than in Washington. In response to the financial crisis, we can expect a broad range of financial industry legislative and regulatory changes, direct government involvement in plenty of economic enterprises and financial institutions, and fiscal policies meant to spur economic growth.

The risk, of course, is that U.S. lawmakers will draw up new rules and regulations that weigh on the free flow of finance and investment for years to come. In short, the injection of political populism into the creation of a new financial industry regulatory framework will produce all kind of unintended consequences.

Second, 2009 will prove a tough year for South Asia. The locus of the world’s terrorism/security risks has been moving steadily eastward over the past decade-from Israel/Lebanon to Iraq/Iran and now to Afghanistan/Pakistan/India. Pakistan’s internal political, economic and security problems are creating spillover effects into Afghanistan and India; and responses from both countries (and from the United States) exacerbating Pakistan’s instability and increase security tensions across the region. Perhaps the biggest risk of all — a major terrorist attack inside the United States — is much more likely to come from terrorists operating out of Pakistan/Afghanistan than from anywhere else.

Third, 2009 will be the critical year for risk in Iran. Ultimately, the United States and its European allies are privately prepared to deal with a nuclear Iran. The Israeli government isn’t, and is under much greater domestic pressure to block it. Given the strong possibility that Likud leader Benjamin Netanyahu will become the next Israeli prime minister early this year, we can expect Israel to continue to take a confrontational approach toward Tehran.

Iran will hold its own presidential election in June. The country’s hardliners are increasingly unpopular on the economy, but they’re much stronger on national security and the nuclear issue. That will give them all the motivation they need to answer real or perceived Israeli threats with threats of their own — and with support for proxies in Lebanon and the Palestinian territories. We could also see Iranian moves against U.S. warships in the Strait of Hormuz and the use of friendly Iraqi groups to stir up trouble in the south of Iraq. 

Fourth, with the impact of the global financial crisis, politics have taken an interesting turn in Russia. Despite the continued popularity of Prime Minister Vladimir Putin and a lack of organized political opposition in the country, we’re still starting to see significant social unrest across Russia. For the first time in years, we’ve seen serious demonstrations, in 30 cities, following the imposition of import duties on foreign-made used cars. We’re likely to see much more turbulence in 2009, as the economic downturn forces factories to close and workers off the job. Russians have seen this kind of hardship before, but only in the context of a very different kind of economic system. 

Where could this go? The Russian government won’t likely have much tolerance for dissent. And with the highest levels of anti-Americanism (and, in many quarters, of broader xenophobia) of any significant emerging market in the world, this has the potential to make security a serious concern — and to lead to boycotts of western goods. The Obama administration is not likely to keep quiet during a crackdown in Russia. That’s part of why Russia’s relations with the United States and many European countries are likely to get even worse in 2009. The Germans, who are more dependent on the Russians economically and, to some extent, politically, will play the role of wild card.