economist

With headlines still dominated by case numbers, hospital admissions and vaccine rollout rates, it’s no surprise the pandemic remains the dominant force influencing both the near-term global and Australian economic outlooks. Not only does COVID-19 continue to disrupt economies worldwide, but changes in private sector behaviour and official policy responses alike are upsetting, unsettling and distorting economic relationships and cross-border linkages. Currently, the consequences range from ragged global and national supply chains now struggling with scarcities in staffing, vehicles, containers and shipping capacity, to shortages in semiconductors and raw materials that have disrupted production and boosted input costs, and on to the expanding range of asset markets that have been inflated to precipitous levels by record low interest rates and central bank asset purchases. The economic fallout from these developments is likely to persist for some time. Yet it’s also important to remember that the pandemic isn’t the only major force with the potential to reshape the contours of the world economy.

One powerful reminder of this came on 15 August, when Taliban forces seized control of Kabul, the capital of Afghanistan. Instant assessments were many and varied. For some, this was a dramatic symbol of the fraying of the Pax Americana and the decline of US power, marking a major geopolitical turning point akin to the fall of Saigon in 1975. For others, it delivered a message on the follies of nation building and Western interventionism; or a lesson on the failure to deliver economic development and reliable governance; or perhaps it was just the latest demonstration of Afghanistan’s longstanding role as the “Graveyard of Empires”. From the perspective of the global economy, however, it was a notice that geopolitical developments, as well as pandemics, can have a profound impact on international economics.

Although the sterile models of textbooks might seem to suggest otherwise, economics, national power, international relations and even war have long been intimately connected. This is perhaps most obvious in the case of international trade. In Power and Plenty, their magisterial survey of trade and the world economy over the course of the Second Millennium, Findlay and O’Rourke begin by noting that “...the greatest expansions of world trade have tended to come... from the barrel of a Maxim gun, the edge of a scimitar or the ferocity of nomadic horsemen... For much of our period, the pattern of trade can only be understood as being the outcome of some military or political equilibrium between contending powers.”

In more recent times, the post-WWII international economic order that helped stitch back together the ties of international commerce between the industrialised economies of the West was underpinned by the power of the US, even as the Soviet Union used its own geopolitical weight to forge a different kind of economic regime in the Communist bloc, with the cross- country allocation of resources drive by the political choices of central planners rather than the price signals of markets. The subsequent failure of the Communist part of this Cold War economic ecosystem — which, in an incredibly short span of time, saw the near-complete collapse of what had just a few years earlier appeared to be deeply entrenched networks of international trade and economic relationships — itself then helped to propel the trade component of an era of hyper-globalisation that dominated the world economy between the fall of the Berlin Wall and the onset of the global financial crisis.

Competition for global influence

The symbiotic relationship between international economic and political orders extends beyond trade to encompass international financial relationships. Economic historians such as Harold James highlight the correlation between international monetary systems and global security orders, noting that just as the 19th- century financial order was constructed around the Gold Standard, so the security order of that era rested to a significant extent on the Pax Britannica. Britain’s move to quit the gold standard was closely tied to its relative decline as a great power and its fading economic ability to support that status. Similarly, President Nixon’s decision half a century ago to close the “gold window” not only marked the end of the Bretton Woods era of fixed-but-adjustable exchange rates, but was also closely linked to US military failure in Vietnam and an unwillingness to sustain the associated fiscal burdens.

Significant changes in the international political order, then, have tended to be associated with parallel adjustments in the international economic order, with the causality frequently running both ways. And while the fall of Kabul alone is arguably an unlikely candidate for an international regime-ending or regime- transforming event, it is easier to see it as symptomatic of a broader shift in the global balance of geopolitical power.

The heart of that geopolitical rebalancing is found not in Central Asia, of course, but rather in the shifting equilibrium between great powers as the world adapts to a relatively less powerful US and a relatively more powerful China. As the latest edition of the US National Intelligence Council’s Global Trends report predicted in March this year, over the next two decades, “the intensity of competition for global influence is likely to reach its highest level since the Cold War... These power dynamics are likely to produce a more volatile and confrontational geopolitical environment.” One sign of this uncertain new environment is the continuing run-up in global military spending, which according to the Stockholm International Peace Research Institute (SIPRI) rose to US$1981b (in 2019 prices) in 2020 — the highest level of spending since 1988, the earliest year for which SIPRI has a consistent global estimate. The days of the post-Cold War global peace dividend are now long behind us.

Along with greater uncertainty and a heavier economic burden from higher global defence spending, an intensification of great power competition would impose additional costs on the world economy, including by intensifying existing pressures towards deglobalisation, boosting protectionism and triggering calls for increased national self-sufficiency and reconfigured supply chains. It would further destabilise already struggling international economic institutions, undermine the prospects for multilateral cooperation on key areas such as climate change, weaken attempts to set international standards and increase the drift towards a bifurcated world economy in areas such as technology and telecommunications, while also likely intensifying concerns around cybersecurity.

At a minimum, this implies significant headwinds for global productivity and world economic growth. However, past experience suggests the consequences for the current structure of international economic relations could prove to be much greater than that.