Our 2017 forecast includes projections for several regions. Here are some highlights.
The United States:
- U.S. foreign policy will shift toward nationalism and this will change U.S. relationships throughout the world.
- The U.S. will not experience a recession in 2017 but will show signs of one by the end of the year.
- The U.S. will seek to enforce or renegotiate trade deals such as NAFTA. Further multilateral trade agreements are unlikely.
- The U.S. will seek to redefine trade relationships on a basis more advantageous for the U.S. and China will be the first target.
- The U.S. will try to limit exposure to instability in the Middle East and Eastern Europe by shifting the burden of maintaining stability to allied forces.
- In Asia and the South Pacific, the U.S. will maintain close military relationships with key countries, such as Japan and Australia. The U.S. will also continue to develop closer ties with India and will maintain relations with smaller countries like the Philippines.
- The U.S. will increase cooperation with Russia in fighting the Islamic State in the Middle East.
Despite these improvements, the real relationship between the U.S. and Russia will continue to be defined by opposing fundamental interests.
- The U.S. will work with the Turks to stabilize the situation in Syria at the expense of the Syrian Kurds; the U.S. will increase cooperation with Iran in the fight against IS in Iraq.
- The U.S. will not be able to disengage from fighting IS or defeat IS decisively.
- In Afghanistan, the U.S. will keep limited troop numbers on the ground but the Taliban will continue to advance their control over parts of the country.
- Germany will see a drop in exports in 2017.
- Italy’s banking crisis will continue. It will morph into a political crisis and a confrontation with Germany and the European Union.
- Non-euro EU member states, especially those in Eastern Europe, will be exposed to the stagnation in the German economy.
- The refugee crisis will continue in 2017. Differences between European countries on how to deal with the crisis will continue and border controls, already a fact of life, are likely to be extended.
- The U.S. will pressure the Europeans to commit to NATO. European states will agree but will not live up to their financial commitments to the organization.
- Brexit will continue to have a political impact on Europe in 2017 but will have a limited effect on the U.K. and the EU member states’ economies.
- The U.S. and NATO enforcements on the Eastern containment line with Russia will continue in the East, while the West will focus on debating better ways for the EU to defend its borders and increase internal security.
- Russia’s economy will face severe challenges, and this will begin to manifest as social unrest, especially in the countryside.
- Oil prices in 2017 will not rise high enough to offset Russia’s economic woes.
- Russia will seek to continue and formalize the frozen conflict in Ukraine.
- Russia will be open to a certain degree of cooperation with the U.S. over fighting IS in the Middle East.
- Russia will use proxies to assert its influence in some of its traditional borderlands, including the Balkans, Central Asia and the Caucasus.
- President Xi Jinping will solidify his dictatorship in China in 2017, and the crackdowns on unrest and potential rivals will increase in severity.
- Unemployment in China will increase in 2017 and lead to unrest, but not enough to undermine the Communist Party’s rule.
- China will feel pressure from the U.S. and will look to respond in asymmetric ways, such as involving itself in the domestic affairs of other countries in the region.
- No war will occur in the South China Sea or the Taiwan Straits.
- Japan will increasingly appear to be the decisive power in East Asia.
- North Korea will continue to develop its nuclear program, but no war will break out as a result.
- Central Asia’s instability will accelerate into crisis. Kazakhstan, Uzbekistan and Turkmenistan are the most vulnerable countries.
- Indian Prime Minister Narendra Modi will try to increase the power of the state, especially over the Indian economy and will fail. GDP growth and foreign direct investment will fall.
- India and Pakistan will not go to war over Kashmir.
- The Taliban will build on gains made in the past year, gaining more control of Afghanistan, and Pakistan will see an increase in domestic insurgency due to spillover.
The Middle East:
- Regional powers will compete for influence as a result of the chaos in the Sunni Arab world; Turkey and Iran will be the most active competitors.
- Turkey will increase its military footprint in Syria, and Iran’s position in Iraq will improve in 2017.
- Saudi Arabia will be forced to scale back its regional policy agenda, especially concerning the war on its southern flank in Yemen.
- Raqqa will not fall in 2017, but the Islamic State’s conventional power will weaken.
- Gridlock in the Venezuelan government will break in 2017. The government of President Nicolás Maduro in its current form will not survive 2017.
- Brazil’s economy will finally end two years of deep recession and return to modest GDP growth.
- The Argentine economy will show signs of normalization as a result of President Mauricio Macri’s reforms.
- The U.S. and France will very selectively engage in security operations in Africa.
- Low-income countries in East Africa – Ethiopia, Kenya, Tanzania and Uganda – will see their economies grow multiple points above global and regional average growth rates in 2017.
Long-Term Technological Transformation:
- 2017 will be the beginning of a long decline in microchip-based industries that will not be reversible. These industries will be reduced to desperately looking for new and more dubious applications.
- Between now and 2030, there will be an overlap with a new technology that is not yet obvious, which will revolutionize life the way the internal combustion engine and the microchip did.
As we have been forecasting, the major force driving the international system will be rising nationalism deriving from the economic and social forces unleashed during the 2008 financial crisis. We forecast this development both in our 2016 forecast and our 2040 forecast. The process is now intensifying and the forces building within nations are now affecting the functioning of the international system. Increasing nationalism can be seen in the United States, Europe, Russia and China and is a prime cause of changes in international patterns that have been in place since 1945 and more intensely since 1992.
The 2008 crisis had three consequences. The first is economic stagnation or relatively low growth in the advanced industrial countries. The second is the rise of nationalism and challenges to multilateral relations. The third is increased instability and insecurity in countries dependent on exports in a stagnating global system.
The export crisis, discussed in our 2016 forecast, originated in the Euro-American recession after 2008. This in turn posed a severe problem for China. That in turn undermined the price of industrial commodities, particularly oil. The global export crisis imposed stagnation on most of the world’s economies and forced them to seek internal solutions where no external solutions were available. Constraints on export growth spread stagnation globally.
During periods of economic expansion, all segments participate, some far more than others. After 2008, the condition of the class that benefitted less from prior growth saw their condition decline in absolute terms. This generated massive internal tensions, with nations increasingly divided between internationalists who wanted to resurrect the pre-2008 system and nationalists who wanted to move away from exposure to international forces. The internal tension was not confined to Euro-American nations, but was visible in China and Russia as well. In all nations, internal pressures, and the political response to them, will shape international behavior in 2017.
The world in 2017 will see a divide between countries that can sustain themselves through stable domestic consumption and those that are dependent on exports. Far more countries are heavily exposed to the international system and will have extremely difficult domestic problems; less exposed countries will have tensions, but more manageable ones.
Examples of major countries with few options are Saudi Arabia, Russia, China and Germany. Three of these have already experienced a contraction of revenue from exports, either through falling prices or contracting demand. Germany has not yet experienced a decline in exports but will in 2017. The primary country that has alternatives to exports is the U.S. Few other nations are in this position, save for Brazil and to some extent Japan, which has low enough exports and high enough domestic demand that substitution is possible.
With options comes strategic and political stability. Countries with few options develop internal tensions of such immediacy that they can rapidly turn into international tensions. Germany, for example, is already locked into international disputes due to dependency on trade that will intensify in 2017 as its trade position weakens. Russia is using international adventures to maintain political stability at home. China is imposing a political dictatorship while simultaneously engaging in naval demonstrations off its coast. In most cases, these moves are not motivated by strategic goals that can be achieved in 2017 and are aimed at domestic political objectives. In Saudi Arabia, declining trade has already had consequences on its ability to act internationally. Russia will experience similar constraints, while China retains some room for maneuver.
The United States
We begin with the U.S. because it is the most powerful, and therefore important, country in the world. It is also undergoing internal stresses that will inevitably be reflected in its foreign policy. President-elect Donald Trump’s election represents the first significant shift toward nationalism, and this will be reflected in U.S. foreign policy. This shift should not, however, be overstated. The U.S. has an extremely complex political system, and the president is both the most visible and institutionally weakest part of the system. Therefore, Trump’s election is simply the first step in an extended process. Except in the event of war, foreign policy shifts do not happen quickly in the U.S.
Nationalism already was a strong force in the U.S., but it has now reached a critical mass, and this means U.S. relations with foreign countries will change. Our long-term forecast says that the U.S. will maintain greater distance from global conflicts, will engage more selectively, and will rely on regional balances of power. Trump will want to achieve all three objectives, in his own way. He will want to pull the U.S. out of the Middle East after quickly defeating the Islamic State, eliminate and renegotiate various free trade agreements and bypass NATO to deal with countries directly.
Trump will encounter a great deal of difficulty achieving many of these goals because disengagement is complex and all presidents confront institutional resistance and inertia. Even so, the overall U.S. posture towards the rest of the world has changed. If you look closely at Trump’s foreign policy aims, they are all consistent with our long-term forecast for American foreign policy. Trump’s election represents a surge forward in our long-term forecast, and that will have ramifications for U.S. relationships with traditional allies and old foes.
Before we can turn to the U.S. role in the international political system, we must begin with the U.S. economy because of increasing concern over the possibility of a cyclical recession in 2017. Even the foremost economic experts will confess that determining the precise timing of a recession is impossible; if it wasn’t, we would all be wildly rich. Even so, a recession in the U.S. would be an extremely significant geopolitical event because of the challenges countries like Germany and China would face should demand in the U.S. fall off substantially.
Recessions are signs of a healthy economy. A recession eliminates inefficiencies in the market and gets rid of excesses, the result being short-term pain but long-term general health. Every recession is different, but often starts with an overpriced asset class; high confidence breeds a lower sense of caution, and a fundamental vulnerability creeps into the system. As companies begin to pull their money out of long-term investments and into short-term investments to counteract the vulnerability, the dominoes begin to fall, leading to a recession.
Right now, the U.S. has an irrationally high-performing stock market, reaching record highs every month. An argument can also be made that recessions happen on average every six or seven years or so, and that would indicate that the U.S. is due for a recession in the near future. There is a danger in thinking too mechanistically, however, and the fact that the last recession ended just over seven years ago does not by itself presage a recession. But if the U.S. goes without a recession for another few years, it will begin to enter unprecedented ground.
Apart from those two indicators, we have not seen to this point other signs that a recession is imminent within the next 8-12 months. The most telling sign of a recession is often the yield curve between short-term and long-term bonds, and while it appeared in the summer of 2016 that the yield curve on the 3-month and 10-year bonds was beginning to flatten, interest rates have diverged once more. As of Dec. 5, the yield rate on the 3-month bond was 0.49 and on the 10-year bond it was 2.39. This means a recession most likely will not come in 2017, but by the end of the year the signs of a recession may become apparent. If we are wrong and a recession does occur, many of the economic challenges we predict, particularly for Germany and China, but also for other major exporters to the U.S., will be exacerbated.
In terms of trade, the U.S. will look to enforce or renegotiate trade deals such as NAFTA so that they are more advantageous to the U.S. The problem with NAFTA for the U.S. is not competition from Mexican companies – it is competition from European and Asian companies that enter Mexico to get the benefits that NAFTA offers. The U.S. will try to close those loopholes while keeping NAFTA in place. Further multilateral trade agreements are unlikely.
U.S. Strategy Abroad
As we said in our 2016 forecast, the U.S. has been moving to reduce its engagement in global conflicts because of overextension. This has been done in the face of intense friction that characterize the beginnings of a domestic shift. Trump will intensify disengagement but will face the same friction as President Barack Obama, limiting his success.
Trump will attempt to selectively reduce exposure to international instability by limiting the number of troops on the ground and shifting the burden to allied forces. We see this happening in the Middle East as well as in Eastern Europe. It is a doctrine of limited and selective engagement. Trump will pursue and expand this strategy to include other issues such as trade. He will not only make engagement more selective but also will re-examine existing commitments. Social forces require a shift in trade and investment policies, and in both, China will be the first target. This is because China is more dependent on its trade relationship with the U.S. than the U.S. is on China, and because a successful outcome in China will shape other discussions. We expect this to be the focus of U.S. strategy in 2017, while the U.S. will also attempt to shift its strategy in the Middle East and pursue a formal acceptance of the frozen status of the Ukraine conflict. We will look at some of these relationships more closely, beginning with Asia.
The U.S. has touted its “pivot to Asia” in recent years, but in 2017, the U.S.’ re-examination of its relationship with Asia will result in some changes. The overlying strategic dynamic will remain the same, but the U.S. will become more assertive, particularly with China. The most important strategic aim for the U.S. will be redefining trade and investment policies on a basis more advantageous for the U.S. It is unclear how much legal authority a U.S. president has in terms of concrete policy options, such as raising tariffs without congressional approval or labeling China a currency manipulator. What is clear and more important is that the U.S. will stop behaving as if China is its equal and start treating China as a still important but relatively weaker regional power.
This means that the U.S. will still cooperate with China on shared interests, but it also means the U.S. will be more assertive in demanding Chinese acquiescence to a renegotiation of the China-U.S. economic relationship and lowering tensions in the South and East China seas. Because China is more dependent economically on the U.S. than the U.S. is on China, and because Chinese naval power does not pose a meaningful threat to American naval power, China will have no choice but to accept some of Washington’s demands. The challenge for China will be couching these changes in such a way that does not undermine Chinese President Xi Jinping’s authority at the domestic level. As for U.S. engagement with the broader Asia Pacific region, the U.S. will maintain close military relationships with key countries like Japan and Australia, and will push those countries to take on more of the burden of containing China, as well as North Korea. Finally, the U.S. will continue to develop closer ties with India and will maintain relations with smaller countries like the Philippines.
Relations between the U.S. and Russia will improve in 2017, as both sides will be interested in formalizing the current situation in Ukraine, but the underlying fundamentals of the relationship will remain the same. The U.S. does not have the desire or ability to fight decisively for Ukraine, and neither does Russia. Therefore, the current informal frozen conflict will see some kind of formalization in 2017. U.S. posture in Eastern Europe, however, will change only in that the U.S. will ask more of its allies and will exert intense pressure on its European partners to increase military expenditures according to their commitments as NATO members. The U.S.’ bilateral relationships with the countries of the Intermarium – the region between the Baltic Sea and the Black Sea – will continue to develop apace.
The U.S. and Russia may also see a superficial thaw in tensions around Syria. The U.S. and Russia share a common enemy in the Islamic State. The two sides also already work together despite the public bluster and the various failures at the diplomatic level. The U.S. will be willing to work more openly with Russia in fighting IS, but the two sides will remain at loggerheads about the future of Bashar al-Assad’s regime.
The Middle East
In the Middle East and Afghanistan, Trump will try to end U.S. wars, just as Obama tried to do, but he will not be successful in 2017.
The U.S. will not have the troop levels or political will necessary to defeat IS by itself. The fight against IS will progress slowly and bloodily in 2017. There is no silver bullet for IS despite Trump’s bravado. The battle for Mosul will bleed into 2017, and the battle for Raqqa will take shape by the end of the year. The U.S. is now openly cooperating with both Turkey and Iran in its various operations against IS. That cooperation will continue and accelerate in the coming year, though at times different goals will lead to very public disagreements. In Syria, the U.S. will pull back as much as it can and rely increasingly on Turkey rather than the Syrian Kurds to achieve its tactical goals against IS. In Iraq, it will try to reach a compromise with Iran whereby Iran helps fight the remnants of IS but does not rule Baghdad as a fiefdom. All the while, IS elements will go back to guerrilla warfare and terrorist attacks as they are slowly removed from governing territory, making it difficult for the U.S. to disengage completely.
In Afghanistan, the U.S. will also not manage to destroy the Taliban, which is increasing the amount of territory under its control. There is even less will to commit additional U.S. forces in this theater, and the U.S. will attempt to make the best of a losing situation, keeping limited troop numbers on the ground until it can secure terms that allow it to proclaim some kind of hollow moral victory – which will not happen in the coming year.
The Brexit referendum in 2016 highlighted the distance between the political elite and the electorate. This is not a characteristic of the U.K. alone and we will see more examples of this divide throughout Europe in 2017, as the popularity of anti-system and nationalist parties will rise. Similarly, the gap between Brussels and European Union member states will grow as politicians are forced to listen to their electorates at home, which perceive Brussels as increasingly disconnected from reality. We do not predict the outcome of elections, but we see two divisions in Europe that will be reflected in election campaigns throughout the year. First, there is a divide between the interests of different member states, as some states want to maintain a close union and others want more independence. Second, each country is experiencing an internal split between internationalists who want more connectivity between states and nationalists who want greater focus on domestic interests. These conflicts, driven by post-2008 realities, will create shifts in governments and in government policies.
Problems in the German economy will exacerbate an already unstable and fragmented European continent. The EU’s economic growth will be limited, partly because the U.S. economy is expected to grow only moderately. Considering the general global slowdown and the German dependency on the EU and the U.S., Germany will see a drop in its exports in 2017. With international demand shrinking, the German economy will also be affected: Investment and employment in the industrial sector will slow down in 2017, which will cause a drop in domestic consumption. The structural problems causing German economic stagnation will also lead to intensifying banking problems.
While Brexit will continue to have a political impact on Europe in 2017, it will have a limited economic impact on Britain and EU member states. The details of Britain’s withdrawal need to be worked out before the business sector can figure out how to adjust. However, business links between the U.K. and EU will remain, as they are founded on business interests and not political ties.
In our 2016 forecast, we predicted a banking crisis in Italy. This crisis has emerged and the share of non-performing loans (NPLs) in the Italian banking sector remains around 17 percent. The Italian government will continue to struggle with this ongoing crisis in 2017. Italian Prime Minister Matteo Renzi has already been driven out of office and further political ramification will emerge, including more calls for nationalist economic policies and clashes with directives from Brussels. In 2017, the question will be: What will Germany do about this? The situation in Italy cannot continue indefinitely, and Renzi’s defeat signals that Italy will resist EU directives or German austerity measures to address NPLs. Germany faces elections of its own in the coming year, and regardless of the result for Chancellor Angela Merkel, the issue will be whether Germany maintains its current demands. If it does, this could further drive Italian sentiment against the EU, or force Italy into an even deeper crisis by making Italians bear the brunt of bailing out the banks. Either scenario weakens the EU and strengthens nationalist arguments throughout the eurozone.
Besides Italy’s banking crisis, the main challenge for all eurozone countries will be to incentivize investment. European banks will continue struggling to adapt to current market conditions, cut costs and get rid of bad debt. The factors limiting the profitability of the banks will intensify in 2017, due to generalized slowdown in growth, which will keep interest rates low. Deutsche Bank is the most urgent case highlighting the problems facing the German and European banking sectors. The bank will continue to search for solutions to its problems in 2017. Merkel will try to avoid getting involved because of upcoming elections, and the political implications will depend on the bank’s restructuring plans.
The non-euro EU member states will also be hit by the general economic slowdown and in particular by the stagnation of the German economy. Exports account for 70-80 percent of GDP for Eastern European countries with the exception of Poland and Romania, where they make up just below 50 percent of GDP. Germany is the main trading partner for all of these countries. Depending on the country, between 20 and 30 percent of exports go to Germany. With the exception of Romania, every country is also highly dependent on its neighbors. All of these countries are also part of the German supply chain – the manufacturing process for German export goods has been distributed regionally, with different countries specializing in different stages of production. A drop or even a stagnation in global demand for German exports will trigger a drop in industrial production and trade for these countries, which in turn will cause declining economic conditions.
Eastern European countries’ growth in 2017 will be supported mostly by domestic demand. These countries will continue modernizing their economies, and public sector investments will continue to grow. This will trigger some growth in 2017, while the slowdown in Western Europe, particularly Germany, will keep growth low.
In addition to structural economic differences, Eastern and Western Europe will continue to have different foreign policy priorities. U.S. and NATO enforcements on the eastern containment line will continue, as these countries regard Russia to be their main threat. The West will continue debating ways for the EU to better defend its borders and increase internal security, considering the migration crisis of the last two years. While long discussions on the future of EU defense will continue in Brussels, little will be done. The lack of European unity and divergent national interests make consensus impossible, especially on such important matters as defense.
While the U.S. focuses on pulling back and managing its affairs from a distance, Europe has no such luxury. In 2017, Europe will have to make strategic decisions on NATO, under pressure from the U.S. The Europeans’ discussions in 2016 on building a security union to tackle terrorism and organized crime and strengthen defense cooperation will continue in 2017, but will remain in the discussion phase. The Europeans don’t have the money and the political will to invest in such a project. At the same time, the U.S. will pressure the Europeans to commit to NATO. While they will agree to do so, we doubt that they will live up to their financial commitment to the organization. The anti-establishment and nationalist parties will likely increase their anti-NATO rhetoric.
Nationalism on the Rise
Brussels’ power will continue to erode in 2017 while domestic politics will become more important, with nationalism and populism continuing their rise. The socio-economic distress will likely cause tension throughout Europe.
Germany and France will both have elections in 2017. Considering their socio-economic problems, the already growing nationalist rhetoric will likely gain ground in the electoral discourse. At the same time, we will likely see renewed calls for secession and independence coming from European communities and regions that disagree with their national governments. The refugee crisis will continue in 2017, posing both economic and security problems for European governments. While refugee flows have slowed down, they haven’t stopped, and will continue in 2017. Differences between European countries on how to deal with the crisis will continue and border controls are likely to be extended.
2017 will also be a difficult year for Russia. The social consequences of Russia’s economic problems will intensify next year, in spite of those projecting a return to positive GDP growth in 2017. Small indications of these problems have already appeared, including unpaid workers in small districts in an oil-producing region and minor protests over lack of funds in small Russian cities. These will increase in magnitude and intensity in 2017, but overall, popular disillusionment will not challenge President Vladimir Putin’s rule in 2017. We expect that in hindsight the coming year will be an inflection point in the long-term destabilization of Russia that we predict will reach a boiling point by 2040.
We do not forecast commodity prices, but because of the importance of the price of oil to the Russian economy, we cannot avoid making a call one way or another. It seems to us that prices will not go up in 2017. We do not foresee any geopolitical conflict that will cause oil supplies to be severely limited in 2017. We predict that the market will still be oversupplied and face decreased demand, especially in the context of slowing growth in China and stagnant growth in both Europe and the U.S. Regardless of the attempts by OPEC and others to will away this situation, it will endure.
At the very least, we can say that oil prices are not going to rise enough in 2017 to offset Russian expenditures, and that means Russia will remain in a difficult financial situation. As a result, Russia will make cuts to social services, but at the same time will try to maintain the level of military spending necessary to reach goals set in its State Armaments Program for 2011-2020. Russia will therefore run a budget deficit and begin to exhaust its reserve funds. This along with the budget cuts will cause dissatisfaction and unrest in the Russian interior and in rural areas far removed from Moscow and the wealthiest parts of Russia.
Russia will continue to legitimize the political regime in Moscow to those who suffer economically by demonstrating Russian power internationally without meaningfully exercising it. The worse the Russian economy gets, the bigger these demonstrations will have to be. Russia’s military has improved markedly since 2008, but Russia does not have the military force necessary to both conquer and occupy Ukraine, nor would it be wise at this juncture for Russia to invite the political backlash that would come by attacking any of its border states. Ukraine will remain Russia’s top national security priority in 2017, and Russia will seek to continue the frozen conflict in Ukraine; it doesn’t want the situation to escalate, but it needs the conflict to stir Russian nationalism in the face of Western aggression. In Syria, Russia will be open to a certain degree of cooperation with the U.S. over bombing IS and will attempt to show that its support of Assad played a key role in weakening IS. That same support for Assad, however, will remain a major sticking point between Russia and the U.S., and Russia and Turkey. Russia wants to avoid getting bogged down in Syria, so the priority will be finding a way to claim a significant victory in some fashion in 2017, whether through cooperation with the U.S. or not.
Russia will also look for additional ways to demonstrate its power as its economic problems become more severe. With the U.S. looking to limit its engagements, opportunities will arise for Russia to assert its influence in some of its traditional borderlands – including the Balkans, Central Asia and the Caucasus. Russia is likely to use its leverage in the Balkans, as the region is a powder keg sitting atop a dangerous mix of economic underdevelopment, various ethnic and religious conflicts, and declining legitimacy of international institutions. Russia will especially look to demonstrate its power in areas with significant Russian populations. Russian military exercises and snap drills will continue in order to show off both Russia’s increasing capabilities and great power status. These drills will actually demonstrate the limits of Russian capabilities, but they will create a certain degree of hysteria in Eastern Europe all the same, especially as the U.S. pushes countries in the region to take greater responsibility for their defense.
All of these moves will appear to be evidence of Russian aggression, but they will really be signs of Russian weakness. In 2017, Russia will have to face the consequences of declining oil prices. The Russian population will begin to feel the effects, and this will become the main focus of the Russian government. The most important developments for Russia will be internal, and while we do not expect the government to be challenged in 2017, the countryside will increasingly descend into a real crisis and that will begin to turn public opinion against the current government.
In East Asia, China will face its greatest test as its economy continues to shift into a normal growth pattern and a more assertive U.S. seeks to redefine the parameters of the U.S.-China economic relationship. China will respond much as it has, by trying to balance between its contradictory goals. On the one hand, it wants to encourage long-term economic health by implementing tough reforms. On the other, it is forced to protect short-term growth to maintain social stability. This is a race between economic privation and the Communist Party’s strength, and the outcome will determine China’s future for the next generation, as well as the limits of Chinese foreign policy in 2017. By the end of 2017, we will see Xi become a de facto emperor as a means of preventing unrest and regionalism brought on by China’s economic woes.
This will happen as China’s declining growth rates continue. China has a number of underlying economic problems as a result of slowing growth, and these problems will continue. Unemployment is the most dangerous problem for the Chinese political system’s stability. We believe unemployment is much higher in China than is currently reported and we expect unemployment to rise in 2017, even if the Chinese don’t report it. A looming housing bubble, the devaluation of the yuan and rising debt are among the other problems facing the Chinese government, and spasms in these and other areas have the potential to spark unrest in 2017. Tensions between the provincial governments and the central government in Beijing will also increase, as Beijing will ask hard-hit regions to make even more reforms, and those regions will either fudge their numbers to convince Beijing they are following orders or request more assistance in the form of transfers from wealthier coastal regions.
Though there will be a tangible uptick in unrest in 2017, its effects should not be overstated; it will not challenge the Communist Party’s rule. The main event driving domestic developments in China besides the underlying economic problems will be the 19th Party Congress, which will be held at the end of 2017. Xi has already eliminated most of his potential rivals, but he will continue to consolidate power through his anti-corruption campaigns and direct oversight of the People’s Liberation Army. As Xi centralizes control over China, he will deal more harshly with any who oppose him.
Chinese activities away from the mainland will be shaped and constrained by a new U.S. administration looking to redefine the parameters of the U.S.-China trade relationship. Because China is dependent on the U.S. economy, China will have to make some compromises. In our 2016 forecast, we said any moves by China in the South and East China seas would largely be feints and gestures, and that forecast remains in place for 2017, as China is not yet willing or able to disrupt the status quo. China will continue to modernize its military and navy and to trumpet its many achievements to anyone who will listen, but it will remain the weaker power in the U.S.-China relationship. China will feel pressure from the U.S. and will look to respond in asymmetric ways in 2017, such as involving itself in the domestic affairs of other countries in the region. 2017 will be a challenging year for Chinese foreign policy, as Xi will struggle to make China appear more powerful than it is.
Japan’s Quiet Rise
As China moves toward economic normalization, Japan will increasingly appear to be the decisive power in East Asia. Japan is in the midst of a long period of economic stagnation, but on the flip side, this stagnation has been accompanied by stability. Japan does not have China’s poverty levels or massive discrepancies in regional wealth and therefore overall will be in a much more stable position. Japan is also less dependent on exports for economic stability, which will continue to help Japan avoid some of the political and social problems affecting major exporters in the region. More pressing will be the increasing security threats that Japan is facing, which will include Chinese feints in the South and East China seas. This will be compounded by the new Trump administration in the U.S., which will ask Japan to take a bigger and more assertive role in managing the region and its own affairs. As a result, Japan will take a more defensive posture to threats and will explore ways to assert its interests in the region. This will include further military development and increasing efforts to work with neighboring powers.
North Korea’s Empty Threats
The outlier of East Asia is still North Korea. No forecast of Asia can be complete without mentioning North Korea, but barring a collapse of the regime in Pyongyang (which we do not expect in 2017), the country is not significant to the overall global system. Through its nuclear program, however, North Korea has created a false impression of itself as a significant and dangerous power. This is part of a strategy designed to protect it from foreign attacks or destabilization attempts.
In 2016, North Korea conducted approximately 20 missile tests with some successes and partial successes and some failures. It conducted two nuclear tests, both of which were deemed successful. In 2017, Pyongyang’s goal will be to achieve a higher success rate for its missile program, especially its intermediate-range Musudan missile, which it first tested in April 2016. North Korea will also issue various threats and statements from Pyongyang. The global media will obsess over these tests, but no more will come of them. There will be much diplomatic outrage, but no war, and the situation in North Korea at the end of 2017 will not be much changed from 2016.
In our 2016 forecast, we predicted Central Asia would be on the verge of crisis by the end of the year. In 2017, economic issues tied to reduced revenue from energy exports and Russia’s weakening economy will further destabilize the entire region. Kazakhstan, Uzbekistan and Turkmenistan are the most vulnerable countries, the first two because of infighting and unrest related to political succession, and Turkmenistan because of the severity of its current economic problems. Each of the five Central Asian states will also experience a spillover effect from the spreading insurgency in the western and northern provinces of Afghanistan and greater infighting among the anti-Taliban factions.
In Kazakhstan, doubts about who will succeed President Nursultan Nazarbayev will begin to create volatility in 2017, which will be exacerbated by continued struggles in the oil-dependent Kazakh economy due to low prices. Kazakhstan will likely see more incidents of civil agitation, as well as Islamist terrorism. Further complicating matters in 2017 will be the president’s efforts to crack down on corruption (especially in the military) and his wider reform agenda.
In Uzbekistan, the ongoing transition following former President Islam Karimov’s death will create additional room for instability. Shavkat Mirziyoyev, who was prime minister under Karimov and acting president after Karimov’s death, won the presidential election on Dec. 4 and will not see immediate challenges to his power. That said, power struggles among the various regional factions, as well as increased Islamist activity, will increase in 2017.
In Turkmenistan, food shortages and delays in civil servants’ salary payments will intensify. The drop in Russian imports of natural gas from Turkmenistan and the discounted rates at which China is importing natural gas will continue to undermine the country’s financial position. Despite these problems, the regime of President Gurbanguly Berdymukhamedov will contain social unrest and/or militancy.
The most important questions for the region in 2017 are: What is the intent of Indian Prime Minister Narendra Modi’s aggressive economic reforms and can they succeed? Modi – whose right-wing Hindu nationalist Bharatiya Janata Party came to power in 2014 with a sizeable majority – has been successfully pursuing policies to boost growth and encourage foreign direct investment (FDI). But in November, he removed three-quarters of the country’s money supply from circulation to rein in the large informal economy. Modi will try to increase the power of the state in 2017 by attempting to centralize control over the economy and boost the popularity and power of his political party ahead of important upcoming state elections. Demonetization was a bold move with two key purposes: first, to add a significant amount of capital to the state’s coffers by taxing those who have been shielding their money from the state, and second, to deal a blow to rival parties that use cash to buy votes. More moves similar to this will come in 2017. Modi has already declared that the real estate and gold markets will be his next targets in the coming year, and this will cause further dysfunction in the Indian economy.
Modi will not succeed in achieving his objectives, and the negative fallout from this will manifest in lower GDP growth and political infighting in 2017, and could also jeopardize FDI. It must be kept in mind that India is really a coalition of nations with a weak central government. This fact will make it very hard for Modi to achieve his goals without suppressing the inevitable unrest that will follow. Either his money grab will turn into a power grab or his government will fail to centralize power. If it fails to centralize power, the failure will be due to serious resistance to the new measures from stakeholders of the current system and popular supporters of the government, as the reforms will make daily life harder for the average Indian. Either way, India is in for a rough year ahead economically and politically. Modi wants an Indian nation-state with a coherent economic strategy; instead, he will get the same complex multinational country that exists now with a weaker economy.
On the foreign policy front, little will change for South Asia’s dominant power, but recent fighting across the border between Indian and Pakistani forces in the disputed Kashmir region will continue into 2017. This intensified fighting has been at levels not seen in 15 years, but both sides have their respective reasons for ensuring that war does not break out.
Afghanistan’s Intensifying Conflict
The other major issue in South Asia in 2017 will be Afghanistan. The Taliban will build on gains made during 2016, which will result in more areas falling out of the Afghan government’s control and will make prospects for negotiation with the Taliban bleak. The more the Taliban’s power increases, the less open the Taliban will be to negotiate. While nowhere near the level of the Taliban, the Islamic State has been making advances as well in Afghanistan and this will continue in 2017. Because Pakistan borders this conflict and is deeply connected to its major players, Pakistan will feel a spillover effect and could see an increase in domestic insurgency in 2017 at the same time as it deals with a deteriorating relationship with India.
The Middle East
In our 2016 forecast, we identified the Islamic State as the center of gravity in the Middle East. Though IS will remain a significant actor in 2017, regional powers’ attempts to manage the evolving power vacuum will be the main factor shaping the region. Our model states that the Middle East has four main powers (Turkey, Iran, Saudi Arabia and Israel). The region’s principal competitors, Turkey and Iran, will be the major players for 2017.
These two countries, along with the U.S. and Russia, will be entangled in an increasingly complicated conflict. The Americans and the Russians will try to extricate themselves from the region for different reasons. This will gradually bring the Turks and the Iranians into greater competition. In sharp contrast, Saudi Arabia’s ability to shape the region will decrease whereas Israel will continue to avoid entanglement in the region’s morass.
Turkey Steps Up
Turkey’s efforts to greatly step up its involvement in Syria will be the hallmark of the Middle East in the coming year. Despite the ongoing massive civil-military overhaul at home in the wake of the July 15 attempted coup, Ankara will be forced to increase its military involvement in northern Syria. It will significantly increase its troop presence in the territory enclosed between the northern Syrian towns of Azaz, al-Bab, Manbij, Jarabulus and al-Rai. In this area, Turkey will work with its Syrian proxies to mount assaults against both the Syrian Kurds and IS. This will be a slow buildup consisting of several thousand personnel. In this process, however, Turkey will avoid confrontation with the Assad regime and its Russian and Iranian backers. Turkey will focus largely on its chief goal: undermining the Syrian Kurds. Weakening IS will remain a secondary goal that will be pursued only as progress is made on the primary goal. In an effort to contain the expansion of the Kurds, Ankara will try to redirect Arab rebel forces against IS and build Turkish influence in these groups.
Iran’s Strengthening Position
Turkey’s efforts to shape the conflicts in Syria and Iraq will force Iran to confront Turkish forces and their local allies via its own proxies. Having invested a great deal of resources to help the Assad regime regain the upper hand in the civil war, Iran will increasingly focus on ensuring that Turkey does not erode the gains Tehran has made thus far. Tehran will work closely with Shiite and Kurdish forces in Iraq to limit Turkey’s involvement in the country’s Sunni areas. Thus, in 2017, we can expect Turkish-Iranian competition in the region to become more pronounced – even as Iran faces uncertainty at home with presidential elections on May 19. Irrespective of internal factional struggles, Iran will try to leverage the incoming Trump administration’s aggressive stance on IS to its advantage and use it to try and offset complications on the nuclear agreement. In addition, the fact that Iran succeeded in avoiding a cut in its oil production as part of the Nov. 30 OPEC agreement will help the country strengthen its position.
Iran will also increase pressure on Saudi Arabia. But the kingdom will not be in a position to directly confront Iran. Riyadh will have no choice but to allow Ankara to take the lead in preventing Tehran from exploiting the chaos in the Arab world. While Turkey has the ability to shape U.S. policies in the region, the Saudis have no choice but to live with how the Americans and the Turks manage the region. The Saudis will be severely constrained by the economic malaise that they are suffering due to a sharp decline in oil revenue. Even though it relented and has agreed to reduce crude output, Riyadh is unlikely to reverse its deteriorating financial position given that oil prices are unlikely to reach $90 per barrel, which the Saudis need to balance their budget. Thus, the financial crunch will further undermine Saudi Arabia’s ability to act beyond its borders in 2017. Consequently, Riyadh will be forced to scale back on what was an assertive regional policy agenda in 2016, especially with regards to the war on its southern flank in Yemen.
IS will be under increased pressure in 2017, but will remain ensconced in its stronghold of Raqqa until a coalition of forces powerful enough to dislodge it appears, which will not happen by the end of 2017. Despite suffering losses, IS will continue to exploit the competing interests of various stakeholders. IS will lose control of some core territorial holdings in 2017, but it will make attacking forces pay dearly for their gains and will continue to carry out significant guerrilla and terrorist attacks.
Eurasia is experiencing a high degree of instability and destabilization. However, this instability will not be felt in the Western Hemisphere, particularly in South America. The regional shift to center-right politics that started in 2016 will continue in 2017 but will no longer be the defining geopolitical event for South America. Domestic economic performances will instead take center stage in the region, which is known for its production and export of raw materials and commodities. South America’s two largest economies – Brazil and Argentina – will be in a position to resume a leading role in economic and political matters, especially at the regional level.
Brazil’s economy will finally end two years of deep recession and return to modest GDP growth. The country is buffered from the export crisis thanks to its low level of exports as a percent of GDP (13 percent), a large domestic market and a positive economic outlook for the U.S. and Argentina, Brazil’s second and third largest trading partners, respectively. In Argentina, the economic reforms put in place by the government of President Mauricio Macri will start benefiting the economy in 2017. The economy will show signs of normalization such as inflation rates multiple points lower than years past, freer trade flows due to less domestic regulation and less government subsidies.
The most notable political event in the region will be the political crisis in Venezuela. The political gridlock that lasted throughout 2016 will end in 2017. There will be a transformation of the government and the administration of President Nicolás Maduro in its current form will not survive 2017. The opposition now has the ability to call upon tens of thousands of demonstrators across the country on a regular basis. If the dialogue between the government and the opposition fails, the opposition will be forced to take even more drastic social and political measures in 2017. Food and medical shortages show no signs of improving. The government only had $11.75 billion in international reserves as of Nov. 30 – after starting the year with $16.33 billion – and already has sold off much of its gold reserves. International institutions are adding pressure by threatening suspension. Simply put, the 2016 status quo is unsustainable and the breaking point will arrive in 2017.
The remaining countries in the region will experience economic growth but lower than pre-2008 levels. Chile, Ecuador and Venezuela will remain the most vulnerable to the export crisis due to higher reliance on exports as a percent of GDP and the large role commodities (specifically copper and oil) play in their economies.
Sub-Saharan Africa will not play a formative role in the defining geopolitical events of 2017. National or regional events, such as significant unrest or political power transitions, will be notable but will not shift the fundamental behavior or fate of world powers like the U.S., Russia and China.
However, the region will intersect on a secondary level with the major themes for 2017. The intense levels of nationalism in Europe mean that European governments will continue to try to stem the flow of migrants from sub-Saharan Africa. European powers, including Germany, will closely monitor the continent and dedicate the least resources possible to ensure stability in the region. This can be done in a variety of ways including (but not limited to) carrying out development programs, funding education programs and providing support for security efforts.
Similarly, the U.S. and France will continue to monitor the security situation in the region, particularly the strength of extremist groups in the Horn of Africa and the Sahel region. Washington and Paris will very selectively engage in security operations in the area through advising, training, carrying out special forces operations and sharing information. Washington will increase this level of activity in 2017 while Paris will be more constrained, as its security forces are overstretched and being used more heavily domestically.
Countries highly dependent on oil and metals exports, such as Nigeria and Angola, will see arrested and stagnate growth like others suffering from the export crisis. Countries with less dependence on natural resource deposits and larger low-wage basic manufacturing industries will fare well. In particular, low-income countries in East Africa – Ethiopia, Kenya, Tanzania and Uganda – will see their economies grow multiple points above the global and regional average growth rates in 2017, despite potential waves of moderate unrest that is typical for the region.
Long-Term Technological Transformation
Now that our projections for each region have been outlined, we will conclude by noting a significant long-term shift that will have global effects. The shift will begin gaining traction in 2017, and its effects will be confused with forces specific to 2017, though they are part of a long-term development. Global productivity growth has been declining since 2008, after a period of growth dating back to the 1980s. In 2016, U.S. productivity declined in absolute terms for the first time in over a decade. The decline in productivity now becomes a fundamental part of the global equation. The economic expansion since 1982 has been built on productivity and its decline indicates the structural reasons the crisis of the middle and lower-middle class can’t be solved.
The problem is linked with the core technology that led the 1982-2008 expansion: The microchip revolutionized industrial, administrative and government functions, increasing productivity consistently. But productivity increased per person employed and not across the entire public. The financial reasons for restructuring business created the appetite for change. The microchip created the means for change. Part of that change was eliminating many jobs. The greater efficiency of American workers – and their increased pay – encouraged many companies to eliminate processes and this involved large numbers of workers. These processes were exported to low-wage countries. What remained in the U.S. was high-value processes, using highly skilled workers at all levels, supported by growing applications of the microchip. Less skilled workers were marginalized, less by unemployment than by being confined to less skilled jobs and lower real wages.
The decline in productivity this year is the pivot toward a new reality. The reason for the decline had to do with the maturation of microchip-based technology. The microchip began entering the consumer and commercial markets around 1975, with the introduction of microchip-based calculators and watches (by Hewlett-Packard and Casio, respectively), followed shortly by the first computers. That makes the industry’s commercial activity about 50 years old. Ford Motor Company was founded in 1903 – the microchip is now as old as Ford was in 1953. The automobile was a mature product by then, with some minor innovations still to come, but with the primary focus on styling and marketing.
This was culturally the high point of automobiles, when new models were accompanied by great excitement. Twenty years later, Chrysler was in such a bad state that it had to be bailed out. Automobiles were a commodity, and the Japanese and Germans surged into the American market. The microchip is no longer cutting edge. The period of creating new applications, such as the spreadsheet, that revolutionize work is past. Now the emphasis is on styling and minor innovations. New applications still excite the consumer as cars did in 1953, but the level of innovation has peaked.
Therefore, we have seen a decline in productivity. We have now entered a tough period between when an old technology peaks and a new technology emerges. The collapse in the American auto industry in the 1970s, following a long period of decline that appeared on the surface as continued success, did not create the economic crisis of the 1970s but contributed to it and made recovery much more difficult. We are now in a period similar to 1955-1970. Microchip technology remains the central industry, with some new industries being spawned, but it cannot maintain its growth. The early sign of this was the decline of Microsoft (which was once an innovator) and the collapse of Hewlett-Packard, as well as the new, and predictable, difficulty Apple is having maintaining profit levels.
That means that as the global system struggles to break free from 2008, a new constraint – falling productivity – will restrain growth and increase the impact on the middle and lower-middle classes. 2017 will be the beginning of a long decline in microchip-based industries that will not be reversible. These industries will be reduced to desperately looking for new and more dubious applications, such as Apple Pay, the company’s version of a digital credit card. The search for new markets based on minor innovations was a sign of the industry’s decline.
Between now and 2030, there will be an overlap with a new technology that is not yet obvious, and that will revolutionize life the way the internal combustion engine and the microchip did. But if that emerges in 10 years, it will be at least 15 years before it has any impact on the economy. From now until 2030, the economic crisis will be intensified by this.