Political Risk In Asian Markets

Address by Professor the Hon Gareth Evans, Chancellor Australian National University, President Emeritus International Crisis Group and former Australian Foreign Minister, to 2011 Credit Suisse Asian Investment Conference, Hong Kong, 21 March 2011

In the last few days I’ve had occasion to look at three very fat reports from three very well-fed groups of specialists recently trying to predict the world’s risks in the years and decades ahead – one from the US National Intelligence Council called Global Trends 2025, another from the UK Ministry of Defence called Global Strategic Trends – Out to 2040, and another from the Word Economic Forum called Global Risks 2011. And, apart from a few tentative phrases about possible “turmoil” at some unspecified time in the future, not one of them even began to predict the popular revolutions in the last three weeks that have transformed North Africa, and maybe the whole Middle East…

It is actually nothing new for experts to miss these things. It is what happened with the outbreak of World War I, the collapse of the Soviet Union, 9/11 and scores of other huge and sudden changes in the security environment. And of course it has happened over and again with major, transformative economic shocks, not least the global financial meltdown of 2008.

The gap between self-confidence and actual performance in expert forecasting ability has been wonderfully documented by the Berkeley psychologist Philip Tetlock in his long term study of 284 people who made their living “commenting or offering advice on political and economic trends”. It is not a study that has done much for the morale of experts, but it certainly cheers up everyone else. Over a twenty year period he asked his experts to rate the probability of various things occurring, in three possible ways – the status quo persisting; more of something happening (e.g. political freedom, economic growth); or less of something (e.g. repression, recession). After analysing more than 82,000 such forecasts, his conclusion was that the experts performed worse than if they had simply assigned an equal probability to all three outcomes. They were, in other words, poorer forecasters than dart-throwing monkeys.

That doesn’t of course stop our public intellectuals – particularly those who specialise in big overarching theories of everything (the end of history, the clash of civilisations and so on) – rationalising their errors or omissions and moving boldly on to their next big mistake. And we all know that there’s only one thing the media likes better than an expert with a grand, simple idea or prediction that’s quite likely to be wrong – and that’s two such pundits who don’t agree!

Just as it’s the custom in the US to commence a speech with a usually-not-very -good joke, so is it the custom in this part of the world to commence one with a usually-not- very-persuasive expression of humility. So let me say that in this case – knowing what you and I both now know about the fallibility of predictive judgment – if I was anything other than humble in talking about the Asian political risk landscape, I’d be having you on.

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But we all have to move on, and make the best judgements we possibly can, on the best available information. I have to justify my invitation to speak to you. And you as investors and executives don’t have the luxury of staying in bed each morning with the covers pulled over your head – as you well might want to with the amount of political and economic uncertainty that’s out there in so many parts of the world.

It’s not just the big calls you have to make on interest rate, exchange rate and commodity price movements, which of course can be just as much influenced by major political events as purely economic events and natural disasters like the Japan tsunami. If you want to maximise your opportunities and stay ahead of your competitors, you also have to make big calls about specific country situations which are often laden with political risk judgments: whether to get in or stay out, or pull out, of a particular emerging market; whether to put massive funds into a specific infrastructure project that will be dependent on government blessing for years to come, but in a political environment which looks potentially fragile; whether you can afford the reputational risk of association with a regime that looks able to guarantee stability, but only at the price of domestic repression; and so on and on.

In making these calls in the case of particular countries, there is no substitute for detailed case-by-case analysis – which is field-based and shoe-leather based, not just internet and leather-chair driven – because so much of it is dependent on questions of individual personality, and the intensity of underlying community sentiment, which just can’t be accurately read at a distance. There is a lot of such information out there of this kind – not least from my own old organisation, the International Crisis Group – which I suspect is much less well utilised than it could and should be.

That said, major, destabilizing political turning points are often very hard to predict, even for those very close to the ground. In North Africa and the Middle East there has been a sense for quite a long time, among those of us following the situations there, that street sentiment has been building up against the ruling regimes, particularly among unemployed and underemployed youth, and that this was something distinct from – albeit to some extent being used by – explicitly Islamist feeling. But that that sentiment would erupt when and where it did, in Tunisia, and on the scale that it did, was beyond anyone’s capacity to read.

Once the ball was set rolling, what would happen next has been a little easier to read – but not much easier. Republics in the region seem to be at more risk of disintegration than the kingdoms and sheikhdoms which have strong tribal legitimacy (and in the case of Saudi Arabia religious legitimacy as well); countries with minorities ruling over majorities (like Bahrain and Syria) seem to be more at risk than those with a majority group in the saddle; and countries which are more repressive (like Algeria, Libya and Yemen) seem to be more at risk than whose which have been less so (in particular the Gulf states, which have generally found it more effective to buy off trouble with energy revenues than repress it outright) – though this is less clear.

I make that qualification because, unhappily, when taken to extremes, repression can be extremely effective in protecting a ruling regime, at least in the short to medium term. If an army or police force is prepared to shoot its own people in cold blood – as Egypt’s and Tunisia’s armies were not, but Libya’s has been, and Myanmar’s was in this region, and if the international community does not forcefully intervene on the side of the repressed – regimes can survive. But there is a question for how long, before the pressure cooker does finally burst. Bahrain and Yemen are the big Middle East test cases as we speak.

In this part of the world, China is clearly wrestling with this dilemma right now. It is difficult to see popular unhappiness here as being at, or growing soon to, anything like the boiling point of Tunisia, Egypt and Libya, with so much growth and economic opportunity. But tensions and stresses are abundant, and it is not clear that they can be permanently contained by the memory of the Tienanmen massacre and the kind of heavy security crackdown that is now being imposed around the country to ward off any possible Middle East contagion.

Some leaders like Premier Wen Jiabao do seem to understand that the only long-term guarantee of internal stability is to move forward on a serious political reform agenda – and, as he said to the National People’s Congress recently, acting to “solve problems that cause great resentment among the masses”. But it is not clear to what extent this view is shared by the next generation of leaders shortly to take office, and by other key elements within a by no means monolithic and united governing structure. On what we have seen so far there is reason for optimism, but it has to be cautious optimism.

There is plenty to talk about, had we the time, in other internal situations still festering around the region, for example, in Myanmar, to some extent in Sri Lanka and Nepal, and in parts of Thailand, the Philippines, India and Indonesia. But by and large, in-country political risk situations don’t have the potential to generate the wider regional or global-scale uncertainties or catastrophes which would have much greater ramifications for investment decision-making.

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What will have a major impact in this respect, and basically determine the whole future of the region, will be, I think, the working out in the months and years ahead of four absolutely crucial sets of relationships – between China and the US; China and its immediate neighbours; China and India; and India and Pakistan. If these can all be managed reasonably smoothly, with no more than the normal quota of bumps and grinds along the way, then the future is very bright indeed; but if any of them go bottom up in a really major way, you’ll wish you’d kept your money in a mattress.

China and the United States. The bilateral relationship is currently being reasonably managed by both sides, following a visible stepping back by China from some of its more aggressive postures last year on territorial waters issues which had attracted a sharp US response; and the constructive visit by Wen Jiabao to Washington in January. .

But – and it’s a very big but – there still remains the huge underlying issue of how the US will respond over the next few years to the dramatic acceleration in China’s economic growth, and all the stretching of wings, not least in rapidly increasing military capability, that is going with that. The central dilemma for Washington remains that which I heard Bill Clinton pose at a private gathering nearly a decade ago, in words that still – much more than a lot of things he said and did publicly while in office – echo strongly with me, and I think will with you:

America has two choices. We can use our great and unprecedented military and economic power to try to stay top dog on the global block in perpetuity. Or we can seek to use that power to create a world in which we are comfortable living when we are no longer top dog on the global block.

My own sense is that the US will be sensible enough to make the second choice, and that that is certainly the direction in which President Obama wants to go. But if there is a shift back toward an uncompromising insistence on maintaining absolute dominance in the region, as well as globally, then there is every chance things will end in tears.

China and its Neighbours. China’s relationships with Japan, ROK, Taiwan and with its disputed-sea-boundary neighbours in the South China Sea are all reasonably quiet right now, but the capacity for blow-up is never very far away, and every commentator has a favourite “flashpoint”. Beijing’s overwhelming preoccupation is with maintaining internal stability, and there is no rational basis for picking foreign policy fights in its neighbourhood or anywhere else. But there is a periodic risk in the current environment of adventurism and overreach, as we saw with some of the posturing – apparently driven by military and resource-focused interests – in both the South and East China Seas in the last year.

History looms as a constant undercurrent, with Chinese nationalist sentiment – against Japan, and to a lesser extent the ROK - periodically allowed emotional rein by the leadership in recent years if diversions from domestic troubles have been required. And the relationship with Taiwan has its own always potentially explosive dynamic, with existential passions close to the surface on both sides of the Strait – though again, very much under wraps at the moment in the positive environment generated since President Ma Ying-jeo and the KMT regained government.

A critical relationship is Beijing’s with Pyongyang. Senior officials privately claim frustration with their inability, however hard they try, to keep North Korea policy, particularly on the nuclear question, on a reasonable track. While some scepticism is in order, China ought to be taken seriously when it says it has to be cautious about applying the food and energy leverage it has, because its overwhelming priority has to be avoiding at all costs triggering the North’s implosion, with all the population movement and regional instability that would generate.

And I don’t personally believe, though some still do, that Beijing is obsessed with maintaining the status quo in order to keep the US – through its Seoul ally - at arms length from its own borders. Overall the North Korea situation looks reasonably manageable and containable, but it seems likely to continue to generate stress in the region for some years to come.

China and India. The two home-grown top dogs on the Asian block have had a long history of border and other tensions. That’s been compounded on the Chinese side by a fairly conspicuous lack of respect towards the quality of Indian democracy and economic management. And on the Indian side by its resentment at China’s UN Security Council status, and more recently China’s activist presence in the Indian Ocean. It cannot be assumed that difficulties between them will evaporate any time soon.

But since the very visible deterioration of relations in 2009 – over Washington’s bending of the Nuclear Non-Proliferation Treaty rules with its bilateral nuclear deal with India, and what China saw as an exercise in attempted strategic encirclement being mounted by the ‘Quad’ (Japan, US, India and Australia) – real efforts have been made to patch things up, with Wen Jiabao’s visit to Delhi in December proclaiming success in “managing differences, maximizing opportunities”, and a return visit scheduled for later this year. The stakes are too high for things not to stay patched up, but this could well be a bumpy road.

India and Pakistan. So long as relations between these two nuclear armed states remain as poisonous as they have traditionally been – whether the issue is Kashmir, jihadist militancy, Hindu extremism, or the conduct of the war in Afghanistan – it is entirely reasonable for policymakers, and investors, elsewhere in the region, and the wider world, to remain quite anxious as to where it might all lead.

The internal situation in Pakistan is more troubling than anywhere else in Asia at the moment. The quality of Indian democracy might not be breathtakingly good, but in Pakistan it is breathtakingly bad. One piece of good news is that the country does have a burgeoning middle class with a taste for democracy and a hunger for genuine good governance. But it’s overwhelmed by the bad news. The army still calls the shots, and calls most of them wrong when it comes to relations with India and Afghanistan. Pakistan has a terrible past record on nuclear proliferation, and arguably sees its nuclear weapons not as a basis for durable stability – as the major nuclear weapons states always have, however wrong-headedly – but rather for deliberate instability, to keep India off-balance. Religious extremism is intensifying. Regional and communal tensions are acute. And the education system is appalling, symptomatic of the governmental malaise across the board.

Attempts keep being made to restart major bilateral talks between India and Pakistan, and there is everything to be gained, not least economically, by fully opening borders and reaching agreement on outstanding contentious issues, including settling the international border in Kashmir at the existing line of control (which for years has seemed to just about everyone else in the world the obvious solution), and preventing potentially disastrous disputes in the future about water. But army politics in Pakistan and party politics in India continue to block progress, and there is a history of smaller tensions rapidly escalating and becoming explosive.

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Overall in Asia, with the heavy qualification of what I have just been saying about the India-Pakistan relationship, I think it’s right to be cautiously optimistic about the political risk outlook. I am well aware that to be an optimist about anything in international affairs, in today’s world of recurring disaster and drama, is to run a strong risk of being branded ignorant, incorrigibly naïve or outright demented. But nonetheless I think there are some solid foundations for me taking that risk.

One is a very visible shift away from the age-old instinct to resort to violent conflict to solve problems. We sometimes lose sight of the fact that while South Asia continues to generate a good deal of anxiety, North East and South East Asia in recent decades have undergone a quite extraordinary transformation, from being literally the most war-torn region in the world from 1946 to the end of the 1970s, to now being just about the least violent region in the whole international system.

Moreover, this has all been just part, albeit a big part, of a spectacular, but spectacularly under-reported, global phenomenon. Since the end of the Cold War, as counter-intuitive as this will seem to most of you - given what’s in every newspaper you read and every bulletin you watch - the truth is that many more old conflicts have ended than new ones have started; the number of major conflicts (those causing 1,000 or more battle deaths a year) have declined by 80 per cent; and the number of those dying violent deaths in such conflicts has also declined by around 80 per cent.

There are a lot of questions we can ask as to why this is so. In the case of declining civil conflict, how much of this has been associated with the end of the Cold War and its proxy conflicts? How much with the impact of economic prosperity and rising incomes in changing the opportunity costs of rebellion and increasing the relative strength of the state? how much with much greater international activism in peacemaking, peacekeeping and peacebuilding? How much with a growing acceptance (even by China, as its non-obstructive vote in the Security Council on Libya last week shows) of universal human rights, including the responsibility to protect civilians against mass atrocity crimes?

Again we can ask, in the case of dramatically declining international conflict, how much of the disappearance has been due to a recognition that the degree of today’s economic interdependence makes war a crazily counterproductive option for just about every state? How much to international conflict prevention activism? How much, perhaps, to a new kind of cultural aversion to war, not previously discernible in human behaviour, after the catastrophes of the 20th century?

I can’t give you decisive answers to those questions, but my own experience tells me that just about all the factors I’ve mentioned have played a significant part in generating today’s comparative tranquillity in this region, and the optimist in me persuades me that there is every reason to believe that they will continue to operate in the future, provided policymakers remain attentive to the main game and sensitive to the real interests of their own populations.

There is one other recent development that also encourages the optimist in me, and I think should in you, and that is some decisions that have been made in the last few months to create region-wide policy-making architecture in the wider Asian and Asia Pacific region that might actually work.

Up until last year there were three obvious basic gaps in that dialogue and cooperation architecture: no security forum bringing all key players together at leaders level; no inclusion of India in the key economic and trade forum – APEC; and, in the only forum with potential for broad-ranging dialogue on all major policy issues, security, economic, and broader socio-political – the East Asia Summit –no inclusion of the US and Russia.

It has now been agreed that from this year the East Asian Summit will now include both the US and Russia. This means an annual meeting of leaders from all the key regional stakeholders – China-Japan-ROK, the ASEAN ten, India, Australia-New Zealand, and the US and Russia – which is able to debate in free-ranging way all the key economic, security and strategic political issues (including the environment) that will be crucial to our common future.

Of course what we need with this new architecture, if it is really going to enhance stability, prosperity, state security and human security, is real dialogue and real policy cooperation that will not only defuse potential conflicts and maintain overall stability, but will produce real incentives for open investment and strong economic growth.

What we don’t need is just another expensive series of photo-opportunities for people posing in silly shirts making set-piece speeches endorsing pre-cooked lowest-common denominator communiqués.

But, knowing governments and officials and politicians as we do, even for the most extreme optimists among us – which I know includes most of you, because if you weren’t you would long ago have all jumped off bridges – achieving that might just be a bridge too far.