South America

By Ian Bremmer

Sometimes there's less to a story than meets the eye. Take Venezuelan President Hugo Chávez's announcement last week that he would freeze diplomatic and commercial relations with Colombia. There's nothing new about tensions between these two governments, but markets responded badly to what sounded like a drastic step. This story is much ado about almost nothing.

Chávez is angry that Colombia has invited a few hundred additional US troops into the country, granting them access to three Colombian military bases. (There are currently about 300 American soldiers in the country. Colombia's government insists it will not amend an existing bilateral agreement that caps the total of US troops at no more than 800.) Colombian President Alvaro Uribe insists the troops are there to help target narcotics trafficking, but Chávez has warned his people of an impending Yanqui invasion. Meanwhile, Uribe accuses the Venezuelan government of selling military materiel to FARC guerillas inside Colombia.

There's nothing new about any of this tension. Trade between Venezuela and Colombia briefly shut down in 2005 after Colombia captured a FARC spokesman in Caracas. It happened again in 2008 after a Colombian bombing raid killed FARC's second in command inside neighboring Ecuador, a Venezuelan ally. In both cases, trade between Colombia and Venezuela briefly halted but was quickly restored.

That will happen again this time, because the two governments need the commerce more than they need the conflict. About 14 percent of Venezuela's imports come from Colombia. Venezuela needs these products, particularly processed food, because the tight price controls Chávez has ordered and his ongoing threats to nationalize companies and entire industries have depressed production levels inside his country. Closing the door to inexpensive and easily accessible Colombian imports would worsen already significant shortages and put extra pressure on inflation and fiscal accounts.

The dependence works both ways. About 18 percent of Colombia's exports go to Venezuela. President Uribe has fewer political vulnerabilities than Chávez, and with an election next year, some fear he might take a tougher than usual line -- rallying core supporters, riding out protests from the export sector, and boosting his chances of securing a third presidential term.

But Uribe will probably abandon hopes for a third term, since he's unlikely to win support from lawmakers to launch the referendum he would need to remove constitutional term limits. Uribe already faces criticism that he hasn't done enough to refloat the country's floundering economy. It makes little sense for him to make economic matters worse, just as he's moving into retirement.

It's one thing for Chávez and Uribe to stir up nationalist fury in a bid to change the subject from tough economic times. It's quite another to launch a mutually damaging trade war that can only make matters worse.

JUAN BARRETO/AFP/Getty Images

by Eurasia Group analyst Erasto Almeida

Brazil has navigated the global financial crisis relatively well, and is well positioned to resume economic growth in 2010 and beyond. Responsible macroeconomic policies are probably here to stay, even when a new president takes office in January 2011. New vast oil discoveries will further reduce the country's vulnerability to external shocks and offer a number of new investment opportunities. So what's at stake for the markets in the 2010 elections? It will be important to watch the role of the state and national champions in key sectors such as oil, power, and mining.

No matter who wins the presidential election, it is highly unlikely that Brazil will return to the kind of irresponsible macroeconomic policies it had in the past. The country's largest leftist party, the ruling Worker's Party (PT), has not only embraced responsible macroeconomic policies but, very importantly, benefited politically from its decision, as shown by President Luiz Inacio Lula da Silva's reelection in 2006 and 80 percent approval ratings.

Lula's chosen candidate to succeed him, Chief of Staff Dilma Rousseff, is unlikely to change course. Jose Serra, the governor of Sao Paulo from the opposition Brazilian Social Democracy Party (PSDB), who will probably be her main adversary, is even more market friendly. Rousseff and Serra might differ on how to calibrate policies, but neither one will significantly alter the status quo. The 2010 electoral cycle may contribute to some fiscal slippage and generate noise on monetary policy with the likely departure of central bank governor Henrique Meirelles, who wants to run for office. Yet even if a less predictable candidate emerges and wins the election, a shift away from voters' preferences for low inflation is unlikely. Brazil remains overall a sound long-term bet for investors.

With macroeconomic stability here to stay, what differentiates the two main candidates is their view on industrial policy and the state's role in key sectors of the economy. Rousseff has a much more state-centered view than Serra, perhaps even more than Lula. Her view is already present in the current government, where she is the key policy decision-maker, but it would probably become more salient in a new PT administration. Investment from state-controlled energy company Petrobras, for instance, has been a key component of the government's counter-cyclical policy. More recently, the government seems to have decided to propose that Petrobras be the sole operator of the new deep-sea oil province. There may be similar moves, if on a smaller scale, in the power sector, for example, with a greater role for state-owned utility Eletrobras. Brazil's National Development Banks (BNDES) will play an increasingly important role in providing financing for companies and projects. Rousseff wants greater private investment as well, but as Brazil's economy and state revenues grow, she will have more room to push for industrial policies and national champions. If Jose Serra and the PSDB win, however, the state and national champions would have much less involvement.

The big question that remains open, of course, is who will the election. While the presidential race is expected to be tight and it's still early to make concrete predictions, the odds seem to be in Rousseff's favor. Although she is behind Serra in current polls, has never run for office, and lacks Lula's charisma, she signifies continuity -- which is likely to be the popular trend. Brazilians are happy with the economy and recent improvements in their lives. Studies show a steady expansion of the lower-middle class, which grew from 42 percent of the population to 52 percent in the past seven years. This progress helps explain Lula's record high approval ratings, which will also be Rousseff's main asset. If she wins, she won't put economic stability at risk, but Brazil will most likely see the state take a heavier hand.

EVARISTO SA/AFP/Getty Images

By Eurasia Group analyst Daniel Kerner

Argentina has seen better days.

Following a dramatic political and economic crisis in late 2001 and the largest sovereign default in recent economic history, Argentina enjoyed a remarkable economic recovery over the next several years. Under President Nestor Kirchner (2003-2007), a favorable international environment helped boost the country's economy at a record pace, enabling him to consolidate power and to become one of the most popular and successful presidents in Argentine history. His popularity (approval ratings of close to 70 percent for most of his mandate) allowed him to transfer political power to his wife, Cristina Fernandez de Kirchner, who was elected president by a comfortable margin in October 2007.

But the trouble began even before Nestor Kirchner stepped aside. Despite his political success, his government's reluctance to address rising inflation, unpaid external debt and energy shortages began to raise doubts over the sustainability of Argentina's growth. Inflation began to climb in 2005. The government responded with expansionary fiscal and monetary policies, manipulated inflation statistics, and heavy and sustained pressure on the private sector to keep prices low. Hopes that the Fernandez de Kirchner administration would more openly address these problems were quickly dashed.

But it was last year's four-month conflict with the farming sector over export taxes that delivered the heaviest blow to the Kirchners' popularity. The conflict began after the government sharply raised taxes on soybean exports and refused to reduce them despite massive protests. The taxes were repealed only after the senate voted against the government's proposal. The government's decision to shore up its fiscal position by nationalizing local pension funds further undermined confidence in both the government and in Argentina's economic prospects.

But it was last weekend's election results that finally closed the door on the Kirchner era in Argentine politics. Months ago, the Kirchners knew they had a fight on their hands. Afraid a bad economy would only get worse, the government surprised many observers by pushing forward the date of mid-term elections from October to June. Aware that even the earlier elections would leave them at a disadvantage in key electoral districts, the Kirchners upped the stakes. Nestor Kirchner himself announced that he would seek a lower house seat representing the province of Buenos Aires.

He lost. And the government lost its majority in both houses of congress. In fact, government candidates fell in most of the country's largest electoral districts, including the Capital, Buenos Aires, Cordoba, Entre Rios, Mendoza and Santa Fe.

The Kirchners were hoping to maintain what was left of their grip on the Peronist Party and to dominate the political agenda heading into the next presidential election in 2011. Instead, the sun rose Monday morning on a new set of opposition leaders, like Vice President Julio Cobos, Senator Carlos Reutemann, and Buenos Aires mayor Mauricio Macri, who are well positioned to challenge for the presidency in two years. The country's most powerful politician, Nestor Kirchner, resigned Monday as leader of the Peronist Party. Though two years remain in her presidency, Cristina Fernandez de Kirchner has become a lame duck.

The key economic policy question is whether the Kirchners, who have refused to negotiate or compromise with rivals both inside and outside the Peronist Party can navigate the newly treacherous political waters.

If so, they'll have to fundamentally shift the way they've done business for the past six years. That's why it probably won't happen -- and why Argentina's political and economic forecast will remain mostly cloudy until a new president is elected in 2011.

CLAUDIO SANTANA/AFP/Getty Images

By Ian Bremmer
 
The first five "fat tails" are detailed in the entry below. Here are the second five. Again, each of these scenarios remains unlikely. But in each case, the impact of the global economic meltdown on a particular state's real economy has dramatically increased the likelihood of a fat tail occurring -- from 2 percent or 3 percent six months ago to 10 percent to 20 percent over the next several months, a serious enough concern to warrant focused attention.

6. Turkey's secularists lash out

Reinvigorated by their solid performance in recent local elections and still seething over last year's failed bid to close the ruling justice and development party (AKP), Turkey's opposition secularists in the military, media, and business elite are emboldened to try again, launching a public campaign to build opposition to the ruling party across the country. A sharper-than-expected economic contraction provides them with a new political opportunity to take on the AKP in the courts.

Weakened by the AKP's own poor election showing, Prime Minister Recep Tayyip Erdogan struggles to manage the nationalist and radical Islamist elements within his party. Convinced that his political survival depends more on party unity than on building consensus across the political class, Erdogan overplays his hand by trying once again to amend the constitution. The high court orders closure of the AKP and bans Erdogan from office. Turkey then finds itself in an institutional crisis that brings policymaking -- and the country's bid to join the European Union -- to a grinding halt in the middle of a recession. Foreign investors abandon ship, moving capital into less risky markets.

7. Argentina opens up

Fat tails can offer opportunities as well as risks.  That's the case in Argentina.  There the global recession could unravel the country's economy. The government's inability to manage the fallout would push its poll numbers sharply lower, persuading advisors to President Cristina Fernandez de Kirchner to advance the date of legislative elections from October to June to allow her allies a chance to face voters before the opposition gets organized and the economy deteriorates further. The president's husband, former president Néstor Kirchner, would head the government's legislative list.

Against the backdrop of spiraling social discontent, President Kirchner's Peronist party loses its lower house majority, and Néstor Kirchner would finish behind dissident members of his own party in Buenos Aires. The president resigns, and Vice President Julio Cobos becomes president. Kirchner's departure opens new policy possibilities. The Cobos government reduces state interference in domestic markets, removes restrictions on the farming sector, and improves the transparency (and therefore the credibility) of the national statistics institute. He signs an agreement with the IMF and promises to resolve the country's outstanding debt problems, quelling fears of default. This leads to a serious improvement in market sentiment.

8. The emirates disintegrate

The weakness of existing federal institutions has pulled back the curtain on a serious problem -- Emirati leaders haven't been able to respond in a coordinated way to the financial crisis. Abu Dhabi has jumped in to recapitalize the other emirates, but its strong moves to extend political control could push angry royals in Dubai, Ras al Khaymah and Sharjah, to look for future opportunities to reassert their independence.

Under this scenario, once the financial crisis passes, the smaller emirates try to kickstart their economic programs, provoking a federal veto. Sheikh Mohammed bin Rashid al Maktoum of Dubai tries to reestablish his economic autonomy by launching new infrastructure projects without the approval of Abu Dhabi's al Nahayan family. Abu Dhabi then blocks Dubai's negotiations with international partners, damaging Dubai's credibility and humiliating its royal family. Sharjah tries to restart talks on gas imports from Iran and Ras al Khaymah considers the same option. The Abu Dhabi-dominated federal government opposes the process. The smaller states then create a new federation or simply become independent states, and the UAE federation ceases to exist. The weak institutionalization of federalism and the UAE's increasingly personalized politics make this scenario not quite as unlikely as it seems.

9. Japan's policy paralysis

Japan's Liberal Democratic Party (LDP) will likely lose control of the lower house of parliament, the chamber which selects the prime minister, in an election that must be called by September 10. The opposition Democratic Party of Japan (DPJ) will likely win a majority of seats outright and form a new cabinet or a large plurality and forge a coalition with independents and LDP defectors.

But the more worrisome scenario involves the DPJ failing to win a majority of lower house seats, creating a chain reaction of party schisms that paralyze the coalition building process. The LDP loss aggravates already bitter internal rivalries, splintering the party that has ruled Japan almost continuously for more than 50 years. Internal battles over policy also plague the DPJ. If more conservative DPJ members form alliances with former LDP members, the DPJ could fall apart as well, further complicating the coalition-building process at a moment of economic uncertainty.

Japan is then ruled (as it was during the mid 1990s) by a fragile and fractious multiparty coalition that can't advance reforms needed for response to the economic crisis, deregulation, and foreign-policy priorities like reinvigorated relations with Washington, undermining Japan's value as an economic and security partner. This scenario provokes anxiety over the future strength of the Japanese economy and its security alliance with the United States. It then takes several years for the country's leading political parties to redevelop along ideologically coherent lines.

10. Poland runs off the rails

In Poland, the Civic Platform (PO)-led ruling coalition has successfully promoted a moderate, pro-market, pro-western agenda and has become one of Eastern Europe's most stable and capable governments. But under this fat tail scenario, the global economic outlook pushes Poland into a severe recession. Following an anti-market, anti-foreigner, and thinly veiled anti-banking/anti-Semitic electoral campaign, the populist/nationalist Law and Justice party (PIS) takes power in 2011, and the country turns inward. The new government blames capitalism (as well as the west in general and PO in particular) for all of Poland's ills. Its policy agenda is economically statist and culturally intolerant and nationalist.

The PIS-led government asserts control over a broad range of state and quasi-state companies in sectors like energy, mining, and banking/insurance. Officials appoint boards of directors for these companies based less on competence than on political loyalty. Poland withdraws its commitment to join the eurozone. The government scores domestic political points via attacks on both the EU and Russia -- with negative strategic and economic consequences. PIS launches corruption "witch hunts" against former communists, PO party loyalists, and foreigners, destabilizing Poland's economy and generating capital flight.

Click Here for The 10 crises you aren't expecting but should be (Part 1)