Note: Today is the fourth in a series of posts that detail Eurasia Group's Top Risks for 2013.
With the votes counted and the cliff averted, 2013 ought to be a year of substantial legislative accomplishment. Term limits ensure that President Obama can afford to be bolder than a first-term president in offering up concessions in exchange for tangible policy achievements. Republicans, eager for better vote results in 2014 and 2016, should be ready to prove they can get positive things done. The U.S. economy looks set for stronger growth. On energy (the shale revolution) and trade (the Trans-Pacific and Trans-Atlantic deals), there are game-changing possibilities to be had. On immigration, the two parties have incentives for cooperation, and both Democrats and Republicans have said that entitlement and tax reform are needed to boost long-term, sustainable growth.
Unfortunately, we can expect another year of zero-sum partisan combat. Elected officials from the two parties are now appealing to increasingly separate constituencies with quite different values on questions of budget and borrowing. A significant number of House Republicans worry more over primary challenges within their reliably conservative districts than about damage to their party's national brand. Democrats, in turn, have seized on issues like immigration reform and women's health issues to deepen their support with groups they believe Republicans are alienating. Obama says he will not negotiate over the debt ceiling. House Speaker John Boehner vows to never again negotiate privately with Obama.
Add volatility elsewhere in the world and the conviction among many investors that the U.S. remains the safest port in any storm, and complacency has begun to take root in Washington over the need to correct chronic imbalances. Borrowing costs remain low, leaving bond markets with less power to discipline elected officials than at almost any time in recent U.S. history. Absent substantial market pressure, U.S. politicians now have little incentive to risk pain by cutting spending and raising taxes in ways that would substantially reduce the federal debt.
A battle over the debt limit and government spending begins in February. Should Washington not produce a deal in time, the U.S. government would shut down, significant automatic spending cuts would take effect, and the government would default on its debts for the first time. The two sides will eventually have to find a way out of the impasse, but political and market volatility is unavoidable.
Compared with more volatile emerging markets, the downside from even worst-case U.S. scenarios is limited. But in a year when political compromise might have turbocharged growth, that opportunity is likely to be wasted.
On Friday, we'll profile Risk #5: the JIBs -- Japan, Israel, and Britain.
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Eurasia Group's weekly selection of essential reading for the political risk junkie -- presented in no particular order. As always, feel free to give us your feedback or selections @EurasiaGroup or @IanBremmer.
1. "Freshmen From Kennedy to Double Amputee Join Polarized
Steve Walsh, Bloomberg
An interesting glimpse at some of the new personalities in the 113th Congress, a group of representatives that runs the gamut of conceivable paths to Washington -- and the new Congress breaks records, with 81 women in the House and 20 women in the Senate (both all-time highs).
How to reconcile the similar economic growth we've seen in Mali and Ghana with their starkly different development trajectories? There's no simple answer, but this piece is a good primer on many of the variables involved.
3. "The Art of Snore"
John Arquilla, Foreign Policy
On US defense spending, are there more than budget cuts to fear? Is there an innovation deficit? Arquilla outlines what he perceives as shortcomings in the current military spending approach -- as well as some interesting solutions.
4a."Myanmar Launches Airstrikes on Kachin Rebels"
Simon Roughneen, Christian Science Monitor
4b."Burma's Military Follows Own Course in War against Kachin
Jonathan Manthorpe, The Vancouver Sun
When Barack Obama and Hillary Clinton visited Myanmar in November, it was an historic occurrence -- the first-ever US presidential visit to the country, and a firm endorsement of the recent reforms that have taken place. But while national hero and opposition leader Aung San Suu Kyi warmly greeted the visitors, she also admonished that "we have to be very careful that we are not lured by a mirage of success." Fighting between the military and Kachin rebels in the north has clouded reform efforts. And, as Jonathan Manthorpe explains, Myanmar's relations with China -- and water security issues -- underpin much of the issue. These are two sources of conflict that are only trending upward throughout the region as a whole.
5. "Better Than Human"
Kevin Kelly, Wired
At Eurasia Group, we've devoted a lot of attention to the long-term labor force impact that the advent of robotics and 3D printing will have, particularly on emerging markets like China, where the country's greatest resource -- cheap labor -- could very well become one of its biggest obstacles as its citizens are displaced from manufacturing jobs following technological advances. Kelly looks on the bright side of a robotic future, outlining the opportunities for innovation and productivity that come with a mechanized work force. His vision is a bit rosy, but it's a useful counterweight to the much-discussed downside risks.
By Risa Grais-Targow
Cuba. Oil. Two words that tend to get U.S. politicians hot under the collar, though usually not in the same sentence. That could change as the 2012 campaign season heats up in the U.S. and as Cuba's plans for offshore oil exploration materialize. The Chinese-built, Italian-owned Scarabeo 9 rig is scheduled to enter Cuban waters in August or September, and a consortium of international oil companies is set to begin drilling soon after. The struggling island nation, which currently depends on generous oil deals from its friend and neighbor Venezuela, has high hopes that its potential offshore resources might rev up its sagging economy. (Cuba claims that it has 20 billion barrels of "probable" oil in the continental shelf just off Havana, while the U.S. Geological Survey thinks that number is closer to 5 billion barrels.) But as the rig makes its steady way from Singapore, officials in Washington are getting anxious. Many lawmakers doubt that Cuba has the regulatory capacity or expertise to drill safely, particularly without the U.S.-manufactured equipment that the more than 50-year-old embargo has kept out of Cuban hands. And with BP's spill in the Gulf of Mexico still fresh in the U.S. public's mind, politicians are flagging the possibility of a Macondo-like spill 50 miles off the Florida coast.
The specter of such a disaster has already prompted several legislative efforts to punish foreign firms that drill in Cuba -- or at least those who chose not to comply with U.S. safety standards. Since January, Congressional hardliners from Florida have introduced three bills proposing to deny contracts to such firms or visas to their employees. The bills are designed to appeal to anti-Castro constituencies in the run-up to the elections, but widespread haggling over the issue is set to increase as Cuba's drilling plans progress, and the issue could become a talking point for presidential candidates in battleground states. For its part, Cuba will keep scrambling to convince the international community that it will uphold international safety standards. But those PR efforts will do little to cool the heated debate brewing on the Hill.
That said, none of the bills is likely to move anytime soon, given another powerful constituency: oil. Pro-drilling legislators in the House will be wary of punishing foreign oil companies (some of which have U.S. operations). The issue will also be overshadowed by pre-election priorities such as job creation. In the absence of Congressional action, the administration will likely take an ad-hoc approach. It might twist companies' arms behind closed doors, as it recently tried to do with Spain's Repsol, to get them to abandon their plans altogether. Or, if that doesn't work, it might simply push for guaranteed safety compliance. Measures that involve engaging directly with Cuban officials are unlikely, leaving room for less controversial alternatives such as allowing companies that specialize in emergency response to contract with Cuba and creating some kind of exception to the embargo that allows Cuba to use certain U.S.-manufactured equipment to prevent or minimize spills.
Risa Grais-Targow is a member of Eurasia Group's Latin America practice.
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By Risa Grais-Targow
By all rational measures, Cuba is effectively irrelevant to the United States. The island is small, its economy is about the size of New Hampshire's, and since the collapse of the USSR it poses no strategic threat. Yet the Castros have a habit of popping up in the headlines. In part, that is because of the inevitable fascination with a small country that has been a foreign policy irritant for the United States since 1959 and, more recently, its outsized role in Florida politics. But change is coming to Cuba, slowly but surely, and with change comes the possibility of unexpected volatility.
Cuba is gearing up for the first Cuban Communist Party (CCP) congress in 14 years, to be held April 16-19. Much of the event will be focused on formalizing Raul Castro's small steps toward economic liberalization (e.g., trimming the state's workforce and allowing more room for entrepreneurs) outlined in a November 2010 wish-list of 300 reforms. Another, perhaps more important, development will be the identification of the next generation of leaders, including the appointment of a new second-in-command for the CCP (the second most powerful position in Cuba). The long delay since the previous CCP congress suggests that there has been much internal wrangling over that issue.
The Castros are clearly on the way out (Fidel is 84 and Raul is 79), and the CCP has promised that the congress will usher in a new generation of leaders. Just how new and young they will be remains to be seen. On March 25, Raul Castro announced that the 50-year-old Economy and Planning Minister Marino Murillo, who has been the architect of much of the economic reform agenda, would now oversee its implementation as a sort of economic czar, signaling Raul's devotion to the reform process. The CCP may, however, simply shuffle senior party members into new positions rather than appoint younger reformers.
Such developments could also be important for the U.S. and perhaps trade with Cuba. Unless Congress decides to revisit the issue, the Helms-Burton Act of 1996 stipulates that the Cuban embargo cannot be lifted while the Castro regime is still in power. A shift in the leadership could also open the way to dealing with other potential concerns. For example, Cuba is actively exploring for oil in the Gulf of Mexico, raising U.S. concerns about how it would handle disasters similar to the 2010 Macondo well blowout.
But the CCP faces deeper challenges than this round of leadership refreshment. Most young Cubans are disenchanted with the regime. They have spent most of their lives in post-Soviet Cuba dealing with grinding economic hardship. Finding true believers among that generation is likely a difficult task and the regime's ability to implement meaningful reforms will affect the stability of Cuban politics further down the line.
Risa Grais-Targow is an analyst in Eurasia Group's Latin America practice.
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By Ian Bremmer and David Gordon
Many investors wrongly assume that congressional gridlock will present few risks in 2011 and may even provide the predictability that investors look for. But a divided government can throw up unnecessary roadblocks to necessary policy changes. It can also push the White House to rely more heavily on executive powers, which are harder to predict and influence, to get things done. At a time of sluggish economic recovery and still high unemployment numbers, congressional gridlock is especially damaging.
U.S. gridlock poses three major risks this year:
First is the risk that there will be no movement on policies that investors and business leaders want to see. The most important of these is housing finance reform. Democrats and Republicans are not far apart on potential solutions, but the tough issues of winding down Fannie Mae and Freddie Mac and deciding what to do on affordable housing limits prospects for success. Failure to resolve the issue would prolong a key driver of the weak recovery, as would failure to take substantive action on the recommendations of President Obama's bipartisan deficit commission.
Second, in 2011, headline risk will be driven by both parties promoting priorities for which there is no path forward. The Republicans want to substantially revise the Dodd-Frank financial regulation bill, but they don't have the power to do it, even if they threaten to hold up funding for the Securities and Exchange Commission and the Commodity Futures Trading Commission. President Obama will resuscitate immigration reform despite the fact that the legislation will not pass the Republican-controlled House.
Third is the risk that a road-blocked White House takes heavier-handed administrative actions that are hard to predict or influence. As President Obama finds little room to legislate next year, he is likely to turn to the things he can accomplish on his own. Understanding how the president can use his powers will be critical to getting 2011 forecasts right.
On Monday, we'll take a closer look at Top Risk no. 8: Pakistan, which faces a near perfect storm of political, economic, and social crises.
Ian Bremmer is president of Eurasia Group. David Gordon is the firm's head of research.
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By Dan Alamariu
Despite rising concerns over a Republican Senate filibuster, over the next month or so, the U.S. Congress will probably pass the most comprehensive financial regulatory reform overhaul since the aftermath of the Great Depression. Yet the proposed overhaul has drawn strong criticism-from the left and the right-for not doing enough to prevent the next crisis, whether in dealing with too-big-to-fail banks, oversight of "shadow banking" or by not providing solutions for dealing with Government Sponsored Entities like Fannie Mae and Freddie Mac. Market reaction to each step in the congressional process has only added to the skepticism. Bank stocks gained both when the reform bill cleared the Senate and when it was reported out of the House-Senate conference. That indicates that investors see reforms as "manageable" for the financial sector.
In the very short term, the markets and the bill's critics have a point: it could have been tougher. It won't be a replay of the Glass-Steagall Act that separated investment from commercial banking in 1933.
But these reactions miss a crucial point: The reforms currently debated in Congress represent only the opening salvo of a larger reform process that will take years to complete and whose outcome will be both unexpected and more stringent on financials than the currently debated legislation.
Despite its critics, the Dodd-Frank bill (assuming it clears the Senate) will limit some of the activities that helped trigger the crisis. Large systemically important banks will need to hold more capital. Consumer protections will go a long way toward addressing issues like mortgage lending. Derivatives rules will move a significant number of these products into clearinghouses, allowing for increased transparency. Add enhanced investor protections, reforms of credit rating agencies, and changes to corporate governance, and you have something more substantive than its critics appear to realize. These may not be the radical solutions that some prefer, but they will have a large long-term cumulative impact on the U.S. financial sector.
It's impossible to say, of course, whether these measures can head off the next meltdown. The new rules will also create new risks and new loopholes that will be exploited. That's always the case with regulatory reform. But the current package will nonetheless limit the scope of financial activities that banks undertake today, and there are just too many changes in the Dodd-Frank bill to conclude that the proposed reforms are a wash. Their impact will be staggered, as rules based on the legislation will come online over a two-year period, if not longer. But they will impose significant hurdles on large financial institutions, which may become less competitive relative to smaller institutions. It may not be the sudden change that critics prefer, but it could still lead to a welcome and gradual diminution of the too-big-to-fail risks over time.
Second, the current legislation is far from the last word. Congress will take up regulatory reform again next year, following the Financial Crisis Inquiry Commission (FCIC)'s report in December. Mandated by Congress last year, the FCIC is based on the Pecora Commission that investigated the causes of the Great Depression and provided the rationale for the landmark pieces of legislation of the Great Depression Era (the Glass Steagall Act, the Securities Act of 1933, and the Securities Exchange Act of 1934). The FCIC has kept a relatively low profile until now, but its findings will bring another round of legislation. It remains unclear what we can expect on the 2011 agenda; that will depend on the post-election balance of power within Congress, on the perceived impact of the current regulations, and, obviously, on the findings of the FCIC. But there will be another debate and more legislation.
Then there's the bigger picture. Regulatory reform following a crisis is often a matter of trial and error. New rules are written, and sometimes rewritten. More regulations are introduced as the economic picture changes and as new risks land on the policymakers' agenda. Congress was still passing new pieces of Depression-era reform as late as 1940.
Congress may no longer have an 11-year attention span, but the current round of reform marks the beginning of a process that will last several years. And Washington won't be the only source of change. The Basel capital accords, which set the thresholds for capital reserve requirements, liquidity, and leverage that financial institutions must hold, are also being negotiated. This complex multilateral process involving all the developed economies, will take years to implement, once the changes are agreed on, likely later this year or early next. Finally, the United States will need to harmonize its extensive regulatory reforms with other large jurisdictions, most notably the European Union, and further changes to the regulatory environment will be needed.
The complexity and time-span of this process guarantees that nobody can predict exactly how the United States and global architecture will look in three or four years. A surge of economic growth -- or another financial crisis -- might radically change the list of available options. One thing we can say for certain: The current debate is merely the "end of the beginning" for reform of the U.S. financial sector.
Dan Alamariu is an analyst in Eurasia Group's Comparative Analytics practice.
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There are several fascinating elections due this year. Next month, we can look forward to Britain's most unpredictable outcome in 100 years. In Poland, former Prime Minister Jaroslaw Kaczynski has become a presidential candidate in hopes of succeeding his twin brother Lech, killed in a plane crash earlier this month. Japan's ruling DPJ faces a referendum on its first turbulent months in power with upper house elections this summer. In November, recession-weary Americans will go to the polls to elect a new congress.
With all that going on, you probably haven't thought much about next month's local elections in North Rhine-Westphalia, Germany's largest state. Eager to institutionalize a post-bailout era of greater fiscal discipline, the German government is preparing to push for a major revision of eurozone rules in the form of a new European Union treaty. The aim is to build momentum behind a drive for fiscal consolidation and greater powers to enforce rules across the currency union.
But it's hard to imagine that Chancellor Angela Merkel's government will get what it wants. Irreconcilable differences remain among key European states, and Germany doesn't have the political power it held a generation ago in the run-up to introduction of the euro. Today's union is much larger, and the perceived benefits of convergence are worth less. The contentious debate over a new treaty will unfold just as the battle is heating up to replace Jean-Claude Trichet as president of Europe's Central Bank.
The immediate concern is that Standard & Poor's lowered Greece's debt rating to junk on Tuesday and Portugal by two steps. The big longer-term worry for Europe is that politicians locked into tough deflationary programs (in Greece and beyond) will take the once-taboo step of pushing for debt restructuring. We're not talking about the break-up of the eurozone, no matter how much apocalyptic rhetoric we hear in days to come or how many pundits write articles this fall with titles like "Who killed Europe?" But the less dramatic risks for European fiscal policy are plenty serious.
That's where Germany's local elections come in. The balloting in North Rhine-Westphalia, home to more than 20 percent of Germany's citizens, will provide a real test of Angela Merkel's center-right government. A bad result would jeopardize Germany's shot at tax reform. More to the point, it would weaken the entire eurozone by undermining support for fiscal discipline at the heart of Europe.
A return of the German left, even a modest one, will generate much more expansionary policy than we saw during the grand coalition period between 2005 and 2009. That will create stronger institutional support for German labor demands, driving a rebalancing within the eurozone as German labor costs begin to rise. That will undermine European competitiveness at a delicate moment in the union's recovery from recession. Over the longer term, it's hard to imagine Europe's fiscal woes improving in that environment. That's why I believe strongly in the eurozone, but not in a strong eurozone.
Ian Bremmer is president of Eurasia Group and author of The End of the Free Market: Who Wins the War Between States and Corporations? (Portfolio, May 2010)
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Thus far, the Obama administration isn't making much of a showing. Undersecretary of State Bob Hormats did a strong job on yesterday's U.S.-China panel. But there's little coordination and not much of a message. If Secretary of State Clinton is too busy, why not send Vice President Biden? Combined with perfunctory foreign policy mention in the State of the Union, I'd suspect it's a feeling that anything but domestic issues isn't going to play well politically. That's not the strategy I'd be going with.
So for the American delegation, it's the U.S. private sector that's leading the charge here. And the omnipresent Barney Frank -- who yesterday told a private industry group to stop listening to what congress says, and look at actual policies ... do they have anything to complain about? Heads nod reasonably sagely.
Meanwhile, criticism of imminent political explosion grows as the nights wear on. Rogue economist/historian/documentarian Niall Ferguson, distinctly unshaven (proffered excuse--he forgot his razor on his flight from Delhi), wagered me $100 that the United States would have a new Secretary of Treasury by June 1st this year. Wager accepted. Howard Lutnick of Cantor Fitzgerald said he'd go $100 for Sept. 1. The bankers are always pushing it.
Ian Bremmer will be blogging from Davos this week sending reports and commentary from inside the World Economic Forum.
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The Call, from Ian Bremmer, uses cutting-edge political science to predict the political future -- and how it will shape the global economy.