In a socially and economically integrated world in which so many problems transcend borders, the need for international cooperation has never been greater. But cooperation requires leadership, particularly when interests diverge or free-rider opportunities abound. Leaders set the agenda. They persuade others to take actions they would not otherwise take. They have the leverage to coordinate responses to international problems. They also have the wealth to provide public goods that others cannot afford and services no one else will pay for.
Yet for the first time since the end of the Second World War, the world lacks predictable global leadership. In the United States, partisan combat and mounting federal debt have downgraded hopes for full recovery from the 2008-09 recession. The European debt crisis, meanwhile, has crippled confidence in that region’s institutions and its future. In Japan, the rebuilding following last year’s earthquake and tsunami has proven far easier than recovery from two decades of political and economic malaise. A generation ago, these were the world’s powerhouses. Today, they are struggling. Meanwhile, emerging powers such as China, India, Brazil and Indonesia are too preoccupied with domestic challenges to accept a larger share of global political and economic leadership.
Nor are global institutions likely to fill the vacuum. At the height of the financial crisis in November 2008, political leaders of the world’s established and emerging countries gathered in Washington under the banner of the G20 — the international body that was intended to replace the unrepresentative G7. The Washington summit helped to limit the damage, but the sense of collective crisis soon lifted, cooperation quickly evaporated and G20 meetings have since produced little of substance. In essence, there is too broad a divergence of opinion within the G20 on fundamental political and economic values to provide consensus on any but the most urgent issues.
To make matters worse, institutions such as the UN Security Council, the World Trade Organization, the International Monetary Fund and the World Bank no longer reflect the world’s true balance of political and economic power. In years to come, we will find ourselves in a G-zero world — a world in which no single power or alliance of powers is ready to take on the challenges of global leadership.
This lack of global leadership poses a number of obvious challenges. It makes it all but impossible to build consensus on what to do about climate change, droughts, floods and the food-price shocks they trigger — let alone trade, commerce and security, issues that have been managed internationally for over half a century. In a world where every nation must fend for itself, persuading states to share the costs and burdens of international security will be more difficult than ever to accomplish. In this and countless other ways, a leaderless world will incubate new sources of conflict and make almost all of them more difficult to manage.
Yet for every risk there is an opportunity, and for every loser there is a winner. Some governments, institutions, companies and individuals will adapt well to a leaderless world. The first key to surviving and thriving in this period of great transition is to recognize that changes to the global system will enable an unprecedented number of governments to play by their own rules. Such countries are made more prosperous and secure by a world without leadership and have more options and greater influence than they had before.
What does that mean for Canada? To be sure, Canada’s export-powered economy remains vulnerable to slow growth in the United States. But thanks in part to the financial crisis and its impact on US purchasing power, the percentage of Canada’s exports to countries other than the United States jumped from 18 percent in 2005 to more than 25 percent just four years later.
In addition, Canada now draws nearly 40 percent of its imports from countries other than its giant neighbour to the south. This trend is not simply the product of the global market meltdown; Canada and Canadian companies were working to build commercial ties with Asia for years before recession took hold in the United States, and Canada has made considerable progress toward a free trade agreement with the European Union (EU). Canada exports large volumes of oil, but also natural gas, industrial machinery, auto parts, timber and many other products to many different countries.
Institutions such as the UN Security Council, the World Trade Organization, the International Monetary Fund and the World Bank no longer reflect the world’s true balance of political and economic power. In years to come, we will find ourselves in a G-zero world — a world in which no single power or alliance of powers is ready to take on the challenges of global leadership.
In short, Canada is well on its way to becoming a pivot state, a country capable of avoiding excessive dependence on one powerful commercial partner by diversifying its trade and investment relationships. The G-zero order offers Canada and Canadian companies important opportunities, which the country’s political and business leaders should seize. Of these, the most important, and potentially most lucrative, are in Asia.
There are many compelling reasons for Canada and Canadian firms to look toward Asia for growth opportunities. China’s insatiable appetite for resources presents a natural outlet for Canadian oil and gas, especially as US policymakers vacillate on the Keystone XL pipeline. And for Canadian investors, the allure of an ever-growing Asian market is undeniable. China is now Canada’s top Asian trading partner, with bilateral trade reaching $28 billion in the first half of 2011. In addition, cash-rich Asian companies, particularly Chinese state-owned enterprises (SOEs), are acquiring stakes in Canadian firms, seeking both assets and expertise.
However, before Canadian investors lock themselves in Asia’s embrace, they must recognize the risks inherent in growing exposure to Asian markets and consider all of the complexities of looking east. In particular, Canadian companies and investors should look more closely at two particular risks: regional instability in Asia and the rise of state capitalism.
Asia is home to more rising powers and international conflicts than any other, so the list of potential risks is long. China aspires to be the dominant regional power, but India is too big to accept a secondary role. For all its setbacks, Japan remains one of the world’s wealthiest countries and, consequently, an influential power. South Korea is a leading emerging power. Indonesia will become a more important regional power, and Thailand will remain one of Asia’s most dynamic economies. Terrorist attacks inside India by Pakistan-based groups periodically underline the fact that historical enmity and religious grievances might one day generate another round of armed conflict between the two countries.
In addition, there is no EU-style union of Asian states on the horizon or even an Asia-wide security forum to address, much less resolve, conflicts as they arise. The central tension in Asia is that many countries will try to create or maintain security ties with the United States even as China becomes their main economic partner. That situation is not sustainable over the long term because such ties clash with China’s desire for regional hegemony, and Beijing’s economic influence gives Chinese policy-makers increasing leverage in the region.
Over time, the battle for influence in Asia between Beijing and Washington will undercut their economic relations. As China’s consumer markets expand and US relative purchasing power declines, East Asian countries are rushing to expand trade ties with one another and with China. Last year, China became the largest trading partner of, and the single biggest export market for, all other Southeast Asian countries. China’s free trade agreement with the 10 countries of the Association of Southeast Asian Nations, which took effect in 2010, involves more people than any trade deal in history.
In this volatile environment, bilateral trade agreements, regional economic cooperation and ad hoc arrangements will dominate. Economic activity will coalesce around regional centres, rather than being globalized. In these conditions, bilateral or regional initiatives will implement favourable rules for a small set of countries. This growing regionalism will create additional costs for business, because firms will have to analyze various trade and investment deals to determine where to source and sell their products.
The breakdown of international standards and the rise of protectionism will make it more difficult to maintain low-cost, multicountry supply chains. It will offer opportunities for corporations that are readily able to adapt and cherrypick opportunities for investment and cost efficiency between different states. Countries that are not tied too closely to one market will enjoy a more diverse range of partners over time.
As Canada becomes more deeply engaged in Asia, investors will be exposed to the vagaries of geopolitical tensions. Decisions by Ottawa to welcome the Dalai Lama, engage with Taiwan or even make critical statements on Chinese human rights practices could have an increasingly negative impact on investors. Companies operating in disputed territories such as the South China Sea could be exposed to greater scrutiny from Beijing. And collaborating with certain Asian firms in third markets could generate unease among American investors or regulators. These risks can be mitigated but will require flexible strategies.
In a G-zero world, partnerships between private entities and governments or state-owned or state-favoured companies will also become more prevalent. To navigate this environment successfully, multinational corporations must be able to transform a state-backed rival into a commercial partner by offering something that a government-controlled enterprise cannot get anywhere else, such as access to advanced technology or services that demand unique expertise. To succeed, they must become even more nimble and develop the capability to enter and exit advantageous partnerships involving a host of local private and/or state actors.
For Canadian companies, the state capitalist trend poses several threats. First, state-run companies and investment funds tend to be burdened by the same bureaucracy, waste and political cronyism that characterize the (often authoritarian) governments that control them. State-owned oil companies now control such a large percentage of the world’s oil reserves that the mismanagement, corruption and inefficiency that plagues their operations will drive up the prices we all pay for energy. These same factors also increase the cost of doing business with state-run companies and may lead to delays, corruption and higher priced products.
Second, Western multinationals continually find themselves at a disadvantage when faced with state-owned competitors that can count on home governments for generous support and political muscle. To shelter domestic producers from foreign competition, governments can impose quotas, limiting the amount of a particular good that enters the country, or provide subsidies and/or loan guarantees that allow them to produce goods more cheaply.
As Canada becomes more deeply engaged in Asia, investors will be exposed to the vagaries of geopolitical tensions. Decisions by Ottawa to welcome the Dalai Lama, engage with Taiwan or even make critical statements of Chinese human rights practices could have an increasingly negative impact on investors.
State capitalist countries can also use more subtle means to tilt the playing field in favour of local companies. The headed by professional managers rather than state bureaucrats — should be treated differently than other foreign multinationals. China’s oil and gas majors in particular remain highly political creatures. Their ties to the Chinese Communist Party and to the government are strong, and their decision-making processes state can require licences that apply mainly to imported goods, limit imports to a small number of ports of entry or impose stringent (or unattainable) health, safety or environmental standards. Governments can direct local banks to favour domestic over foreign borrowers. Or the state can simply refuse to enforce existing laws and regulations. The unwillingness of Chinese officials to protect foreign firms’ intellectual property rights has undermined Beijing’s relations with several other governments but accomplishes the state’s domestic political goals.
Finally, the secrecy with which many of Asia’s SOEs and sovereign wealth funds operate creates myriad risks and challenges. The governments that control sovereign wealth funds insist that their mission is to maximize return on investment, not to advance political goals. Yet, because so many of them operate behind a veil of secrecy, the rest of the world is essentially expected to take their word for it. The leaders of free-market countries such as Canada have no proof that foreign governments seek to exploit their openness and thereby gain political advantage. But neither do they have evidence to the contrary. They are left to weigh the cost of shutting out much-needed investment against hypothetical threats.
Given these risks, SOEs looking to invest in Canada — even those headed by professional managers rather than state bureaucrats — should be treated differently than other foreign multinationals. China’s oil and gas majors in particular remain highly political creatures. Their ties to the Chinese Communist Party and to the government are strong, and their decision-making processes and strategic calculations will remain highly opaque, even to their foreign partners and allies. Understanding a partner’s ambitions and weaknesses — both inside and outside of Asia — will be crucial for the success of any joint venture on Canadian soil.
As noted above, there are compelling reasons why Canada and Canadian firms should look toward Asia for growth. In the process, however, corporate risk managers must assess and monitor the quality and transparency of economic governance. The good news is that, over time, Asia’s state-owned corporate giants are veering toward greater operational efficiency and environmental responsibility. Growing awareness of political and security risks will shape these firms’ strategies: their need to partner with international peers will grow as their appetite to engage in risky investments wanes. In the long run, their corporate governance practices will align more closely with those of Western firms. Canadian investors have much to offer their Asian counterparts, not least deep-water exploration expertise as well as advancements in unconventional energy development — the future growth areas for Asian oil and gas firms, in the region and abroad.
Natural resources will continue to figure prominently in Canadian-Asian trade and investment ties. As China’s demand for oil and gas continues to increase, SOEs will seek to secure more resources and acquire expertise to develop their domestic unconventional oil and gas plays. Canadian investors will find opportunities in this burgeoning market, including the chance to capitalize on inflows of Asian cash to develop Canada’s domestic resources.
However, Asian money does not come cheaply these days, and Asian SOEs are no longer happy to hand over cash simply to add one more asset to their portfolios. With those firms more pressed by their government and by their own commercial strategies to minimize risk and losses, they will demand more for their money — including a bigger say in operational decisions and greater access to managerial and technological know-how. While collaboration with Asian companies makes sense in the short term, Canadian investors must bear in mind that doing so will create more serious competitors over the longer term, both in the Asian market and overseas.
Recognizing risks does not mean closing doors. The temptation will be great to block some of these companies from access to Canadian markets, as US officials have done in the past. In some cases, this may be appropriate, since state-owned companies tend to be less transparent than their privately owned rivals. Those that fit this description clearly merit scrutiny. But barring SOEs and/or sovereign wealth funds from investing in Canadian markets would come with an opportunity cost, and there are good reasons to welcome both foreign state-directed investment and partnerships between Canadian and foreign state-owned companies. Beyond the direct opportunities these relationships may provide for Canada and its domestic economy, partnerships can boost the prospects of Canadian companies operating abroad.