No Comment, Six Questions — January 17, 2008, 8:20 am

The Risk Horizon for 2008: Six Questions for Ian Bremmer

The EurasiaGroup’s President, Ian Bremmer, is one of the best-known political risk analysts advising investors on the New York and London capital markets. He is the author of an important new system for quantifying political risks associated with investment in emerging markets, much of which is encapsulated in his recent book, The J-Curve. With 2008 breaking, I asked Dr. Bremmer to take a crack at forecasting some of the major features of the investment risk horizon for 2008, taking a look at the Middle East, Russia, Pakistan and South Africa, as well as developments on the home front in the United States.

1. 2007 was something of a rollercoaster ride for U.S. relations with Iran, with mounting speculation about a “military solution” unexpectedly deflated by the issuance of a National Intelligence Estimate (NIE) that put the Iranian nuclear project further off on the horizon than previously thought. Yet, there were palpitations just in the last few days in the Straits of Hormuz. What sorts of risk do you expect we’ll see in the Middle East and in Iran? And what impact will U.S. domestic politics have on these issues?

In 2008, the Bush administration will rely on unilaterally imposed sanctions to sustain pressure on Iran to halt its enrichment of uranium. These sanctions will target Iranian banks, governments, and politically prominent individuals, and Washington will lean on foreign governments, banks, and companies to do the same. The sanctions are unlikely to have much effect on the consensus within Iran in support of the nuclear program.

But although the release of the NIE certainly changed the calculus in the conflict, there are several reasons why U.S.-Iranian tensions will remain an important source of political risk for 2008.

First, the NIE reduces–but does not eliminate–the risk of some form of military action. The document acknowledges that Iran was working to develop nuclear weapons until fall 2003 and warns that Tehran is “continuing to develop a range of technical capabilities that could be applied to producing nuclear weapons.” The document does not claim that Iran has halted uranium enrichment or stopped developing its longer-range missiles. It says simply that Tehran has suspended the production of warheads. Even that finding comes with only “moderate confidence.”

That’s why the U.S. and Israeli governments are more worried than ever. They fear that Iran remains extremely dangerous and that the NIE limits their ability to build credible international support for sanctions. The NIE gives Russia and China in particular political cover to protect their commercial interests in Iran at the expense of efforts to halt Iran’s uranium enrichment program.

Paradoxically, the NIE could actually make an Israeli attack on Iran more likely. The report’s authors argue that Iran halted its weapons program four years ago “primarily in response to increasing international scrutiny and pressure resulting from exposure of Iran’s previously undeclared nuclear work.” Many Israelis fear the document will ease that pressure, allowing Iran to simply pick up where it left off. They also fear that the war in Iraq, a slowing U.S. economy, and an American electorate weary of costly international commitments will deprive U.S. policymakers of the political capital they need to face down Iran-even if Israel’s national security is on the line.

This fear could push Israel to launch airstrikes of its own against Iranian nuclear sites. That probably won’t happen in 2008, but the risk is greater than many think.

Another part of the puzzle worth watching: Iran will hold parliamentary elections in March. That vote will be crucial for President Mahmoud Ahmadinejad’s political future. If he wants a cooperative legislature-and to boost his own re-election chances next year-he needs his allies to win.

As the elections loom, Ahmadinejad would much rather talk about U.S. and Israeli aggression than the 19 percent inflation and gasoline rationing that his government’s economic mismanagement has imposed on the Iranian people. That gives him obvious political incentive to create more trouble beyond Iran’s borders. By trying to boost his domestic popularity by generating greater tension with the U.S., EU, Israel, and much of the Arab world, he may well generate new risks with potentially market-moving implications. Iran will likely continue to fuel Sunni-Shia tensions in Iraq and bolster Hamas in the Palestinian Territories and Hezbollah in Lebanon. The recent incident in the Straits of Hormuz, however exaggerated it may have been in the media, underlines just how easily Iran and the U.S. might stumble into direct confrontation–with obvious implications for oil prices.

2. On Pakistan, you have raised the possibility that Pervez Musharraf’s presidency might not survive the year. Can you expand on that a bit? In particular, has America developed a Pakistan policy as opposed to a Musharraf policy? What do you see as the most plausible succession scenarios for Pakistan? In addition to that, do you consider Pakistan the center stage for the U.S. struggle against politically oriented Islamic terrorist groups?

The Bush administration once had a straightforward Pakistan policy: bolster Pervez Musharraf. That seemed the best way to keep that country stable and to maintain an important ally on the frontlines of the battle against al Qaeda and the Taliban. Washington already recognizes that this strategy is no longer viable.

First, despite Musharraf’s assurances that only he can combat extremism in Pakistan, the country’s military has been unable to extend its control into the tribal areas along the border with Afghanistan. Sympathy for both the Taliban and al Qaeda runs deep among the tribal leaders who dominate that territory. In fact, there’s support for Islamic militancy within some segments of Pakistan’s military and intelligence services. This problem has always limited Musharraf’s ability to give Washington a final victory over Islamic militants fleeing Afghanistan.

Second, Musharraf could never have indefinitely resisted demand within Pakistan for a return to a civilian-led, democratically elected government. The Pakistani electorate’s impatience with Musharraf’s broken promises to restore democracy has been growing for years. It peaked last fall with the return to the country of two exiled former prime ministers, Nawaz Sharif and the more popular Benazir Bhutto.

Knowing this, the Bush administration pushed Musharraf to strike a power-sharing deal with Bhutto that might have given Washington both halves of what it wants in Pakistan: a firm hand on the country’s nuclear weapons and internal security and some measure of democratic legitimacy. Bhutto’s assassination in December has forced U.S. policymakers to improvise.

But the potential good news from Pakistan is that the military, not Musharraf, is the ultimate guarantor of the country’s stability. Musharraf has finally resigned his military command, and the army has a new commander. The United States-and, importantly, India-have a relatively high degree of trust and confidence in General Ashfaq Pervez Kiani. Mr. Kiani has begun to hint that he may follow through on support for democracy, with or without backing from Musharraf.

If Pakistan’s armed forces throw support behind free and fair elections scheduled for February 18, Washington might still get the best of both worlds in that country-military-backed stability and an elected government. There’s very little this new government (or Washington) can do for the near term to reclaim areas of Pakistan lost to Islamic radicals. But the nightmare scenario of total state collapse is highly unlikely.

Current U.S. policy is to press Musharraf to hold parliamentary elections as scheduled on February 18. Washington would still like to see Musharraf share power with either Makhdoom Amin Fahim, Bhutto’s replacement as the Pakistan People’s Party candidate for prime minister, or Nawaz Sharif and his Pakistan Muslim League-Nawaz. Washington will never fully trust Sharif. U.S. officials fear that his reliance on political ties with Islamic political parties makes him an unreliable ally. But following Bhutto’s murder, Sharif is the best known and most experienced democratic politician in the country.

As for Musharraf, his presidency may not survive 2008 precisely because he has become both extremely unpopular and politically expendable. The military may decide it can no longer afford its association with him. U.S. policymakers may soon come to much the same conclusion. The Bush administration isn’t there yet, but with a deteriorating security situation inside neighboring Afghanistan, Washington may well create trouble for Musharraf by ordering new airstrikes on suspected militants on the Pakistani side of the border.

Finally, if Pakistan is not the center of gravity in the war on terror, it’s because the threats posed by al-Qaeda inspired groups in north Africa and inside Europe-as well as risks created by the increasing power and sophistication of Hezbollah’s arsenal-make terrorism a dangerously decentralized source of potential turmoil. But Pakistan’s nuclear weapons and material, its political turbulence, and the sheer size of the territory its government can’t control make Pakistan an unusually potent source of terrorism-related risk.

3. American public discourse about Iraq has continued to travel in strangely defined ruts. Most recently the discussion all seems to turn on the question “Is the surge working?” But you have said that the Bush administration continues to get the military decisions in Iraq right and the politics wrong. Looking at the shifting constellation of political forces inside Iraq, how do you assess the situation, particularly against the benchmarks of achievement of the political objectives the United States announced in going in, that is, constructing a stable, democratic society which is friendly to the U.S.? How do you expect things to unfold politically inside of Iraq in this U.S. election year?

Despite news in recent days of modest political progress in Baghdad–progress that is probably even more modest than the international media understands–Iraq faces increased risk of serious fragmentation this year.

The troop surge has achieved important military objectives and may achieve more. But its ultimate purpose is to enable Iraq’s elected leaders to forge the tough political compromises on which Iraq’s future stability will depend. That isn’t happening. Prime Minister Nouri al Maliki’s government remains crippled by corruption, incompetence, and rivalries within the Shia-led United Iraqi Alliance. Despite the recent announcement of a deal that would allow some Sunni Baath Party members to again hold government jobs, Maliki probably won’t (and maybe can’t) draw enough Sunnis into positions of real authority within the central government to ease their fears of Shiite dominance. Crucially, Shia and Sunnis appear no closer to agreement on a fair sectarian division of Iraq’s oil revenue.

Most worrying for Washington, U.S. leverage with Iraq’s government is now surprisingly limited. The refusal of Iraqi leaders to participate in the U.S.-hosted Annapolis conference on peace between Israel and the Palestinians in December was especially stunning, since President Bush and Secretary of State Condoleezza Rice had lobbied Maliki personally. Even Syria sent emissaries to the conference.

No one should have been surprised that the Shia-dominated central government refused to be part of Washington’s security pact with Sunni tribal leaders-the most widely acclaimed accomplishment of the surge. Officials in Baghdad rightly fear that when Washington finally begins to withdraw significant numbers of troops, Sunnis will use the American weapons and cash they’ve been stockpiling to attack their Shia rivals.

The military surge was also meant to undermine radical Shiite cleric Moqtada al Sadr and disarm his Mahdi Army militia, the most powerful in the country. Unwilling to risk a head-on collision with U.S. troops, the Mahdi Army has gone quiet. But Sadr and his soldiers will rejoin the fight for power, influence, and wealth in Iraq as soon as U.S. troops begin heading for the exit.

Then there is the politically inspired violence in the south, an area beyond the surge’s impact. As British troops withdraw from the oil-rich southern Iraqi region around Basra, no foreign power will be able to prevent an intra-Shia conflict over the spoils. Shiite leaders in the southern provinces continue to demand that Baghdad pass a law on federalism that gives local leaders political control of the area. If that law isn’t forthcoming, many Shia in the south will abandon any pretense of support for Maliki’s government. If the law is passed, battling Shiite factions will probably ditch their informal agreement to stop attacking one another and fight for best position ahead of the new political order.

Basra province is home to Iraq’s only ports, a region crucial for the security of most of Iraq’s oil exports, which account for more than 95 percent of the central government’s export revenue. There is no military solution to this problem; only an unlikely deal among bitter Shiite rivals can bring lasting stability to the southern provinces.

And don’t forget the Kurds. The trouble they can cause in Iraq will be even more obvious in 2008. To win support from Kurdish leaders for approval of the new Iraqi constitution in 2005, Baghdad agreed to allow residents of the northern city of Kirkuk to hold a referendum on the city’s political future. The central government knows that Kirkuk’s majority Kurds will likely vote to place the city (and the oil that lies beneath it) under the jurisdiction of the Kurdish Regional Government.

Under heavy pressure from both Baghdad and Washington, Kurdish leaders agreed late last year to postpone the vote for six months. But no one can expect them to postpone it again. That’s a big problem for both Shia and Sunnis, who fear that Kurds will not share the city’s energy wealth.

U.S. troops will eventually leave Iraq. Shia, Sunnis, and Kurds know it. Nouri al-Maliki and Moqtada al Sadr know it. Iran knows it. That’s why military progress does little to bring about political progress–and why Iraq is no closer to lasting stability than before the surge began.

4. Turning now to U.S. domestic politics, national security issues dominated the nationwide races in 2002, 2004 and even in 2006, although the latter election showed some remarkable shifts in whom the voters trust more on national security questions. Polling so far in 2008 shows a fairly strong shift away from national security and toward the economy. On the Republican side, immigration has emerged as an extremely hot topic. Which of the political parties is in the best position to make use of national security as an issue, in your view? Do you see protectionism and anti-immigration moves on the horizon for the main election, and if so, what consequences do you see for NAFTA and other trade relationships?

First, we must remember that the U.S. election campaign is one terrorist attack away from a major shift in focus. An attack inside the U.S.–even one much smaller in scale than 9/11-or a major strike against U.S. troops in Iraq could shift voter attention away from economic issues. There is no way of knowing how likely such an attack might be, but it’s a risk we have to keep in mind.

On immigration policy, the wildcard is Arizona Senator John McCain. If he wins the Republican nomination, immigration reform won’t be much of an issue in the presidential campaign, because his position on the issue differs little from those of the leading Democratic contenders. But if one of the other Republican candidates becomes his party’s standard-bearer, immigration will become an important wedge issue that Republicans will certainly try to use against the Democratic nominee. Anxiety over illegal immigration will certainly play an important role in many congressional races around the country.

On protectionism, it is Congress, not the White House, which will drive policy. Democrats are highly likely to maintain majority control of both houses of Congress in November. We’ve already seen moves by the current Congress to add labor and environmental provisions into free trade agreements. The Democratic presidential frontrunners have pledged to support that approach, as well, including plans to make changes to NAFTA meant to protect American jobs. The Republican candidates, particularly McCain, are more outspoken in favor of “free trade.” But a Republican president would face determined opposition on Capitol Hill on a wide range of trade-related issues. Generally speaking, Democrats are much better positioned than Republicans to take advantage of voter anxiety over the economy, particularly if the U.S. slides into recession this year.

Finally, we are likely to see a widening of the mandate of the Committee on Foreign Investment in the United States, the inter-agency executive branch body charged with ensuring that proposed foreign investments in U.S. assets do not threaten U.S. “national security.” We may see a greater oversight role for Congress. We may also see a much broader definition of national security. New barriers to foreign investment won’t help with longer-term U.S. growth and could generate new sources of tension between Washington and other governments.

5. You’ve written that Russia is, after Iran, the “single country in the world most willing to challenge the existing geopolitical order.” But Russia will also witness a political transition of some sort this year, as Putin leaves the presidency. Do you expect Russia to rock the boat in Europe on energy issues, on politics or both? What do you see as the flashpoints? Give me your most plausible scenarios for 2008.

Domestically, I see very little risk of instability in Russia for 2008. Putin is in charge, and he will remain in charge. His handpicked successor, Dmitry Medvedev, will be elected president in March. Putin may well become prime minister. We can expect continuity inside Russia precisely because Putin will remain the senior partner in their political alliance as Medvedev grows into his new job.

In fact, it’s likely to be a good year for many foreign investors in Russia. Medvedev, a capable technocrat, will lead further liberalization in the non-strategic sectors of the Russian economy. The established rules of the road for foreign investors, which have gotten much clearer over the past year, will become even clearer in 2008.

But as your question suggests, Russian foreign policy is likely to be a big source of risk this year. First, U.S.-Russian relations are now at their lowest point since Leonid Brezhnev sat in the Kremlin. (European-Russian relations aren’t much better.) With elections taking place in both Russia and the United States, and with hostility toward the other government a solid vote-winner, things are likely to get worse. Western investors were pleased with the choice of the market-friendly Medvedev as president. But he is likely to have little influence on the conduct of Russian foreign policy–a portfolio which will remain in the hands of Putin and the former military and security types in the Kremlin, the men responsible for Russia’s increasingly assertive and self-confident foreign-policy approach.

There are several potential flashpoints. The first is in the Balkans. If Kosovo declares independence with significant international support this year, Moscow will likely respond by reinforcing its ties with two breakaway republics within Georgia, a former Soviet Republic now governed by a pro-Western president who is constantly at odds with Moscow. Russia might eventually recognize the independence of these enclaves and could potentially insert troops under the pretext of protecting Russian citizens living within them. Any destabilization or open conflict in Georgia could also have spillover effects on trans-Caucasian energy routes.

In addition, Russian-EU tensions over energy supplies will persist. The Kremlin will continue to use energy exports to exert pressure on Ukraine, Belarus, and the Baltics to preserve Russia’s political leverage vis-à-vis their governments. Moscow might cut off gas again toward the end of the year, though that’s not likely. Ukraine will probably stick to the price it negotiated with Gazprom, Russia’s state-owned gas monopoly, late last year. But if recently-elected Ukrainian Prime Minister Yulia Tymoshenko decides she can win votes by antagonizing the Kremlin, she could provoke another gas disruption by challenging existing energy deals.

Moscow continues to resist pressure to sign on to European proposals for an energy charter that would open Russia’s upstream and pipeline assets to more foreign ownership and competition. At the same time, Russia is aggressively pursuing downstream assets in its business and energy relations with Europe, generating anxiety and resistance within some European countries. The EU, with US support, will continue to try to develop new pipeline routes from the Caspian that skirt Russian territory and are not dependent on Russian-controlled infrastructure.

Finally, U.S.-Russian tension will continue over Washington’s plan to deploy components of a missile defense system in Poland and the Czech Republic, Moscow’s suspension of its commitments under the Conventional Forces in Europe treaty, and its weapons sales to Venezuela, Iran, and Syria. In particular, Russia’s decision to complete construction of Iran’s nuclear reactor at Bushehr and to provide Tehran with advanced air-defense systems will further undermine any Bush administration attempts to salvage the relations Bush and Putin appeared to enjoy when both men first assumed office.

6. You recently published ‘The J Curve: A New Way to Understand Why Nations Rise and Fall.’ The book provides a fascinating set of analytical tools for understanding countries, especially those on the margins and in the developing world. Have you observed any developments in the world since the book went to press that you wish you had covered or that you think you’d pick up in a revised second edition?

The situation in Pakistan has certainly become much more precarious since the book came out. But, as I mentioned earlier, it’s the Pakistani military, not Musharraf personally, that keeps that country from a headlong dive into the unstable dip in the J curve.

South Africa is undergoing some important changes, as well. Unfortunately, evidence is growing that I was right when I warned that “divisions within the ruling elite” will deepen if “progress lags toward a post-apartheid reapportionment of South Africa’s wealth.” That country, vitally important as a source of stability and growth in southern Africa, is headed for a presidential election in 2009. President Thabo Mbeki has become a lame duck. His bitter political rival, Jacob Zuma, has been elected head of the ruling party, the African National Congress. As Mbeki’s supporters search for ways of undermining Zuma’s chances of becoming president next year, Zuma may be forced to fall back on core supporters in the country’s trade union movement and Communist Party. We’re not headed for violence in the streets, but the investment climate may well cloud over in the next several months.

jcurvefinal

I would add a final point on some increasingly stable governments. After all, we’ve been discussing only those countries where various forms of risk are growing. As I argued in an afterward in the paperback version of the J Curve, “a state need not be democratic to successfully transition to the right side of the curve,” where political and social stability is reinforced by greater openness to cross-border flows of ideas, information, and people. Dubai and Singapore are not politically mature democracies by any definition. But they are increasingly open to the changes wrought by globalization-and increasingly stable as a result. Dubai may have a hard time in 2008 as the U.S. presses its government to track and freeze Iranian assets held within the city-state, but there won’t be any domestic crisis of confidence in the leadership of Sheikh Mohammed bin Rashid al-Maktoum.

An emerging consensus in favor of political openness and disciplined macroeconomic policy appears to be taking hold in Brazil, Mexico, Peru, Poland, Hungary, the Czech Republic, and many other emerging market countries. There are plenty of good news stories for 2008.

Read more about political risk analysis and how to approach it in the current global markets environment in Ian Bremmer’s J-Curve. You can buy a copy here.

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