Alt causes to economic decline – geopolitical risks tank the economy.

How can we measure geopolitical risks and what does this tell us?

Measuring geopolitical risks is an important but arduous task. One method is the geopolitical risk index (GPR), which is constructed using the frequency of articles in leading newspapers that discuss adverse geopolitical events such as wars, terrorism and tensions among political organisations (Caldara and Iacoviello, 2022).

As a continuous measure of risk, higher GPR values indicate higher intensity of adverse events, increased probability of negative events in the future, and greater expected intensity of future negative events.

Related empirical studies show that higher GPR values are associated with higher oil prices (Mignon and Saadaoui, 2024), lower firm- and country-level investment (Wang et al, 2023), higher inflation, lower economic activity and lower trade (Caldara et al, 2022), more volatile capital flows (Kaya and Erden, 2023) and lower levels of private sector credit in emerging markets (Lu et al, 2020). Figure 1 shows the evolution of the GPR and the specific index for the UK since 1985. Three observations stand out: First, the global and UK-specific indices are highly correlated. Second, the index captures well-known historical events associated with wars, terrorism and other international conflicts such as the First Gulf War, the 11 September 2001 attacks on the United States, and Russia’s invasion of Ukraine. Third, the index has recently spiked with the renewed conflict between Israel and Hamas from October 2023. Although the index has eased slightly in the following months, it remains in the top 5% of the historical series. While the GPR is useful for tracking how geopolitical risks develop over time and for empirical research, it has certain limitations as a risk measure: First, the index is not forward-looking and has limited predictive power for the potential evolution of risks. Second, being an aggregate measure of geopolitical risks, the index fails to distinguish between the different risks, each with distinct probabilities of occurrence and impacts. Third, the index is unable to capture the complexity, sources and persistence of risks. As a result, risk analysts typically complement GPR indices with qualitative analysis, expert consultation, probability-based assessments and scenario analysis to provide more dynamic and tailored risk assessments. What are the major risks facing the global economy today? Many of the significant geopolitical risks that the world faces in 2024 come from existing conflicts and tensions. Experts have identified the elections in the United States (amid increasing polarisation and declining trust in the country’s political system); a possible escalation of the Israel-Hamas conflict into a wider conflagration in the Middle East; and a further deepening of the Russia-Ukraine war as top of the list (Bremmer and Kupchan, 2024). In relation to the crisis in the Middle East, a central-case scenario of a limited military conflict has been suggested (Bremmer and Kupchan, 2024). But the likelihood of a larger regional war has increased due to the Houthi attacks on ships in the Red Sea. In addition, although less likely, there is a risk that the regional war could result in actions against or by Iran that could significantly disrupt Iranian and global oil supplies. Further, the crisis in the Middle East could have a significant impact on global markets, even without disrupting oil supplies. Given that approximately 12% of global maritime trade passes through the Red Sea, the Houthi attacks are likely to keep freight insurance rates elevated, cause longer trade journeys, disrupt supply chains and increase inflationary pressures. At the same time, the situation in Ukraine is becoming increasingly challenging as the likelihood of a de facto partitioning of the country has increased (Bremmer and Kupchan, 2024). Russia holds material advantage and its economic and military capabilities have strengthened. Ukraine, on the other hand, grapples with manpower shortages and needs to enhance defence production. What’s more, political and economic support from the United States is weakening, while the European Union (EU) is affected by fiscal limitations and a lack of political consensus. Political implications – such as damage to the credibility of NATO and the United States – aside, a partitioned Ukraine would continue to pose challenges to the global economy, particularly through further disruptions to oil and food markets.

Outside these major risks posed by conflicts, the world is facing others posed by unregulated and more powerful artificial intelligence (AI) tools, increased protectionism, which disrupts the trade of critical minerals, and the failure to address macroeconomic and financial market vulnerabilities.

Increased cooperation among rogue states – such as Iran, North Korea and Russia – and the setbacks to the Chinese growth model also bring international risks (Bremmer and Kupchan, 2024).

Lastly, researchers’ assessment of global risks indicates a high probability of sub-par global GDP growth due to tighter monetary policies (Bremmer and Kupchan, 2024). More generally, the probability of a deeper economic contraction, resulting from monetary overtightening, financial shocks and higher energy prices due to heightened geopolitical risks has slightly increased with the escalation of conflicts in the last quarter of 2023.

How might elections and political risks affect the economy?

Over half of the world’s population will vote in general or local elections worldwide this year. Unsurprisingly, therefore, elections will be a key political theme in 2024.

Some elections, such as those in Indonesia, Mexico and Türkiye, may have limited local or regional effects. Others, such as those in India and Russia, will not produce surprising outcomes.

Others still could have significant foreign policy implications. For example, the result of the recent elections in Taiwan could affect relations between China and the United States, while those in Iran could affect the trajectory of the Israel-Hamas conflict and lead to commodity price spillovers.

The upcoming European elections are also crucial as they will determine the composition of the EU parliament at a time when far right parties are on the rise and the bloc is becoming increasingly polarised.

The US elections are likely to have the greatest impact on the world’s political and economic outlook. The return of former president Donald Trump could affect the global economy in three main ways.

The first is through increased pressure on the Federal Reserve – the US central bank – and unconventional fiscal policies (tax and public spending). Although Trump pushing for interest rate cuts could harm the disinflationary process, his unconventional tax cuts could put even more pressure on fiscal balances through higher deficits. In addition, his proposed policy of imposing 10% tariffs on all imported goods could further disrupt supply chains and have a significant impact on US GDP and household wellbeing, particularly if trade partners retaliate (Lee, 2023).

Finally, Trump’s position on foreign policy and security issues, particularly regarding NATO, could alter global power dynamics. And regardless of the election outcome, the US political system is becoming increasingly dysfunctional, and citizens’ trust in political and social institutions has reached historically low levels.