Geopolitical Risks and the International Business Environment: Challenges for Transnational Corporations and their Global Supply-Chain

Journal of Political Risk, Vol. 4, No. 6, June 2016

By Braz Baracuhy

Abstract

Traditional Geopolitical Risks for GSCs (Source: PWC – Transportation & Logistics 2030 [p. 17])

Traditional Geopolitical Risks for GSCs (Source: PWC – Transportation & Logistics 2030 [p. 17])

The geopolitical underpinnings of economic globalization are changing. Transnational corporations (TNCs) and their network of supply-chains have to operate in a business environment in which emerging geo-economic forces are interacting with shifting geopolitical realities. The challenges for geopolitical risk management will increase in a world of multiple poles of economic power.  TNCs and firms operating globally will need to develop a sense of strategic awareness of the new geo-economic spheres of influence and the systemic geopolitical risks reshaping the interdependence of countries and companies in the global marketplace. Corporate geopolitics need to be an essential component of business strategy.

Geopolitics and the global economy interact in multiple and complex ways.  The world economy is grounded on an inescapable reality: linkages among national economies through flows of trade and investments cannot exist outside the global geopolitical context.[1]  And that geostrategic context is changing. After an initial phase of perfect confluence between geo-economics and geopolitics that shaped globalization in the 1990s, the international system is now witnessing the structural mismatch between global geo-economics and geopolitics. Confluence is coming to an end. New geo-economic powers are decoupling from prevailing geopolitical conditions and starting to shape the international political environment.

Under changed circumstances, TNCs and firms linked to their international operations are now facing a complex set of geopolitical risks. TNCs´ production and trade networks of global supply chains (GSCs) will be particularly affected. The strategic management of global supply chains require the integration and coordination of cross-border functions – such as logistics, operations, transportation, and trading – which are geographically located. Apart from traditional geopolitical risks linked to the business location, TNCs will have to deal with a new set of systemic geopolitical risks. Corporate and business strategists need to cope with the twin forces of an evolving polycentric globalization coupled with the complex geo-economic interdependences among countries in a tangled web of production, trade, and investment networks.

The World Used to be Flat

Globalization has undergone a structural shift.[2] Changes in the international balance of power are reshaping the conditions under which the process of economic globalization evolves with repercussions for international business.

Globalization in the 1990s was essentially mono-centric, based on the post-Cold War structural power convergence between geo-economics and geopolitics.

The North Atlantic was the geo-economic center of the world. The globalization process spread out of that North Atlantic core to encompass the whole world of trade, investment, and financial relations. To a large extent, the G-7 synthesized this global geo-economic powerhouse. In the early 1990s, the G-7 generated 55% of the world output and was responsible for 53% of global exports. To be sure, within the G-7, the USA had a leading role in building and sustaining this geo-economic structure of growth, production, trade, investment, innovation, and institutions. The USA functioned as the dynamic hub of the global economy, intertwining Western Europe and Japan as economic partners and security allies.

Geopolitically, the globalization process benefited from the post-Cold War unipolar power architecture, having the USA as the undisputable pole of geopolitical power. Acting in concert with its allies in Europe and Asia, the US has enjoyed preeminence in projecting global power worldwide. This unipolar situation has safeguarded the security structure of sea-lanes which are vital for the global economy (the “command of the commons”[3]) and the stability of a rules-based framework of trade, finance, and security arrangements built during the Cold War years (from the GATT/WTO to the IMF, the World Bank, and the UN).

Brookings Institution author Thomas Wright coined the term “unipolar concert” to describe a concert of powers that “rested on US unipolarity and hegemony as well as the collective willingness [of the other major powers] to work within it.”[4] Indeed, such “unipolar concert” blended the geopolitical and geo-economic components of a mono-centric globalization.

However, by the end of the 2000s, a structural divergence began to emerge between global geo-economics and geopolitics, decoupling the former from the latter and shaping the power structure of a polycentric globalization.

A multipolar geo-economic power structure took shape in terms of the economic dynamism of production, trade, and investments. The center of geo-economic gravity moved away from the North Atlantic towards Asia. This deconcentration of economic power meant that established geo-economic poles (the USA, Europe, Japan) had now to coexist with new geo-economic poles of power (China, India, Brazil, among other emerging economies). In geo-economic multipolarity, diversity and complexity become the rule. New spheres of geo-economic influence are gradually evolving, as the Chinese-led “One Belt, One Road”, linking Eurasia from East Asia to Europe through infrastructure, trade, and investment initiatives. New institutional settings of economic governance have been established at the global and regional levels, such as the G-20 in 2008, the New Development Bank and the Asian Infrastructure Investment Bank in 2015. In other words, a new global economic order is in the making.

As a result, the unipolar geopolitical power structure became increasingly under pressure from the geo-economic transformations. In geopolitical terms, the US remains the undisputable military pole, although other poles of power, particularly China, are gradually translating their economic capabilities into military and diplomatic resources.[5] The international system could well develop into a bi-multipolar world, a hybrid configuration of power, having the USA and China as bipoles, coexisting in complex and shifting relationships with a number of multipoles. In the meantime, however, one reality is clear: the new geo-economic poles of power are decoupled from the main geopolitical pole of power in terms of security commitments. And, by implication, economic interdependences no longer perfectly coincide with security arrangements – as they used to for Germany and Japan in the 1980s. As a result, Michael Mastanduno reminds that: “The US dominance in the international security arena no longer translates into effective leverage in the international economic arena”.[6]

Awareness of such systemic geopolitical risks is vital for global business. The structural confluence between geo-economics and geopolitics generated uniformity in the globalization process. The end of confluence is generating multiformity. Nowadays, the process of economic globalization takes place under the shadow of a different balance of power. TNCs from established and emerging geo-economic powers coexist and operate in the global marketplace. They are re-charting the geo-economic map of production and trade networks. In the process, a complex web of geo-economic interdependences with varying degrees of power symmetries among countries is being woven.

The Globalizing Business of Production Networks

Globalization in the 1990s was a fertile ground for the activities of transnational corporations, especially those from the G-7 countries. In fact, many analysts describe TNCs as the main drivers of globalization.[7] The revolution in information and communication technologies reduced costs of communication and coordination; Asia offered opportunities for investments, reallocation of labor costs, and potential consumer markets, as China´s model of Special Economic Zones exemplifies; and, above all, the “unipolar concert” provided the mono-centric confluence of geo-economics and geopolitics that created an almost geopolitical risk-free world for TNCs.

This was Thomas Friedman’s “flat world”, in which the “globalization system” replaced the “cold war system” as the basic configuration of the international system.[8] Globalization´s mono-centric uniformity seemed poised to rule the world. That specific mono-centric convergence between geo-economics and geopolitics was somehow perceived as the natural condition of global affairs. So much so that it was easy to be oblivious, as Fareed Zakaria pointed out, that “the flat economic world has been created by an extremely unflat political world.”[9] It took the 2008 financial crisis to unfold the tectonic shifts in global power taking place over the first decade of the 21st century.

Taking advantage of that “flat world”, transnational corporations changed the organization of production and trade on a global scale by dispersing functions geographically.  Global supply chains – or global value chains (GVCs) as they are known in the trade literature – intertwined countries in the international flows of investments, trade in goods and services, financing, research and development, logistics, and trans-border transportation. GSCs generated “complex and dynamic economic networks made up of inter-firm and intra-firm relationships.”[10]

Economist Richard Baldwin calls this process of expanding TNC networks as globalization´s “second unbundling”. If the “first unbundling” was associated with the transportation revolution since the late 19th century and the reduction of transportation costs for moving goods, people and ideas, the “second unbundling” was linked to the revolution in information and communication technologies in the late 1980s that reduced costs of communication and coordination and created the conditions for firms to disperse geographically their production processes via outsourcing and offshoring. [11]

The organization of global supply chains has mainly been regional. They form, as Richard Baldwin aptly observed, regional “factories” – mainly “Factory Asia”, “Factory North America”, and “Factory Europe”. Companies from “headquarter economies” (essentially the US, Germany, Japan, and increasingly Korea) shape the network and establish a hub-and-spoke structure with “factory economies”.[12]

GSCs create a specific kind of cross-border trade: global-supply trade – which has been identified as a defining feature of contemporary international trade. The United Nations Conference on Trade and Development (UNCTAD) estimates that supply-chain trade (intra-firm and inter-firm related) accounts for 80% of global trade.

Supply-chain trade is also predominantly regional, reflecting the GSCs´s regional manufacturing structures. A hub-and-spoke pattern in trade relations is formed around key trading nations at the regional level. In those GSCs, exports are markedly composed of import and processing of intermediate inputs. In 2007, for instance, 5% of the gross value of China’s exports and 6% of Korea’s exports consisted of intermediate inputs from Japan; 37% of gross value of Mexico’s exports and 18% of Canada’s exports consisted of intermediate inputs from the USA; 12% of the gross value of Poland’s exports, 7% of Spain’s and Portugal’s exports, as well as 5% of France’s and Italy’s exports consisted of intermediate inputs from Germany. Although supply-chain trade takes place predominantly within those ‘regional factories’, there are complex inter-regional interdependences. The US, China, Germany, and Japan are at the heart of supply-chain trade at the global level.

Risky Business for Global Supply Chains

TNCs and their GSCs are now facing two types of geopolitical risks – the traditional risks of location and the systemic risks of geo-economic multipolarity. The first type of geopolitical risk is associated with the very nature of GSC production networks, which organize “functionally fragmented and geographically dispersed production processes”[13]; the second type is related to the new geo-economics of the polycentric globalization and the interdependences among countries involved in GSCs.

According to a study conducted by PriceWaterhouseCoopers (PWC), 90% of world trade flows through 39 gateway regions and involve global logistic hubs and chokepoints.[14] These geographic realities define the geopolitical-risk landscape of global supply chains. As shown on the map below, geopolitical gateway regions are locations that concentrate large flows of cargo, making them vital to global supply chains and particularly sensitive to disruptions (China Seas, Indian Ocean). Likewise, geopolitical logistic hubs (e.g. Singapore, and the Hong Kong-Shenzhen freight cluster) are vital to the processing of trade flows; and finally geopolitical chokepoints are the critical spots for the security of trade flows, such as the Panama Canal, the Strait of Hormuz, the Suez Canal, and the Strait of Malacca.

With such geographic concentrations, traditional geopolitical risks, such as interstate tensions and conflicts, terrorism, piracy, and cyber-attacks have immediate impacts on the global supply chain business and trade. Traditional geopolitical risks can affect the security of sea-lanes and shipping routes, as well as transportation and logistics infrastructures.

At the systemic level, emerging geo-economic powers and their national firms are now key players in the global geo-economic landscape. New geo-economic spheres of influence are being drawn. A number of TNCs from emerging countries are entering the global marketplace, establishing their own global supply chains and, as a consequence, redefining the world map of geo-economic players. Geo-economic strategies of emerging powers are facilitating that process.

Beyond the commonly held view of China as a global manufacturing hub; India, as a service center; and Brazil, as an agriculture and commodity power house, those countries are far from being exclusively encapsulated in those activities. A number of TNCs from each of those countries display a much more complex and sophisticated link with the GSC business. Brazil´s Embraer, India´s Tata, and China´s Lenovo are good examples. These TNCs are hubs of regional and global supply chains. Brazil’s Embraer, for instance, marshalling inputs from over 700 suppliers around the world, relies on the strategic management of its global supply chain for international competitiveness. These new TNCs are competing in the top league of global business and changing the composition and origin of GSCs. So the question for many emerging countries´ firms is no longer how “to join” GSCs – which can, of course, still enhance competitiveness by substituting domestic value chain integration in some sectors and by improving domestic infrastructure and logistics – but rather how “to build” their own regional and global production networks.

New trade corridors are being shaped within Asia, South America, and Africa, as well as between those regions while those GSCs are formed. Trade flows along those corridors are re-charting global supply chains and establishing new trade patterns.[15]

In a condition of polycentric globalization, geo-economic interdependences are a source of systemic geopolitical risks for the activities of TNCs involved in GSCs. The situation of geo-economic interdependence affects three dimensions of countries’ relations with one another and should be clearly understood by TNCs: (i) the sensitivity and vulnerability; (ii) the symmetry; and (iii) the balance of benefits.

The “GVCs participation rate” (GVC-PR) produced by UNCTAD indicates the share of a country’s exports that is part of a multi-stage trade process. It shows the extent of the country´s export integration into international production networks and measures the extent of a country’s exposure to and dependence on GSCs trade.[16] According to UNCTAD, in 2010, Singapore had a GVC-PR of 82% with a significant upstream component; Germany had a CVC-PR of 64%, equally distributed in upstream and downstream components; the USA had a CVC-PR of 45%, with a high concentration in the downstream component; and Brazil had a CVC-PR of 37%, also with a high concentration in downstream activities. [17]

The “GVC participation rate” also indicates a country’s sensitivity and vulnerability in relation to supply-chain trade.[18] Sensitivity is related to impact costs on a country associated with changes in one part of the GSC. Vulnerability is related to adjustment costs a country will incur in order to find a systemic alternative to the GSC. So, for instance, the higher the participation rate, the higher a country’s sensitivity and vulnerability in relation to GSCs (e.g., shocks along the GSC, export restrictions, country-specific risks, TNC bargaining power, etc).

Geo-economic interdependence also raises the question of symmetry in countries’ relative position within the GSC network. Some countries are less dependent than others in relation to GSCs. And less dependence is a source of power in interdependence.

There are two basic structural asymmetries within the GSCs: (a) between headquarter economies and factory economies and (b) between hub economies and spoke economies. “Headquarter economies” (the US, Germany and Japan above all, though increasingly Korea) whose firms concentrate high-tech and know-how (managerial, marketing as well as technological) use the GSCs to combine their firm-specific knowledge with low-cost labor. “Factory economies” (Factory Asia, Factory Europe, and Factor North America) provide labor. In each of these “factories”, regional hub-and-spoke structures of interdependences are formed. An important objective for China and other emerging economies is to become a “headquarter economy”, moving the ladder up from “factory economies”.

The comparison between the relative positions of the US, Canada, and Mexico offers an example. The US has the “full package” of competitive firms in all sectors (agriculture, manufacturing, services) and is able to capture multiple dimensions of GSCs (inputs to other countries´ exports, such as IT services, but also exporting high value-added final products of GSCs, such as iphones and ipads). The US also participates as a headquarter economy in several GSCs in different parts of the world, while Mexico and Canada are predominantly spokes in the “North America factory”. The US has little dependence on intermediate imports from Canada and Mexico, but Canada and Mexico (and their firms) have high overall dependences on intermmediate imports from the US. The North America Free Trade Agreement (1994) facilitated this hub-and-spoke structure.

The balance of benefits is another important feature of GSC interdependence. It makes a significant difference if a country is a headquarter economy or a factory economy to reap relative benefits from GSCs. Headquarter economies choose to focus on the most profitable activities and to offshore less profitable activities to factory economies. Being a headquarter economy and the hub of a supply chain will bring more relative gains than being a factory economy and a spoke of a supply chain. Given the distinction between headquarter economies and factory economies, the in-built uneven distribution of relative gains among countries involved in the GSC has the potential for distributive conflicts over the inequality of benefits. Not by chance China’s economic reforms aim, among other goals, to advance the country’s position in the GSC hierarchy, from a factory to a headquarter economy. Moving from assembly activities based on low costs of labor to high value-added activities and products is the name of the game for large emerging economies.

The geo-economics of mega-regional trade negotiations will have a profound impact on TNCs and their supply chains. As the GSCs have changed the patterns of trade and investment flows in Asia, particularly associated with the US headquarter economy, the Trans-Pacific Partnership (TPP) becomes essential to help firms from headquarter economies to offshore production stages to factory economies. The TPP ultimately aims at locking in deeper rules and disciplines (favorable property rights, competition policies, investment rules, disciplines on state-trading enterprises, harmonization of rules, etc.) which will protect the production and investments of the TPP-area headquarter economies and assure access and advantages for their final products. The TPP can enhance the trading power position of existing headquarter economies.

Finally, as TNCs have shaped GSCs, their operations can also restructure them. New technologies may impact GSCs (e.g. 3D printing, computer integrated manufacturing, etc.) and create the conditions for “reshoring” tasks and functions produced abroad. Labor and energy costs may also affect the conditions of GSCs’ competitiveness (e.g. rising manufacturing or transportation costs in Factory Asia and the shale gas revolution in the US are cases in point). Those changes will certainly affect current geo-economic interdependences among countries involved in GSCs and impact on the definition of systemic geopolitical risks.

Conclusion

The globalization process is undergoing fundamental shifts as its geopolitical and geoeconomic underpinnings evolve. The confluence between those two dimensions of global power has come to an end. New geo-economic powers have decoupled from the geopolitical framework that shaped the globalization process since the 1990s. The end of the “unipolar concert” is also the end of the “flat world” of globalization. From the rise of emerging countries´ TNCs and their supply chains to the complex interdependences of GSCs and the negotiations of mega-regional trade agreements, the great game of geo-economics is being redefined.

These transformations have important repercussions for international business. Geopolitical risks are now beyond the traditional elements associated with location and business operations in unconventional markets. Systemic geopolitical risks linked to the polycentric nature of globalization and the geo-economic interdependences of global supply chains are inescapable elements for TNCs´s global strategies.

Geopolitical risks cannot be avoided, but they can be managed. For TNCs, political risk insurance coverage or alternative sources of supply are important forms of dealing with those risks. But the fundamental challenge for transnational corporations´ global business strategies is to develop what I call “corporate geopolitics”. It essentially means that TNCs and firms operating globally must integrate, at the level of their corporate and business strategies, a sophisticated degree of geostrategic awareness on international transformations and trends. For companies with global reach, corporate geopolitics seeks to provide geopolitical risk analysis, assessment, and management, blended with government relations, as coherent and systematic inputs for the business and corporate strategy processes. Against the backdrop of changes in the global economic order, geopolitical understanding and management will be an invaluable source of competitive advantages for companies. Corporate geopolitics should help business understand the tectonic shifts in the world map.

JPR Status: Opinion

Braz Baracuhy is a diplomat and specialist in geopolitical risks. He joined the Brazilian Foreign Ministry in 2001 and has worked with economic diplomacy, policy planning, and international trade negotiations. He currently heads the Ministry´s agriculture & commodities trade negotiations unit, having previously served in Beijing, Geneva, and Lima. He attended the Grand Strategy program at Yale University and studied International Relations at the London School of Economics, the Pontifical Catholic University of Rio de Janeiro (PUC-Rio), and the Instituto Rio Branco (Brazilian Diplomatic Academy), where he teaches strategic planning. He contributed as an expert on geopolitical risks to the World Economic Forum and is a member of the International Institute for Strategic Studies (IISS), collaborating with the IISS Program on Geoeconomics & Strategy. The opinions expressed here are strictly personal and do not necessarily reflect those of his institutional affiliations.

Endnotes

[1] A good discussion put forward by Sanjaya Baru, “Understanding Geo-economics and Strategy” – A New Era of Geo-economics: Assessing the Interplay of Economic and Political Risk, IISS Seminar 23-25 March, 2012. See also the World Economic Forum report Geo-Economics: Seven Challenges to Globalization (2015).

[2] A detailed account of those shifts can be found in Braz Baracuhy (2015) “The Evolving Geo-Economics of World Trade” in Sanjaya Baru & Suvi Dogra Power Shifts and New Blocs in the Global Trading System. London: IISS and Routledge.

[3] Barry R. Posen (2003) “Command of the Commons: The Military Foundation of U.S. Hegemony”. International Security, Vol. 28 (1).

[4] Thomas Wight (2015) “The Rise and Fall of the Unipolar Concert”, Washington Quarterly, vol 37 (4), p. 10

[5] The IISS 2014 Military Balance, for instance, estimates that the US 2013 defense budget of US$ 600 billion is only slightly smaller than the other top 15 countries´ defense budget combined. China has the second highest defense budget (US$ 112 billion), followed by Russia (US$ 68 billion).

[6] Michael Mastanduno (2009) “System Maker and Privilege Taker: US Power and the International Political Economy”, World Politics  vol 61(1), p. 123.

[7] Gustavo H. B. Franco (1997) “Globalização: uma perspectiva histórica” Política Comparada: Revista Brasiliense de Políticas Comparadas  vol 1 (2); Raymond Vernon (1998) In the Hurricane’s Eye: The Troubled Prospects of Multinational Enterprises Cambridge: Harvard University Press; for a recent discussion on globalization and the challenges and opportunities for companies, see David Collis (2015) International Strategy: Context, Concepts and Implications London: Wiley, pp 12-38.

[8] Thomas L. Friedman (2005) The Lexus and the Olive Tree. Farrar, Straus & Giroux, 1999; and The World Is Flat. Farrar, Straus & Giroux.

[9] Fareed Zakaria (2005) “The World is Flat: The Wealth of Yet More Nations”. The New York Times, May 1.

[10] Gary Gereffi (2014), “Global Value Chains in a post-Washington Consensus World”, Review of International Political Economy, vol 21 (1), p. 10. See also Hult T, Closs D, Frayer D (2014) Global Supply Chain Management. New York: McGraw-Hill.

[11] Richard Baldwin (2006) “Globalisation: The Great Unbundling(s)”. Economic Council of Finland.

[12] Global production networks are mainly formed in manufacturing industries such as electronics, aeronautics, automotive, machinery, textile, chemicals, and plastics, among others. Extractive and service industries integrate several GVCs providing inputs for many other industries’ exports – commodities, agribusiness, and mining are good examples.

[13] Richard Dicken (2011) Global Shift: Mapping the Changing Contours of the World Economy, 6th ed, London: Sage, p.7.

[14] PriceWaterhouseCoopers, Transportation and Logistics 2030, vol 4, Securing the Supply Chain. www.pwc.com/tl2030

[15] PriceWaterhouseCoopers, Transportation and Logistics 2030, vol 3, Emerging Markets – Ne Hubs, New Spokes, and New Industry Leaders? www.pwc.com/tl2030

[16] There are two components of a country participation in GVCs. The upstream links, referring to imports of foreign intermediate inputs by country A to be used in country A’s exports, i.e., higher foreign content in A’s export; and the downstream links, referring to exports by country A to be incorporated as intermediate inputs in other countries’ exports.

[17] UNCTAD (2013), “Global Value Chains and Development: A Preliminary Analysis”, page 12.

[18] Impacts also depend, among other factors, on the participation of trade in the country’s overall economic growth and on the political economy of winners and losers from trade in the economy. A point to consider is that large countries with significant domestic markets tend to have a lower participation in international trade, as shown in data from the World Bank on merchandize trade (exports plus imports) as a share of GDP in 2013: USA (23%), Brazil (22%), China (45%), India (41%), compared to Germany (71%), Korea (82%), Singapore (263%), and Hong Kong (422%).