Executive Summary

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Third Quarter 2012

Eurasia Group Global Trends Quarterly

Executive Summary In collaboration with PricewaterhouseCoopers, Eurasia Group is monitoring and assessing major trends shaping the global business environment. This document summarizes the findings of five white papers. The extraordinary breadth and depth of the current worldwide economic turmoil and its gradual stabilization create new uncertainties in international and local political environments. Now, more than ever, it is crucial to understand emerging global trends.

Politics, Sustainability, and the Retail and Consumer Sector Gas Boom Feeds Power Sector Shift The Illusion of European Growth Strategies Implications of the Eurozone Crisis for Africa The Lure of Protectionism: Crisis Measure or Emerging Trend?

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Third Quarter 2012

Politics, Sustainability, and the Retail and Consumer Sector Key points

Business implications

The fortunes of the world’s largest retailers and consumer goods manufacturers are linked closely with global sustainability issues. Environmental challenges and an expanding global population will dramatically squeeze the availability of natural resources and change consumer behavior in the coming years. And it will be difficult for companies to contain costs and stay relevant to their customers. At present, however, the global political environment is not conducive to reaching agreement on sustainable solutions. A lack of consensus will result in fragmented policymaking, thereby creating an unpredictable, country-based regulatory environment and compliance issues for firms. Despite the private sector’s efforts to control and/or ameliorate its sustainability challenges, this political context will aggravate the situation in three key areas: water use and scarcity, climate change, and commodity scarcity and price volatility.

• For retail and consumer firms, environmental stability equals business stability. A failure to address the global challenges of environmental degradation, poverty, hunger, and resource scarcity will have a detrimental impact on the retail and consumer sector, which relies on agricultural commodities, natural resources, and consumers’ purchasing power. • In the absence of global agreement, retail and consumer firms must familiarize themselves with local and national sustainability regulations. Different countries will have different policies and practices when it comes to water, agriculture, and climate change. This is likely to complicate compliance for firms with global supply chains. Furthermore, national policies and regulations are likely to change as governments change.

Middle class consumption, 2000–2050 100

Other Other Asia

80

Percent

India 60 China 40

Japan

20

EU US

0

00

20

05

20

10

20

15

20

20

20

25

20

30

20

35

20

40

20

45

20

50

20

Sources: Kharas, H. (2010), The Emerging Middle Class in Developing Countries, OECD Development Centre Working Paper No. 285, p29, http://dx.doi.org/10.1787/5kmmp8lncrns-en; data from Wolfensohn Center for Development.

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Third Quarter 2012

Gas Boom Feeds Power Sector Shift Key points

Business implications

The abundance of natural gas will have long-term ramifications on fuel-switching in the power sector, affecting commodity markets, utilities, and manufacturing companies. As the shale gas boom moves beyond North America, the market conditions that have influenced a recent US trend of economics-based fuel-switching to gas from coal could be duplicated. Moreover, policy planners wary of environmental externalities associated with coal use in the power sector could be coaxed into adopting more stringent regulations targeting carbon dioxide as well as more localized pollutants such as mercury, sulfur dioxide, and nitrogen oxides. Yet in order for gas to take on a larger role in the power sector, gas pricing structures must be altered. And significant investment is needed for upstream exploration activity for more challenging gas resources, such as unconventionals and offshore conventional gas, as well as midstream and downstream infrastructure to make use of the fuel. This will take time, and though there are already processes in place in Europe and China that could open up market space for natural gas, coal remains more economically competitive in current market conditions.

• Commodities markets will be volatile: The issue of coal versus gas switching in the power sector will remain volatile based on the economic competitiveness of the fuels. Already, US gas supply has disrupted previously held projections that the US would be a pillar of LNG demand. Instead, the US will become an LNG supplier in the next five years while, in the event that environmental regulations stay in place, more coal is freed up for exports. This excess coal is feeding into an oversupplied world market that is suppressing thermal coal prices in Europe, thereby boosting the competitiveness of coal there. In order for gas to become more competitive, European utilities will continue to push for a delinking of oil and gas prices, a process that is ongoing yet will unfold gradually. In Asia, the oil-gas price linkage is stronger, but a shift is also underway there, with China exercising a strategy of diversifying its gas mix in order to rein in gas prices.

100

15

80

12

60

9

40

6

20

3

0

r l g p t v c n b r r y n l g p t v c n b r r y n l g p t v c n b r r y n l g p t v c n b r r y n l g p t v c n Ju Au Se Oc No De Ja Fe Ma Ap Ma Ju Ju Au Se Oc No De Ja Fe Ma Ap Ma Ju Ju Au Se Oc No De Ja Fe Ma Ap Ma Ju Ju Au Se Oc No De Ja Fe Ma Ap Ma Ju Ju Au Se Oc No De Ja Feb Ma

2007

2008

2009

Left axis

2010

2011

$/mmbtu

bcf/day

Shale revolution impact on US gas market

0

2012

Right axis

Consumption (bcf/d)

Henry Hub price ($/mmbtu)

Production (bcf/d) Source: Energy Information Administration

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Third Quarter 2012

The Illusion of European Growth Strategies Key points

Business implications

After more than a year of austerity—the widely undisputed cure and response to the eurozone sovereign debt crisis—the debate is now shifting rapidly toward promoting growth. Even as fiscally conservative countries such as Germany have pressed for strict austerity measures, the growth discourse is emanating more and more from countries such as France and Italy. Nevertheless, it is nearly impossible to achieve growth in the short term for two reasons: First, viable growth at this stage will mostly require structural reforms, which take time; second, the bold steps required at the EU level, such as deeper integration, will fail to generate consensus among member states in the near future and would take years to implement. Consequently, more effort to address growth can be expected, but businesses should prepare for a low-growth environment at least in the short to medium term.

• Assessing divergent EU markets in the longer term: Divergent needs could lead to growing imbalances among EU countries and to the emergence of a twospeed EU economy with some member states (such as Germany) rebounding more quickly, and others continuing to struggle to return to growth. Peripheral economies will gradually become more competitive for labor and manufacturing. Companies with a long-term country-specific strategy will be better positioned to maintain market share and benefit from a return to growth in specific economies. • Opportunities for public-private partnerships: Sustained austerity, despite talk of encouraging growth, will lead to sluggish economic growth, and large stimulus measures will be unlikely given deficit targets. Governments may look to the private sector more and more to finance infrastructure projects they are unable to fund, in order to stimulate employment figures and boost their economies. As a result, public-private partnerships may become more attractive in some countries.

GDP growth and fiscal position of key economies Real GDP

Debt (percent of GDP) Deficit (percent of GDP)

2011

2012

2011

2012

2011

2012

Eurozone

1.5

-0.3

88

91.8

-4.1

-3.2

Germany

3

0.7

81.2

82.2

-0.8

-0.4

France

1.7

0.5

85.8

90.5

-4.1

-3.2

Italy

0.4

-1.4

120.1

123.5

-3.6

-0.7

Spain

0.7

-1.8

68.5

80.9

-7.3

-4.8

Source: European Commission, European Economic Forecast, Spring 2012

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Third Quarter 2012

Implications of the Eurozone Crisis for Africa Key points

relative, though. It may cost European corporations market share over time, but it need not be terminal. Instead, this dynamic could force greater cooperation between European and emerging market entities. Western multinationals are beginning to strike major joint ventures with Chinese counterparts—for instance, Total and Tullow’s linkup with the China National Offshore Oil Corporation in Uganda and Rio Tinto’s partnership with Chinalco in Guinea.

Although Europe is Africa’s largest source of foreign aid, remittances, and FDI, and it buys a noteworthy amount of the continent’s non-oil exports, the eurozone crisis is unlikely to inflict significant harm on African economies. China and other emerging markets provide a buffer against the effects of European recession and austerity, and African economies are also more resilient and less dependent on Europe than at any point since their independence. While not immune to a downturn, business opportunities on the continent will continue to be robust, especially for corporations with an already established presence. And new market entry opportunities may arise in countries looking to diversify away from European linkages.

• Closer business-to-government relations: Proactive corporate engagement with relevant government agencies, including multilateral institutions, along this partnership model can help market entry and expansion in Africa. US government agencies such as the Overseas Private Investment Corporation, the Export-Import Bank, and even the US Trade and Development Agency will likely continue to ramp up their modest but effective investment and trade promotion activities on the continent. Relative to foreign aid or costly new spending initiatives, such commercially grounded engagements are well suited to the age of austerity underway in Europe and looming over the horizon in the US.

Business implications • Opportunities for collaboration between Western and EM corporations: European corporations, like their US counterparts, complain that they receive limited diplomatic backing from their parent governments, particularly as compared to emerging market companies. This decline in influence is

Africa’s exports to the EU by region Percent of total exports in 2008

60 50 40 30 20 10 0

tr

al

n Ce

ca

ca

ca

ri Af

Ea

st

ri Af

th

or

N

ri Af

rn

he

t ou

S

Source: African Development Bank (AfDB), 2010 4

a

a

ric

ric

Af

es W

f tA

A CF

e

on

z nc

fra

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Third Quarter 2012

The Lure of Protectionism: Crisis Measure or Emerging Trend? Key points

which industries are strategic or growth priorities for a particular government will determine opportunities and risks for companies operating in that sector. Government promotion of national champions in strategic sectors will disadvantage foreign firms. Domestic firms may enjoy government support such as state funding and access to credit, subsidies, tax breaks, and political favors. Investors should think critically about how to remain competitive and relevant to government priorities.

As governments continue to struggle with the global economic downturn, there is growing unease among business leaders about protectionism. Since October 2008, more than 800 restrictive measures have been registered with the World Trade Organization (WTO), estimated to affect 3% of world merchandise trade (and 4% of G20 trade). While some speed bumps were expected following the financial crisis, the continuation and accumulation of these restrictive measures have sparked concerns that protectionism is a longer-term trend. This has stoked fears of trade wars and is threatening international business and trade liberalization more broadly. For business decision-makers assessing operating prospects in various markets, it will be vital to distinguish between ongoing but temporary crisis management measures intended to protect against global economic turmoil, and more fundamental measures such as state intervention for industrial policy purposes.

• Benefits from thinking globally, acting locally: Foreign firms already well-established in certain markets may benefit from reduced competition from others looking to enter. Entrenched firms may benefit from tax incentives and other government support in return for playing by the new rules, seeking domestic partners and suppliers, and expanding their investment in the host country. A so-called glocalization (or multilocal) strategy that localizes operations may be able to reduce tariffs and other costs, strengthen government and social relations, and stay informed about local regulations and loopholes.

Business implications • Businesses seeking growth in other markets should assess risks according to sector: Assessing

Bailout / state aid measure

Consumption subsidy

Export subsidy

Export taxes or restriction

Import ban

Import subsidy

Investment measure

Local content requirement

Migration measure

Non-tariff barrier

Other service sector measure

Public procurement

Quota (inc. tariff rate quotas)

Sanitary and phytosanitary measure

State trading enterprise

State-controlled company

Tariff measure

Technical barrier to trade

Trade defense measure (AD, CVD, safeguard)

Trade finance

Total

Types of trade restrictions implemented by Argentina, Brazil, Indonesia, and Russia since November 2008

Argentina

19

0

2

18

5

0

4

2

0

156

0

0

3

0

0

2

16

6

101

0

334

Brazil

2

0

8

2

0

0

8

4

2

3

2

8

7

0

0

2

130

0

72

6

256

6

0

0

13

5

2

14

1

2

16

6

6

2

3

0

2

13

3

42

0

136

149

6

7

42

6

4

13

6

4

3

14

12

11

6

12

29

174

6

49

0

553

Indonesia Russia

Source: Global Trade Alert Photo credit: Reuters This material was produced by Eurasia Group in collaboration with PricewaterhouseCoopers. This is intended as general background research and is not intended to constitute advice on any particular commercial investment or trade matter or issue and should not be relied upon for such purposes. © 2012 Eurasia Group

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