Global Risks InsightsGeopolitical Risks

Long term impact of protectionism Backlash against free trade and globalization could lead to slower global growth

Global Risks InsightsGeopolitical Risks

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GLOBAL RISKS INSIGHTS GEOPOLITICAL RISKS

CONTENTS

3/14

Since the 2008 financial crisis, growth in trade openness has stagnated and protectionist measures have increased.

Recent years have seen a political backlash against free trade and globalization in wealthy countries, along with a slowdown in export trade. While high-income states have been among the biggest beneficiaries from globalization, there is growing evidence of unequal benefits within countries. Many voters in the United States and Europe blame free-trade agreements for the loss of well-paying, middle-class jobs1.

Brexit and President Donald Trump’s victory partly stem from this growing anti-globalism mood. Since his election, Trump has fulfilled his electoral pledge to remove the United States from the Trans-Pacific Partnership (TPP) agreement, has called for a renegotiated North American Free Trade Agreement (NAFTA) to reduce the US trade deficit and is reportedly considering a 20% tariff on imports of steel and possibly other goods2.

In the past, protectionism has led to more instability, including conflicts between countries3. Other factors, such as Chinese curbs on foreign investment, are raising business concerns about China’s commitment to openness. Growing China-US military tensions over the South China Sea could spill over to accelerate the trend toward more trade and investment restrictions.

Note: GDP is reported as the cumulative difference between Base Case and scenario variant (in billions of US dollars); Extreme Poverty measures those living on less than $1.90 per day (in millions of people); Middle Class includes those living on more than $10 per day (in millions of people); Instability is reported as the number of countries experiencing higher levels of instability relative to the Base Case.

GLOBAL RISKS INSIGHTS GEOPOLITICAL RISKS

Long term impact of protectionism Backlash against free trade and globalization could lead to slower global growth

01 Federica Cocco, ‘Most US Manufacturing Jobs Lost to Technology, Not Trade,’ Financial Times, December 2, 2016, https://www.ft.com/ content/ dec677c0-b7e6-11e6-ba85-95d1533d9a62.

02 http://www.businessinsider.com/trump-steel-tariff-china-germany-japan-global-recession-2017-6.

03 Dale C. Copeland, Economic Interdependence and War (Princeton, NJ: Princeton University Press, 2014).

Source: World Bank, Global Economic Prospects, June 2017, p.26 https://openknowledge.worldbank.org/bitstream/handle/10986/26800/9781464810244.pdf

Risk of protectionism

Protectionism: scenario variants

Base Case 2016

82,000GDP billion USD

950Extreme Poverty (less than $1.90/day)million people

2,480Middle Class ($10+/day)million people

Instability number of countries

Base Case 2035

141,400

710

3,950

––

Globalism Resurgence

25,900

-22

68

0

Protectionist Victory

-18,000

33

-54

64

Sources: Bown and Irwin (2015), Google Trends, World Bank.

A. Weekly average Google Trend search for ‘protectionism’, ‘trade restrictions’, ‘trade war’, and ‘import tariffs’. 2017 average is year-to-date. Latest observation is May 21 2017.

B. Global trade is defi ned as the average of exports and imports in percent of global GDP. Applied tariff rates based on the weighted mean for all products.

250 -

200 -

150 -

100 -

50 -

2012-15 2016

A. Discussion of protectionism

2017

Incidence

25 -

20 -

15 -

10 -

5 -

B. Global trade and tariffs

TariffsPercent

- 40

- 30

- 20

- 10

TradePercent of GDP

1947Pre

1948Post

1984Pre

1972Post

1987Post

1999Post

2012-15

Geneva Kennedy Tokyo Uruguay Latest

Protectionism has become an important source of concern. A spiral of retaliatory trade restrictions could undo gains from past trade liberalization.

4/14Risk of protectionism

Sources: Bown and Irwin (2015), Google Trends, World Bank.

A. Weekly average Google Trend search for ‘protectionism’, ‘trade restrictions’, ‘trade war’, and ‘import tariffs’. 2017 average is year-to-date. Latest observation is May 21 2017.

B. Global trade is defi ned as the average of exports and imports in percent of global GDP. Applied tariff rates based on the weighted mean for all products.

250 -

200 -

150 -

100 -

50 -

2012-15 2016

A. Discussion of protectionism

2017

Incidence

25 -

20 -

15 -

10 -

5 -

B. Global trade and tariffs

TariffsPercent

- 40

- 30

- 20

- 10

TradePercent of GDP

1947Pre

1948Post

1984Pre

1972Post

1987Post

1999Post

2012-15

Geneva Kennedy Tokyo Uruguay Latest

Protectionism has become an important source of concern. A spiral of retaliatory trade restrictions could undo gains from past trade liberalization.

5/14

Greater protectionism leading to slower global growth would hurt all countries, but developing ones are most vulnerable.

We modeled several scenarios, including ones which saw a renewed emphasis on global trade which we called ‘Globalism Resurgence’ and another on more protectionism or ‘Protectionist Victory.’ Over an almost twenty years out to 2035, the difference between the scenarios in terms of global GDP is an overall $44 trillion. Low-income countries are particularly hard hit, suffering 8 percent drop in GDP while high-income countries would see a 5 percent drop.

The foregone gains seen in Protectionist Victory, as compared to Globalism Resurgence, are felt more strongly in countries that have not yet been able to take full advantage of the global economy. Africa and Central America, for example, appear the most sensitive to long-term protectionist policies.

With some European countries, such as those of Southern Europe, already forecast to see lower levels of growth over the coming decades in the Base Case, an increase in global protectionism on the scale simulated in Protectionist Victory could translate into an economic slowdown.

Greater protectionism leading to slower global growth would hurt all countries, but developing ones are most vulnerable.

The difference in the number of people living on $10 or more per day between Globalism Resurgence and Protectionist Victory would be more than one hundred and twenty million people by 2035, or roughly the size of Mexico’s or Japan’s population today.

While the rough proportion of middle- and upper-class population in high-income economies remains largely the same across these scenarios, increased global protectionism undermines the growth of a middle class in the rest of the world.

The probability of violent domestic conflict increases in sixty-three countries in Protectionist Victory. The growing violent conflict is driven by stalling human development and government capacity in Protectionist Victory. India, Egypt, the Philippines, and Thailand are among those that experience the greatest increase in risk of instability under Protectionist Victory.

GLOBAL RISKS INSIGHTS GEOPOLITICAL RISKS

Major Geopolitical Implications

$10

The difference in the number of people living on $10 or

more per day

between Globalism Resurgency and

Protectionist Victory would be

more than one hundred and twenty million people by 2035, or roughly the size

of Mexico’s or Japan’s population today.

View Protectionist victory in G20 countries

6/14

Base case Base caseProtectionist

victoryPercent decrease from base case

2016 2035 2035 2035

Argentina 550 940 900 4.8%

Australia 1,600 2,450 2,370 3.2%

Brazil 2,550 3,610 3,460 4.2%

Canada 1,940 2,590 2,500 3.7%

China 10,650 31,030 30,300 2.4%

France 2,980 3,820 3,690 3.4%

Germany 3,980 4,520 4,430 2.0%

India 2,570 9,860 9,580 2.9%

Indonesia 1,150 3,010 2,920 3.2%

Italy 2,200 2,480 2,380 4.0%

Japan 6,150 6,700 6,520 2.8%

Korea South 1,370 2,280 2,270 0.4%

Mexico 1,320 2,240 2,140 4.6%

Russia 1,920 2,390 2,300 3.9%

Saudi Arabia 780 2,330 1,290 2.9%

South Africa 450 740 700 4.6%

Turkey 910 1,820 1,750 3.8%

UK 2,870 3,840 3,700 3.7%

USA 17,200 23,160 22,480 2.9%

Total G20 63,140 108,810 105,680 2.9%

GDP IN BILLION USD UNDER THE BASE CASE AND PROTECTIONIST VICTORY SCENARIOS

Protectionist victory in G20 countries would imply a 2.9% decrease of GDP across these countries.

Protectionist victory in G20 countries

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If mutual tariffs were established and stayed in place, because of growing hostilities or a mutual trade conflict, separate spheres of Chinese and US economic activity would likely be created, rewiring current trade networks and significantly disrupting supply chains.

China has one of the highest participation rates in global value chains. With the rise in China’s economic importance, many countries that had been closely aligned with Western countries are increasingly reliant on Chinese trade.

Over fifteen to twenty years, separate China-US spheres of economic activity could result in a $95 trillion cumulative reduction in global exports. Foreign-investment growth would slow globally, but the United States and China would probably increase foreign aid to allies and partners to shore up ties.

The reduced trade would put the world on a lower economic growth trajectory. Global GDP would be reduced by a cumulative $35 trillion, leading to twenty million additional people living in extreme poverty, forty-five million additional people living on less than $3.10 per day.

GLOBAL RISKS INSIGHTS GEOPOLITICAL RISKS

Worsening in China-US ties creates a risk of large scale protectionism

GDP Reductions from separate US and Chinese spheres

Source: Frederick S.Pardee Center for International Futures

China has one of the highest participation rates in global value chains

GDP REDUCTIONS FROM SEPARATE US AND CHINESE SPHERES

Percent reduction in GDP relative to Base

4.2 or more 4.2 to 3.3 3.3 to 2.6 2.6 to 1.9 1.9 to 1.2 1.2 or less

NO DATA

Source: Frederick S. Pardee Center for International Futures

8/14GDP Reductions from separate US and Chinese spheres

GDP REDUCTIONS FROM SEPARATE US AND CHINESE SPHERES

Percent reduction in GDP relative to Base

4.2 or more 4.2 to 3.3 3.3 to 2.6 2.6 to 1.9 1.9 to 1.2 1.2 or less

NO DATA

Source: Frederick S. Pardee Center for International Futures

9/14

We used the Zurich Risk Room – a global risk analysis tool, designed to help illustrate the impact of multivariate risks on individual countries and regions – to model a scenario on the risk of protectionism.

We chose to contrast the level of economic risk facing G7 countries and Switzerland compared with BRICS (Brazil, Russia, India, China and South Africa), highlighting the countries that are better positioned to exploit protectionism changes.

Although the chart indicates that most G7 countries are in a better position to fend off protectionism, Brexit and President Trump’s election show that a powerful popular backlash against globalization has grown up even in rich and economically stable countries. While Chinese President Xi-Jinping has positioned himself as a defender of globalization, the chart shows that China and other BRICS countries could be vulnerable to protectionist pressures.

With slowing economic growth in the BRICS, the emerging middle classes may feel stymied as their lofty aspirations go unmet. Among all countries, Brazil is the most vulnerable because of a lingering recession and protracted political crisis. The eight factors which we saw influencing the ‘Risk of Protectionism’ include Burden of Customs Procedures; Currency Inconvertibility; Non-tariff Barriers to Trade; Trade Tariffs; Trading Across Borders; Burden of Government Regulation; Effect of Taxation on Incentives to Invest and Brain Drain. The risk indicators highlight the free movement of goods, persons, services and capital and relevant laws, regulations and administrative provisions. On the other side are the ‘Economic and Political Instability’ factors (as proxied by, for example, employment of working-age population, income inequality, state failure and armed conflict risk) whose absence or presence would decrease or increase economics’ ability to manage protectionism risk.

GLOBAL RISKS INSIGHTS GEOPOLITICAL RISKS

Insights from the Zurich Risk Room

View the ‘Risk of Protectionism’ and ‘Economic and Political Instability’ chart

With slowing economic growth in the BRICS, the emerging middle classes may feel stymied as their lofty aspirations go unmet.

The Zurich Risk Room is a global risk analysis tool, designed to help illustrate the impact of multivariate risks on individual countries and regions. The tool has the ability to look at risks in single dimensions as well as show the complex interactions between many different types of risks.

Source: Zurich Risk Room

Note: Data shown for each continent is an average of all countries it contains. Data is not shown individually for all countries in each continent.

LOW

RIS

K H

IGH

RISK

RISK OF PROTECTIONISM

HIGH

LOW

Economic and political instability

EURO

PE

AUSTRIA

IREL

AN

DSWIT

ZERL

AN

D

LUX

EMBO

URG

UN

ITED

KIN

GD

OM

SWED

ENNORW

AY

NETHER

LANDS

GERMANY

FINLAND

BELGIUM

DENMARK

PORTUGAL

HO

NG

KON

G S.A

.R.

RUSSIA

SPAIN

FRANCE

ITALY

UKRAINEAUSTRALIA-PACIFIC

NEW ZEALAND

AUSTRALIA

CA

NA

DAU.A

.E.

SING

APO

RE

BAH

RA

IN

PHILIPPINES

JAPA

N

QA

TAR

MA

LAY

SIA

TAIW

AN

OMAN

KORE

A SOUTHINDONES

IACHINA

INDIATHAILAND

SAUDI ARABIA

TURKEY

SOUTH AMERICA

KUWAIT

LEBANON

PAKISTAN

CHILE

PERU

COLOMBIA

BRAZIL

ARG

ENTIN

A

AFRIC

A

SOU

TH A

FRICA

VEN

EZUELA

NORTH AMERICA

UNITED STATES

ASIAIS

RAEL

MEXICO

EGY

PT

Economic and political instability and risk of protectionism

10/14

The Zurich Risk Room is a global risk analysis tool, designed to help illustrate the impact of multivariate risks on individual countries and regions. The tool has the ability to look at risks in single dimensions as well as show the complex interactions between many different types of risks.

Source: Zurich Risk Room

Note: Data shown for each continent is an average of all countries it contains. Data is not shown individually for all countries in each continent.

LOW

RIS

K H

IGH

RISK

RISK OF PROTECTIONISM

HIGH

LOW

Economic and political instability

EURO

PE

AUSTRIA

IREL

AN

DSWIT

ZERL

AN

D

LUX

EMBO

URG

UN

ITED

KIN

GD

OM

SWED

ENNORW

AY

NETHER

LANDS

GERMANY

FINLAND

BELGIUM

DENMARK

PORTUGAL

HO

NG

KON

G S.A

.R.

RUSSIA

SPAIN

FRANCE

ITALY

UKRAINEAUSTRALIA-PACIFIC

NEW ZEALAND

AUSTRALIA

CA

NA

DAU.A

.E.

SING

APO

RE

BAH

RA

IN

PHILIPPINES

JAPA

N

QA

TAR

MA

LAY

SIA

TAIW

AN

OMAN

KORE

A SOUTHINDONES

IACHINA

INDIATHAILAND

SAUDI ARABIA

TURKEY

SOUTH AMERICA

KUWAIT

LEBANON

PAKISTAN

CHILE

PERU

COLOMBIA

BRAZIL

ARG

ENTIN

A

AFRIC

A

SOU

TH A

FRICA

VEN

EZUELA

NORTH AMERICA

UNITED STATES

ASIAIS

RAEL

MEXICO

EGY

PT

Economic and political instability and risk of protectionism

11/14

Country code Country name Region Risk of Protectionism (0-1)

Economic and Political Instability (0-1)

ZRR Metric(0-10)

ZRR Rank(out of 174)

CHE Switzerland Europe 0.19 0.10 3.10 2

GBR United Kingdom Europe 0.20 0.26 3.59 7

DEU Germany Europe 0.30 0.23 3.75 10

CAN Canada North America 0.31 0.27 3.89 15

USA United States North America 0.25 0.31 3.92 17

JPN Japan Asia 0.34 0.26 4.05 24

FRA France Europe 0.43 0.35 4.55 30

CHN China Asia 0.41 0.46 4.64 36

IND India Asia 0.41 0.53 4.75 40

ZAF South Africa Africa 0.50 0.59 5.30 86

RUS Russia Europe 0.50 0.58 5.33 89

ITA Italy Europe 0.49 0.54 5.36 91

BRA Brazil South America 0.65 0.62 5.92 142

The eight factors which we saw infl uencing the ‘Risk of Protectionism’ include Burden of Customs Procedures; Currency Inconvertibility; Non-tariff Barriers to Trade; Trade Tariffs; Trading Across Borders; Burden of Government Regulation; Effect of Taxation on Incentives to Invest and Brain Drain. The risk indicators highlight the free movement of goods, persons, services and capital and relevant laws, regulations and administrative provisions. On the other side are the ‘Economic and Political Instability’ factors (as proxied by, for example, employment of working-age population, income inequality, state failure and armed confl ict risk) whose absence or presence would decrease or increase economics’ ability to manage protectionism risk.

‘Risk of Protectionism’ and ‘Economic and Political Instability’

12/14

Fundamental challenges to the global economic and political system created by major western powers after World War II are creating highlyuncertain environments for companies. Crisis management approaches can help focus on the identification and mitigation of protectionist risks. Many firms benefit from global value chains which can be essential to their very existence. Restructuring supply chains is not a simple task. There may not be a lot of time to restructure supply chains, particularly as governments are likely to react swiftly once any one government enacts trade restrictions.

Companies will need to develop business continuity plans that anticipate having to arrange substitute suppliers and designate alternative manufacturing or retail sites.

New technological innovations such as 3D printing can in some cases allow for more manufacturing in place and, as such, could provide a way for companies with manufacturing needs to lessen dependence on global supply chains.

GLOBAL RISKS INSIGHTS GEOPOLITICAL RISKS

Ways to mitigate Risk

Countering Supply Chain Disruptions It is very important for companies with critical supply chains that they understand their exposures to geopolitical actions. Technology can be useful in developing a holistic picture of the critical supply chain.

Companies can adopt a number of mitigation strategies including the purchase of supply chain insurance to protect against supply chain disruptions. In addition, many political risk insurance (PRI) policies cover against import and export embargoes or license cancellations which might be imposed in a trade war or for other reasons.

As supply chains are disrupted, another knock-on effect is the financial impact on both buyers and suppliers along the supply chain. If companies are unable to deliver to their customers due to supply chain disruptions, their own financial health can be jeopardized. Large, unexpected increases in tariffs could increase costs to such a degree that buyers default on contracts.

Again, insurance, such as trade credit insurance, can play an important role in mitigating the risk for companies with these types of exposures. Increased protectionism is likely to raise costs for manufacturers in other ways: higher inventory handling costs, alternative sourcing options from higher cost suppliers, transportation delays due to border controls and customs charges.

In export-dependent countries, reduced trade could translate into lower economic growth, higher unemployment and political unrest, leading to higher risks for firms with exposure in these countries. PRI is one solution to cover some of the most catastrophic of these risks, including but not limited to political violence causing damage to assets.

Business associations are already vigorously engaging governments and policymakers on the business consequences of key trade policy changes. It is still unclear how far these efforts can go to influence governments that are under pressure from a groundswell of protectionist and nationalist sentiment. However, the stakes for firms and for entire economies are too high to ignore. An awareness of key industrial clusters within a supply chain is also important as there can be a tendency for human skills to be clustered around a certain location, which may be impacted by geopolitical tensions.

Dealing with unintended consequencesIndeed, setbacks to global trade will likely cause a number of unintended consequences, and government economists will be under pressure to conduct very sophisticated analyses to determine the full impact on their respective economies. Assessing the impact of protectionism on consumers, tax revenue, economic growth, and companies is a massive exercise in itself, but then trying to predict how other governments will respond is an even more daunting exercise. Scenario planning will be a key tool to assess these risks.

Public-Private Partnership Governments will also need to develop continuity plans, examining the impacts on national security from cutoffs supply chain disruptions or increased costs of imports. Governments and companies should both consider using tools such as bold scenario planning to map the potential second and third order effects resulting from greater protectionism. Governments may not be aware of their dependence on global value chains for their ability to carry out vital government functions. An inventory of ways that key government functions rely on imports could prevent later surprises. As a way to mitigate disruptions, governments could explore strengthening trade relationships with nonrestrictive countries and sometimes this can lead to productivity gains and economies of scale not previously thought. For companies active in global markets, assessing the likely course of events will become ever more difficult, but it is some consolation that there are risk management techniques to help mitigate the potential financial impacts.

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Approaches from business continuity management, especially scenario planning, can help with the identification and mitigation of risks. A method to achieve this is Total Risk Profiling® (TRP®). It is a structured approach to identifying, assessing and monitoring risks and improvement actions. Embedding Zurich’s TRP® methodology can further help ensure a company’s risk management culture is consistent and effective.

Scenario-based thinking and decision makingTRP® is a proven workshop-based risk identification and prioritization method developed by Zurich. Based on the premise that you know your business, operations and markets better than anyone else, TRP® tends to produce the best results when used with a team of professionals who are directly involved and/or have expert knowledge of the scope being analysed.

The facilitator-led team will then develop a risk profile by determining relative ratings (in likelihood/ impact terms) of risk scenarios. It uses these risk scenarios to define the underlying issues, breaking them into their components of vulnerability, trigger and consequence.

A ‘tolerance boundary’ is defined as an expression of appetite for risk and this is used to prioritize risks. Action plans are developed to improve the prioritized risks and bring them within the team’s tolerance for risk.

GLOBAL RISKS INSIGHTS GEOPOLITICAL RISKS

Total Risk Profiling® on Protectionism

TRP® on Protectionism – Vulnerability identificationPotential key questions to identify potential vulnerabilities related to the protectionism scenario, to develop risk scenarios, quantify financial severity and assess probability in a case of the protectionism scenario might be the following:

Characteristics of your business/organization• Based on your geographical spread and/or

concentration how much of your turnover is going to be vulnerable to various protectionism scenarios

• How much are your various suppliers (Tier 1, 2 or even 3) affected? How well know are your bottleneck suppliers, known and easy will it be to substitute them and at which cost?

• How dependent are you of key industrial clusters that might be affected by protectionist measures that result in a complete cut off such a whole supplier base?

• As a typical export business how difficult will it be to defend your market share in key markets that are affected by protectionism?

Management style and strategy• How much vulnerable are you to license and

contract terms cancellations?

• Could protectionist measures affect your creditworthiness or the ones of your suppliers and customers?

• Could embargoes create compliance issues with laws and regulations?

External factors• As supply chains become disrupted, how likely

is it that as a 2nd order knock-on effect your buyers and suppliers could default?

• How likely is it that an unexpected large increases in tariffs increase costs to such a degree that your buyers default on contracts?

• What is the likelihood that 3rd order effects, like lower economic growth resulting into political violence, will result from protectionism in one of your key production countries, supplier base or markets?

Operations and procedures• How likely could an increased protectionism

raise costs for manufacturing, like higher inventory handling costs, alternative source options from higher cost suppliers, transportations costs/delays due to border controls and customs charges?

• How well established and tested are your contingency plans?

• Are key human skills also been clustered around a certain geographic location, which may be impacted by geopolitical tensions?

• How big is the potential that embargoes affect the reliability of your key production facilities?

Timing and availability• How big is the potential that embargoes affect

the supply of raw material or components to key production facilities?

• How resilient are you in terms of inflation, interest, or currency exchange rate fluctuation in your markets?

Action plans are developed to improve the prioritized risks and bring them within the team’s tolerance for risk.

Key featuresTRP® is a highly efficient way to optimize the risk/reward balance across your enterprise.

The structure of the TRP® risk identification process provides a sound basis for detailed quantification of more complex risks.

TRP® helps to set the agenda for internal audit or enterprise risk management to monitor risks at or just below the risk tolerance boundary.

The opportunity to define multiple triggers with different consequences helps to identify the true drivers of a risk undertake.

The principles of TRP®, which can be applied in a wide variety of circumstances, represent a tried and tested approach to address these challenges.

Risk reduction/ Risk improvement advice

Risk improvement catalog

Vulnerability identification and assessment

Vulnerability catalog

Risk mapping/ Risk tolerance boundary

Risk profile

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Zurich Insurance Company Ltd Mythenquai 2 8002 Zurich Switzerland

173003681 (07/17) TCL

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