The (Ex) Washington Realist

President of the Eurasia Group and TNI contributing editor Ian Bremmer lays out his predictions for 2006:

To kick off 2006, I’d like to rank the biggest political risks I see for the coming year. Then, all the upside...as well as the headlines we can safely ignore.

First, a quick overview. I see a couple of significant macro risks for 2006 (China and avian flu) and the political-risk horizon still looks seriously problematic for global energy. But a broader number of potential hotspots will drop off the radar (particularly Taiwan, North Korea, and much of the Middle East). On balance, 2006 looks like one of the better years in terms of political risk in the post-September 11 environment.

So starting with the biggest risks of the year, in descending order:

1) Iran. An escalation of tension over Iran’s nuclear program is a near certainty for 2006; even the potential for a military confrontation (surgical strikes by US/Israel and the risks of Iranian response) is steadily increasing...60% by the end of first quarter 2007.

Just how far is Mahmoud Ahmadinejad prepared to press his luck? Or as some wags put it, is the Iranian president crazy like a fox…or just crazy? The answer may not matter much in the near term for two reasons. First, the broad institutional base around Ahmadinejad is politically inexperienced and fundamentally hostile to the west (imagine the most retrograde elements of Turkish prime minister Erdogan's AKP party, i.e. virulently anti-US...but actually running the country's central institutions). Second, it's hard to find any incentive for Ahmadinejad to back down.

On the latter point, despite mounting concern from the US and Europe, there's very little effective international pressure on the Iranian government at the moment. A host of non-aligned states (and an even broader group of multinationals) are still willing to cut commercial deals with Tehran. Meanwhile, despite some public infighting among conservatives, Ahmadinejad has largely consolidated his domestic power, benefiting from the support of supreme leader Khameini (the ultimate arbiter of nuclear policy) and an increasingly cohesive new cabinet. The new ministers, as well as recent high-level replacements throughout the bureaucracy, are much more hard-line (and less market-oriented) than their predecessors.

In that context, there's little reason for Ahmadinejad to back down on nuclear negotiations (indeed, if anything, he has become more bellicose, going out of his way to provoke Israel with a series of hostile public statements). The most likely outcome is that the IAEA negotiations (and sideline diplomacy between Iran and Russia) will produce no breakthrough by March, and Iran will be formally referred to the Security Council.

Iran has already said that such a referral would provoke further limitations on—if not the expulsion of—international inspectors and a resumption of uranium enrichment. The easiest way out of the thicket (and what white house officials are privately hoping for, though certainly not banking on) is that, at that point, Iran’s intransigence will be so obvious—and dangerous—that china will back off its threat to veto sanctions against Iran and will press Tehran to accept a deal (as when china, at least early on, pressured North Korea over its nuclear program). That could happen, though Beijing isn't likely to press too hard, given its need for Iranian energy...but even in that scenario, it's reasonably likely Tehran will refuse to back down. After all, North Korea has gotten away with worse...and there's no credible threat to actually go to war with Iran.

That leaves the unlikely possibility that Ahmadinejad’s regime might be toppled from within--perhaps at the behest of erstwhile leaders like Ali Akbar Hashemi Rafsanjani, who would be happy to see the back of the Iranian president. But short of assassination (which I’m not about to lay odds on), it's not happening.

So either way you look at it, the conflict over Iran’s nuclear program appears likely to escalate. The next question—timing. How long will it take for last-ditch diplomacy and half-hearted economic sanctions/asset freezing to fail? And will the US/Israel blink at the last moment? Given strong international (and Arab) concerns about Iran, and Israeli prime minister Ariel Sharon’s increasingly secure political position, we don't expect capitulation.

Even before the dispute reaches a head, there’s likely to be plenty of new risk generated. Iran will look to make energy and other commercial deals with politics in mind. Tehran may use its leverage in Iraq to limit Iraqi oil output. Iran may cut a symbolic amount of oil output to protest the application of diplomatic pressure. Japan and us allies in Europe may see disruptions in long-term supply contracts with Iran. Us pressure on China, India, European states, Japan, Malaysia, and others to halt deals with Iran will create some market instability. For all these reasons, Iran clearly leads concerns for political risk in 2006.

2) China. 2006 continues to look extremely strong for Chinese economic growth—we'd be surprised to see even a modest slowdown. But markets continue to consistently underrate political risks in china. These risks are growing, both internally and internationally.

On the domestic front, the rigidity of the Chinese communist leadership and its bureaucratic machinery leaves the party increasingly unsteady in the face of spiraling social discontent. Most demonstrators will continue to focus their anger on local authorities, but the growth of local-level NGO’s and the increasing ease of internal communications means that small provincial protests can quickly spread to other parts of the country... And pose serious challenges for the Chinese political system itself.

Beijing is taking a harder line on corrupt regional officials and business leaders—and has made public example of those accused of abuse of power. But there remains zero tolerance for challenges to the communist party or calls for policy changes, no matter how justified. Beijing has raised the stakes by putting in place tens of thousands of new "counterterrorism police" to quell riots and over one million local police to monitor the internet. These measures have been—and will continue to be—ineffectual.

At the same time, China will increasingly be seen as a growing threat in the international community. It is in East Asia that the prospects for geopolitical conflict represent the biggest structural shift in global politics since the fall of the Soviet Union, and nowhere is the anxiety over china’s growth greater than in Japan. Japanese foreign minister Taro Aso recently said as much, when he spoke candidly about the china threat. Much the same sentiment is growing within the US Defense Department.

Sino-Japanese relations will become even more problematic in 2006, with China’s rapid growth provoking a more assertive Japanese foreign policy. Because the balance of regional political and economic power is steadily tilting in China’s favor, it is Japan that is more likely to initiate the market-moving risks. Japanese leaders may draw policy lines in the sand which china feels compelled to cross. Two flash points in particular bear watching in 2006—in the spring, Japan may decide to drill for gas in contested areas of the East China Sea; in September, two Japanese officials with hard-line views on Beijing, chief cabinet secretary Shinzo Abe and foreign minister Aso, are the most likely candidates to replace Koizumi. Either flashpoint could lead to wide-scale anti-Japanese demonstrations in China, which could further upset economic relations between the two countries.

The Bush administration will remain on the sidelines, neither quelling nor inflaming these tensions—though closer US-Japanese military relations will irritate Beijing. The more immediate Washington-generated market risks come from possible protectionist legislation in congress, particularly in the run-up to mid-term elections, when populist appeals are especially profitable.

3) The rise of the left in Latin America. In recent years, central bankers have provided most of the risk in the region, and political scientists have had little to contribute. Not this year.

Economic fundamentals should be sound throughout Latin America in 2006 (with the marginal exception of Chile)...but the politics will be increasingly problematic. The spate of elections in the region will be influenced by the growth of anti-Americanism there, spearheaded by the increasingly effective (and quite popular) Venezuelan president Hugo Chavez. That's creating bigger uncertainties for Brazil, as Lula has an uphill struggle toward re-election. It's problematic in Mexico too, with the possibility of a tight presidential race and the rise of populist Andres Manuel Lopez Obrador, leader of the party of democratic revolution.

The tilt of Argentina toward Venezuela will further complicate the region’s politics. (erratic president Nestor Kirchner has appointed a strongly pro-Chavez politician and former leftist guerilla as his defense minister.) With bold steps toward nuclear proliferation in Iran and North Korea, 2006 could be the year Chavez decides to follow suit and contend for regional security primacy. For the first time in a decade, Latin America is an area of significant political risk—and it's hard to see markets not reacting negatively to these developments.

4) Iraq--the Kurds. Of all the flashpoints in postwar Iraq, the Kurds have been the dog that hasn't yet barked. They're doing extremely well economically, their political institutions are functional and increasingly mature, and they therefore have no reason to challenge the status quo. But this year, that status quo may be put to the test. Gubernatorial elections (in November '06) will force Kurdish political contenders to offer opposing programs, and it will become expedient for some Kurdish factions to publicly support a platform of independence. In addition, cooler heads will struggle to postpone a divisive 2007 referendum on the final status of the oil-rich city of Kirkuk.

The political debate over Kirkuk and a gradual withdrawal of US troops (particularly from hotspots) will raise the stakes over control of Iraq’s energy resources. A hard-line Kurdish position on both independence and Kirkuk will raise hostilities with the Sunnis, and possibly with Turkey. With growing Iranian influence over southern Iraq (and over the 'central' Iraqi government), Iraq will look less functional a year from now than it does today.

A quick note on Turkey—it's worth noting the reasonable likelihood that Turkey/EU accession talks will come to an impasse over Cyprus in mid-2006. That would increase domestic pressure on Erdogan's government to intervene in northern Iraq if and when Kurds push for autonomy. The Turkish prime minister may decide to invite a coalition partner to join his government, if he believes that pressures from the EU and Kurds might cut into his political margin for error in advance of 2007 elections.

5) Avian flu. It's difficult to quantify the global pandemic threat, because, while scientists agree it's coming (and increasingly likely), nobody has a well-informed prediction of whether it's really a one- or a ten-year risk. Still, biosecurity worries represent a massive fat tail for global markets... And even in its absence, the combination of lack of transparency in key countries (particularly China), together with the near complete lack of preparation by international institutions will cause both market-wrenching headlines, false scares, enormous expenditure, and legislative activity.

In short, biosecurity bears a close watch this year. Market attention tailed off considerably as 2005 came to a close, but headlines in 2006 will bring these worries to the fore very quickly. That will be particularly noteworthy in Southeast Asia—in Indonesia, where almost no steps have been taken to limit the likelihood of an epidemic, and in China, where the government sees full transparency on the issue as a direct threat to political stability. There's already evidence of significant cover-ups by Beijing, and new Chinese cases of bird-to-human transmission will set markets on edge.

6) Nigeria. With 2007 presidential elections looming, it looks likely that president Obasanjo and his parliamentary supporters will push to amend the constitution, to allow him to run for a third term. There's good reason for the international community to support him—he's proven adept at handling macroeconomic policy, and the likeliest presidential alternatives (particularly vice president Abubakar) all look much less capable. But if the country’s holdouts and have-nots decide that their opportunities to share power are dwindling, they will create trouble for Obasanjo in the run-up to the elections, and Nigeria will become particularly unstable in 2006. Though recent shifts in Nigeria’s coalition politics have dimmed Obasanjo's chances, 16 southern governors are now demanding constitutional change—so it's a good bet the process will continue.

Add the tensions in the Niger delta and the pending trial of militia leader Asari Dokubo, and the risk of serious violence and large-scale, sustained oil supply disruption is growing. Africa doesn't usually make international headlines, but with continued strong economic growth from China and India, and in the absence of a sudden serious drop-off in energy demand from the west, Nigeria deserves our attention.

7) Terror. Since the beginning of the war on terror in 2001, international counterterrorist efforts have made considerable headway in tracking down the leadership, funding, and network of Al Qaeda. But the organization remains more resilient than international intelligence agencies had hoped, and local terrorist networks (more Al Qaeda-inspired affiliates than a part of the broader organization) continue to pose a threat to western assets all over the world.

Most problematically, Iraq and the north Caucasus have emerged as the two largest training camps for terrorist organizations; and both are beginning to export terror beyond their borders.

Russia remains at greater risk of a "macro" terror event in the coming year than any other country in the world—recent catastrophic radiation levels at nuclear plants in Chechnya reveal the broader danger. Terrorist threats to the core of governance are also a risk in Iraq (where an assassination of ayatollah Sistani by Sunni terrorists, for example, would be a tipping point in bringing the country into civil war).

Beyond that, terror threats remain considerably higher in continental Europe (and certainly in East Asia), where the indigenous Muslim populations are considerably harder to police, than in the US. An increasing threat also exists in Iraq’s neighbors, particularly Jordan and Lebanon, where counterterrorist capacity remains low. We also remain concerned about energy infrastructure in the gulf, which remains vulnerable (with the strong exceptions of Saudi Arabia and the UAE). Kuwait, in particular, is more vulnerable than is widely accepted.

* * *

Now, the places we don't have to worry about.

Taiwan. The strong showing by the opposition KMT in recent parliamentary elections only bolstered our underlying view that president Chen is too isolated to pull off a threatening move toward independence in the run-up to Beijing’s Olympics in the summer of 2008. Rather, China's willingness to accept Taiwan’s gradual economic dependence on the mainland (in the hopes of creating a de facto single state) will overwhelm local Taiwanese discomfort with their eroding international position. The US (and Taiwan’s traditional Asian allies) will stay on the sidelines. Cross-strait confrontation is not a concern for 2006.

North Korea. The US has capitulated on North Korea, and the six-party talks are stalled. We expect there will be another round of six-party negotiations at some point this year, and they will prove equally uneventful. China and South Korea, meanwhile, will slowly but steadily improve their bilateral relations with Pyongyang. (South Korea, whose leading candidate to be the next unification minister will commit to a faster-track sunshine policy, has essentially accepted North Korea's status as a nuclear power.) It's a big problem long term (both in terms of broader proliferation and the eventual North Korean succession issue), but nothing for markets to worry about in 2006.

Russia. President Putin’s recent political shakeups notwithstanding, it remains unclear whom Putin is planning to anoint as his successor. We're prepared to bet he's not going to make the move for a third term himself; which means the run-up to 2008 will be a difficult investment climate, and indeed should see some additional capital flight from worried oligarchs. But, barring the macro terror incident discussed above, we shouldn't see any threats to Russia’s governance, its international relations, or its energy production. Post-2008 is another story—Russia’s never been successful with the power-sharing concept of dvoevlastie (literally "two powers").

India/Pakistan. Bilateral relations still look extremely positive—there’s even a chance for a breakthrough military agreement over Kashmir. Either way, we see strong political stability in both countries. We expect India to continue to over-perform economically through improved governance, the benefits of long-overdue infrastructure investment over the last few years, and the efforts of global firms to diversify away some of their china risk. One small worry—terrorism targeted at economic disruption in Bangalore. But we think it's too marginal a risk for serious concern in 2006.

Israel/Palestine. Prime minister Ariel Sharon looks set to win big in March elections, and together with an ineffectual Palestinian authority, there's going to be very little movement on the road map. Essentially, the Israelis will consolidate their political gains, cut their losses, and seek to move on. The Palestinians don't have such good fortune, and Hamas is likely to make significant gains in popularity—and at the polls—in the coming year. But in the middle term, that's going to force even Hamas to become less extreme, to eventually sit down at the negotiating table with the Israelis, and to bargain from a very weak position. Meanwhile, Israel’s economy (with its technology boom) looks robust. While we're in the area, international pressure on Syria should recede, and sporadic fighting aside, we expect neither open hostilities with Israel nor deterioration toward civil war in Lebanon.

The Persian Gulf. Nearly all the governments of the gulf region have deployed substantial portions of their recent budget surpluses toward shoring up domestic political support. Several—notably Saudi Arabia, Bahrain, and Kuwait—have even implemented gradual political reforms, which could ultimately improve the sustainability of their regimes. Massive population growth and a lack of economic diversity remains an enormous risk for the House of Saud in the long term, but it's very long term...there's nothing in the coming three years that looks regime-threatening.

Southeast Asia. Continues to look pretty strong. We see significant increases in foreign investment, as the US, China, and Japan compete for regional influence. There's also the benefit of surprisingly good governance from Susilo Bambang Yudhoyono's government in Indonesia, which is set to have a particularly strong 2006.

The Caspian. All quiet this year—no more colored revolutions, despite the recent “managed” elections in Azerbaijan and Kazakhstan. All the countries of the region will work to play growing Chinese economic interests off Russian efforts to maintain political and military dominance, while maintaining at least a modicum of American interest. And, for the most part, they'll succeed.

* * *

Last but not least, a moment on the United States.

The Bush administration has largely succeeded in winning back Republican support for White House policy; but the Democrats are largely lost, so we're going to see strongly partisan politics in the run-up to mid-term elections. Bush has six months of only modest troop draw-downs to limit criticism of his Iraq policy, but sniping will become increasingly aggressive as mid-term elections approach. Meanwhile, legislation will stall, and the deficit will grow.

A host of scandals will continue to roil both the administration and the congress, and it's nearly certain there will be significant additional indictments related to the Plame case. All the while, vice president Cheney and key white house staffers will remain very much under fire; and the Bush administration will have a hard time clearing house until the scandals break.

The main point—significant U. S. efforts at transformational foreign policy (whether in China, Iraq, the greater Middle East, North Korea or elsewhere) have been rolled back in favor of more modest goals... Maintenance of Republican support, preparation for mid-term elections, and efforts to keep the economy humming...all while trying to keep their heads down.