NEW YORK, Jan 22 (Reuters) - Government intervention to try to limit the damage from the global financial crisis means that politicians now play a central role in determining the outlook for world markets -- and political risk has rarely been higher.
Dan Alamariu, a comparative analytics specialist at leading political risk consultancy Eurasia Group, answers questions from Reuters on the implications of state intervention:
Q - Eurasia Group has forecast that the U.S. Congress will be the top global source of political risk this year. Why?
A - In the context of the ongoing financial crisis, the interaction between the Obama administration, the U.S. Congress, regulatory bodies and markets is bound to produce a number of important legislative and regulatory changes. In this mix, the U.S. Congress is a political wildcard.
Many expect a Democratic-majority Congress to seamlessly collaborate with the Obama administration. But a newly emboldened Congress could try to take the lead from the administration on financial and economic reforms.
Among other things, this raises the possibility of legislative overreach, pork-barrel spending and delays due to disagreements between the legislative and executive branches. Congress could significantly hamper, distort or delay Obama's ambitious economic and financial reform agenda.
Q - Which other countries will see the greatest increase in political risks in 2009 due to increased state intervention?
A - One major change that occurred over the last year is that governments are becoming increasingly involved in economic decision-making... It follows then that political risks, and regulatory risks in particular, will increase in states where this takes place, both in developed states (e.g. the U.S., the EU and Japan) and in large emerging markets...
That said, state intervention in the economy is not necessarily bad. In many cases bailouts are all that stand between a bad recession and a full economic meltdown. However, state intervention raises the spectres of protectionism, corruption and special interests having a greater role in economic policy-making.
Q - What about countries like China where the state has always played a more activist role? Does this mean there will be less of a change in their political risk profile in 2009?
A - China's political risk profile will be comparatively lower than other states, if only because political risks have increased elsewhere. The risk of social and political instability remains low in the short term, as the Chinese population principally blames the West for China's current economic woes.
In economic matters however, there is a risk of increased protectionism, especially when it comes to strategic industries, where foreign participation will be less welcome. On the other hand, China's announced $586bn fiscal stimulus package could create some opportunities for foreign investment in infrastructure building and servicing.
Q - Plenty of the world's top brains will be involved in drawing up government policies to tackle the crisis. So why does Eurasia Group think the outcome is likely to be so negative?
A - Plenty of the world's top brains were also involved in designing the complex derivative products that made the current global economic crisis possible. If the road to hell is paved with good intentions, then the road to bureaucratic quagmire is papered with very smart policy proposals.
Financial crises are notoriously difficult to "fix": nobody has an effective blueprint or track-record, so even the smart people in charge are winging it.
Q - If the problem is that governments follow national interests but tackling the crisis requires global coordination, doesn't the G20 provide the forum for this kind of cooperation?
A - The G20 may provide a good discussion forum for developed states and large emerging markets. But the G20 is unlikely to be an effective forum. If it was difficult building consensus in the old G7/8; having twenty players at the table will only make reaching consensus more difficult.
Within the G20, when it comes to global financial reforms, countries with large financial markets will have the dominant voices. The U.S., UK, France, Germany and Japan will lead any reform proposals, with some input from China and other members.
Q - Is there a risk of governments introducing more protectionist measures that stifle trade?
A - At the G20 summit that took place in November 2008 member states affirmed a commitment to free trade. Since then, G20 member states such as Russia, India, Brazil and Indonesia have already adopted protectionist measures. If nothing else, this underscores how difficult it is to get international cooperation right, beyond the rhetorical level.
Governments have significant incentives to protect domestic industries, both in emerging markets and the developed world. Increases in tariffs, regulations and the use of bailouts to protect domestic industries are taking place in many large economies. Whether these policies will devolve into outright trade wars is still a small risk now, but one worth watching.
Q - Are there any governments that may surprise us and get it right in 2009 in terms of intervention?
A - Sure. The U.S., as well as the EU and some key emerging markets, such as China, India and Brazil, have all used state intervention to fend off the worst possible outcomes of the financial crisis. That is a positive development.
However in a crisis environment that is largely unpredictable, the question to ask is not whether governments will get it right, but whether they will simply be able to cope. We have already seen a number of smaller states, from Bulgaria to Iceland, economically and politically unable to respond to the crisis, and coming under significant social pressure.
Q - Hasn't the financial crisis disproved the belief that free markets generally produce better solutions when state intervention is minimsed?
A - Markets may not function all that well when left to their own devices, but government intervention is not always an improvement either. Governments and regulation have an important role to play in correcting market excesses, but here the theory is also often at odds with what governments practice.
Governments, whether for selfish political reasons or out of misguided, but well-intentioned motives, often enact political solutions to current problems that prove inefficient or create bigger problems down the road. That is why government intervention, however well-meant, also creates significant risks. And given the large scope of government intervention in the U.S. and elsewhere, this is a key risk to watch. (Editing by David Fox)