National Security Network

The National Security Implications of the Global Financial Crisis

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Report 29 May 2009

International Economy International Economy

In February Dennis Blair, Director of National Intelligence, told Congress that the economic crisis had replaced terrorism as the “the primary near-term security concern” for America.  From the increased likelihood of state failure, to devastating effects on the world’s poorest countries, to the reshaping of the international order, the repercussions of the financial crisis are already dramatic – but their long-term consequences remain unpredictable.

In the near-term, the gravest threat to U.S and global security comes from the destabilization of geopolitically critical states.  Economic instability in Pakistan adds to a witch’s brew which already includes a growing insurgency, a terrorist safe haven, nuclear weapons, regional tensions with India, and internal political instability.  Ukraine’s economic problems leave it vulnerable to interference from an aggressive Russia.  And Mexico’s close relationship and proximity to the United States make it of critical concern.  Other important states such as Argentina, South Korea and South Africa also remain vulnerable.

The financial crisis has also had other negative security effects.  It has been devastating for some of the world’s poorest countries, who rely heavily on investment, aid and remittances from the world’s wealthiest states – all streams that are dwindling.  The crisis has created an opening for organized crime, which as bank lending dries up, has become the lender of last resort in many poor countries.  Disgruntled citizens have created instability in even wealthy countries like Greece and Iceland, and may provide much steeper challenges in states without well-established political institutions.

The long-term implications for America’s role in the world and the overall balance of power are still unclear.  In the short term, the U.S. position is likely to strengthen relative to other state because of the dollar’s role as a reserve currency.  But in the long-term, the crisis has called into question the American model of capitalism and the U.S.’s role as global economic leader.  It has also empowered China, which has used its large reserves to gain greater leverage in the world economy.  Rising states are seeking a greater voice in world economic institutions, a fact that was plainly evident during the G20 summit. In all these areas, political observers will do well to brace themselves for extra turmoil caused by economic uncertainty – and seek extra shock absorbers wherever they can be found.

The Economic Crisis and State Failure

Weak and failed states are already a key U.S. concern because of their ability to shelter terrorists and criminals, promote the spread of weapons of mass destruction and general lawlessness, and incubate environmental, health and humanitarian crises.  The global economic crisis is hitting less-developed countries with job losses, falling government revenues, and price instability – all of which place already-weak states an even greater risk.  There are a number of potential “hot spots” across the globe that are at a greater risk either because they have been particularly hard hit by the economic crisis or because of preexisting political instability.  Countries like Argentina, South Korea, South Africa, or perhaps one of the commodity exporters are all at risk.  Pakistan, Ukraine and Mexico, however, stand out as three immediate concerns because of their economic vulnerability, their geopolitical position, and their potential impact on the security of the U.S. and the broader stability of their regions.

Pakistan’s economic crisis, combined with a growing insurgency, rising extremism among its population, the terrorist safe haven in the Northwest and its possession of nuclear weapons make it a primary concern. As a recent Atlantic Council report says, “The state of Pakistan’s economy is every bit as worrisome as its security situation.” The strong growth during the Musharraf years was due in large part to the inflow of foreign investment and remittances.  But this was the result of Musharraf policies focused on short term growth, leaving the country ill prepared when the global financial crisis hit.  This combined with investors’ concerns over growing political instability, lack of security, corruption, and a faulty judicial system, left Pakistan in economic turmoil.  Since the beginning of the financial crisis Pakistan has received a 7.6 billion loan from the IMF, $300 million loan from the Asian Development Bank, and $1 billion in support from the United States, yet the crisis continues.  Given the stakes in Pakistan – a country of 170 million people, a nuclear weapons arsenal, a terrorist safe haven in the Northwest tribal areas, and a budding Taliban insurgency –economic instability is of great concern.  [Atlantic Council, 02/09. Niall Ferguson, March April 2009. UPI, 10/21/08. Reuters, 12/11/09. 4/17/09. WS Journal, 11/9/08]

Political disarray in Ukraine, exacerbated by the financial crisis, leaves an opening for Russia that could have profound and violent implications. One of the countries hardest hit by the financial crisis has been Ukraine, with industrial output declining by 30% as global demand for steel and chemicals plummets.  Ukraine's currency, the hryvnia, has fallen dramatically in value, and as a result investors in Ukraine who borrowed a great deal in foreign currencies are seeing the relative value of their debt skyrocket.  In addition to Ukraine’s 20% inflation, the country is also suffering from high energy prices due to a diplomatic showdown with Russia this past winter. At the end of last year, Ukraine received a $16.4 billion loan from the IMF. The economic crisis is likely to test Ukraine’s already weak and fractured political system.  The relationship with Russia is a key source of instability.  A recent Foreign Affairs article identifies three targets of opportunity for Russian interference in Ukraine: energy security; minority rights for Russian speaking Ukrainians; and control over the Crimea.  Russia itself suffers from a flagging economy and may be tempted to use a renewed push on Ukraine to bolster the regime’s popularity at home.  Whether this resulted in a dramatic reversal of Ukraine’s geopolitical orientation, or just increased uncertainty, it would have negative effects well beyond Ukraine’s already long borders – affecting NATO, European Union and U.S. interests and making it much more difficult for the US, Russia and Europe to work together on other issues.  [Foreign Affairs, May/June 2009. NY Times, 3/8/09. The Economist, 3/23/09. U.S. News & World Report, 4/17/09. CNBC, 5/15/09. Max Bergmann, World Politics Review, 5/19/09]

Mexico’s proximity to the United States makes its economic stability a direct concern for U.S. security interests.  Mexico is America’s third largest trading partner and our third largest supplier of oil. The United States provides 50% of Mexico’s foreign direct investment.  This economic interdependence caused a great deal of pain in the Mexican economy when the global financial crisis began on Wall Street.  The combination of decreasing demand for Mexican products in America, a decline in remittances from relatives working north of the border, and a general decrease in investment in the Mexican economy will likely cause prolonged economic hardship.  After paying off all of its previous IMF loans in 2000 ahead of schedule, Mexico now has had to establish a $47 billion line of credit with the IMF and has recently agreed upon a $5 billion loan from the World Bank.  While the government of Felipe Calderon struggles with the economic crisis, it is also embroiled in a “do or die battle” with multiple drug cartels and now also battling an epidemic of swine flu that arose without warning.  Mexico’s proximity and close relationship to the United States makes it a chief concern for American policy makers.  Violence has already spilled over the border with a rash of kidnappings and violence on the U.S. side.  And the quick trans-border spread of the swine flu epidemic is further evidence that preventing insecurity in Mexico is directly in America’s interests. [Foreign Policy, March/April 2009. U.S. News & World Report, 4/17/09. U.S. Department of State, 2008. William Hoover, ATF, 2/07/08. Center for American Progress, 03/07. Gen. Barry McCaffrey, 12/08. Brookings, 3/04/09. WS Journal, 3/31/09. NASDAQ, 5/26/09]

Short-term Challenges For All States, Especially Poorer Ones

The is periphery at a greater risk as investment, aid and remittances all decline.
  As is often the case, the world’s poorest are the hardest hit in difficult times.  With estimates showing that the global economy is likely to shrink for the first time since World War II, developing countries are looking at an economic contraction of between $270-$700 billion and an expected 53 million more people forced to live on less than $2 a day this year, from an already staggering 2.6 billion people- wiping out much of the progress made through the Millenium Development Goals.  Poorer countries have recently depended heavily on both foreign investment and foreign aid to fuel their development.  In a time of economic uncertainty, investors tend to pull back to “safer” investments in developed countries, depriving businesses in developing countries of needed capital. It is also tempting for lawmakers in developed countries to cut funding targeted at helping people abroad.  But foreign assistance goes into vital public works, keeping many countries moving and people receiving paychecks.  In addition countries on the periphery depend a great deal on remittances from family members working in richer nations, and as the economies of these “source countries” continue to stagnate, developing countries often feel the pinch first.  Countries like Moldova and Haiti have already been hit hard by the decline.  Other countries that depend heavily on remittances that are feeling the effects are Lebanon, Jordan, Morocco, Egypt, Tunisia, and most of Latin America. [2015 Millennium Campaign, 2009. Daily Star, 4/9/09. Washington Post, 4/17/09. Voice of America, 3/16/09]

Transnational threats and terrorism can pose an increasing threat in times of economic crisis.  With the recent outbreak of swine flu spreading across the globe in a matter of days the world has seen just how interconnected we truly are.  Another transnational threat that is amplified by the financial crisis is organized crime.  With banks unable to lend, one of the only sources of credit is from organized crime.  In Italy for example, experts say that organized crime is already the biggest business.  And as organized crime increases in power, the power and control of the state decreases.  Another concern is an increased risk of terrorism.  As we have already seen with the Mumbai attacks, the economic crisis is not a deterrent for terrorism.  This along with the rise in extremism, in places like Pakistan, caused by economic hardships creates an increased potential of a transnational threat. In addition as governments concentrate on other issues there may be decreased funding and focus on dealing with both short and long term transnational issues ranging from global epidemics to climate change. [Washington Post, 3/1/09. Foreign Policy, March/April 2009]

Social unrest and disgruntled citizens put governments in danger.  From the collapse of the Icelandic government, to the protests in Greece and events in Moldova, we have already seen how the global economic crisis has contributed to social unrest, even the collapse of governments.  As unemployment continues to rise, so does the potential for an increase in crime, labor strikes, increased nationalism/xenophobia, food riots, and radicalism.  This is true even for relatively stable and wealthy countries, as we saw in Greece at the end of last year and at the May Day protests across Europe this year. In some countries there is also the concern that rioting could expand along ethnic lines, exacerbating more dangerous and protracted conflicts. [Eurasia Group & Price Waterhouse Coopers, Global Trends 1st Qtr. 2009. United Nations, 3/25/09. The Telegraph, 5/1/09]

Long-term Implications of the Global Economic Crisis

In the short-term, the U.S. is relatively better off than the rest of the world, but in the long-term the credibility of the American model of capitalism has been called into question.
  Because of the dollar’s role as the reserve currency, the United States holds a unique advantage in the global economy.  Combine this with the political and economic stability of the U.S. and America is the most attractive country for investors.  However there are many around the world that have lost confidence in the United States as the global leader on economic matters.  While there were always aspects of U.S. policy unpopular around the world, America was generally trusted to get its finances correct.  The current crisis has many people questioning America’s fitness to lead the global economy, demonstrated by the German Finance Minister saying that America has lost its “financial superpower status.” While some of the skepticism is deserved, rival governments may also fuel this belief by pushing blame on the U.S., in order to avoid responsibility for their own policy failures.  Either way, the confidence in America, particularly American-style capitalism, is dwindling.  In addition, the United States will continue to seek funding for its debt from China. Maintaining dollar reserves allows China to keep its currency low, which boosts its exports and increases its position in the global economy. However, it is uncertain if China will continue to fund America’s debt as it has over the last decade.  The U.S. faces an intense challenge in showing leadership that posits a new “American model” that can regain trust and support for the U.S. role.   [Ian Bremmer, Foreign Affairs, May/June, 2009. Brian Katulis, TPM, 3/18/09]

China will likely rise in relative global standing.  While no country is likely to benefit from the economic crisis, rising powers, notably China, are likely to improve their relative standing in the global order.  China has been hit by the economic crisis, but still remains relatively insulated and maintains substantial foreign reserves.  China has already made moves to solidify this strategic advantage, from government sending investors to buy American property to loans and aid efforts in Latin America.  The respect shown towards China at the April G20 Summit in London is indicative of its greater role.  During this time of shifting powers, America’s relationship with China will be increasingly important.  U.S. Engagement with China, both bilaterally and through international organizations, on all matters from economic to security will be of vital importance.  [Roger Altman, January/February 2009. Liz Economy, May/June 2009. Washington Post, 4/23/09. NY Times, 4/15/09]

As the “G20 countries” rise in influence, a more multi-polar form of global governance will take shape.  Other countries that will likely benefit in relative power because of the economic crisis, and already have, are midsized emerging market economies, exemplified by the G20.  With all eyes on the G20 Summit in London this year looking for a response to the financial and economic crises, a signal was sent that rising and regional economies like Brazil, India, Turkey and South Africa will play an increasing role in global governance.  The more influential role of the G-20 has bolstered its status as a new, more legitimate forum for global economic governance.  The result of the summit confirmed this with a greater role for the G20 nations in global financial regulations in oversight. This shift should be accelerated by implementing needed governance reforms at the IMF that give developing countries a greater say in the fund’s management. [Foreign Policy, The Call, 4/6/09. Brookings, 4/9/09. Mikhail Gorbachev, 4/27/09. Carnegie Endowment, 4/3/09. Carnegie Endowment, 5/7/09]