You're not imagining things: The end of the -3-

Even if India does not become a formal ally to Western countries, it will continue to position itself as an independent, rising power whose interests are more aligned with the West than with China and its de facto allies (Russia, Iran, North Korea, and Pakistan). Moreover, India is a formal member of the Quadrilateral Security Dialogue (the Quad) with the U.S., Japan, and Australia, the explicit purpose of which is to deter China. Japan and India have longstanding friendly relations and a shared history of adversarial relations with China.

Japan also invited Indonesia, South Korea (with which it is pursuing a diplomatic thaw, driven by common concerns about China), Brazil (another key Global South power), and Ukrainian President Volodymyr Zelensky to the G7. In each case, the message was clear: The Sino-Russian friendship "without limits" is having serious consequences for how other powers perceive China.

In its final communiqu?, the G7 explained at length how it will confront and deter China in the years ahead. It decried Chinese "economic coercion" and expansionism in the East and South China Seas, stressed the importance of an Indo-Pacific partnership, and issued a clear warning to China not to attack or invade Taiwan.

In taking steps to "de-risk" their relationships with China, Western leaders settled on language that is only slightly less aggressive than "de-coupling." But it isn't just the diplomatic argot that has changed. According to the communiqu?, Western containment efforts will be accompanied by large investments in clean energy and infrastructure across the Global South, lest key middle powers be drawn into China's sphere of influence through its Belt and Road Initiative.

Meanwhile, the Western-Chinese tech and economic war continues to escalate. Japan recently imposed restrictions on semiconductor exports to China that are no less draconian than those introduced by the U.S., and the Biden administration has since pressured Taiwan and South Korea to follow suit. In response, China has banned semiconductors made by the U.S.-based chipmaker Micron Technology (MU), and has begun to restrict exports of some critical metals over which it has a near-monopoly in production and refining.

Likewise, U.S. chipmaker Nvidia (NVDA) - which is quickly becoming a corporate superpower, owing to surging demand for its advanced chips to power AI applications - is facing new constraints on selling to China. U.S. policymakers have made clear that they intend to keep China at least a generation behind in the race for AI supremacy. To that end, the U.S. CHIPS and Science Act of 2022 introduced massive incentives to re-shore chip production.

The risk now is that China will leverage its dominant role in producing and refining rare-earth metals that are key inputs in the green transition. China has already increased its exports of electric vehicles by about 700% in value terms since 2017, and it is starting to deploy commercial airliners that eventually could compete with Boeing (BA) and Airbus (FR:AIR). So, while the G7 wants to deter China without escalating the cold war, the response from Beijing suggests that it has failed to thread the needle.

The U.S. and China cold war will mean more fragmentation of the global economy.

Of course, the Chinese would like to forget that their own aggressive policies contributed to the situation. In interviews marking his 100th birthday in May, Henry Kissinger - the architect of America's "opening to China" in 1972 - warned that unless the U.S. and China find a new strategic understanding, they will remain on a collision course that could end in outright war. The deeper the freeze, the greater the risk of a violent crack-up and military hostilities this decade.

Even without an actual hot war between the U.S. and China, a colder war will mean more fragmentation of the global economy, more balkanization of global supply chains, more de-risking or decoupling, and more restrictions on cross-border flows of goods, services, capital, people, data, and knowledge. Neoliberal free trade is out; industrial policies, "homeland economics," subsidies, and secure trade are in, as the world increasingly divides into two economic, monetary, financial, currency, trade, investment, and technological domains.

Climate risks are climbing

At the same time, the costs of climate change will continue to increase rapidly. Scientists now expect global average temperatures to reach 1.5deg Celsius above pre-industrial levels - the Paris climate agreement target - in the next five years. To hold temperature increases there, greenhouse-gas emissions would have to be cut by half by 2030, which is basically impossible. Even if all the commitments made at COP26 in Glasgow and COP27 in Sharm El-Sheikh were to be met - a very big if - temperatures would still be on track to hit 2.4degC above pre-industrial levels by the end of this century.

Humanity's handling of climate change amounts to a slow-motion, but accelerating, train wreck.

In the absence of real action, greenwashing, greenwishing and greenflation have become rampant. The good news is that there are many technological options that can accelerate decarbonization and help us achieve net-zero emissions with limited impact on economic growth: renewable energy, carbon capture and storage, clean and green hydrogen, and nuclear fusion.

The bad news is that fusion is still a long way from commercialization, and many of the other options remain costly compared to fossil fuels. Humanity's handling of climate change amounts to a slow-motion, but accelerating, train wreck.

Making matters worse, poorer emerging markets and developing countries are facing dire economic prospects. After an anemic recovery from the COVID pandemic, they bore the brunt of higher food and energy prices following Russia's invasion of Ukraine. Higher inflation has eroded real incomes, and their currencies have weakened against the U.S. dollar (DX00). This, combined with higher interest rates, has left many nations with unsustainable debts. The International Monetary Fund and the World Bank estimate that about 60% of poor countries and 25% of emerging markets cannot service their debts and will need to restructure them.

Social strife, political instability and AI's rise

Against this backdrop, increased poverty, climate change, inequality, and social strife could easily lead to domestic political instability or even failed states, causing mass migration and fueling the trend toward economic populism. Most of Latin America is now ruled by left-wing populists, while far-right authoritarian populism is on the rise in other parts of the world.

In the U.S., former president Donald Trump is the clear favorite to win the Republican Party's nomination for the 2024 presidential election, and could well retake the White House. In the U.K., the demagogic Boris Johnson remains very popular. A party with fascist roots is running Italy, and the far-right Marine Le Pen remains the de facto opposition leader in France. In Turkey, the recently re-elected President Recep Tayyip Erdogan continues to consolidate autocratic rule. Until the Hamas attack, Israel was governed by the most right-wing coalition in its history. And, of course, Russian President Vladimir Putin and China's Xi have formed a new authoritarian axis.

Finally, in the year since Megathreats appeared, AI has become an even bigger topic, owing to the public release of generative AI platforms like ChatGPT. I had originally predicted that deep-learning architectures ("transformer networks") would revolutionize AI, and that does seem to be what has happened. The potential benefits - and pitfalls - of generative AI are profound, and they are becoming increasingly clear. On the positive side, productivity growth could be sharply increased, vastly enlarging the economic pie; but, as was true of the first digital revolution and the creation of the internet and its applications, it will take time for such gains to emerge and achieve scale.

The risks associated with AI are also becoming clear. Many worry about permanent technological unemployment, not just among low-skilled blue-collar workers, but also across creative professions. In an extreme scenario, the economy two decades from now could be growing at a rate of 10% per year, but with unemployment at 80%. A related risk, then, is that AI will be another winner-takes-all industry that turbocharges income and wealth inequality.

AI also will have a similar effect on disinformation, including through "deep fake" videos, and various forms of cyber-warfare, especially around elections. And, of course, there is the small but terrible risk that advances in AI will lead to AGI (artificial general intelligence) and the obsolescence of the human species.

The debate over whether tech firms should be regulated more strictly, or even broken up, continues to intensify. But the obvious counter-argument is that America needs Big Tech and AI firms to assure its dominance over China, which is doing everything it can to become a military superpower.

Fortunately, if AI does usher in a world of 10% annual growth, a UBI or substantially more income redistribution could well be possible. Moreover, AI also could help us address other megathreats such as climate change and future pandemics. While none of these positive outcomes can be taken for granted, given the power and influence that elites wield, problems of distribution are always easier to tackle in a high-growth setting than in a low-growth one.

While stagflationary forces will weigh on growth and exacerbate megathreats in the medium term, the future could be bright if we can avert a dystopian scenario in which megathreats destructively feed on each other. Our first priority will be to survive the next few decades of instability and chaos.

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12-02-23 1445ET

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