The silver lining for labour markets

Offshoring jobs makes less sense when technology can help speed products to local markets

Rana Foroohar




Much of the news of the past few days has come to us from the global level — climate change battles at the G20; doubts about the future of the World Trade Organization; Russian president Vladimir Putin’s assertion that liberalism has “become obsolete”. But to really understand why the world is so fractured today, you have to go local and look closely at why labour’s share of the economic pie has been squeezed so much in recent years, particularly in the US and western Europe.

Globalisation usually gets the blame for the declining labour share and the subsequent discontent among working-class and, more recently, middle-class voters. But a recent report into the US labour market conducted by the McKinsey Global Institute found that globalisation was actually bottom of the list of the top five reasons that labour’s share of national income has declined since the turn of the 21st century.

In fact, the biggest reason for the declining labour share, according to the study, is that supercycles in areas such as commodities and real estate have made those sectors, which favour capital over labour, a larger part of the overall economy. But reason number two — a rise in the importance of intangible assets in our economy — tells us much more about worker (and voter) discontent.

Intangible assets including computers and software depreciate much faster than tangible ones such as machinery and factories. The shorter lifecycle and continually falling price of new technologies — as well as their productivity enhancing effects — mean more money goes towards investing in them, leaving less for labour. That, combined with the fact that automation has damped incomes, represents 38 per cent of the total decline in labour share since 1999, according to MGI’s calculations.

This is where the local picture within countries starts to matter quite a lot. As most of us know, automation and the speeding up of capital substitution because of technological shifts have hurt traditional industrial areas disproportionately — that is one of the reasons the US ended up with a president like Donald Trump.

But in the future it will also radically favour a few regions: according to a second McKinsey report to be released on July 11, a mere 25 cities and regions could account for 60 per cent of US job growth by 2030. They will not all be the ones you would think. Tech hubs will benefit, of course, as will commodity-rich areas and tourism centres catering to the wealthy. But so will any number of other cities and regions with economic development plans designed to capitalise on a silver lining to the declining labour share story. When labour makes up less of the overall cost of producing goods and services, then offshoring jobs starts to make less sense.

What does make sense is being closer to customer demand, a trend that was growing for a decade before today’s trade wars led companies to start reconsidering supply chains for political reasons. For a good 10 years, says MGI chairman James Manyika, “the importance of cheap labour has been declining relative to the importance of demand signals”. MGI’s own figures show that less than 20 per cent of goods trade today is from a low-wage country to high-wage one. This is in part due to the fact that China and other emerging markets consume more of what they make themselves and are developing their own domestic supply chains, a process increasing speed because of trade tension.

Western companies are also eager to locate production closer to their customers, a trend enabled by a “just-in-time” culture and enabled by technologies including 3D printing and artificial intelligence. As social media drives trends, consumers do not want to wait weeks for a product their favourite Instagram influencer is pushing today.

That dynamic favours speed to market above all else, which in turn favours localisation. Consider how companies such as Nike and Adidas have built highly automated “speed-factories” in the US, Mexico and Germany to roll out the latest styles faster and more cheaply.

Such trends could help turn back the declining labour share trend in the US, as well as in European countries including the UK, France, Germany and Italy. Yet unless the EU can maintain its single market unity over the long haul, it could lose out on the reshoring trend, since no single nation has enough demand or production capacity to support an entire regional supply chain on its own.

In the US, the risk is that the shifting labour market dynamics will sharpen the political divides that already exist. Many “left behind” cities are home to more Hispanics and African Americans. Job categories that will be automated fastest are entry-level positions typically done by the young. Meanwhile, the over-50s are at the highest risk of job loss from declining skills. One can easily imagine these shifting trends exacerbating the culture wars, age wars and political populism that already loom.

The solution: shift policy to support human capital investment, just as we do other types of capital investment. The US must change its tax code to allow companies to write off investments in workers in the same way they do those in machinery. If we continue to subsidise software without supporting people, the future looks grim.

Thumbs Down to Facebook’s Cryptocurrency

Only a fool would trust Facebook with his or her financial wellbeing. But maybe that’s the point: with so much personal data on some 2.4 billion monthly active users, who knows better than Facebook just how many suckers are born every minute?

Joseph E. Stiglitz

stiglitz259_GettyImages_bluewhitetalkbubblethumbsdown


NEW YORK – Facebook and some of its corporate allies have decided that what the world really needs is another cryptocurrency, and that launching one is the best way to use the vast talents at their disposal. The fact that Facebook thinks so reveals much about what is wrong with twenty-first-century American capitalism.

In some ways, it’s a curious time to be launching an alternative currency. In the past, the main complaint about traditional currencies was their instability, with rapid and uncertain inflation making them a poor store of value. But the dollar, the euro, the yen, and the renminbi have all been remarkably stable. If anything, the worry today is about deflation, not inflation.

The world has also made progress on financial transparency, making it more difficult for the banking system to be used to launder money and for other nefarious activities. And technology has enabled us to complete transactions efficiently, moving money from customers’ accounts into those of retailers in nanoseconds, with remarkably good fraud protection. The last thing we need is a new vehicle for nurturing illicit activities and laundering the proceeds, which another cryptocurrency will almost certainly turn out to be.

The real problem with our existing currencies and financial arrangements, which serve as a means of payment as well as a store of value, is the lack of competition among and regulation of the companies that control transactions. As a result, consumers – especially in the United States – pay a multiple of what payments should cost, lining the pockets of Visa, Mastercard, American Express, and banks with tens of billions of dollars of “rents” – excessive profits – every year. The Durbin Amendment to the 2010 Dodd-Frank financial-reform legislation curbs the excessive fees charged for debit cards only to a very limited extent, and it did nothing about the much bigger problem of excessive fees associated with credit cards.

Other countries, like Australia, have done a much better job, including by forbidding credit card companies from using contractual provisions to restrain competition, whereas the US Supreme Court, in another of its 5-4 decisions, seemed to turn a blind eye to such provisions’ anti-competitive effects. But even if the US decides to have a non-competitive second-rate financial system, Europe and the rest of the world should say no: it is not anti-American to be pro-competition, as Trump seems to have recently suggested in his criticism of European Commissioner for Competition Margrethe Vestager.

One might well ask: What is Facebook’s business model, and why do so many seem so interested in its new venture? It could be that they want a cut of the rents accruing to the platforms through which transactions are processed. The fact that they believe that more competition won’t drive down profits to near zero attests to the corporate sector’s confidence in its ability to wield market power – and in its political power to ensure that government won’t intervene to curb these excesses.

With the US Supreme Court’s renewed commitment to undermining American democracy, Facebook and its friends might think they have little to fear. But regulators, entrusted not just with maintaining stability, but also with ensuring competition in the financial sector, should step in. And elsewhere in the world, there is less enthusiasm for America’s tech dominance with its anticompetitive practices.

Supposedly, the new Libra currency’s value will be fixed in terms of a global basket of currencies and 100% backed – presumably by a mix of government treasuries. So here’s another possible source of revenue: paying no interest on “deposits” (traditional currencies exchanged for Libra), Facebook can reap an arbitrage profit from the interest it receives on those “deposits.” But why would anyone give Facebook a zero-interest deposit, when they could put their money in an even safer US Treasury bill, or in a money-market fund? (The recording of capital gains and losses each time a transaction occurs, as the Libra is converted back into local currency, and the taxes due seem to be an important impediment, unless Facebook believes it can ride roughshod over our tax system, as it has over privacy and competition concerns.)

There are two obvious answers to the question of the business model: one is that people who engage in nefarious activities (possibly including America’s current president) are willing to pay a pretty penny to have their nefarious activities – corruption, tax avoidance, drug dealing, or terrorism – go undetected. But, having made so much progress in impeding the use of the financial system to facilitate crime, why would anyone – let alone the government or financial regulators – condone such a tool simply because it bears the label “tech”?

If this is Libra’s business model, governments should shut it down immediately. At the very least, Libra should be subject to the same transparency regulations that apply to the rest of the financial sector. But then it wouldn’t be a cryptocurrency.

Alternatively, the data Libra transactions provide could be mined, like all the other data that’s come into Facebook’s possession – reinforcing its market power and profits, and further undermining our security and privacy. Facebook (or Libra) might promise not to do that, but who would believe it?

Then there is the broader question of trust. Every currency is based on confidence that the hard-earned “deposited” into it will be redeemable on demand. The private banking sector has long shown that it is untrustworthy in this respect, which is why new prudential regulations have been necessary.

But, in just a few short years, Facebook has earned a level of distrust that took the banking sector much longer to achieve. Time and again, Facebook’s leaders, faced with a choice between money and honoring their promises, have grabbed the money. And nothing could be more about money than creating a new currency. Only a fool would trust Facebook with his or her financial wellbeing. But maybe that’s the point: with so much personal data on some 2.4 billion monthly active users, who knows better than Facebook just how many suckers are born every minute?


Joseph E. Stiglitz, a Nobel laureate in economics, is University Professor at Columbia University and Chief Economist at the Roosevelt Institute. He is the author, most recently, of People, Power, and Profits: Progressive Capitalism for an Age of Discontent (W.W. Norton and Allen Lane).


Forecast Tracker: 2019 Second Quarter Update

The trade war roller coaster, the economy's other shoe, the offensive against Iran.

By GPF Staff

 

The two most important predictions we made in December 2018 were that the United States and China would reach a short-term accommodation on trade and that the United Kingdom would leave the European Union with a deal. As we reach the midpoint of 2019, the data on both these issues is inconclusive at best. U.S.-China talks have become something of a roller coaster and seem to always progress just long enough to be held hostage by either U.S. President Donald Trump or Chinese President Xi Jinping for domestic political purposes when it suits them. Just a few days ago, Trump reversed course, saying the U.S. could do business with Huawei. As for the U.K., having blown through yet another Brexit deadline, the country is now mired in a leadership contest that has to be resolved before it can realistically withdraw. In both cases, our read of the underlying interests and constraints remains unchanged.

The same could be said for our forecasts regarding the status of the global economy. The U.S. economy is showing signs of recession (a yield curve inversion between three-month and 10-year bonds, now almost a month old) while at the same time exhibiting higher-than-expected growth rates and even growth in real wages. The simple truth is that there has never been a time in economic history where monetary policy has led to the availability of cheap capital for this long, nor has debt ever accumulated in the global system quite as much as it has now. It’s tempting to predict the future by parsing the trade negotiations between the U.S. and China or noting the price of oil after Iran and the U.S. bicker with each other, but there are much larger structural forces at work here, and one cannot help feeling that, like investors, many countries are waiting for the other shoe to drop.

As for Iran, we should note that while our 2019 forecast did not specify the degree to which the U.S. would curb Iranian influence in the Middle East, it emphasized that the U.S. and a coalition of like-minded allies would try to do so. In fact, it was a focal point of a forecast that is solidly on track. Even so, it isn’t time to rest on our laurels just yet. There were some flaws and omissions – we didn’t see the coup attempt in Ethiopia coming, for example. But the fact that there have been only a few big surprises and no obvious missteps tells us we have at least asked ourselves the right questions.

The following tracks each of our individual forecasts in full. As always, we encourage you to take a look and to let us know what you think.

 

A Cycle Ends


The U.S. and China will reach a deal on trade, but it won’t end the trade war.

Inconclusive
 

This forecast took an abrupt turn in early May. By all accounts, a deal was imminent if only the two sides could agree on mechanisms to make it stick. Then, suddenly, the U.S. accused China of reneging on various commitments, and by the end of the week, U.S. tariffs on $250 billion in Chinese goods were increased by 15 percent. Things only intensified from there, with both sides making a series of moves you’d probably do only if you thought the window for a deal had closed. Nonetheless, we still think both sides have ample interest in striking at least a limited deal – and that, ultimately, the issue will hinge above all on whether economic and political pressure in the U.S. rises enough to compel the White House to settle for quite a bit less than it has demanded in public. Indeed, tensions have cooled enough for Xi and Trump to meet last weekend at the G-20 summit, and the two sides are reportedly discussing a “cease-fire,” with the U.S. holding off on imposing new tariffs on a staggering $300 billion in Chinese goods in order to allow China to save enough face to return to the negotiating table (and to stave off a mounting backlash from U.S. businesses).

The technology front of the trade war recently got much more interesting. The U.S. had targeted Chinese tech giants like Huawei and had started the process of starving them of critical foreign components like semiconductors. In response, China threatened to cut off the U.S. from rare earth elements. And then, just like that, on June 29, Trump reversed course, saying U.S. companies could, in fact, sell to Huawei. Yet he left open the possibility that Huawei will again be deemed a threat to national security down the road, particularly if trade talks stall once more.
 

A decline in living standards will lead to social unrest in Russia. It won’t be enough to effect regime change.

On Track
 

In general, the Russian economy is slowing down, and the Kremlin is looking for new methods of economic development. According to preliminary data, Russia’s gross domestic product grew by just 0.5 percent from January to May, and slowed to zero in May. The living standards of Russians continue to fall. Real incomes, despite some growth in wages, are decreasing – a result of increased consumer lending and the reduced activity in the gray sector of the economy.

Yet there was only modest protest activity in the second quarter. There were no demonstrations against falling real incomes (or at least they were not announced). The biggest protests covered issues largely unrelated to living standards: border issues in Ingushetia and Dagestan, churches in Yekaterinburg, the construction of landfills in Arkhangelsk, and so on. (It’s worth noting that authorities reportedly used heavy force to break up the protests.)

One area we seem to have gotten wrong was that value-added tax reform would dramatically increase the costs of products, and that Russian households would suffer for it. That hasn’t yet happened, we believe, because we failed to take into account that most Russians spend nearly half of their income on food and utilities, and the VAT rate on basic products never changed.

Still, we consider our forecast on track. The standard of living continues to fall, and the nature of the protests has changed. The protests are less intense than they once were, but they are now qualitatively different: Much of the population understands that it can join protests on their own, not under the auspices of a political party, as is so often the case.
 

To manage the fallout of the trade war, China will intensify its suppression of internal dissent and employ modest fiscal stimulus to sustain growth.

On Track
 

As we mentioned in our first quarter update, this forecast has already proved accurate, more or less. Throughout the second quarter China has moved forward on the programs announced earlier in the year and implemented new ones and corresponding monetary policy to support it – all while resisting the urge to let the stimulus flow freely. In April, China began to offer subsidies to support the purchase of home appliances to encourage domestic consumption. It reaffirmed its support for small businesses, including by lowering the interest rate on loans, and in May it followed up with a cut to the reserve requirement ration to buttress the economy during the trade war.

Beijing also announced new measures to reduce individuals’ taxes to encourage spending while relaxing restrictions on local government spending – the biggest source of stimulus in the wake of the 2008 crisis. Total credit in China continues to expand, but the country still has some severe liquidity problems, and it can’t quite figure out how to get lending to the private sector. As a result, additional stimulus is likely.

As for suppression, Beijing continues to crack down on labor groups, religious groups and any other civic organization capable of organizing against the state. Its crackdown on wayward elements in the army continues; 70 senior officers were reportedly demoted last week for connections to an ousted general. Curiously, the Communist Party of China also outlined plans to send millions of youth to the countryside for “volunteering” assignments, a throwback Mao’s mobilization during the Cultural Revolution.
 

Economic growth in much of the European Union will slow, and some countries’ economies will contract. Germany is especially vulnerable to a recession.

On Track
 

Headlined by Germany and Italy, European economies continue their trend of slow growth. German first quarter output came in a bit stronger than expected but was still a tepid 0.4 percent. The IHS Markit Purchasing Managers’ Index suggests that Germany will see modest growth again in the second quarter, but expectations for the next 12 months are the weakest they have been in more than four and a half years. Italy peeked out of its recession in the first quarter, growing by 0.1 percent, but the Italian national statistics bureau has already warned the public not to get used to it, saying last week that there was a “relatively high” chance that the economy contracted again in the second quarter. For the eurozone economy as a whole, growth is expected to tick back to 0.3 percent this quarter after 0.4 percent growth in the first three months of the year, according to the joint assessment of the German Ifo Institute, the KOF Swiss Economic Institute, and the Italian statistical institute Istat.

Poland continues to be an exception. In terms of GDP per capita, the Polish economy has reached 71 percent of the average level of the EU. So far, the economy is stable, supported as it is by record-low unemployment ahead of elections, but the sharp rise in consumer prices can lead to a slowdown in economic growth. It is expected that the slowdown, although quite soft, will begin after the elections, which will be held later this year.
 

U.S. economic growth will slow. The U.S. is approaching the end of its current expansionary cycle, and a recession before the year’s end would not surprise us.

Inconclusive
 

Three months ago, we concluded that while the exact timing of the next recession was in doubt, it was clear that U.S. economic growth was slowing. Its subsequent economic performance quickly humbled us. Data from the U.S. Department of Commerce in April showed U.S. GDP growth rise to 3.2 percent, beating most consensus forecasts and exceeding our own expectations. In May, the good times continued to roll. The initial estimate of first quarter growth beat consensus estimates on how far down the growth rate would be adjusted (official data shows a 3.1 inflation-adjusted growth rate for the first quarter).

That’s not to say that all news is good news for the economy. The three-month and 10-year yield curve inverted briefly in March before recovering, only to invert again at the end of May. This time the inversion seems to have more resilience, having widened in recent weeks. The yield curve inversion is not ironclad proof of imminent recession, but it is a valuable sign for gauging how investors feel about the U.S. economy. And apparently they are pessimistic despite better-than-expected growth rates, low unemployment (3.6 percent), and even some positive if tepid growth in real wages.

All of that comes in the context of U.S. trade policy that can best be described as uncertain. With the U.S. and China resuming trade negotiations last week ahead of the Trump-Xi meeting, there may be even more room for the U.S. economy to grow. For now, we are downgrading our grade of this forecast from on-track to inconclusive.

 



The Race for Power in the Periphery


Ukraine and Belarus are the two places with the potential for a U.S.-Russia confrontation. Ukraine is at risk of falling apart. Russian influence in Belarus will threaten Poland.

On Track
 
Russia continues to strengthen its western borders and to employ more peaceful methods to attract residents of the occupied territories, including the issuance of Russian passports to the civilians of Donbass. Meanwhile, increased NATO activity close to Russia’s borders has prompted retaliation: In the second quarter, Russia conducted a variety of military exercises and plans to hold around 100 drills before winter. Russia has also enhanced its military presence on the border with Ukraine. The United States, for its part, has sent U.S. military instructors to Ukraine. Washington will also deploy additional troops to Poland. NATO conducted air defense drills in northern Poland and is now preparing for the Sea Breeze naval exercises, which will start July 1.
It’s worth noting that although they were not in our initial forecast, the Baltic states are becoming an increasingly relevant front in the U.S.-Russia confrontation. Estonia recently hosted the world’s largest cyber exercise. Latvia reported Russian naval vessels at its borders. Sweden decided to return troops to an island in the Baltic Sea. And the multinational BALTOPS military exercise took place with the participation of 18 nations, 50 ships, two submarines, three dozen aircraft and about 8,600 personnel – all along the Estonian coast.
 

China will continue to militarize islands in the South China Sea and build up naval, missile and air power capabilities, making it more difficult for outside powers to operate freely in those waters. Japan will take a bigger leadership role in creating a multinational coalition to contain China. India and Australia will become more prominent in the Indian Ocean and in the South Pacific, respectively.

 
On Track
 

Things unfold slowly on this front, with major inflection points few and far between. But all the key trends underpinning this forecast have continued. Military cooperation among the four members of “the Quad” – Japan, Australia, India and the U.S. – is continuing to build as these countries gradually increase the scale and frequency of joint military exercises, port visits and so forth. Some notable developments: Australia is reportedly planning to build a new port near Darwin for the U.S. Marines; there was a notable uptick in high-profile Japanese and Australian warship visits across Southeast Asia; Australia and India began talks on an intelligence-sharing mechanism; Australia, Japan and the U.S. launched a trilateral infrastructure initiative to balance against Belt and Road Initiative projects in the South Pacific; annual major U.S.-Philippine exercises included components aimed squarely at China that had been shelved by the Philippines’ president; and European powers such as France, the U.K. and Germany deployed warships to the Indo-Pacific. All the while, China did what it does, “salami slicing” its way through the South and East China seas, regularly antagonizing regional states like the Philippines but never so much that it leads to a total breakdown in ties or pushes opportunistic Southeast Asian states firmly into the U.S. camp.
 

Brazil will try to strengthen ties with countries in the Northern Hemisphere.

 

On Track

 

Efforts to improve ties with the U.S. and Israel focused on economics. President Jair Bolsonaro announced a trade office in Jerusalem, and Petrobras, Brazil’s state-owned oil company, expressed interest in offshore oil exploration in Israel, an activity that would indirectly support Israel’s Eastern Mediterranean claims and strategic interests. Brazilian banks expanded their presence in the U.S., while aerospace company Embraer made progress toward being able to sell a new cargo plane in U.S. markets. Authorities also passed measures to open Brazil’s economy in the hopes of creating a more attractive business environment. Perhaps most notable was that Washington finally backed Brazil’s accession to the Organization of Economic Cooperation and Development.

On the political front, the forecast is clear cut. Brazil acted on behalf of Washington’s interests but usually only when doing so intersected with its own. Brasilia, for example, is now reviewing Brazilian Development Bank funding previously sent to Cuba and Venezuela, and it challenged in international courts Bolivian President Evo Morales’ bid for indefinite reelection. In other areas, however, Brazil defied Washington, resisting U.S. and Israeli efforts to join an alliance against Iran and maintaining pragmatic ties with China. While on a visit to Beijing, Brazil’s vice president advocated increased investment and trade and declined to rule out working on 5G projects with Huawei. For now, we’re comfortable saying the forecast is on track, even if the political aspect of it throws things off down the road
 

The Monroe Doctrine will be relevant for the first time since 1991.

On Track
 

Over the past quarter, the U.S. maintained sanctions on Venezuela, introduced sanctions on Nicaraguan leaders and began full implementation of the Helms-Burton Act to put pressure on companies operating in Cuba. But Washington’s main focus in Latin America was Mexico, on migration in particular. The U.S. put pressure on its southern neighbor to stop migrants crossing from Guatemala into Mexico, reduce the flow of migrants through Mexico to the U.S., and to serve as a “safe third country” – which would entail hosting asylum seekers from other countries while they await their court dates in the U.S. (Mexico has not yet agreed to this last item.) The Pentagon, meanwhile, resumed natural disaster training exercises in the Northern Triangle countries (Guatemala, Honduras, El Salvador). The Department of Homeland Security partnered with Guatemalan authorities on migration and human trafficking, and the White House floated the possibility of working with Guatemala toward a safe third country agreement. There are also signs that El Salvador will fall in line with U.S. policies, with President Nayib Bukele announcing that his anti-gang campaign will target gang financing, a strategy advocated by the U.S.
 

Uzbekistan will begin to challenge Kazakhstan as Central Asia’s regional power.

Inconclusive
 

It was mostly quiet on the Central Asian front this quarter. Uzbekistan and Kazakhstan continued to pursue foreign investment to bolster their economies. If competition between the two was less evident, it may be because both were busy managing serious internal challenges. Uzbekistan was trying to lower an unemployment rate that rose to nearly 10 percent, introduce changes to its legislative system, answer the question of migrant laborers, and mitigate cross-border threats from Afghanistan. Kazakhstan, meanwhile, held presidential elections that were accompanied by anti-government protests and mass arrests. The newly elected president, the country’s second since the fall of the Soviet Union, is likely more concerned with strengthening his government’s domestic position than challenging Uzbekistan’s regional position.
 

North Korea will not give up its nuclear weapons or substantially dismantle its missile program, but neither will it resume testing intercontinental ballistic missiles. The U.S. will adopt a policy of containment toward North Korea, and U.S.-South Korea interests will further diverge over unification.

On Track
 

This forecast earns an upgrade from “inconclusive” to “on-track” because of what happened in the second quarter. On May 24, North Korea tested missiles – except that they were short-range, not intercontinental, and though they make South Korea uncomfortable they don’t faze the United States. After a breakdown in talks between U.S. President Donald Trump and North Korean leader Kim Jong Un, the two mercurial leaders seem to have patched up their differences by exchanging flattering letters, and while the U.S. intelligence community has said it does not believe North Korea is prepared to denuclearize anytime soon (a stance we have held here for more than two years), both the U.S. president and secretary of state are optimistic that talks between Pyongyang and Washington will soon resume.

Relations between the U.S. and South Korea have been relatively mild, though the U.S. is once again agitating for South Korea to assume more of the financial burden of stationing U.S. troops on the Peninsula, a somewhat disheartening development for Seoul considering it just renegotiated a similar deal back in March that it had assumed met Washington’s approval. We may see some more diplomatic fireworks and perhaps even another Trump-Kim summit before year’s end, but even so, all signs point to this forecast remaining on track for the remainder of the year.
 

The U.S. and the Taliban will reach a deal in Afghanistan. By the end of the year, the U.S. will announce a schedule for withdrawing the bulk of its remaining forces from the country.

On Track
 
U.S.-Taliban talks continue, although the Taliban refuses to let the Afghan government participate. Still, in June the government unconditionally released 800 Taliban prisoners, intended as a goodwill gesture, and other signs also point to progress in the talks. Taliban representatives have been criss-crossing South Asia and the Middle East, presumably seeking input from everyone interested in Afghanistan’s future, including Iran, Pakistan and China. The Taliban recently claimed that an agreement had been reached on the timeline for the U.S. withdrawal, although Washington hasn’t confirmed it. U.S. Secretary of State Mike Pompeo also paid a visit to Kabul, during which he said Washington hopes to reach a peace deal by Sept. 1. And though he said the Taliban understand that the U.S. intends to withdraw its troops, he added that no timeline has yet been established. That’s likely to be a focus for the new round of talks that began June 29 in Doha.

European Disunion

 

The European Union and Italy will avoid a major confrontation in 2019. The underlying problems – namely, Italy’s debt-laden economy and political fractiousness – combined with Brussels’ need to assert its authority will make their peace temporary, though it will last the year.

Inconclusive
 

The “difficult discussions” predicted by European Commission Vice President Valdis Dombrovskis in March have certainly come to fruition. The Italian government’s flirtations with a de facto parallel currency and challenges to the independence of the Bank of Italy are more than we expected. Brussels has been more measured: Though it is still threatening Rome with disciplinary measures, it has privately indicated it will give the government time to make the numbers work. We still don’t think the EU will take the unprecedented step of sanctioning a member state, nor do we think Italy is serious about abandoning the euro.

In Rome, fractiousness persists. But the League and 5-Star Movement have completely reversed spots on the totem pole – the junior coalition partner League doubled its support in the polls (from 17 percent to roughly 35 percent) and in last month’s European Parliament election, while 5-Star’s support has fallen by half (from 33 percent to around 17 percent). League party chief and Deputy Prime Minister Matteo Salvini still frequently threatens to bring down the government, and now even Prime Minister Giuseppe Conte, who is not aligned with any party, has warned that he will quit if the League and 5-Star can’t work together. The government is wobbling, but it’s waiting for something to give it that final push.
 
The U.K. will leave the EU with an agreement in place. The compromises the British government will make to do so will divide the United Kingdom.
Inconclusive
 

The second quarter was even more eventful for this forecast than the first, which is saying something considering how much transpired in the first three months of the year. Since last we revisited the Brexit soap opera, the EU has granted the U.K. an extension until Oct. 31 to remain in the bloc, British Prime Minister Theresa May resigned on May 24, and the Conservative party looks poised select as her replacement Boris Johnson, one of the most outspoken and well-known advocates of Brexit in the lead up to the 2016 referendum. Johnson has made it clear that his preference is to secure a deal with the European Union, but also that he is prepared to take the U.K. out of the EU without a deal and to trade with Europe under World Trade Organization rules if he cannot secure the necessary concessions from his European interlocutors. The EU does not want to offer up more concessions, but it also does not want a no-deal Brexit, and so may be willing to give Johnson some superficial victories – or perhaps even yet another extension. The harder issue for whoever ends up replacing Theresa May will not be dealing with Brussels but securing enough votes in the House of Commons to pass a deal. Perhaps Johnson is just the sort of charismatic political figure to create the coalition necessary to squeeze such a deal through parliament, or perhaps he will collapse under the strain of his own penchant for controversy.

If the first half of this forecast remains in the balance, the second is quickly coming to fruition. A recent poll by the Sunday Times found that if Johnson does indeed win Britain’s premiership, Scottish voters would support independence by a 53-47 majority – a striking reversal considering most polls have shown that, despite Brexit, support for Scottish independence had not reached a critical mass. In May, thousands protested in Wales for independence, and a recent June poll indicated that some 36 percent of respondents might favor Welsh independence, a result that would have been unimaginable even last year. Of course, those numbers could retreat if Johnson or someone else manages to achieve an orderly Brexit, but even that rabbit can be pulled out of a hat, it will remain to be seen how much of the underlying damage is permanent. In any case, this forecast remains too up in the air to judge with certainty.
 
Economic difficulties and political differences in the EU will exacerbate popular disillusionment with establishment politicians and parties on the left and right.
Inconclusive
 
The primary indicator we were watching this quarter was the performance by euroskeptic parties in the European Parliament election in May, and the most we can conclude is that it was inconclusive. True, those parties gained a few more seats, but overall, they fell well short of expectations and relied heavily on Italy’s League party for most of their gains. It’s also true that the mainstream conservatives and social democrats lost support, but the liberal and green parties made gains, too. Perhaps most surprising, turnout was the highest in two decades – not quite an indicator of swelling disillusionment. On the national level, perhaps the most vivid representation of the growing disenchantment at the start of the year was France’s yellow vest protests. Late last year, some 300,000 protesters were in the streets throughout the country; lately they have struggled to break 10,000 nationwide.

 

 




Iran’s Enemies Strike Back

 

Iran’s position in Syria and Yemen will weaken.

On Track
 
Most evidence continues to suggest that Iran is struggling to fund its militias in Syria and, to a lesser degree, Iraq. Nonetheless, Houthi rebels have continued attacking Saudi targets with missiles that were very likely sourced from Iran. Tehran spends less on the Houthis than on its militias in Iraq, Syria and Lebanon, so we might see an Iranian retreat from the Syrian theater even as Tehran continues its lesser support for the Houthis. But it’s worth noting that one Voice of America report has claimed that Iran, which had earlier withdrawn Hezbollah forces from Syria, has redeployed them to combat the recent rebel advance in the northwestern provinces. If any meaningful redeployment of militias to the Syrian front were to be confirmed by subsequent reports, they would be a challenge to the forecast.
 
Israel will attack Hezbollah in Lebanon.
On Track

Israeli military drills that were meant solely to confront Hezbollah were a focal point of the quarter. In mid-April, Israel Defense Forces conducted two-week drills with active military and reservists to assess combat readiness for complex and urban areas. In May, the IDF started testing a new rocket alert system that more accurately pinpoints locations under threat. In early June, there were drills in in which army cadets simulated a takeover of a Lebanese village held by Hezbollah. Most notable was that every branch of the Israeli military held massive joint drills in mid-June to train for a combat scenario involving the Gaza Strip, Syria and Lebanon. They emphasized rapid airstrikes to hit enemy positions before crews can launch their rockets toward the Israeli homefront, quick turnaround of troop redeployments and interception of any remaining rockets launched toward Israel. There was also a strong component for providing cover and close coordination with ground forces in the field converging on targets. All of these maneuvers simulated an invasion of Lebanon against Hezbollah.

While it’s true that drills are routine for any military, the context in which these exercises took place suggests the forecast’s accuracy. In early April, there were reports of a new Hezbollah missile factory in Lebanon, and in late May Hezbollah ordered fighters from Syria to report back to southern Lebanon for new deployment orders. There has also been a handful of border incidents; for instance, a small drone from Lebanon briefly entered Israeli airspace, and a clash broke out at the Fatima Gate after Israel installed security cameras along the Blue Line. All this is topped with a notable uptick in hostile rhetoric coming from multiple leading Israeli officials.
 
Turkey will increase its military presence in Syria. The U.S. will make limited territorial concessions to Turkey on Kurdish autonomy.
Inconclusive
 
Turkey has continued to threaten to intervene more forcefully in Syria, positioning modest amounts of materiel near the border, and conducting small-scale patrols and occasional raids on militant elements. But pressure from the U.S. and Russia, along with continued (if unsteady) progress on establishing a buffer zone along the Turkish border in northwestern Syria despite the partial U.S. withdrawal from the region, has mitigated Kurdish threats to Turkey enough to persuade Ankara to hold its fire. Moreover, Turkey has not proved ready for the kind of deployment that would be necessary to move into northern Syria, hold the territory, and eject the Kurdish forces it wants gone, all the while preventing the Islamic State from recapturing territory.

However, Syria’s offensive against Turkish-backed rebel groups in Idlib and elsewhere has intensified, with the Syrian military allegedly targeting a Turkish outpost multiple times since April. This is perhaps now the greatest risk – greater even then the Kurds – Turkey will face if it moves farther into Syria, even if its main objective is to gain leverage in its quest to deal with Kurds east of the Euphrates.

As it stands, though, a new counteroffensive by Turkish-backed rebels in Syria suggests Ankara still thinks it can lean on its proxies to look after its interests – and the reported arrival of reinforcements from Hezbollah suggests the counteroffensive is indeed making Syrian President Bashar Assad and his patrons nervous. The counteroffensive is also aimed at pressuring Russia to shift its focus from reining in jihadist rebel groups to reining in Assad, and Moscow’s interests in cooperating with the U.S. to curb Iran’s influence in Syria are increasing. For the time being, Turkey is unlikely to feel the need to take matters in Syria into its own hands.
 
Turkey will increase drilling in the Eastern Mediterranean and repel foreign presence in what it considers to be its exclusive economic zone around Northern Cyprus.
On Track
 
This forecast gained quite a bit of traction in the second quarter. In late April, the “Turkish Republic of North Cyprus,” which is recognized only by Turkey, announced it would begin drilling for oil and natural gas in Cyprus’ exclusive economic zone. Less than two weeks later, Turkey announced that seismic research in the area was complete and that a second drillship was en route to the Eastern Mediterranean. In both cases, the U.S. and members of the European Union expressed their concern and disapproval, calling on Turkey to show restraint. And in both cases Turkey rebuffed the concerns and reiterated its claims over the area. In addition, as part of a longer-term process, the U.S. took several measures to strengthen its ties with key allies opposed to Turkish activity in the area. The U.S. Senate Committee on Foreign Relations pushed through a bill that lifts an arms embargo on Cyprus, increases energy cooperation with Cyprus, Greece and Israel, and establishes U.S. oversight over potential Turkish violations in Cyprus’ EEZ. Finally, the U.S., U.K. and Israel conducted a joint defensive counter-air exercise over the Eastern Mediterranean.