Time to Put Geopolitics on the Board Agenda

A hot topic today is environmental, social and governance performance, otherwise known as ESG. Many corporate boards and senior managers now pay close attention to ESG and want to know how well their companies measure up.

But at the risk of further muddying the acronym waters, we should add another “G” to ESG. The extra G stands for geopolitics.

Geopolitics, broadly defined, is when countries compete for global influence and economic and political power. Countries want to protect their security and counter nations that might threaten them. Through geopolitics, they look to undermine rivals (while perhaps propping up the fortunes of friendly countries).

You don’t have to look far to see geopolitics in action today. Russia’s attack on Ukraine is an obvious example. Russia wants to flex its military muscle and regain the international clout it had when it was the Soviet Union. The U.S. has—to the surprise of many—rallied NATO allies and mounted a forceful economic and financial counterattack to support the people of Ukraine as they fight to save their country.

Another geopolitical tussle is brewing between the United States and China. The relationship between the world’s two largest economies has gotten adversarial as disputes over Taiwan, intellectual property protection, trade deficits, 5G networks and human rights heat up. Not long ago, the U.S. only had to worry about China’s surging economic clout. Now, it must contend with China’s growing military power too. Meanwhile, at home, America is in turmoil. Deep political divisions undermine the country’s stability and hinder its capacity to unite against external threats. Russia and China have inflamed those divisions, largely through social media.

These are just a few of the obvious geopolitical battlegrounds. There are more, and the pandemic has made things worse. Take the world’s supply chains for example. For years, people took smooth, reliable supply chains for granted. But the pandemic revealed how complex and vulnerable supply chains are to geopolitical disruption. At the pandemic’s height, as countries scrambled for vital medical supplies, relying on foreign supply for critical items became unwise.

Political assumptions gone wrong

Deciphering what today’s geopolitical risks mean for Canadian businesses is a complex and pressing task. Canada is an export nation and our businesses have for years relied on, and benefited from, stable and predictable global political foundations. Now, those foundations are shaking.

How did we get here? We can trace the roots of many of today’s geopolitical battles to a profound political misjudgment some 35 years ago. As the Cold War ended, many countries began to liberalize their economic policies. Tariffs came down and free trade agreements went up. The interwoven global economy as we know it took shape.

The consensus was that globalization was good. And indeed, it appeared to benefit everyone. Advanced economies got cheap imports and deployed the resultant savings elsewhere. Emerging markets got manufacturing jobs, investment and growth. It was a win-win. 

But there was a problem. Globalization relied on two political assumptions. First, shared economic prosperity would smooth over political differences between nations. Second, undemocratic countries joining the global economy would politically transform and their citizens would win freedoms. The idea was that to compete, these countries would need to become transparent, informationally open societies. Modern competition, which relies on creating and applying knowledge in innovative ways, would force domineering political regimes to liberalize. Their increasingly prosperous citizens would then press for more say in how they were governed.

Both assumptions were wrong.

China has proven quite capable of maintaining, if not increasing, state control while simultaneously building an advanced economy. If anything, the Chinese Communist Party is more dominant now. It has no intention of relinquishing the control that has allowed the country to advance economically at such an astounding clip. China’s central government has been able to strengthen its control of both heavy basic industries and advanced high-tech sectors. To do so, it has employed tactics that include cheap loans, toleration and encouragement of intellectual property theft, joint ventures that mandate the transfer of management know-how and policies that keep markets closed to foreigners. These are all standard tools in China’s mercantilist toolbox.

Meanwhile, growing prosperity around the world has not eliminated sharp political differences between nations. Many job losses in Canada, the U.S. and other developed nations since the 1990s were structural and permanent. Some who lost jobs believe the global competitive game is rigged. The result is a shift back to protectionism among developed markets and stronger nationalism in domestic politics. Brexit and the rise of Donald Trump exemplify this trend.

All this shows that it is no longer possible for corporate leaders to pay attention to ESG without adding the second G. Geopolitical risk must be factored alongside environmental, social and governance performance.

A four-step solution

So, how should Canadian boards and executives integrate geopolitics into their thinking? First, it is not realistic to ignore or divest completely from large, emerging markets. Canadian prosperity depends on access to high-growth economies and diversified export patterns. Trade and investment can still occur, even when geopolitical differences exist.

But investment must occur with a clear eye and a realistic appraisal of the nature of that competition. Economic activity alone does not lead to a fundamental change in political behaviour or the calculation of state interest. When push comes to shove, countries protect political interests before economic ones. The debate in Canada and other countries about whether to deny Huawei Technologies access to next-generation 5G wireless networks to protect against potential suspected espionage is a case in point. So too are sanctions that the U.S., Canada, the European Union and others put on Russia, or the decision of many large oil companies to exit from their Russian investments. Germany’s decision to freeze the Nord Stream 2 gas pipeline from Russia will surely cause its citizens to pay more for gas. But Germany is making a geopolitical calculation that higher prices in the short-term are worth it to fight Russian aggression in the long-term.

Second, planning for geopolitical risk should be evaluated like any other risk. Resultant actions can include diversifying supply chains, enhancing measures to protect intellectual property and forming alliances with like-minded companies facing similar threats. While big domestically, Canadian corporations are small when compared internationally. The collective heft of joint geopolitical positions by key industry players might help Canadian firms internationally.

Third, governments should pay more attention to the geopolitics of business. Supporting investments in emerging technologies or aiding companies to develop advanced technologies is critical. So too is oversight of who is trying to access proprietary data, particularly intellectual property protection of basic and applied science. Some countries are already reinvigorating their review of foreign investors along geopolitical lines. The Canadian government should keep this on the front burner too.

Fourth, capital providers must extend their ESG perspective. It is fine to demand better ESG performance from companies. But investment funds need to monitor where their money goes and the behaviour they are implicitly rewarding when they invest. If they mostly value and fund financially smart but geopolitically risky moves—insisting on lean production networks, outsourcing critical manufacturing and not vetting partners with a geopolitical eye—then they are likely to slow, rather than accelerate, ESG progress.

Prominent business leaders have written books advocating for “principles” and “values” to govern business activity—American billionaire investor Ray Dalio and former Bank of Canada governor Mark Carney among them. However, it is naive to overestimate how widely such sentiment is shared. There is no global consensus on what those “principles” and “values” are, and whether companies should even follow them.

The road ahead will be geopolitically tumultuous for the global economy. That is more normal than not. The last 35 years or so have lulled us into thinking that geopolitics no longer matters. It does. Boards, business leaders and governments need to pay attention.

David Detomasi is the Distinguished Faculty Fellow of International Business at Smith School of Business. He is the author of the upcoming book Profits and Power: Navigating the Politics and Geopolitics of Oil published by University of Toronto Press.

This article was updated on March 4, 2022.