As geopolitical risks grow, businesses are slow to respond

Geopolitical tensions are on the rise and politicians, policymakers and pundits now consider them inescapable and increasingly powerful influences on all forms of activity.

Recent events have given geopolitics a new urgency, but you’d think that they have been a constant consideration of executives in an era of global supply chains and ever more integrated markets. You’d be wrong — at least as far as boardrooms are concerned.

Remarkably, geopolitical concerns have figured little in business decision-making (save for those who regularly navigate the treacherous political shoals of the Middle East). That appears to be changing, however, but executives are playing catch-up as understanding geopolitics becomes a prerequisite for success in an increasingly unstable environment.

The chorus warning of the impacts of geopolitics is deafening. Last week the U.S. Federal Reserve noted in its twice yearly Financial Stability Report that “geopolitical tensions pose important risks to global economic activity, including the possibility of sustained disruptions to regional trade in food, energy and other commodities.”

The Bank of Japan agreed in its July report on the economic outlook, highlighting “extremely high uncertainties regarding the outlook, such as over geopolitical factors ... heightened geopolitical risks (that) could change the trend of globalization ... (and) heightened geopolitical risks and other factors will have a significant impact on corporate behavior.”

BOJ Gov. Kazuo Ueda underscored that last point in remarks to financial world heavyweights in Jackson Hole, Wyoming, in August, warning that “trade and foreign direct investment patterns in Asia are changing partially in response to rising geopolitical tensions ... recent diversification seems to reflect a response to geopolitical risks. The net effect of the latter on Japan and the world economy remains very much uncertain, but skewed to the downside.”

Businesses get it. According to Oxford Analytics’ latest survey, released in August, businesses named geopolitical tensions — those related to the Taiwan Strait, the Korean Peninsula and the invasion of Ukraine — as the biggest threat to the global economy now. CBNC cites Jamie Thompson, author of the survey, who explained that “Geopolitical tensions are now the main focus of concern, both in the near term and the medium term.”

The World Economic Forum’s 2023 Risk Report similarly placed geopolitical risks within its top 10 list of both short- (two year) and medium-term (10 year) global concerns. Readers of this column two weeks ago will recall that geopolitical tensions topped foreign businesses’ concerns about the China market. In the latest annual survey by the Japan Bank for International Cooperation of Japanese companies with operations overseas, released in December 2022, 85% of companies said geopolitical risks were significant.

It’s remarkable then that those same businesses have been slow to internalize geopolitical risk into their decision-making. They are playing catch-up as vulnerabilities created by global production networks have been exposed by heightened tensions among states. The Financial Times has reported on the rush to hire “former diplomats, senior servants and politicians” to advise executives.

Some companies have established desks or departments to assess geopolitical risk. In my conversations with individuals who work these desks, they complain that they are overworked and understaffed. They also sense that they are a box to be ticked off as decisions wind their way through the C-suite, providing input but having little weight — until something goes wrong.

The most farsighted companies in Japan have, says the FT, created the position of “chief geopolitical risk officer,” while Mitsubishi formed a global intelligence committee headed by the president to assess “geopolitical risks, economic conditions, new technologies, policy trends” for management.

The process has been slow, however, and lags considerably behind the need. (I thought the need for geopolitical risk assessment was obvious when I first came to Japan decades ago and the gap between Japanese and Western perspectives on economic engagement was painfully clear. After all, that was the height of U.S.-Japan trade tensions.)

David Lee, a business professor at Hong Kong University’s Business School, adds that businesses are “generally reactionary, responding after something has happened.” That is natural, “but there’s still a deficit in being proactive and strategic in thinking about geopolitical risk.”

There are several explanations for the sluggish response. First, there is difficulty defining and applying geopolitics to business. Frederic Jallat and Lorenzo Coronati, of the ECSP Business School in Paris, insist that there is no consensus on the precise meaning of the term in management or other academic disciplines, adding that it tends to be a generic word that encompasses all nonbusiness risks.

Dictionary definitions refer to the influence of geography on politics, making geopolitics a function of physical location. Yet, in the current moment, location has little to do with geopolitical pressures. It is precisely the distance and seeming lack of physical connection that is so confounding. Why do companies have to worry about developments thousands of miles from their operations and markets? Why, for example, should South Pacific states have anything to do with U.S.-China tensions?

Adding to the confusion is analytical laziness that associates geopolitical risk with political risk. Researching this piece, I was struck by how many articles put “geopolitical risk” in the headline but after a first desultory mention, only discussed political risk. It may be a crude and somewhat arbitrary distinction, but I separate the two by calling decisions that account for the policies of one government — will it adopt a new tax regime? — political risk and those that demand navigation of competing policies by rival states — the U.S.-China tech war is a great example — to be geopolitics.

A second obstacle is the mindset of most executives. Leaders need to update their operating assumptions. Hong Kong University’s Lee explains that “Most CEOs came of age during a period of globalization when free markets and trade were assumed to be net goods. But the ground has shifted.” A relentless focus on efficiency has given way to the prioritization of security and resilience. The move from “just in time” to “just in case” strategies reflects this new approach.

More confounding still is the speed with which business decisions have assumed a normative dimension. Lee points to Christophe de Margerie, the former CEO of French energy conglomerate Total (now TotalEnergies), who was dismissive when asked to respond to Russia’s 2014 annexation of Crimea: “We are involved in business; we are not involved in politics,” he said. That lofty perspective has crumbled. Business executives have been forced to choose sides after Russia’s 2022 invasion of Ukraine. The once-unbridgeable space between business and politics has vanished.

Lee adds that most organizations approach risk function by function. For example, a financial institution has teams to monitor credit risk, legal risk, market risk, operational risk and regulatory risk, along with others. Geopolitical risk cuts across all categories and must be tackled on its own terms.

His thinking mirrors my own, which is a good thing since he is co-author of our yet-to-be-published book on the new national security economy. His contributions focus on the impact of this phenomenon on businesses. He has three suggestions for how executives can address this challenge.

First, add expertise. Companies not only must develop geopolitical understanding internally but they also need it on their boards. Second, ask the right questions and apply a national security lens to most business plans. Third, accept that business and politics are interlinked. The West’s separation of business and politics is a historical anomaly and a cultural particularity. It is dangerously naive when dealing with companies for which there is no separation of national and business interests.

Eventually, geopolitical risk must become integrated into business decision-making and a routine part of strategic planning. The world is being transformed; executives must keep up.