Europe: Changing of the Guard

The most significant development in Europe in the year 2006, as we expected in our last annual forecast, was Germany's re-emergence as a major global power. Under Chancellor Angela Merkel, Berlin seized the mantle of European leadership from Paris and has been the mover and shaker of European politics.

On some of the details in our previous annual forecast, we did stumble. For example, we expected British Prime Minister Tony Blair to step down in 2006 and whatever Italian government formed after Italy's general elections to fall; neither event happened. But both of these aberrations only reinforced Germany's centrality. In staying on, Blair has destroyed his ability to transfer power to someone (Chancellor of the Exchequer Gordon Brown) who might regenerate the Labor Party's political fortunes. Italy's Romano Prodi now leads a nine-party coalition that makes the preceding, haphazard government look rock-solid. Add in a France that is also in the midst of an internal leadership feud -- with elections scheduled for April and May 2007 -- and the stage was cleared for Merkel to lead Europe in spirit in 2006. Even events beyond Europe -- primarily the repeated energy crises involving Russia -- only weakened the European Union's ability to act and strengthened Berlin's.

Germany will attempt to capitalize on this in 2007.

Merkel, now with a year of experience under her belt, faces a rare opportunity. Germany is one of only a handful of countries that will not be mired in internal politics in 2007. Russia, the United States, South Korea and China are all gearing up for elections; and France, the United Kingdom and Egypt are managing leadership transitions. This makes Germany the country with the greatest opportunity to impact European and global developments. Merkel's only challenge is not biting off more than she can chew.

However, this does not necessarily mean Berlin will be successful.

The EU presidency is a funny thing, rotating as it does in six-month stints among the member states and thus giving Malta and Luxembourg as much time to shape the EU agenda as the union's powerhouses receive. Normally, only the largest EU states have the power and authority to meaningfully affect union-wide policies. Since one of those states holds the presidency for the first half of 2007 -- and since that state is Germany -- this will be the European Union's best chance to fix its various institutional problems.

Successful EU presidencies are marked by the choice of one or two specific, manageable, achievable programs that no major EU state opposes. For example, the most successful EU presidencies in the past several years have been Finland (1999), Sweden (2001) and Spain (2002), which dealt with Kosovo, demographics and terrorism, respectively. During all three presidencies, the leaders of those states selected topics over which there was little disagreement and, in some cases, an agreed-upon urgency.

In contrast, the most spectacular failed presidencies were Belgium (2001) and the United Kingdom (2004). In both cases, the states' leaders took on controversial topics that faced deep opposition: establishing an EU-wide tax and reforming the Common Agricultural Policy, respectively.

Germany seems ready to try to rectify Europe's institutional problems. Currently, the European Union uses the same decision-making structure that existed when the union's predecessor, the European Economic Community, was founded in 1958 with only six members. After Bulgaria and Romania's Jan. 1 accessions, the European Union now has 27 members. States have the right to veto any policy with which they disagree, ranging from foreign and military policies to cheese and legal issues. As such, the union is largely ungovernable and is in dire need of reform. Merkel wants to use her turn in the big chair to dust off the European constitution and establish a roadmap for its ratification.

In this she will fail. The constitution, while far from perfect, would somewhat streamline the European Union's decision-making process and lessen the use of national vetoes. Merkel wants to see the constitution adopted in full, in its current form. However, two of the union's most pro-integration states -- France (under Gaullist President Jacques Chirac, no less) and the Netherlands -- have already voted down the constitution in national referendums. All EU members must approve the constitution for it to take effect.

Put another way, it is an already failed document with no future. If anything, should Merkel succeed in restarting the ratification process, it could well prove to be the worst of all worlds. Two Europhilic states have already voted it down (and are likely to do so again), not to mention that it never even went before the Euroskeptic electorates of Poland and the United Kingdom the first time around. Though such a document is essential if Europe is to federalize, unfortunately for Europeanists, it is not an approvable document.

Letting it die its ignoble death in France and the Netherlands would have been the smartest action. Letting it die now would be the second-best choice. But burning resources in order to go through the motions of submitting it to another preordained death is simply a waste of one of Europe's last chances to reform in the near future (aside from the upcoming 2008 presidency of France, another major EU power. Italy, hardly the harbinger of logical organization -- does not take the reins until 2014). It is time for Europe to cut its losses and work with what it has. The decision to do just that will ultimately be made -- just not in 2007.

The doomed constitution is not the only project Merkel aims to tackle. By luck of the draw, Merkel will be in the big chair when potential crises in Bosnia, Kosovo and Serbia come to a head; she will bear the responsibility of relaunching partnership talks with the Russians; and she wants to initiate free trade talks with the United States. Any one of these issues would make for a busy presidency, and Merkel's ambition risks causing her to fail at all of them -- although we have to give her kudos for trying.

Still, even if Germany fails to implement its agenda, it is the only major power that has the freedom to set one. And there may yet be time for Merkel to shift gears. If she can select an issue that the entire European Union can agree on and a policy that everyone can get behind -- such as a common European reaction to the Russian-Belarusian energy crisis that is brewing -- she could become Europe's strongest post-World War II leader.

The opportunity is hers to lose, and the lengthy agenda she has cooked up as of the year's beginning is perhaps the most efficient way to do that.

While Germany settles into its leadership role, France will see the end of its Gaullist era. Former French President Charles de Gaulle believed France was not simply a middle-sized continental power, but a global power. Thus, he felt it was France's duty and right to punch well above its weight on the world stage -- a mindset that often put Paris at odds with Washington's policies. A united Europe was de Gaulle's brainchild in many ways, as it was a means of suppressing German nationalism and diverting German energy into actualizing de Gaulle's view of the world. Ultimately, de Gaulle's goal was to use Europe as a platform from which France could act as a credible global power.

Chirac is the most recent torchbearer of de Gaulle's legacy and has been at or near the top of the French political system for 33 years. Though Chirac and his Gaullist predecessors' successes in uniting Europe should never be ignored, the expansion of the European Union has reduced the possibility of a European superpower to merely an idea. The United Kingdom would never allow itself to be subservient to Paris, Europe's neutrals want no part in a common military policy and the states of Central Europe feel more kinship with the United States than they ever have with France.

But most of all, it is Germany's reawakening that has killed de Gaulle's vision. Germany is once again making policies more sophisticated than apologizing for World War II, and is now developing interests independent of Paris. With Germany back in the game, France simply lacks the economic, political and demographic heft to lead Europe. It might remain a powerful state with an undeniable stake in the Continent's future, but it will never be the pre-eminent leader of a superpower.

We will not attempt to call the outcome of France's April-May 2007 presidential election. For now, socialist Ségolène Royal and conservative Nicolas Sarkozy appear evenly matched. They disagree on a number of issues, from crime to immigration to globalization to labor reform. But on one thing they agree: de Gaulle's legacy has failed, and it is time to try something else.

France will still be a powerful and vibrant state, but it will be a France with a more realistic view of its place in the world. This could bring it more power as it focuses on internal reform or on revitalizing relations with powers -- such as London, Warsaw and even Washington -- at which de Gaulle would have chafed. But what is sure is that France will no longer seek to lead Europe on its own, and this, if nothing else, will punctuate European attempts to form a superpower.

The implications of such abandonment are deep and many. They include, but are not limited to:

· Any serious talk of a special partnership with Russia will end, laying the groundwork for more businesslike -- and colder -- relations.
· Most common European positions, such as they are, on foreign policy issues will collapse, leading to a large-scale removal of a "European" approach to global issues in which the European Union does not have a direct economic interest.
· Outside powers will have the opportunity to play individual European powers against each other -- something of critical importance when one considers that each of the union's 27 members retains veto power over many EU policy realms.

France is on the cusp of change. In May, it will have a new president; in June, it will have a new Parliament. And the country -- and the Continent -- will never be the same.

South Asia: Pakistani Politics in the Spotlight

As we expected, India and Pakistan made little progress in normalizing relations in 2006. Though the Kashmiri militant group Lashkar-e-Taiba carried out a deadly railway attack in Mumbai in July, relations between the rival countries remained in the usual state of distrust, preventing any major breakthroughs. We noted that Pakistani President Gen. Pervez Musharraf would face a galvanized opposition and would be forced to decide whether to stay on as the country's military chief. Musharraf successfully staved off opposition attempts to unseat him, allowing him to keep his dual portfolio as president and head of the military. In line with our 2006 forecast, the Baloch nationalist insurgency added to Musharraf's list of worries. He dealt with the insurgents through a combination of military and negotiation tactics.

Our forecast that India's leftist parties would develop a stronger presence in the government and further hamper Indian Prime Minister Manmohan Singh's privatization efforts was correct. India also worked to expand its global influence by signing a landmark civilian nuclear deal with the United States. The insurgencies in Nepal and Sri Lanka remained significant in 2006, though we failed to predict in the annual forecast that the Maoist rebels and the political alliance in Kathmandu would be able to forge a power-sharing agreement and strip Nepal's King Gyanendra of his powers.

In 2007, the main focus in South Asia will be on the Pakistani political scene, as the country gears up for general elections slated for Jan. 15, 2008. Musharraf battled a heavy wave of domestic criticism this past year, exacerbated by continued U.S. pressure on Pakistan to cooperate on the counterterrorism front -- and by U.S. airstrikes against Taliban and al Qaeda targets on Pakistani soil that resulted in a high number of civilian casualties. Accusations have been flying that Musharraf has spent too much time hobnobbing with U.S. officials in Washington rather than defending Pakistan's territorial integrity; but the general has developed a solid strategy to secure his re-election and outmaneuver the main opposition forces in the country -- namely the Pakistan People's Party (PPP), led by exiled former Pakistani Prime Minister Benazir Bhutto, the Pakistan Muslim League-Nawaz (PML-N), led by ousted Pakistani Prime Minister Nawaz Sharif and the Mutahiddah Majlis-i-Amal (MMA) coalition of Islamist parties.

Musharraf has a comfortable majority in the sitting parliament to help him win a re-election bid, but his standing cannot be assured after the general elections are held and a new parliament comes to power. To consolidate his hold over the government, Musharraf will bend the rules and schedule a legislative vote ahead of the general election to get re-elected to another five-year term. Musharraf could even attempt to bypass this step by calling snap elections in the spring of 2007 if he feels confident enough in his ability to win. Snap elections or no, the legislative election results will be rigged as needed to allow Musharraf's parliamentary allies to hold onto their seats. The opposition forces will then use the allegations of a rigged election to hold street demonstrations, but are unlikely to muster enough support to change the election results significantly. Musharraf will continue with a careful strategy to prevent the PPP, the PML-N and the MMA from uniting in a potent opposition force, fueling distrust among the already severely divided parties by hinting at making deals with the various opposition leaders. Musharraf will also be able to hold onto his position as military chief this year.

The biggest threat to Musharraf's election plan is the potential for large-scale U.S. military activity on Pakistani soil that would undermine the military's confidence in the general and turn public support against him. To enhance his domestic image, Musharraf will distance himself from Washington in the coming year and become even more restrained in cooperating with U.S. forces on the counterterrorism front.

Pakistan's relations with Afghan President Hamid Karzai's government will further deteriorate this year as the Taliban insurgency strengthens. The Taliban will continue opposing NATO forces in Afghanistan and launch a spring offensive. NATO is not likely to have the capacity to surge troop levels and redouble reconstruction efforts. Nevertheless, Afghanistan will remain -- at least for this year -- a priority for the alliance. Because the Taliban lacks the strength to take the country from NATO forces -- and NATO forces are not willing to let things slip that far -- 2007 in Afghanistan will look much like 2006. Security operations will continue, and Taliban forces will improve their tactics and build on operational successes.

India will keep a close watch on political developments in Pakistan, privately preferring the continuation of Musharraf's relatively stable regime. India and Pakistan will go through the motions of continuing peace talks, but those talks will only be for show. Primarily to boost his credibility at home, Musharraf will try to push India into resolving the long-standing Kashmir dispute, and New Delhi will politely rebuff Musharraf's proposals. For India, Pakistan's continued support for Kashmiri militant groups remains the block to any meaningful progress in the Kashmir negotiations.

Kashmiri militant groups operating in India are stepping up their efforts to stage attacks designed to incite communal tensions between Hindus and Muslims and revitalize the Kashmir cause among Indian Muslims. However, such attacks have become routinized enough in India that incidents like the July 2006 Mumbai railway bombings prompt no notable shift in Indian society and policy. Kashmiri militant groups could attempt to vary their target set from the usual crowded market and transportation sites in major cities to the country's much-valued information technology (IT) sector. Such an attack would force an Indian response and threaten the country's ability to sustain a healthy inflow of foreign investment. But the Pakistani government and intelligence service have largely maintained their hold over these militant groups to prevent them from altering their tactics in India. Particularly while in the heat of the election season, the Pakistani regime will be uninterested in provoking a major conflict with India.

That said, Kashmiri militant groups will likely succeed in carrying out another large attack in a major Indian city this year that would fall in line with their usual target selection of markets, transportation hubs and religious and tourist sites. Such an attack will increase tensions on both sides of the border and lead India to implicate the Pakistani regime, but the Indian government led by Prime Minister Manmohan Singh is unlikely to respond with a major military confrontation against Pakistan.

India's attention will primarily be absorbed by domestic political and social issues. No major shift in the Indian political landscape is expected in the coming year; the main opposition Bharatiya Janata Party is suffering from internal divisions and is unable to threaten seriously the ruling Congress party's hold on power. The Congress party's main headache will come from its allies in the Left Front, who will continue to link up with powerful trade unions to resist Singh's privatization efforts and labor policies. As a result, Singh's government will need to turn more toward populist politics in an attempt to quell domestic unrest.

Barring a significant attack by Kashmiri militants on India's IT sector in 2007, the country should experience sustained economic growth in the range of 8 percent, similar to the past year. India's economic focus will be on expanding its automotive, steel, aviation and IT sectors, though substantial growth will be hampered by political considerations and slow infrastructural growth.

The Left Front will also make noise over the Singh government's growing alliance with Washington. India and the United States will cement their landmark civilian nuclear deal this year through a bilateral treaty; however, Singh will maintain a multilateral foreign policy agenda to tame the opposition and avoid getting caught in any binding agreements with the United States that would require it to place a moratorium on nuclear testing or impose punitive measures against Iran.

India will also keep a watchful eye on its porous northeastern border, where a political crisis in Bangladesh spells a likely increase in militant traffic into India. General elections in Bangladesh were scheduled for Jan. 22, but have been delayed following the resignation of the caretaker government. The main opposition, led by Sheikh Hasina of the Awami League, likely has the numbers to win a majority against the ruling Bangladesh National Party (BNP), led by Hasina's bitter rival, Khaleda Zia; however, the Awami League has damaged its secular credentials by allying with one of Bangladesh's most notable radical Islamist parties -- a politically opportunistic move that has dismayed a large number of voters. The Awami League has announced a boycott of the polls until changes are made to the pro-BNP caretaker government in charge of conducting the elections, and until the BNP makes assurances that the elections will be free and fair. The polls are guaranteed to be rigged under the caretaker government, but the Awami League is trying to level the playing field before it takes part. After a series of negotiations and violent demonstrations, the BNP will likely give in to some of the Awami League's demands in order to allow the elections to take place. Nonetheless, the results are bound to be disputed, and Bangladesh will continue to be wracked by political violence for much of the year.

Whether the Awami League or BNP emerges victorious means little in the larger strategic view of Bangladesh; the instability caused by the warring parties is unlikely to wane regardless of which party is in charge. But the political developments in Bangladesh will be a cause for concern for India, as the rival political factions turn increasingly toward radical Islamist parties for coalition support. The growing Islamist influence in Bangladesh will give rise to radical groups that will play host to jihadist and Kashmiri militant operatives with an interest in launching attacks in India. The Indian government will attempt to secure its northeastern border, but is unlikely to intervene directly in Bangladesh.

To India's south, the undeclared civil war in Sri Lanka between the Tamil Tiger rebels and Sri Lankan armed forces will escalate this year in heavy tit-for-tat fighting as the Sri Lankan army attempts to divide the northern and eastern Tamil strongholds in the country. Neither the Tamil Tigers nor the Sri Lankan army has a clear enough advantage to launch a sustained offensive that would result in a decisive victory. India will be concerned with the Tamil refugees flowing into the southern Indian state of Tamil Nadu, but cannot afford to throw its support fully behind the Sri Lankan government for fear of alienating India's sizable Tamil population. The ongoing instability in Sri Lanka will give India's regional adversaries -- namely Pakistan, and to a lesser extent China -- the opportunity to meddle in India's backyard and escalate the conflict by providing arms and support for the Sri Lankan government. These parties are not as interested in helping the Sri Lankan army wipe out the Tamil Tiger rebels as they are in prolonging Sri Lanka's crisis to keep India preoccupied. External involvement, however, could lead the Tigers to target foreign diplomatic personnel in Sri Lanka.

India will at least have one border that it can worry less about this year. Political developments in Nepal in 2006 reached a point where the Maoist rebels now have a solid opportunity to integrate themselves in the country's political and military apparatuses. Parliamentary elections will be held in April 2007, giving the Maoists a chance to enter the government formally. Though this should be a relatively stable year for Nepal, bursts of instability can be expected as dissident Maoist factions resist the integration effort. A return to a militant insurgency is unlikely, but extortion, kidnappings and economic blockades remain usable options for the Maoists.

Latin America: A Year of Introspection

The 2006 annual forecast correctly noted the regional leftist swing in Latin America that impacted the 18-month election cycle, which ended with leftist Venezuelan President Hugo Chavez's successful re-election bid. This regional movement was successful in some countries, with leftist candidates winning in Ecuador, Nicaragua, and, of course, Venezuela. But the movement failed elsewhere, as conservatives won in Peru, Mexico and Colombia. As the forecast noted, the left has divided into two factions: the "Lula" moderates (named after Brazilian President Luiz Inacio "Lula" da Silva's centrist spin on the left) and the Chavista radicals (named after self-appointed regional leftist leader Chavez). This divide is growing and has become more apparent as the moderates have inched ever closer to the center and Chavez and his allies move even further into left field.

As the dust from Latin America's marathon run of elections settles, the newly elected leaders will turn their sights to myriad domestic challenges. The year will be characterized by internal policies that will only peripherally affect regional and global relations. Argentina will have the one prominent presidential election of 2007, but this will enhance the country's self-reflective nature as it engages in internal debate about its economic and social future. Major offensives against out-of-control organized crime will be prominent policy features in many countries, including Brazil, Venezuela and Mexico.

With the left's loss of presidential elections in Peru and Mexico, Chavez's attempt to unify the region under a leftist banner has largely failed. The onus for regional integration is back on the Southern Cone -- which Brazil and Argentina will lead as a trade bloc, rather than an ideological bloc. Overall, however, we expect that regional relations will continue to be fragmented as usual, and the goal of regional integration will remain elusive. Regional politics will remain centered on the common goals of most Latin American countries: economic growth, maintaining legitimacy through social programs and at least the appearance of combating corruption, enhancing energy infrastructure and maintaining domestic order. As long as Latin America remains embroiled in domestic affairs, the United States is unlikely to pay it significant attention in 2007.

Mexico

Mexico's new President Felipe Calderon is focusing aggressively on serious domestic issues: drugs and drug-related violence, immigration, social unrest and the need for reforms in labor, education, finance and energy. Former President Vicente Fox did little to try to stop the drug cartels from doing business; Calderon has the heavy task of assuming control over this largely lawless situation. In one of his first moves as president, Calderon deployed federal security forces to his home state of Michoacan to battle drug cartels and their hired guns. The Michoacan operation has seen some success, and the government plans to send federal security forces to several other troubled states, but the cartels are not likely to sustain any significant damage. The war between drug cartels and the Mexican government is likely to remain at an impasse; Calderon will keep the troops rolling in, and the cartels -- though affected -- will regroup and recover. Tensions between the government and drug cartels will increase since Calderon's plan will root out corrupt security forces and government officials who have facilitated the drug trade. Losing the protection corrupt officials granted them could be a heavier blow to the cartels than any military or police operation.

Calderon is expected to continue this push; he entered the presidency with a weak authority, publicly challenged by his defeated opponent Andres Manuel Lopez Obrador. Calderon's very public battle against crime and drug trafficking will lend him more credibility -- both domestically and with the United States -- as he attempts to push more difficult labor and energy reforms through the legislature. Calderon's experience as a politician, his National Action Party's newly won legislative seats and a potential alliance with the Institutional Revolutionary Party all suggest that he will have an easier time passing reforms than his predecessor did. Assuming he successfully consolidates power, Calderon will also slowly lay the groundwork to address the development of Mexico's offshore oil deposits.

Cuba and Nicaragua

Some countries that rose to the forefront of political discussion in 2006 are unlikely to actually be significant drivers in 2007 -- namely Nicaragua. Nicaraguan President Daniel Ortega will receive significant aid from Venezuela, but that aid will be directed entirely at providing basic necessities such as oil and power generation.

The transition of power from Fidel Castro to Raul Castro has already taken place in Cuba. The island will now go through the long, slow process of pulling itself out of economic ruin. Fidel Castro's eventual death will not greatly affect Cuba, as Raul Castro will deal firmly with any civil unrest. Any potential changes in U.S. policy toward Cuba will depend on a consensus within the Cuban-American community, which has long stood in favor of economically isolating the Cuban regime. However, current divisions in the Cuban-American population's opinion, combined with the new Democratic majority in the U.S. Congress, could open the way to decreasing trade and travel restrictions.

Ecuador, Venezuela and Colombia

The geopolitical impact that Ecuador's newly inaugurated President Rafael Correa will have remains somewhat ambiguous. At this point, Correa seems poised to initiate many political battles. He could seek some debt restructuring and will try to use his overwhelming popularity to push for a constitutional rewrite, but these actions will face opposition in the legislature, could cause domestic unrest and will further alienate international business interests. Correa will clash with Colombia over his refusal to fight the Revolutionary Armed Forces of Colombia (FARC) and his objections to Colombia's decision to spray herbicides on coca plantations along the border. Correa walked a fine line in his campaign rhetoric between asserting his independence and calling Chavez a close personal friend and ally; he will continue trying to find a comfortable balance in 2007, much as Bolivian President Evo Morales did in 2006.

We expect tensions to rise between Colombia and both its old rival, Venezuela, and its newly unhelpful neighbor, Ecuador. In particular, Colombia will grapple with Ecuador and Venezuela in pursuing the elimination of paramilitary and guerrilla groups operating within the country and routinely crossing borders.

Peace talks with FARC have largely stalled under Colombian President Alvaro Uribe Velez's administration, and fighting FARC is especially difficult because neighboring states have offered the group de facto asylum. Ecuador might or might not directly aid FARC, but Venezuela has done so overtly and will likely continue to do so. FARC sees Chavez as an ally and has gone so far as to issue an open letter to the Venezuelan leader saying that FARC needs to preserve an alliance with Chavez in the face of the common enemy of imperialism. Venezuela's motivations in promoting a good relationship with FARC are twofold. First, an angry FARC on its borders significantly threatens Venezuela's security, and a policy of covert mutual back-scratching is a cheap solution. Second, Venezuela is politically opposed to the United States and the largely U.S.-funded war against drugs that Colombia is carrying out. Sandwiched between FARC-friendly Chavez and his Ecuadorian ally Correa, Colombia is set to face diplomatic challenges while fighting the ongoing war with guerrilla groups this year.

Venezuela began 2007 with several Cabinet changes that indicate a trajectory shift for Chavez's government. His goals this year will focus on combating the severe crime wave that is devastating Venezuela and on consolidating leftist parties in the country into a single political group.

In his attempts to install himself as the chief leftist in Latin America, Chavez has largely -- and publicly -- failed. After a year of contentious elections in the region, Chavez is left with noncontiguous allies in the nonpowerhouse states of Ecuador, Cuba, Nicaragua and Bolivia -- and even these have distanced themselves from him. His world tour to secure a spot on the U.N. Security Council yielded a brief foray into the international spotlight but no high seat. In 2007, Chavez will continue to cultivate relationships with Iran, Syria and other regimes at odds with the United States, but these budding relations will form little more than a symbolic cadre of anti-U.S. nations. Chavez will continue to pose little real threat to the United States, partly because Venezuela is thoroughly invested in the U.S. oil market and partly because it simply lacks the capacity to affect U.S. interests.

Venezuela will continue to have fickle diplomatic relations, but any extreme escalations of tension are unlikely. This is not to say that Venezuela has not pursued a noticeable enhancement of its military capabilities. Although deals to buy military transport planes from Spain have fallen through, Russia is set to continue delivery of various military planes and equipment -- including the expected construction of a Kalashnikov factory in Venezuela that will be able to manufacture hundreds of thousands of light arms per year. Though these actions signal an interest in beefing up Venezuela's image in the region, they also are intended to strengthen Chavez's position domestically. He maintains a firm grip on the military and has managed to maintain significant support among the populace, despite a fervent opposition movement. Chavez's military buildup is likely intended to maintain a show of force domestically, not to launch aggressive acts across Venezuela's borders.

Chavez recently announced plans to nationalize the energy and utility sectors, take political control of the Central Bank and assume control of operations in the oil-rich Orinoco Basin. Though Chavez will continue to advance his agenda, he still needs foreign investment -- primarily in the oil sector. Though Chavez has said there will be no negotiations, he has said he will compensate the affected industries from Venezuela's reserves. By avoiding expropriation, Venezuela appears poised to orchestrate a smoother transition to nationalization. However, if pushed, Chavez will adopt a harder line. He wants control and will do what he must to obtain it.

Bolivia and the Southern Cone

In 2007, Bolivia will continue to reform its economy and work on creating a new constitution. In attempting to rewrite the constitution, President Morales must balance the needs of the poor indigenous Bolivians and the wealthier Bolivians who live in the cities of the lowlands. The wealthy want representation in the government and greater autonomy, while the poor want increased coca production and land redistribution. In 2007, the constitutional negotiations will continue, with compromises made on both sides. If Morales is pushed to make even more concessions to coca growers, he will run the risk of prompting the U.S. to further reduce aid.

Though Brazil, Argentina and Chile flirted with the idea of abandoning Bolivia after its natural gas nationalization in 2006, the three countries likely will continue to engage the country. All three depend on Bolivian natural gas, and dreams of independence from the country's turbulent politics remain too costly to be implemented. Ongoing negotiations between Bolivia and Brazilian oil company Petroleo Brasileiro (Petrobras) have held center stage in this process, as Petrobras has vast interest in -- and, through heavy investment, much control over -- Bolivian oil and natural gas. Though Argentina has negotiated a deal with Bolivia to increase natural gas imports, it is likely to increase domestic gas speculation, as the prospects for a pipeline that can handle the necessary flow from Bolivia remain uncertain.

After its 2002 crash, Argentina's economy began recovering, with surprisingly high levels of exports and strict regulation of inflation that continually threatens to get out of control. Argentina will be an important economic leader in South America -- especially in the Southern Cone -- as it continues to recover in 2007. Because Argentina is one of Latin America's largest economies, the country's October elections could set the pace for the region in 2007 and signal a strong move toward the center and away from Chavez's radical left. The elections will prompt dialogue on the future of Argentina's economic policies, including inflation control, energy development and the direction of Mercosur.

Under President Nestor Kirchner, Argentina has cultivated leftist economic policies that have bolstered the country's economy without falling into the anti-U.S. rhetoric of the Chavista left. Overall, the current Kirchner administration has emerged as relatively conservative, a balance of sorts to Chavez's radical anti-U.S. agenda. In the event that Kirchner does not seek re-election, his wife, Cristina Fernandez de Kirchner, is an extremely popular politician who would be likely to win the 2007 presidential election. With either Kirchner at the helm, Argentina will stay in the center left, thus effectively ending the leftist movement in Latin America and maintaining the Argentine balance between more conservative politics and more leftist economics.

Chile will maintain a developed infrastructure, a healthy business climate and relatively low levels of corruption. Chile spent much of 2006 actively seeking out economic ties to the rest of the world -- particularly Asia -- and it will persevere in 2007.

Brazil will continue on roughly the same path in 2007 as in 2006, despite increased crackdowns on organized crime in Rio de Janeiro and Sao Paulo. Da Silva is fighting an uphill battle to increase economic growth to at least match the region's average at about 4 percent. Meanwhile, ongoing infrastructure improvements in the country's interior -- particularly the construction of railroads to move soy and iron -- are laying the groundwork to transform Brazil from a coastal power to a continental-sized power with more balanced demographics.

In sum, 2007 will be a decidedly introspective year for Latin America. Broader intraregional relations will, in many cases, take a backseat to domestic issues as newly elected and re-elected leaders settle into their posts and turn their focus toward their constituents. Domestic problems of rampant crime and corruption will continue to be a policy focus, as will economic policies that promote reform and enhance stability.

Africa: Attracting Outside Interest, But Conflicts Continue

The 2006 annual forecast for Africa accurately said that the major powers involved in African political affairs would diverge. We forecast that world economic players, led by China, would significantly expand their ties to a number of commodity-rich sub-Saharan African countries in order to secure access to the continent's natural resources. We also were correct in saying the United States and Europe would be less active in sub-Saharan Africa in 2006 but would maintain their political relationships there and remain engaged with several African countries on security matters. Though we made the call that the United States would work with countries in the Horn of Africa -- particularly Ethiopia, Djibouti and Kenya -- to contain the spread of militant Islamism, we did not anticipate that what had been disparate Islamic courts would go on to become a force that, by the second half of the year, controlled not only the Somalian capital of Mogadishu but also large swathes of southern and central Somalia.

Africa's major powers, South Africa and Nigeria, were preoccupied with political crises in 2006 -- another forecast we made -- that kept them from successfully mediating Africa's conflicts. South Africa remained embroiled with a since-dismissed rape and corruption case against former Deputy President Jacob Zuma. Along with significant political problems associated with President Olusegun Obasanjo's attempt to amend the country's constitution to permit him a presidential third term, Nigeria faced a significant increase in the number of militant attacks against the country's oil infrastructure and personnel, which caused a reduction in oil output.

In 2007, outside powers including the United States, Russia, China and India will continue jockeying for control over Africa's resources and engaging in bidding wars over oil and gas and minerals concessions. Terrorism concerns will drive greater foreign -- particularly U.S. -- involvement in the Horn of Africa.

Conflict will continue in Sudan's Darfur and southern regions, where insurgent groups remain intent on gaining greater autonomy or outright independence. The Darfur conflict has spilled into Chad and the Central African Republic -- two countries that, along with Sudan, have armed and used militias against each other. Those militias have in turn fomented insurgencies against their own governments.

Because Khartoum feels it necessary to defeat the National Redemption Front -- which is intent on acquiring greater autonomy for Darfur -- no U.N. peacekeeping force will touch the ground in Darfur in spite of widespread international pressure on Sudan to accept such a force. Khartoum will continue opposing the idea of a U.N. peacekeeping force, based on fears that such a force will invade to occupy the country and bring criminal charges against the ruling regime for instigating genocide in Darfur.

As a result of this impasse between Khartoum and the Western governments and nongovernmental organizations that want the Darfur conflict to end, Sudanese President Omar al Bashir will accept a token reinforcement of the existing African Union (AU) mission in Darfur. The beefed-up AU force will likely prove no more successful at containing the humanitarian crisis in Darfur in 2007 than the existing force of 7,000 was in 2006.

Ethiopia -- both supporting and supported by the United States -- will maintain its intervention in Somalia in order to prevent the resurgence of that country's Supreme Islamic Courts Council (SICC) and the al Qaeda suspects it harbors. Though Ethiopia is cooperating with U.S. forces to keep Somalia from becoming a training ground for transnational jihadists intent on launching attacks in the Horn of Africa and beyond, it is also acting out of concern that the SICC objective to create a Greater Somalia will destabilize ethnic Somali lands in Ethiopia (not to mention ethnic Somali areas in Kenya and Djibouti).

While its forces are preoccupied with Somalia, Addis Ababa will face increasing threats from neighboring Eritrea and from domestic insurgent groups demanding more freedom for Ethiopia's Oromo and Ogaden regions. Facing these threats -- along with the ongoing hostilities in Somalia that will only deepen while Ethiopian troops are there -- Addis Ababa will call for peacekeepers from African countries not bordering Somalia to pacify the Islamists and reinforce Somalia's otherwise powerless Transitional Federal Government (TFG).

Despite losing Mogadishu and their control over southern and central Somalia, the Islamists and their militia -- whose approximately 3,000 members buried their weapons and uniforms and blended in with the population to avoid facing Ethiopia's superior forces -- can still regroup and wage a guerrilla campaign against Ethiopian troops and the shaky TFG now centered in Mogadishu. Somalian President Abdullahi Yusuf is a newcomer to Mogadishu, having entered the city Jan. 8 for the first time since becoming president in 2004. Because he hails from the Darood clan in the northern autonomous Puntland region, Yusuf's presidency is distrusted in a country deeply divided by antagonistic and historic clan rivalries. Furthermore, many Somalians consider the TFG a construct imposed by foreign interlopers. Thus, Yusuf and the TFG face formidable challenges as they try to provide law and order in Somalia.

Uncertainty over the deployment of international peacekeepers, Somalis' lack of confidence in the TFG to provide law and order and the continued presence of a dispersed but not defeated SICC all translate into continuing conflict in Somalia. The country will see a return to what most Somalis know best -- clan-based warfare -- as Yusuf attempts to exert his newfound power from Mogadishu. More ominous, though, is the likelihood of guerrilla and jihadist warfare within -- and launched from -- Somalia.

Africa's leading oil producer, Nigeria, will see an increase in nationwide political violence and attacks in the Niger Delta in the run-up to the country's presidential election in April. Umaru Musa Yaradua, governor of northern Nigeria's Katsina state and the ruling People's Democratic Party (PDP) presidential candidate, will likely win the April election. Opposition parties will strive to band together in an attempt to unseat the PDP, but personality clashes will keep the opposition from uniting. Presidential aspirants including Atiku Abubakar of the Action Congress Party and former military ruler Gen. Muhammadu Buhari, the All Nigeria People's Party candidate, will not be willing to yield to other candidates, so the opposition vote will be divided. Violence will intensify in the Niger Delta region. Militant groups will continue attacking the region's oil infrastructure in order to bring attention to their socioeconomic grievances, and those same militants will serve as pawns for politicians striving to fill their campaign coffers and oppose the effective extension of Obasanjo's rule through his chosen successor, Yaradua.

Angola will emerge as the region's wildcard, thanks to an increasingly stable political environment. The government struck a peace deal with the secessionists in the oil-rich Cabinda province in 2006 and is now free to drive increasingly hard bargains for Angola's oil and mineral concessions. To do this, Luanda will become more aggressive internationally by joining the Organization of the Petroleum Exporting Countries and strengthening partnerships with Russia and China. This increasing assertiveness will draw the attention of South Africa, which could view Angola's moves as threats to its hegemony in southern Africa. Angola will work toward holding elections for the first time since 1992 and will conduct voter registrations in 2007 in anticipation of presidential elections to be held in 2008. Angolan President Jose Eduardo Dos Santos will use 2007 to identify and promote his chosen successor.

South Africa will continue to be paralyzed by infighting in the ruling ANC party, which will hold its leadership Congress in late 2007. The government will continue maligning Zuma to prevent him from contesting the party and state presidencies. South Africa begins 2007 with a two-year rotating seat on the U.N. Security Council, and though it will strive to strengthen its role as a mediator of conflicts in Africa and elsewhere, its internal divisions will prevent it from realizing that goal. Increased Russian and Chinese activity in Africa will cause alarm in Pretoria -- which, while welcoming the investment and cooperation these countries will offer, will increasingly resent the narrow terms and conditions that will accompany their involvement. As a result, South Africa will position itself as Africa's champion to resist what will be perceived to be renewed colonial imposition.

The Democratic Republic of the Congo's recent presidential election allowed sitting President Joseph Kabila to retain his office. The country's increasingly stable political system will help it generate greater foreign investment. Kabila will present himself as a democratic leader who is also able to mediate regional conflicts, but he will spend most of his time consolidating his control at home and selling mineral concessions. Kabila will devote scant attention to the simmering Tutsi-led rebellion in the country's largely ungoverned eastern provinces because the insurgency will not threaten his hold on power. Jean-Pierre Bemba, who lost the November 2006 presidential election to Kabila, will serve as an opposition political leader in the country's Senate and will contest Kabila's power from that position.

Zimbabwean President Robert Mugabe will come under increasing pressure from the country's citizens to resolve Zimbabwe's worsening economic problems. Spiraling inflation and the population's inability to feed itself will prompt increasing civic opposition to Mugabe's rule, and Mugabe will rely more on the country's security forces to contain that opposition. Mugabe's recent moves to extend his presidential term by two years -- to 2010 -- is aimed at preventing anyone from his close circle in the ruling Zimbabwe African National Union-Patriotic Front (ZANU-PF) party apparatus from challenging him. However, if Mugabe begins showing signs that his age is catching up to him (he turns 83 this year), he will find members of the ZANU-PF ruling elite forcefully challenging his grip on power.

Cote d'Ivoire has been divided since 2002, when a failed coup attempt led to a civil war. That will not change, as President Laurent Gbagbo maintains control in the southern half of the country. Gbagbo will continue using revenue generated from cocoa and coffee sales to enforce his rule and arm the country's military and his private militias. The big question will be whether the U.N. and French peacekeeping forces will stay and keep maintaining the Zone of Confidence between Cote d'Ivoire's halves. Should the U.N. and French troops leave, nothing would prevent fresh fighting. The United Nations and France want to avoid renewed conflict in the country, yet maintaining the status quo comes at a cost: Gbagbo is effectively protected from any threat to his power. This situation gives him no incentive to strike any sort of peace deal with the 3.5 million northern Ivorians, who oppose Gbagbo's rule because of their exclusion from Ivorian citizenship and full social, economic and political participation.

Global Economy: A Short U.S. Slowdown, A Prolonged Chinese Problem

In our 2006 annual forecast, we predicted that the year would consist of rapid growth for all of the world's major economies despite strong commodities prices. In particular, we expected that the United States, China and even Japan would enjoy a near-unprecedented level of growth and that the United States would only begin to dip as the end of the year approached. We are pleased to report that global growth on the back of strong performance in all regions indeed pushed the limits of what the global economy is capable of. We also predicted that commodity prices would fall back from their dizzying highs. That they did, if only in fits and starts, and not en masse until actually after the New Year.

The U.S. economy at the beginning of 2007 is enmeshed in a slowdown. The expansion that took place over the past four years -- which averaged an impressive 3.4 percent per quarter -- is over, and the system needs to take a bit of a breather. Data supporting this stance include a weak housing market, stubbornly high inflation, robust energy prices, flagging worker productivity and an inverted yield curve -- all classic indicators of economic malaise. This is where the U.S. economy begins the year.

But slowdown does not equal recession, and both for structural and tactical reasons we expect the slowdown to be mild and brief.

Structurally, the foundations of the U.S. economy -- emphasis on technology, a well-developed infrastructure, a culture of entrepreneurship that rewards risk-taking, an educated workforce, etc. -- remain in place. This slowdown is simply a cyclical downturn, not a symptom of a broader structural deficiency. Furthermore, as the U.S. baby boomers mature, their retirement savings are making the world awash with capital. This is keeping interest rates far lower than they would "normally" be, and should contribute to that often-sought-after "soft" landing for the American economy.

Tactically, in the past month commodities prices -- whether corn, oil or copper -- have plummeted from their historical and near-historical highs. When these products' prices fall, economic activity of all stripes tends to get a new lease on life. So just as the American economy is taking a breather, the building blocks of a strong recovery are falling into place. Add in that the U.S. stock markets have not experienced a serious sell-off and it seems that investor sentiment has never really soured. All this indicates a mild correction -- not a recession.

Barring a severe shock to the international system, the slowdown likely will evaporate sometime around the beginning of the third quarter, although if past proves prologue the media will recognize that the U.S. slowdown is real by about the time it has ended.

With the question of how bad it will be answered, there is only one left: How far will it spread?

Japan likely will get the worst of it. Japan's economic problems are nothing new, but they were held in abeyance in 2006 by strong consumer spending. That spending ultimately depends on consumer confidence, and in 2006 Japan had the benefit of an experienced charismatic leader: Junichiro Koizumi. His successor, Prime Minister Shinzo Abe, lacks the gravitas and track record of the spectacularly coiffed Koizumi. That -- plus long-overdue efforts to get serious about axing extra spending -- will combine with decreasing U.S. demand to engineer a slowdown in the Land of the Rising Sun. By the latter part of 2007, Japan will even risk slipping back into the economic catalepsy that ruled it from 1990 to 2004. This is the year when Abe will be tested to see if he can at least keep Japan on economic life support.

Contrary to the expectations laid out in our previous annual forecast -- and a raft of data released early in the year -- 2006 turned out to be a banner year for the Europeans. Though some of the shine came off this growth late in the year, it certainly remains impressive by European standards. Growth is strongest in Germany, but it is hardly paltry in the other major economies. And for the 12 countries that recently joined the union, the mix of an expanded market and EU support payments made 2006 an excellent year.

It would doubly surprise us, however, if the European Union's economic growth sustains itself this year. The euro is close to historical highs; the last time this happened, the slowdown in European exports alone nearly caused a recession. Furthermore, Italy and Germany -- which make up about half of the eurozone --implemented sharp tax increases Jan. 1 as part of their budget-balancing efforts. These increases will undoubtedly cool down growth. Add in a rising housing bubble in several European economies that makes the U.S. housing surge of the past few years look downright miniscule, and it is extremely unlikely that Europe will be able to come anywhere close to replicating its 2006 feat.

The likely exceptions will be the 12 Central European and Mediterranean states that have joined the EU since 2004. However, since their economies account for only about 5 percent of the European Union's total gross domestic product, their strength will have little impact on the combined European bottom line. And before waxing philosophic about "shining Europe," bear in mind that in the EU "banner year" of 2006, growth in the eurozone was an estimated 2.1 percent. That is impressive growth for Europe, but rather sedate from Asian or American points of view.

As long as the global economic slowdown is not severe, pocketbook issues will not significantly change the current momentum of ongoing trade negotiations. The Doha round of global trade talks will continue to flounder, as political changes in France will not reduce French opposition to opening up Europe's Common Agricultural Policy enough to bring about a Doha breakthrough. Meanwhile, the leadership change in the U.S. Congress -- from one that was cautiously supportive of free trade to one that is ambivalent (at best) -- undercuts any gains that will come with a change in French leadership. In short, Doha is dead, and it will remain dead through 2007.

The trade game, therefore, will move to the small groups, particularly in Asia, and to the countless bilateral trade negotiations around the world that have become the main venue for trade talks in the past two years. By the end of 2007, the highlight of the year could be the beginning of serious discussions of a Transatlantic Free Trade Agreement (TAFTA).

In the United States, President George W. Bush will retain some form of fast-track authority, but it will not be the same blank-check authority U.S. presidents enjoyed for all but eight of the past 30 years. Democrats will try to walk a fine line between trying to appease labor and environmental groups on trade issues and reassuring businesses that the party is not anti-trade. Incoming Democratic committee chairmen with sway over trade issues have expressed a willingness to renew the president's authority for fast-track trade negotiations on the condition that heightened foreign and domestic labor and environmental safeguards accompany such trade deals. Such workforce and environmental safeguards abroad will have to be minimal and symbolic if the U.S. trade representative is to be effective, but symbolic statements might be sufficient for congressional Democrats.

The president and Republicans will be forced to concede some worker protection guarantees to Democrats in order to move any potential trade agreements forward this year. Such concessions will be crucial if any progress is to be made in renewing and developing new agreements in Latin American countries -- in particular, Panama, Peru and Colombia -- and with South Korea and Malaysia.

The East Asia Forum will provide the most significant trade agreements in 2007, as the major economies of East Asia begin a series of talks aimed at building on the successful Association of Southeast Asian Nations (ASEAN) Free Trade Agreement, which is harmonizing tariffs and reducing nontariff barriers to trade throughout the region. The ASEAN Free Trade Agreement, for its part, will begin to shift in 2007 from an informal treaty organization to one with specific rules for members. ASEAN boosters see this as a move toward complete EU-style integration by 2015.

German Chancellor Angela Merkel's strengthening position in the European Union could prove an effective platform for her to achieve her long-standing goal of reigniting TAFTA negotiations. The barriers to a successful agreement are high, but both sides probably will be attracted by the prospect of an agreement that would make a full-on NAFTA-vs.-EU trade war unlikely. Progress toward talks will be slow, and little other than a commitment to enter into talks is likely in 2007, but it could nonetheless prove a turning point in global trade relations.

China

We have been pessimistic about the Chinese economic system's long-term stability for some time now. The core problem is that in Asia, capital is treated as a political good to be distributed on the basis of achieving social goals. In contrast, the West broadly uses capital as an end in and of itself. Put another way, Asia splashes its money around to ensure high employment and cares little for its rates of return, while the West prefers a thrifty approach that seeks to maximize efficiency. This makes the Western economies far more adaptable and sustainable, while the Asian economies grow more quickly -- but also suffer from cataclysmic crashes when their inefficiencies overwhelm them.

In the past decade, those inefficiencies have sparked two very different days of reckoning. In Japan, social cohesion was sufficient enough that Tokyo was able to force excruciatingly slow and piecemeal changes to the system. Japan has finally emerged from (parts of) its dysfunction, but only after 15 years of near-zero growth. In contrast, during the 1997 crash Indonesia fell apart nearly overnight because its political and economic systems were not as unified as Japan's, and Jakarta lacked Tokyo's credibility with its populace.

China is a different place. Its political authorities' credibility, like its level of economic development, is somewhere between that of Japan and Indonesia. It cannot afford a Japanese-style malaise, but at the same time it does not live in fear of an Indonesian-style collapse. But perhaps Beijing's greatest advantage is awareness. Not only have the Chinese witnessed the Japanese and Indonesian trials and tribulations, they also have studied the Soviet collapse. This is not a country hurtling headlong into oblivion, ideologically blind to its faults. The Chinese know the bad loan problem is at the heart of their financial weakness and -- unlike the Soviets, Japanese or Indonesians before them -- are taking steps to address it.

At the core of Chinese strategy are efforts to slow the country's breakneck economic growth by forcing the rational, Western-style use of capital and introducing the market discipline that is common in the West. In this they have largely failed, as those benefiting from the old system have the power to ignore central government dictats. Since the central government began taking firm steps to limit growth, it has only accelerated.

This leaves Beijing to manage the problem it cannot solve. The Chinese have done this in two ways. First, they have relocated the bulk of the bad loans to asset management companies, allowing them to declare, with some credibility, that the state banks are clean. Such banks can then approach international entities -- whether institutional or equity -- for investment and managerial assistance in changing the way the banks do business. The bad loans are still there - they have just been shifted into another arm of the government.

The second technique is more basic: lie. According to the official government position, no Chinese state bank has made a single bad loan since 2001. Put techniques one and two together and you have -- on paper -- a financial system in remarkably healthy shape.

This is but one of myriad creative ways in which the Chinese are managing their problems, but all of these successful techniques have one characteristic in common: they are political and security-related in nature, not economic or financial. The state is managing the transition by adjusting Chinese expectations and making fundamental changes in behavior. The Chinese economic system has escaped the central government's grasp, and the government now is using noneconomic tools in its attempts to reassert control.

For 2007, this means that while the underlying core of the Chinese system is as socially unstable and economically irrational as ever, the Chinese are succeeding in using threats, lies, nationalism and force to keep it from melting down. A sort of political reckoning that started when Chinese President Hu Jintao took command began to gather traction in 2006, and could well prove painful in 2007. Subconsciously, foreigners have noticed the difference in timbre in China. Foreign direct investment, while still large, is no longer growing, and many foreign firms are either looking for ways to hedge themselves against government dictats or examining alternate investment locations such as South Korea, Vietnam or the Philippines.

China's leaders are both aware and creative, and the Chinese economy's fall will not happen this year (nor is it likely in 2008, as the patriotic burst from the Olympics will help Beijing hold the center), but do not confuse growth with strength, or market share with profit. China's problems are mounting, not getting solved.

Read part I