Report reveals ‘staggering’ costs of economic fragmentation
Economic fragmentation could be more damaging to the economy than either the global financial crisis or the pandemic, a new report has warned.
Full decoupling between western economies and eastern economies could cost the global economy $5.7 trillion, or up to five per cent of GDP, according to research from the World Economic Forum and Oliver Wyman.
The hit would largely come through lower trade, reduced capital flows and lost economic efficiencies.
Developing economies would be the worst hit if they were forced to trade exclusively with either the western or eastern ‘blocs’, the report said.
It warned that GDP could fall by as much as 10 per cent India, Brazil, Latin America and South East Asia.
The report noted that countries were increasingly using the financial system to advance their geopolitical objectives, with the use of sanctions, subsidies and industrial policies having increased by 370 per cent since 2017.
Matthew Blake, head of the World Economic Forum’s Centre for Financial and Monetary Systems, said the potential costs were “staggering”.
But if capital and trade flows were only restricted in sensitive areas – related to national security and competitiveness – then the impact on global GDP would only be around $600bn.
Global inflation would also be nine times lower compared to Oliver Wyman’s worst case scenario.
“Leaders face a critical opportunity to safeguard the global financial system through principled approaches,” Blake said.
The report laid out a series of guardrails to help preserve financial intermediation even in the event of fragmentation. These include strengthening the capability of international institutions and ensuring that parallel financial market infrastructures are interoperable
“Financial intermediation tends to occur despite geopolitical tensions or even wars,” the report said.
“As such, it offers a powerful tool for bringing actors together to address shared challenges, such as the energy and digital transitions, ageing populations and infrastructure investment, all of which require collective action.”
The report comes amid growing concerns about the risks of geopolitical fragmentation, particularly in the wake of Donald Trump’s inauguration as President.
Trump is preparing to put tariffs of up to 25 per cent on goods from Mexico and Canada by the end of the month, as well as a 60 per cent tariff on China.
He said he was “not ready” to impose the blanket tariffs he threatened during the election campaign, but singled out the European Union as a likely target.
“They’re very tough. They don’t take our cars. They don’t take our farm product, they don’t take almost anything,” he said on Monday night. “We’ll straighten that with either tariffs or they have to buy our oil and gas.”
Following his comments, Ursula von der Leyen, President of the European Commission, warned that the global economy was “fracturing along new lines”.
“The cooperative world order we imagined 25 years ago has not turned into reality. Instead we have entered a new era of harsh geostrategic competition…We will need to work together to avoid a global race to the bottom,” she said at Davos.