Fri. Feb 23rd, 2024

The world is undergoing a significant change, with trade fragmenting as countries put up barriers in the name of “friendshoring,” “de-risking,” and “self-reliance.” This trend could lead to a new cold war and come with the costs of less peace, less security, and less prosperity. While policymakers face difficult trade-offs, there are general principles to prevent the worst-case economic scenario. This is not the first time geopolitical considerations have hindered global trade, as World War I and the Cold War both saw a rise in nationalism. The current trend is similar to that of the Cold War but different in that the degree of economic interdependence between countries is higher today, making the costs of fragmentation likely to be higher. There is also greater uncertainty around who is in which bloc, as countries now swing more frequently in their ideology. Signs of growing fault lines may point to a period of deglobalization, although the share of global trade in world GDP has remained relatively stable. There are also clear signs of fragmentation, as trade between blocs has slowed much more than trade within blocs. Foreign direct investment (FDI) is segmenting along geopolitical lines, and direct links between the United States and China are being severed. Instead of blunted U.S.-China trade, it could be rerouted through other countries, potentially lengthening supply chains and introducing new fragilities. The fragmentation is already a reality and could reshape the global economy, diminishing the efficiency gains from specialization and other benefits of integration. The economic costs of fragmentation could be large and weigh disproportionately on developing countries, with estimated global losses reaching as high as 7 percent of GDP.

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