PAOLA SUBACCHI
LONDON – The world is at last waking up to the ways in which economic interconnectedness amplifies the risks of geopolitical turmoil. But while there is good reason for countries to boost resilience, a wholesale shift from integration to fragmentation, driven by geopolitical hostilities, bodes well for no one’s peace or prosperity.
The global economy is not there yet. While capital flows have declined considerably from their 2007 peak of $12 trillion (22% of global GDP) – a trend that began with the 2008 crisis – economic integration remains strong. Total global trade in goods and services exceeds $40 trillion – a tenfold increase since 1990.
But, from 2016 to 2021, trade restrictions nearly doubled worldwide, owing primarily to tensions between the United States and China. In fact, fragmentation – like globalization before it – would not be possible without China, whose rise transformed the regional competition for economic, financial, and geopolitical clout into a global one. While some hope to balance rivalry with engagement – the European Union views China as “a partner for cooperation, an economic competitor, and a systemic rival” – the dynamics are obviously complex.
The COVID-19 crisis and Russia’s war against Ukraine have also contributed to fragmentation, as they have spurred countries to embrace “onshoring,” “near-shoring,” and “friend-shoring” with a growing sense of urgency. Yes, the pandemic showed that efficiency and cost-effectiveness do not necessarily square with economic security. But while adjustments are needed to strengthen supply-chain resilience, returning to a world divided into economic (and geopolitical) blocs holds serious risks.
We have been here before. Recall that World War I ended three decades of economic integration, showing that “doing business together” is not a sufficient condition for peace. But it is a necessary one.
The economic costs of fragmentation are already mounting. For starters, according to the International Monetary Fund, trade fragmentation could reduce global output by between 0.2% and 7%. Moreover, while trade and trade-related transmission channels have dominated discussions about the risks of fragmentation, international financial and monetary integration is also in peril, and the risks are not as slow-moving or moderate as many seem to think.
Consider sovereign debt. Here, fragmentation is reflected in the heterogeneity of creditors and contracts. In addition, key official creditors are divided along geopolitical lines: China is the largest bilateral creditor for developing countries, having lent them about $498 billion in 2008-21. For comparison, the World Bank lent these countries $601 billion over the same period.
Debt resolution remains the gaping hole in international governance. Countries with unsustainable debt positions lack incentives to address them in a timely way; on the contrary, the fear of losing market access deters such action. But with tighter financial conditions worsening the debt positions of poor countries in Asia, Africa, and South America – 15% of which are already in debt distress, with another 45% at high risk – an agreement on debt resolution is urgent.
The problem is that fragmentation is hampering negotiations, not least because disunited creditors eschew bailouts and haircuts – the main tools used for debt resolution. This was the case just last month, when – on the fringes of the G20 Finance Ministers’ and Central Bank Governors’ Meeting in Bengaluru, India – the IMF brought together representatives from the G7, China, India, Saudi Arabia, and the World Bank to strengthen the framework for resolving sovereign-debt distress.
At that meeting, the G7’s request that sovereign creditors accept haircuts along with private creditors fell on deaf ears. China, the largest external creditor to two of the most urgent cases – holding 35% and 20%, respectively, of the total external debt of Zambia and Sri Lanka – insisted that it was multilateral institutions like the World Bank that needed to accept haircuts, putting an agreement out of reach.
Debt resolution is an important example of the kind of international policy cooperation that is needed to avert global economic fragmentation – cooperation that must include China. But where to begin? A good starting point would be to align China’s incentives with those of other bilateral creditors, multilateral institutions, and the private sector.
More broadly, the G20 should attempt to find common ground among global actors, and work to strengthen policy cooperation in areas with the broadest consensus and the least scope for political tension. For example, it could launch a coordinated initiative to build a global digital platform for international remittances, which would enable migrants around the world to send money home securely and without extortionate fees.
Multilateral mechanisms are needed to prevent unilateral action from producing international spillovers and deepening economic fragmentation. As digital currencies and new platforms become available to settle cross-border payments, countries’ national-security concerns, domestic economic objectives, the need to create buffers against geopolitical shocks, and sheer economic rivalry will encourage them to embrace these new systems as a means of reducing their dependency on the US-dominated financial system. Financial fragmentation will become entrenched, and financial risk management will be significantly weakened. This is not a desirable path.
Over the past three decades, economic integration and cooperation enabled the global economy to triple in size, lifted approximately 1.5 billion people out of extreme poverty, and supported peace and prosperity around the world. To ensure that we do not squander these gains, let alone undermine our ability to confront the challenges of the future (not least climate change), we must find ways to uphold some level of integration and effective cooperation.
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