Introduction: A Global Emergency

The post-war trading system, which is at the foundation of our prosperity and orderly international relations, may be ending. Instead, ahead of us may lie an indefinite period of fragmentation of world trade and a more fractious and unstable world order. As trade rules embodied in the World Trade Organization (WTO)—which are imperfect and outdated but still constitute the bedrock on which the world trade edifice stands (Wolff, 2023)—become increasingly eroded, trade will be reconfigured inefficiently along regional and “friendship” lines. The global economy will slow, expectations of higher living standards will remain unmet, the poverty reduction of decades past may be reversed, and climate action will be impeded (Georgieva, 2023).

This book seeks to address the questions—uppermost in the minds of policymakers and analysts around the world—why fragmentation is happening, how it might evolve, and what can be done to prevent, or at least mitigate, the economic and political disruption that it will bring. I do not claim to provide a definitive answer, nor—frankly—would I expect anyone to do so. Indeed, uncertainty about what fragmentation will bring is the essence of the challenge it poses for policymakers and firms. I aim, however, to advance our understanding of fragmentation by considering both the politics and economic thinking that drive it, and the economic and security context within which it is occurring. I try to sketch possible outcomes of the fragmentation process and suggest policies that respond robustly to the uncertainty the erosion of trade rules is generating.

Along with a succession of crises—the Global Financial Crisis (GFC), China–U.S. tensions, the pandemic, the war in Ukraine—the prevailing narrative on globalization and trade changed. In many quarters trade is no longer viewed as a source of efficiency, growth, and peaceful relations but as a source of unfair competition, inequality, and a threat to national security. What did not change, however, is a compelling body of theoretical and empirical evidence dating back 250 years which shows that nations gain from international trade. If anything, the evidence continues to accumulate. Countries could not have fought the pandemic without trade in vaccines and medical equipment, and without foreign supply of everything when whole nations went into lockdown at various times. As the effects of climate change became more visible in prolonged droughts and other disasters, so did the need for trade in food, solar panels, and critical materials for batteries. As the world’s climate continues to deteriorate, nations will have to choose between agricultural trade and mass migration, and to choose between trade in environmental goods and use of fossil fuels.

Why did the narrative on globalization become so negative and why is the resurgence of protectionism threatening? One reason is as old as the annals of commerce yet remains fundamental. Nations gain from trade but, in sectors where they do not have comparative advantage, workers and capital invested lose, creating a coalition to resist trade. A sequence of crises which undermined confidence in globalization and discredited the prevailing policy paradigm bolstered the political resistance to free trade by those who lose from it. The “Washington Consensus” became the Washington dissensus.

The resistance to trade found new life in three developments. The first is the intensifying rivalry between China and the United States, the world’s superpowers, and largest economies. The second—and connected—development is a revolution and inward turn in the trade policy of the United States, the architect of the post-war system, which has its roots in its increasingly fractious social and political divisions, and to the rising inequality and macroeconomic instability of recent decades. The third development is the mounting concern that WTO rules are outdated and increasingly getting in the way of sovereign preferences in many areas. While traditional agendas such as differences in labor standards and in industrial policy (e.g., support to infant and declining industries) remain insufficiently addressed, even more pressing and divisive issues, namely climate change and national security took center stage.

Economic efficiency mandates that the right policy response to the mounting tensions is not to close trade but to address the problems at the core—to find a strategic accommodation with China, to mitigate the losses of some workers from trade with adequate social support, and to coordinate decarbonization policies. For all its shortcomings, there is enough flexibility in WTO trade rules to accommodate national preferences and where there is not, the WTO offers a means to achieve better coordination without unduly restricting trade. But however valid these arguments are, trade policy is a balancing act between conflicting interests and views, and the balance is rapidly and decisively shifting toward allowing countries more “policy space.”

It takes time for the world economy to change direction and this book shows that the fragmentation of world trade has barely started: it is not too late to prevent fragmentation. Protectionism and rule-breaking in many quarters have been offset by trade liberalization in others, especially under the growing number and increased depth of regional and mega-regional trade agreements. Global value chains continue to show remarkable resilience. Many companies that once called for protection have either become defunct or are adapting, reorienting toward world markets, importing cheaper inputs, drawing on foreign technology, investing overseas, and calling on equity and debt capital from abroad. Trade continues to grow, technology advances, enormous gaps in wages and productivity across the world persist, and the gains from globalization are far from spent.

Yet, the signs that the trading system is on the cusp—that an avalanche of protectionist measures has begun to roll and is building—are unmistakable. These signs now go well beyond the trade war between China and the United States and the sanctions on Russia and Iran. They include, for example, over thirty WTO trade disputes that remain in limbo after its Appellate Body became disabled, a vast increase in trade concerns expressed in WTO committees, large trade-distorting subsidies in the United States which has newly embarked on import-substituting industrial policy, and a widespread expectation that decarbonization measures will cause a new wave of trade disputes. Donald Trump is the Republican candidate in the 2024 Presidential election and has promised to escalate the trade war with China and impose an additional 10 percent MFN tariff on U.S. imports, which would amount to the United States tearing up the WTO and is bound to prompt retaliation by partners that account for most U.S. exports.

Avoiding fragmentation or, at least mitigating the damage it will cause, is possible. An essential condition is for China and the United States to reach an accommodation on trade. The tension in China–U.S. relations is no longer mainly about trade if it ever was, and nor is reduced trade the most worrying consequence of their rift. The rivalry between a rising China and the incumbent United States has preoccupied eminent American scholars such as Graham Allison (2017), John Ikenberry (2014), Henry Kissinger (2011, 2012), and Joseph Nye (2023). The perspectives they offer are diverse, but they build on the same assumption: the nuclear-armed giants have the means to destroy the other without realistic prospect of defense, and so they will coexist or not exist, and must be constantly wary of the risk of escalation. Others of the self-denominated realist school see a military conflict between the superpowers over supremacy in Asia as highly likely (Mearsheimer, 2006)….”

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It is sometimes repeated among economists and policymakers that the more economic dynamics are boring the better, as this would mean that the economy is stable and “in good health”. Sticking to the metaphor, we cannot help but observe that over the last few years the global economy has shown a significant worsening of its own conditions. Geopolitical fragmentation is not the cause of this, or at least not the only cause. However, overlapped with other exogenous negative shocks, it proved to have a strong role in intensifying the magnitude of impact on economic variables such as, for example, energy prices and consequently on inflation, even in its core component.

A structural change in global policy priorities

Political tensions were, indeed, always present in previous years. Besides their intensification, partly inevitable with the economic rise of China in the last decades, the main difference that marked a change with the past is that global economic stability was considered the primary common good, to which other political objectives should be subject to, while now it is clearly the opposite. In other words, geopolitical tensions are more likely to generate international economic consequences, which implies that geo-economics is a matter of renovated importance in a way that has been unusual probably since the end of Cold War. To give just an example, introducing limits to export with the Chips and Science Act, and discriminatory incentives on green technologies with the Inflation Reduction Act against WTO rules, the Biden administration has decided to go through commercial retorsions from other countries, economic tensions with such a strong partner as the EU, to affirm new primary objectives. These refer to the sphere of economic security, as clarified by the Secretary of the Treasury herself.

Such a change in priorities brings together some costs, those of the increased instability. It is worth to assume a long run perspective, and try to understand what these costs are, and who will pay for them. In order to do this, is useful to start considering how economic fragmentation was shaped. Most evident outcomes involved international trade, with a sharp increase in commercial restrictions, both inwards and outwards. These targeted mainly strategic goods such as energy sources and other critical raw materials, military and dual use goods and other technologically relevant products. As an anticipation of this open fight for technological supremacy, also vaccines had been somehow weaponized during Convid-19 pandemic. At the same time, firms started to consider a strong intensification of reshoring initiatives, also in their specific variants of nearshoring and friendshoring, in order to bring back production to safer of more convenient countries. Investments were thus indirectly affected, being gradually redirected, at first evidence mainly with a decrease from the USA (and less from advanced European countries) out of China, rather than in the opposite direction. As far as currencies are concerned, the weaponization of finance against Russia was expected to generate disaffection from the Western-dominated financial infrastructure and from the US dollar, as shown by the fact that China brought up the discussion on currencies in the BRICS context.

Many names for a single issue

It has been widely debated whether the changes we are observing in the global economy should be called de-globalization, slowbalization, fragmentation, decoupling, bifurcation or even fracturing. The discussion is relevant, as terms are meaningful to properly describe a multifaceted phenomenon. It was progressively accepted that a complete decoupling between China and the USA is not likely to happen, as its cost would be too high for both, and that similarly a real process of de-globalization would benefit no one. On the other hand, it is likely to expect a temporary slowdown in the globalization process while global economy assumes the form of a bipolar or multipolar world. We could argue for the latter as, for the moment, the EU has not shown the intention to fully follow the USA in the separation from China, and the other BRICS – with India in first place with the recent crucial visit of Modi in Washington – don’t seem to be eager to fully satisfy the desires of Beijing. In a still very uncertain scenario, ironically what seems surer is that uncertainty will remain high, as the main characteristic of a global economy under geopolitical turbulence. Deviations from baseline scenarios in forecast will be more frequent until tensions persist, and governments and firms -and to some extent also households- should adapt to this new environment and learn to react more quickly to external shocks. The restrictions on gallium and germanium exports recently introduced by China are an example of future sudden changes that are likely to happen.

Implications of a persisting geopolitical fragmentation

The main fears about geopolitical fragmentation refer to the impact on global economic growth. Negative deviations would affect baseline scenarios that already prospect a potential growth generally lower than previous decades in almost all regions of the world over the upcoming years. Even though it is very early to understand the extent of this impact, first estimates have quantified losses between 1% and 12% in GDP, also depending on the level of political tensions and economic fragmentation that will be reached. A second main consequence is the increase of instability of macroeconomic fundamentals, that would result in higher financial risks on private and public debt and a more frequent occurrence of inflation, that may often require economic policy intervention both on the monetary and fiscal side. The combination of low growth and high inflation has resurrected the nightmare of stagflation, the most severe economy the world’s largest economies have not faced since the 1970s.

All these effects (growth reduction, financial risk and inflation) are more likely to hit more strongly the most fragile economies and social classes. Furthermore, if USA-China tensions will not reach a point of equilibrium, a bifurcation in technological standards is likely to happen over the next years, and to some extent it is already beginning to appear. Finally, the level of international cooperation will be reduced, making it hard to address global problems and reach common goals, as well as cultural and scientific sharing could be reduced, with a possible slowdown or differentiated dynamics in technological development and productivity.

Geoeconomic fragmentation is thus a real threat to globalized economy. For a few decades we have lived in the illusion that the economy could be immune or only partially affected by geopolitical tensions, partly induced by an economic theory identifying the economy just with the market. To some extent, this has proved to be true for a limited amount of time and in specific geographies. But as history can show it looks more like it was a phase than the norm. And the past can also teach that there is a concrete risk of a downward spiral, that should be avoided with more cooperation taking back the global economy as a priority in the world leaders’ agenda. 

To read the full commentary as it was originally published by the Italian Institute for International Political Studies, click here.

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