The Economic Harms of Burning Bridges – A Look at Economic Fragmentation, and its Results for Climate and Global Debt
The global economy may be on the brink of a reversal of the steady increase in integration that characterized the second half of the 20th century. The shallow economic recovery in many regions following the GFC (2008–10) coincided with a growing debate, especially in developed economies, about the value of multilateralism and the unequal benefits of globalization. This increasing scepticism toward multilateralism contributed to the growing appeal of inward-looking policies, with policymakers becoming more receptive to erecting barriers between nations, including in the areas of trade, capital, migration, and technology sharing. The United Kingdom’s decision to leave the European Union in 2016 was an example of this broader trend. It was soon followed by a series of protectionist measures and countermeasures in trade between the world‘s two largest economies, the United States and China.
The increasing trend of countries stepping back from international cooperation schemes and the path of increased economic integration, highlights a shift from the previous doctrine that increased international cooperation which has been a major driver of growth since the Second World War. Fragmentation can also be seen in terms of a change in the pattern of cooperation between countries (for example on reducing trade barriers) to being at a regional rather than a global level, with the growth of what might be termed regional economic institutions developing alongside (or what might be interpreted as at the expense of) the multinational organisations such as the IMF and World Bank which were established in the aftermath of the Second World War and the Bretton Woods agreement. At the same time, broader economic and geo-political changes are altering the balances between the Bretton Woods era’s international trade and currency structure, which has been historically dominated by the US and Europe, the group of resource-based countries whose currencies are backed by commodity exports (and often by new technology), and the growth of China and its economic influence from its growth and external investment.
What are the risks?
The effects of increasing global fragmentation are seen through changing patterns of trade, technology, labour, capital, and the provisioning of global public goods. Whilst the proliferation of technology and the trade of goods through patterns of trade reliant on reduced trade barriers has doubtlessly led to the increase in living standards for millions around the world, it is important to highlight that the impact has not been universally good nor even universal. Dislocations from trade and technological change have harmed some communities and increasing political intervention from international investors on primary product dependent economies has led to exploitation. But the potential for diverging economies will not solve that. Rather, it will hit debt-ridden emerging economies and grow the technology gap present between developed and developing economies. Not to mention the impact on the potential for multilateral climate action that will be necessary if we are to minimise the damage the world is incurring in part due to the increase in manufacturing resulting from globalisation and international supply changes.
Research is not conclusive on the total GDP impact of this global decoupling however anywhere in the range of 0.2-7% is expected and, if technological devolvement is added, 12% of international GDP. However, the worrying analysis from the IMF in January said that in addition to trade restrictions and barriers to the spread of technology, fragmentation could be felt through restrictions on cross-border migration, reduced capital flows, and a sharp decline in international cooperation that would leave us unable to address the challenges of a more shock-prone world. This would be especially challenging for those who are most affected by fragmentation. Lower-income consumers in advanced economies would lose access to cheaper imported goods. Small, open-market economies would be hard-hit. Most of Asia would suffer due to its heavy reliance on open trade.
What is the solution?
Due to the current international trade of high inflation and stagnant growth, we need international trade agreements to produce growth rather than increased distortion from more efficient trade. Trade growth is expected to decline in 2023, which makes it even more critical to roll back the distortionary subsidies and trade restrictions imposed in recent years. Beginning with rigorous WTO reorganising and strengthening is the obvious path however due to the diversity of membership priorities and stages of growth necessitating different approaches, agreement on complex trade issues remains challenging. This isn’t even factoring in the geopolitical tension that can make complex trade negotiations impossible. In some areas, plurilateral agreements, among subsets of WTO members, can offer a path forward. Take the services regulation which was agreed between a subset of countries which has expanded to include Timor-Leste, the UAE, and Georgia as of June 2022. This path of initial pluralistic initiatives adding members may not suffer the bureaucratic bloat and agreement stalemates of strong universal multinational agreements despite reaching less people.
We also need to be pragmatic about strengthening supply chains. Recent supply issues including the current vegetable and fruit shortage across much of the UK show the extent that a reduction in free trade agreement without proper substitutes can cause harm. IMF research shows that diversification can cut potential economic losses from supply disruptions in half. Meanwhile, countries should carefully weigh the costs, at home and abroad, of national security measures on trade or investment. We also need to develop guardrails to protect the vulnerable from unilateral actions. A good example is the recently agreed requirement to exclude from food export restrictions the exports to humanitarian agencies such as the World Food Program. But these efforts, while important, aren’t enough. We also need better policies at home, from improving social safety nets, to investing in job training, to increasing worker mobility across industries, regions, and occupations. This is how we can ensure that trade works for all.
We must also make sure that we protect and aid developing economies from the burn placed by debt. Fragmentation reduces the pathways for developing nations to access debt relief as less multinational partnerships means less international cooperation to assist national debt that comes from international sources. The weakening of international bodies means there are less forces to negotiation and enforce debt repayment schemes that lessen the burden of debt whilst still ensuring the maximum that can be paid back is paid back. About 15 percent of low-income countries are already in debt distress and an additional 45 percent are at high risk of debt distress. Among emerging markets, about 25 percent are at high risk and facing default-like borrowing spreads.
There are signs of progress on the Group of Twenty’s Common Framework for debt treatment: Chad recently reached an agreement with its official and private creditors; as discussed in the my last article Zambia is progressing toward a debt restructuring; and Ghana just became the fourth country to seek treatment under the Common Framework, sending a signal that it is seen as an important pathway for debt resolution. But official creditors have a lot more work to do. Debtors and credits need greater certainty and predictable outcomes and time frames to allow for volatility to be limited.
The final major issue is where collective action is realistically most difficult but also the most necessary: Climate Change. Just last year, we saw climate disasters on all five continents, with $165 billion in damages in the United States alone. It shows the massive economic and financial risks of unmitigated global warming. However, to fight this involves the global financing of climate saving measures especially in nations reliant on the profits from carbon-intensive products but also without the credit to diversify or justify the reduction in carbon emissions and further expenditure on climate action. The ability to convert conferences such as COP27 into tangible actions is threatened by the increasing economic fragmentation as they destroy accountability and political will. It also harms the prospect of international funding such as credit guarantees, equity and first-loss investments that provide private funding through public funding momentum.