Geopolitics is leading us to fragmentation. Can it be stopped?

The sanctions on Russia led by the US and the EU are another major driver of global fragmentation. These measures have already reshaped regional trade patterns, leading to a sharp decline in exports of goods from Europe and the US, due to sanctions and partly to the reputational risks of continuing to trade with Russia.
The sanctions on Russia led by the US and the EU are another major driver of global fragmentation. These measures have already reshaped regional trade patterns, leading to a sharp decline in exports of goods from Europe and the US, due to sanctions and partly to the reputational risks of continuing to trade with Russia.

Summary

Geopolitical pressures and non-economic factors are leading to fragmentation in the global economy, with implications for economic stability, growth, and climate change efforts.

Geopolitical pressures and other non-economic factors have put the global economy on a path towards fragmentation. Beyond its inherent risks, this trend will not only have profound implications for economic stability and growth but also could jeopardize efforts to combat climate change.

Heightened geopolitical tensions, especially the escalating rivalry between the United States and China, are the primary catalyst of fragmentation. China, which emerged as the world’s largest exporter more than a decade ago, overtook the US as the world’s largest economy (in purchasing-power-parity terms) around 2016. At the same time, the decline in US manufacturing jobs, partly attributed to the surge in Chinese imports, has fuelled Americans’ discontent with globalization and reshaped their views on China.

Contrary to many Western analysts’ expectation that increased trade would put China on a path to democratization, the country has gone in the opposite direction under President Xi Jinping. Instead of liberalizing and pursuing pro-market reforms, Xi has gravitated towards a state-centric system controlled by the Communist Party of China.

Former US President Donald Trump’s administration responded to these developments by initiating a trade war with China, a move widely viewed outside the US as a protectionist aberration that reflected Trump’s “America First" agenda. But President Joe Biden’s administration has maintained the tariffs.

This should not come as a surprise. The new US consensus on China seems to be, “The more we trade with them, the more they use it against us." The Sino-American trade war has become an integral part of a broader US geopolitical strategy backed by both Democrats and Republicans in Congress. Technological decoupling, which entails curbing high-tech exports to China and restricting the use of Chinese equipment in the US, is central to this strategy.

Meanwhile, the European Union has embraced French President Emmanuel Macron’s vision of “strategic autonomy". By securing access to critical inputs and raw materials, the thinking goes, the EU could deter hostile countries from weaponizing trade. Russia’s use of its oil and natural gas exports as a strategic tool against the bloc in the wake of its invasion of Ukraine, together with the Kremlin’s deepening ties with China, has intensified the EU’s efforts to protect key sectors by reducing its reliance on both countries. Moreover, a growing number of voices within the European Commission and among member states have called for the EU to follow in America’s footsteps, curtail high-tech exports to China, and restrict the integration of Chinese technologies in Europe.

This strategy carries significant risks, as China might retaliate by restricting the exports of essential raw materials required for high-end semiconductors and renewable energy. Already, China, which accounts for 98% of global production of gallium and controls 68% of germanium production in various countries, restricted exports of these inputs for chip fabrication in response to the enactment of the CHIPS and Science Act, which curbed US tech exports to China. More recently, China introduced export restrictions on graphite, a mineral used in green technologies that is predominantly sourced from the country. By 2022, roughly 30% of the world’s critical raw materials were subject to such restrictions, compared to just 5% in 2019.

If the EU limits technology transfers to China, the Chinese could impose export restrictions on essential raw materials before European countries manage to secure alternative sources. Many critical minerals, including those vital to the green transition, are predominantly produced by countries not aligned with the West. Moreover, developing new mines takes time, and the environmental toll of refining and processing certain raw materials might diminish Europeans’ appetite for such activities.

The sanctions on Russia led by the US and the EU are another major driver of global fragmentation. These measures have already reshaped regional trade patterns, leading to a sharp decline in exports of goods from Europe and the US, due to sanctions and partly to the reputational risks of continuing to trade with Russia. While some of this trade has found alternative routes through Central Asia and the Caucasus, the volumes remain comparatively low.

These shifting trade dynamics are playing a significant role in segmenting the global economy. For example, as Western exporters withdrew from the Russian market, Turkey’s exports rose sharply. Exports from China to Russia have also increased, particularly for goods subject to European sanctions.

While the US dollar’s global hegemony has made the Western sanctions regime more effective, these measures might ultimately erode the greenback’s dominance. A decade ago, only one-tenth of Chinese exports to Russia were denominated in renminbi; now, roughly two-thirds are. And a growing number of countries also have begun to denominate their exports to Russia in renminbi, especially those that established swap lines with the People’s Bank of China and those that did not join the Western sanctions regime. Similarly, there has been a noticeable increase in the use of national currencies for invoicing exports to Russia by countries such as India, the United Arab Emirates, and Turkey.

And there is no end in sight to geopolitical tensions, with the tragic developments in the Middle East further polarizing the world.

So, where does all this leave us? At a time of increasing economic fragmentation, global trade is no longer driven by purely economic objectives. Instead, geopolitical factors are increasingly shaping trade policies. The European Bank for Reconstruction and Development, the International Monetary Fund, and others have noted that economic fragmentation will be expensive and will negatively affect almost every country in the world.

In the midst of a climate emergency that demands unprecedented international cooperation, fragmentation also poses a grave threat to planetary health and humanity’s future. The benefits of reducing greenhouse-gas emissions are universal, offering abundant opportunities and incentives for countries to free ride on others’ decarbonization efforts. Against this backdrop, intensifying trade conflicts, accelerating fragmentation, and restrictions on the export of critical raw materials reduce trust, hinder international cooperation, and undermine efforts to tackle climate change effectively.

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