How Fragmentation is Threatening the Globalized Economy



Andrea Brugora | Italian Institute for International Political Studies

The Economy of the New Global (Dis)Order

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.