


We are at a turning point. Trade is fragmenting as many countries erect barriers in the name of “friendshoring,” “de-risking,” and “self-reliance.”
Countries may have valid reasons for pursuing these policies, such as the need to strengthen national security and build resilience. And in the short term, some nations may benefit. If the trend continues, though, we could end up in a new cold war. And the costs—including less peace, less security, and less prosperity—will overwhelm the benefits. Policymakers undoubtedly face difficult trade-offs between minimizing the costs of fragmentation and maximizing security and resilience. But at the same time some general principles can ensure the world does not descend into its worst-case economic scenario.
This is not the first time that geopolitical considerations have impeded global trade and capital flows.
World War I brought a golden era of globalization to an abrupt end, with world trade collapsing as a share of income. The protracted economic hardship that followed paved the way for the rise of nationalist and authoritarian leaders who later plunged the world into World War II. A bipolar world emerged with two superpowers—the United States and the Soviet Union—divided by ideology as well as radically different political and economic structures. Poised precariously between them was a set of nonaligned countries.
This Cold War period, between the late 1940s and late 1980s, was not one of deglobalization—it was in fact marked by a rising ratio of global trade to GDP, driven by the postwar recovery and the trade liberalization policies adopted by many countries in the Western bloc. But it was a period of fragmentation, as trade and investment flows were shaped by geopolitical considerations. During this time, trade between opposing blocs collapsed from around 10-15 percent to less than 5 percent of global trade.
There are parallels today. Over the past five years, threats to the free flow of capital and goods have intensified as geopolitical risks have grown.
Some measures directly target trade and investment: for example, tariffs on aluminum and steel or export restrictions on critical minerals and agricultural products. Other behind-the-border measures indirectly affect trade flows, such as initiatives to boost domestic semiconductor manufacturing and local content requirements.
Around 3,000 trade-restricting measures were imposed in 2023nearly three times the number imposed in 2019. Meanwhile, multinational firms are increasingly discussing issues such as reshoring, nearshoring, friendshoring, and deglobalization in their earnings’ calls.
But while the driving force behind today’s fragmentation is similar to that of the Cold War—that is, the ideological and economic rivalry between two superpowers—the stage is fundamentally different.
To start, the degree of economic interdependence between countries is higher today. Global trade to GDP is now 60 percent, compared with 24 percent during the Cold War. Economies have become much more integrated into the global marketplace, and global value chains are more complex. This will likely raise the costs of fragmentation.
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There is also greater uncertainty around who is in which bloc. During the Cold War, countries tended to clearly align with either the United States or the Soviet Union. Today, within-country swings in the ideology of political leaders are more common, making it difficult to pin down allegiances.
Nonaligned countries now potentially have greater economic heft in terms of GDP, trade, and population. In 2022, more than half of global trade involved a nonaligned country. Given their increased economic integration, these countries can serve as “connectors” between rivals, benefiting directly from trade and investment diversion.
Still, signs of growing fault lines may raise the question: Have we entered a period of deglobalization? If we define deglobalization as a decline in global trade relative to output, then the answer is no—the share of global trade in world GDP today has remained relatively stable, fluctuating between 55 and 60 percent since 2011.
There are, however, signs of increased fragmentation.
Amid slower global growth and the post-pandemic rotation of spending from goods to services, and since the start of Russia’s war in Ukraine, trade has slowed everywhere. However, trade between blocs has slowed much more than trade within blocs. This is especially true in strategic sectors, such as chemicals and machinery, that are used to develop several products, including low-carbon technologies.
There are also clear signs that global foreign direct investment (FDI) is segmenting along geopolitical lines. After Russia’s invasion of Ukraine, the share of announced FDI projects declined more between blocs than across blocs. Meanwhile, about half of announced FDI projects were in nonaligned countries—a sharp increase.
Direct links are also being severed between the United States and China. China is no longer the largest trading partner to the United States, and its share of U.S. imports has fallen by almost 10 percentage points in five years: from 22 percent in 2018 to 13 percent in the first half of 2023. The trade restrictions imposed since the onset of U.S.-China trade tensions in 2018 have effectively curbed Chinese imports of tariffed products.
China is also no longer a prominent destination for outward U.S. FDI, losing rank to emerging markets such as India, Mexico, and the United Arab Emirates in the number of announced FDI projects.
There is suggestive evidence that direct links between the United States and China are simply being replaced by indirect links. Countries that have gained the most in U.S. import shares, such as Mexico and Vietnam, have also gained more in China’s export shares. The same countries are also larger recipients of Chinese FDI.
Large electronics manufacturers have accelerated relocating production from China to Vietnam, given U.S. tariffs on Chinese goods. However, Vietnam sources most inputs from China, while most exports go to the United States.
Meanwhile, Mexico eclipsed China as the biggest exporter of goods to the United States in 2023. But anecdotal evidence suggests that some of the manufacturers opening plants in Mexico are Chinese companies, targeting the U.S. market.
In other words, instead of blunted U.S.-China trade, we could be seeing it rerouted through other countries. And that appears to be lengthening supply chains, reducing efficiency, and potentially bringing new fragilities.
Clearly, fragmentation is already a reality, as geopolitical alignments shape trade and investment flows, a process that will likely continue. Despite efforts by the two biggest economies to cut ties, it is not yet clear how effective they will be in a deeply integrated and connected global economy. But if fragmentation does deepen, what would be the economic cost? And how would those costs be transmitted?
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Trade is the main channel through which fragmentation could reshape the global economy. Imposing restrictions on trade would diminish the efficiency gains from specialization, limit economies of scale, and reduce competition.
The capacity of trade to incentivize within-industry reallocation and generate productivity gains would be stifled. Less trade would also imply less knowledge diffusion, a key benefit of integration, which could also be reduced by fragmentation of cross-border direct investment.
A useful example is Brexit. Because of the extensive interlinkages between Europe and the United Kingdom, Brexit is thought to have had a sizable effect on the U.K. economy.
Fragmentation of capital flows would limit capital accumulation—because of lower FDI—and affect the allocation of capital, asset prices, and the international payment system, posing macro-financial stability risks and potentially leading to a more volatile economy.
The estimates of the economic costs of fragmentation vary widely and are highly uncertain. But recent and ongoing work at the International Monetary Fund (IMF) suggests that these costs could be large and weigh disproportionately on developing countries.
If the global economy were to fragment into two blocs based on U.N. voting on the initial 2022 Ukraine resolution, and if trade between the two blocs were eliminated, estimated global losses would be about 2.5 percent of GDP. But depending on economies’ ability to adjust, the losses could reach as high as 7 percent of GDP.
As for FDI, fragmentation in a world divided into two blocs centered on the United States and China—with some countries remaining nonaligned—could result in long-term global losses of around 2 percent of GDP.
In an extreme scenario, even those who benefit from fragmentation in its mild forms could be left with a larger slice of a much smaller pie. In short, everyone could lose.
Fragmentation would also inhibit our efforts to address other global challenges that demand international cooperation. The breadth of these challenges—from climate change to artificial intelligence—is immense.
Recent IMF analysis shows that fragmentation of trade in minerals critical for the green transition—such as copper, nickel, cobalt, and lithium—would make the energy transition more costly. Because these minerals are geographically concentrated and not easily substituted, disrupting their trade would lead to sharp swings in their prices, suppressing investment in renewables and electric vehicle production.
So, what can policymakers do to prevent the worst-case economic scenario? Three principles can help.
First, countries can seek a multilateral approach at the very least for areas of common interest. For example, a green corridor agreement could guarantee the international flow of minerals critical for the clean energy transition.
Similar agreements for essential food commodities and medical supplies could ensure minimum cross-border flows in an increasingly shock-prone world. Such agreements would safeguard the global goals of averting climate change devastation, food insecurity, and pandemic-related humanitarian disaster.
These are not lofty policy goals but are grounded in ongoing work. Take the last World Trade Organization (WTO) Ministerial Conference, where members agreed to ease intellectual property protections on COVID-19 vaccines and established a food security work program.
Second, if countries deem some reconfiguration of trade and FDI flows necessary, a nondiscriminatory, plurilateral approach can help them deepen integration, diversify, and build resilience.
Plurilateral agreements consistent with the WTO—such as regional trade agreements and joint statement initiatives—are clearly second best to multilateral agreements but could offer several benefits, such as economies of scale, greater market access, and diversified suppliers. By updating the rules to better reflect a changing global economy and allowing new partners to join when they are willing and able to commit to the standards, such agreements can help countries make progress even when multilateral cooperation is difficult. For example, 90 countries representing more than 90 percent of global trade are working together toward common digital trade rules. And 67 members came together around a WTO plurilateral agreement on domestic regulation of services that, when enacted, is expected to reduce trade costs.
Policymakers should be judicious when considering risks to resilience, targeting only a narrow set of products and technologies that warrant intervention on economic security grounds. Before deciding to bring production home, they must carefully consider whether there is truly a lack of suppliers from less risky regions and make an objective assessment of the social and economic costs of supply disruptions. This is especially the case for widely used technologies such as semiconductors.
Third, countries can restrict unilateral policy actions—such as industrial policies—to addressing externalities and market distortions. And make them time-bound. Policymakers should limit the goal of such measures to correcting market failures while preserving market forces where they can allocate resources most efficiently.
It is critical to carefully evaluate industrial policies, in terms of both their effectiveness in achieving stated outcomes and the associated economic costs, including cross-border spillovers.
Domestically, industrial policies may be hard to limit or roll back given their concentrated benefits and diffused costs.
Internationally, such policies may lead to retaliation, which would deepen fragmentation. According to recent IMF estimates, if China introduces a subsidy, the likelihood that the European Union imposes a trade-restricting measure within 12 months in response is 90 percent.
An intergovernmental dialogue—or a consultation framework—on industrial policies could help improve data and information sharing and identify the impact of policies, including their unintended consequences across borders. Greater transparency can allow for better analysis and understanding and, in turn, reduce negative spillovers. Over time, steady lines of communication could help develop international rules and norms on the appropriate use and design of industrial polices, assuaging trade tensions and creating the predictability needed for a well-functioning trading system.
On each of these three principles, we can look for blueprints from the Cold War. Throughout that period, the United States and Soviet Union made several agreements to avoid nuclear catastrophe. Both superpowers subscribed to the doctrine of mutual assured destruction, knowing that an attack by one would ultimately lead to total annihilation.
If we descend into Cold War II, knowing the costs, we may not see mutual assured economic destruction. But we could see an annihilation of the gains from open trade.
Keeping open the lines of communication—as is being done by the United States, China, and the EU—can help prevent the worst outcomes from occurring. The nonaligned countries, which are mainly emerging and developing countries, can deploy their economic and diplomatic heft to keep the world integrated, including through their interventions at G-20 meetings.
Of course, economic integration has not benefited everyone; acknowledging this is critical to understanding additional motivations behind global inward shifts, and domestic policies must adjust to broaden their benefits. But it has helped billions of people become wealthier, healthier, and better educated—since the end of the Cold War, the size of the global economy has roughly tripled, and nearly 1.5 billion people have been lifted out of extreme poverty. It is in everyone’s interest to advocate strongly for a multilateral rules-based trading system and the institutions that support it. It’s the best chance for a world where people can expect a brighter, more prosperous future.
This article is adapted from a speech Gita Gopinath gave to the 20th World Congress of the International Economic Association in December 2023.