Asia and the World Face Growing Risks of Economic Fragmentation – Analysis – Eurasia Review
Geopolitical tensions have raised the prospect that strategic competition and national security concerns could outweigh the shared economic benefits of global trade.
The interdependencies between economies mean that such a prospect would be very costly, especially for Asia. For example, about half of imports into the United States and a third into Europe come from Asia. And, in turn, Asian countries account for nearly half of global demand for key commodities.
In our last Regional Economic Outlook for Asia and the Pacific, we document worrying early signs of fragmentation and provide evidence of the potential consequences of dissolving global trade ties.
One such sign of fragmentation pressures comes from measures of trade policy uncertainty. This measure peaked in 2018 amid tensions between the United States and China, which rose again amid Russia’s invasion of Ukraine, with sanctions against Russia creating uncertainty about the future business relationships.
Even without real restrictions, trade-related political uncertainty can worsen economic activity as companies suspend hiring and investment, and new companies may decide to postpone entering a market.
Our analysis shows that a typical shock to trade policy uncertainty, such as the escalation of US-China tensions in 2018, reduces investment by around 3.5% after two years. It also decreases the gross domestic product by 0.4% and increases the unemployment rate by 1 percentage point. However, not everyone is equally vulnerable.
The effects on investment are even greater for emerging markets and more open economies, as well as for highly indebted companies. Corporate debt has risen dramatically in Asia since the global financial crisis – it has risen further in the wake of the pandemic – suggesting that greater trade policy uncertainty could prove particularly damaging for the region.
As bad as these effects are, the losses would be even greater in the event of actual fragmentation. Against the backdrop of sluggish productivity growth globally, and given the importance of trade, particularly for Asia, we estimate the output losses due to trade fragmentation due to lower productivity. Admittedly, these losses represent a lower bound, as they do not take into account channels such as the effects of a lower capital stock due to reduced investment and potential disruption of knowledge flows.
The fragmentation scenario we model is one where trade is interrupted between trading blocs in sectors that have recently seen increased restrictions, such as energy and technology, and where non-tariff barriers in other sectors are raised to Cold War era levels. To do this, and for purely illustrative purposes, we are dividing blocks modeled on the United Nations General Assembly vote of March 2022 demanding that Russia end its invasion of Ukraine.
If only Russia is isolated from the countries that voted for, the production losses for the world economy are small. However, the losses become considerably greater in more adverse scenarios, such as when the world splits into two blocs, with restricted trade between supportive countries and those that oppose or abstain. Permanent global annual losses are estimated at 1.5% of GDP, with larger losses in Asia and the Pacific countries at over 3% of GDP, reflecting the key role that trade plays in the region . Losses are greater in countries where trade with the other bloc is significant, due to a loss of export markets and the breakdown of complex production networks.
As trade collapses and specialization unfolds, there would be serious consequences for labor markets. In sectors forced to contract due to higher trade restrictions in this illustrative scenario, average job losses in Asian countries are estimated at 7%.
These results focus on trade and ignore any effects of the potential unwinding of financial ties, which, as we document in the chapter, are also very profound. Financial fragmentation can lead to short-term costs of quickly unwinding financial positions, and long-term costs of less diversification and slower productivity growth due to reduced foreign direct investment.
Our work shows that the stakes are high. Policymakers in Asia and elsewhere must act to avoid the adverse effects of further fragmentation and to ensure that trade remains an engine of growth.
Rolling back harmful trade restrictions and reducing uncertainty through clear communication of policy objectives should be a priority. Complementing regional agreements with reforms at the multilateral level, while restoring a fully functioning World Trade Organization dispute settlement system, can not only mitigate the potential negative effects of discriminatory policies on other trading partners, but also help resolve some of the underlying sources of tension.
Above all, however, engagement and dialogue between countries will be essential to avoid the worst scenarios of fragmentation.
*About the authors:
- Diego Cerdeiro is an economist at the IMF and currently works in the China Division of the Asia and Pacific Department. He has done research on international macroeconomics, international trade and network theory. He obtained his doctorate from the University of Cambridge.
- Siddharth Kothari is an Economist in the IMF’s Asia and Pacific Department, where he covers Australia as well as broader regional developments within the Area Studies Division. His main research interests are in macroeconomics and development. He holds a doctorate in economics from Stanford University.
- Chris Redl is an Economist in the Asia-Pacific Division of the International Monetary Fund, where he contributes to the IMF’s Regional Economic Outlook for Asia and the Pacific. His research has focused on exchange rates, the measurement and impact of economic and political uncertainty, and economic forecasting using non-traditional data such as text.
Source: This article was published by IMF Blog