Impact of deglobalization

It seems that the interconnectedness of the world’s economies is in decline and that we are in a state of deglobalization. Trade flows between economies around the world have stagnated, while cross-border foreign direct investment has been in decline for well over a decade. And given the amount of restrictive trade policies currently in place, the rise of protectionist political platforms, and the deterioration of geopolitical relations around the world, it seems that further deglobalization is more likely than reglobalization.

There is a distinct intersection between globalization and geopolitics, and how geopolitical developments are likely to be the driving force of further deglobalization. Major geopolitical shocks in Europe and the Middle East are likely to create geopolitical boundaries and limit interactions between nations supporting opposing sides of conflicts. The U.S. is heavily involved in Ukraine and is virtually conducting a proxy war, and the U.S. support for Israel is unwavering.

The wedge between the U.S. and China is widening as a result of geopolitical developments, and with both countries holding significant influence in the global economic arena, countries around the world could align themselves with either the U.S. or China going forward. This type of fragmentation is a further deglobalization force that could result in economic linkages between U.S. and China-aligned countries ultimately being eliminated, creating two distinct and separate U.S. and China-led blocs. There would also likely be some countries which may opt for neutrality and continue to interact economically with both blocs.

Countries that could identify as neutral are some of the larger emerging market economies such as India, Chile, Singapore, Peru and Qatar, among others. It is estimated that with such a fragmentation scenario, the global economy could lose over 6% of overall output should trade linkages be severed and if no lost trade is retained through new intra-bloc linkages.

Right now, many countries around the world indeed opt for neutrality when addressing global geopolitical conflicts such as the Russia-Ukraine conflict or the Israel-Hamas war. Certain nations have also maintained relationships with both the U.S. and China amid tensions between the world’s two largest economies. Going forward, more countries may choose neutrality amid rising geopolitical risks and U.S.-China tensions as a way to receive concessions. With economic fragmentation a longer-term trend that is likely to unfold in the coming years, both the United States and China are likely to offer concessions to neutral countries in an effort to secure future alignments.

So while it is likely deglobalization will continue and fragmentation will eventually materialize, more nations may pursue a neutral stance on geopolitical events before full fragmentation occurs. The shift to neutrality before full fragmentation may actually be somewhat beneficial for global growth prospects in the short-term as economies around the world could build or enhance economic linkages with the United States and/or China.

However, over the longer-term, as the global economy fractures along geopolitical fault lines, global growth prospects are set to come under pressure. In a fragmentation scenario, trade flows, cross-border foreign direct investment and portfolio flows, labor supply, technology, information etc. would all likely be disrupted. As cross-border activities dwindle and potentially completely cease, the impact on the global economy would likely be significantly more intense. It seems that the continued geopolitical challenges will have significant consequences so fasten the seatbelts for an acceleration of deglobalization.