The geopolitical influence on global trade

The starting point and assumption are that the trend toward globalization has ended. And rather than a resurgence of economic cooperation between countries around the world, it is expected that deglobalization is more likely than re-globalization going forward.

Over the past few years, the geopolitical landscape has materially worsened. Major military conflicts are active on two continents, while less systemic confrontations have popped up across South America, Africa and other parts of Europe and Asia. As far as the more significant conflicts, we have seen countries show explicit support for Ukraine following Russia’s invasion, with others expressing solidarity with Russia. Similar dynamics unfolded after Hamas attacked Israel. Select countries have demonstrated unity with Israel, while others have adopted a more critical stance. These conflicts, in combination with other frictions, are creating global geopolitical fragmentation forces, where countries around the world are becoming more divided on geopolitical issues.

Geopolitical fragmentation could lead to economic fragmentation, a scenario where countries with opposing geopolitical views at least partly sever economic linkages. Economic fragmentation is a risk to the long-term health of the global economy, especially as arguably the two most economically important countries, the U.S. and China, find themselves with opposing geopolitical perspectives, not only related to the Russia-Ukraine conflict and the war in the Middle East, but on many other geopolitical matters.

With the U.S. and China, the two largest economies in the world, and also possibly the most geopolitically influential, there could be a hypothetical scenario where the U.S. and China cut economic linkages due to geopolitical differences, and countries around the world choose to align themselves with either the U.S. or China to show geopolitical solidarity. This aligning of nations ultimately fragments the global economy into two separate and distinct economic blocs, one led by the U.S. and the other by China.

Countries strongly aligned with China dipped sharply in 2021, and while the number of countries labeled leans China countries rose, the number of overall China-aligned countries fell. The trend of fewer China-aligned nations continued in 2022, while U.S.-aligned countries jumped. In fact, 2022 marked something of an inflection point for alignment with the U.S. Alignments were maintained in 2023 as last year saw little in the way of allegiance modifications. Over the past few years, more countries have started voting in coordination with the U.S. in resolutions concerning the Ukraine and Israel/Gaza-related conflicts put forward at the United Nations. In addition, and while not the primary driver of the pivot toward the U.S., countries around the world have become slightly less dependent on China as a trade partner.

There could be several reasons for this. First, a sense of more policy predictability, especially on foreign relations and trade, in the U.S. under the Biden administration could potentially have resulted in countries looking to reengage with the U.S. Also, the pandemic sparked interest in supply chain diversification and corporations relocating operations out of China and closer to the U.S. This nearshoring trend may be shifting trade relationships away from China in recent years. But most notably, Russia’s invasion of Ukraine sparked a global effort to isolate Russia, both economically and geopolitically. China has demonstrated full support of Russia and continues to align itself geopolitically with Russia. As nations around the world isolate Russia, countries have been shifting alignment in favor of the U.S.

Geopolitical fault lines have been erected on trade for some time. U.S.-aligned nations, including the U.S. itself, have become less trade-dependent on China and always China-aligned countries. In 2017, always U.S.-aligned nations traded goods worth 15.2% of the U.S. bloc’s total world trade with China and China-aligned nations. Over time, trade linkages have dwindled, and as of 2023, always U.S.-aligned nations traded goods worth just 13.4% of the bloc’s trade with the entire world with China and China-aligned countries, with the downtrend picking up pace in more recent years. Reduced trade dependencies also exist across the bloc, and less trade between the U.S. and China is not necessarily driving the overall trend. The U.S. and China are slowly decoupling, which trade data indeed reveals; however, always U.S.-aligned and always China-aligned nations, excluding the U.S.-China trade relationship, are also trading less with each other.

Trade between always U.S.- and China-aligned nations was worth 11.4% of the U.S. bloc’s trade with the world in 2017. As of 2023, trade fell to just 10.8%. Similar dynamics exist for China and always China-aligned nations. In 2017, inter-bloc trade was worth 33.2% of the China bloc’s world trade. In 2023, that number slipped to 28.5%. While reduced trade between the U.S. and China is driving softer trade relations between the two blocs, always China-aligned nations are also engaging less with always U.S.-aligned countries on trade as trade linkages have slipped from 24.8% of China bloc world trade to 23% at the end of last year.

Going forward, it is worth keeping a close eye on the state of deglobalization and geopolitics, and how the two intersect with each other. As geopolitical risk remains elevated, scope for further deglobalization certainly exists, especially if already-active conflicts intensify and draw in new stakeholders. The entrance of new actors into any active military or geopolitical conflict introduces the possibility of shifting country-alignments, neutral nations eventually picking a side, and ultimately additional fragmentation forces.

Also, it is worth keeping an eye on the evolution of politics at local levels, particularly the U.S. election. Should U.S. trade policy turn more inward-looking, protectionist and defined by the imposition of tariffs, fragmentation and deglobalization could gather momentum in this scenario as well. Full geopolitical-led economic fragmentation can shave a good chunk off global GDP growth. As of now, geopolitical-induced fragmentation is materializing, but is not necessarily the base case for how the global economy will evolve over the longer term. If fragmentation does gather momentum for any reason and becomes the new base case, the long-term prospects for the global economy would turn less constructive, possibly outright pessimistic. It is clear that the direction is the fragmentation of the world into two blocs and this will impact trade patterns going forward.