2 years ago

Rising risk of geo-economic fragmentation

-Reuters file photo
-Reuters file photo

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The evolution of globalisation is increasingly becoming more uncertain notwithstanding Donald Trump and his "America First" rhetoric and the economic impact of the pandemic. But increasingly unsettled geopolitical climate arising out of the US-China rivalry and the Russia-Ukraine conflict have not only further added to that uncertainty but sharply increased the risk of geo-economic fragmentation. Geo-economics is the increasing convergence of the economic and national security domain and the trade-offs policymakers face in balancing, often conflicting national interests.

But globalisation has created economic interdependencies of unprecedented depth and complexities. There is little debate that globalisation has created significant economic opportunities, but its focus on growth and competitiveness has also been criticised as a source of inequality and economic disruptions. In many ways  globalisation has also raised concerns about perceived national security vulnerability. In fact, globalisation has had opponents for decades but Donald Trump was the first to wage war against it.

For almost three quarters of a century the US had led the world into a rule based system of trade globalisation leading to the establishment of the WTO in 1995. The Uruguay Round of multilateral trade negotiation which led to  the establishment of the WTO was largely successful because for the last time the US and the EU were able to agree on a deal to their mutual advantage and then impose it on the rest of the world.

But that international economic order has come under challenge when in response to Trump-initiated trade war against China, it accused the US of  'deliberately destroying the international order', signalling that US hegemony will not go unchallenged. Also, the G7 made up of the world's largest developed economies which include Canada, France, Germany, Italy, Japan, the UK and the US who collectively account for about 45 per cent of global GDP and 60 per cent net global wealth with only 10 per cent of the world's population no longer calls all the shots at international summits.

More interestingly to the surprise of the US and its close allies, Russia was proven to be not a busted flush as it was supposed to be and so much so that for a while Russia was even taken into the fold of the Club - the G7 and renamed it the G8. But in 2014 Russia was removed from the club after it annexed Crimea from Ukraine and now back to the G7 again. Yet the continued tendency in the US to dismiss Russia led to expand NATO eastward without taking into account Russia's re-emergence as a major military power and its security concerns. 

At the same time, Washington fundamentally outlined an economic policy prescription for developing countries -- that there was a one-size-fits-all kind of solution to the economic problems of all developing countries. It involved privatisation, removal of capital controls and fiscal austerity. But that has also now fallen into disrepute. Furthermore,  globalisation's focus on growth and competitiveness has also been criticised as a source of rising inequality and economic disruptions in developing countries.

The rules have been broken, but the game continues with the risk that current iteration of globalisation at a time when the US is asserting that economic security is national security may turn into deglobalisation. This could lead to enhanced economic rivalry which may also lead to military conflict. It is now clear that globalisation is at a crossroads amid the backdrop of geopolitical rivalry between the major powers.

The pandemic exposed the fragility of economic interdependence as reflected in supply chain disruptions, surging costs and shortages and now the Russia-Ukraine conflict impacting on commodity markets. Also, protectionism shows no sign of abating. Behind some protectionist measures is a shift in industrial policy, primarily led by the US towards security over efficiency in supply chains.

The US now faces an economic rival that is as large or very nearly as large since it overtook Great Britain in the 1870s to become the leading economy in the world. China's GDP soared from US$1.2 trillion in 2000 to US$17.7 trillion in 2021. GDP is an important indicator of economic power because it creates the substructure of power in relation to other nations. In fact, historically  GDP has exercised a very decisive role in shaping international relations.

China has also overtaken the US to become the principal trading partner of most nations in the world. While trade benefits both buyers and sellers but some benefit more than the others and thus creates a web of asymmetrical interdependence providing advantage to some over others. Also, China has established itself as the most essential link in the World's critical global supply chains.

The US dollar has long played an outsized role as the dominant reserve currency which is a crucial enabler for the US government to keep ballooning its public debt and run vast trade deficits. But according to the IMF, the US dollar's share of global foreign exchange reserve fell below 59 per cent in the first quarter of this year, extending a two-decade decline. Furthermore, the aggressive use of sanctions by the US threatens dollar hegemony as countries are mulling to develop alternative payment systems. In fact, time has come for the US to rethink of the use of sanctions as a weapon of economic warfare.

In summary, China is the largest trading nation, the second largest economy and with a population four times larger than that of the US  likely to surpass US GDP by 2040 or even earlier. Also, given the centrality of China in the global economy now, it remains at the heart of multilateral efforts surrounding global public goods like climate change, economic development and pandemic response.

China's rise over the past decades or so has reshaped the global landscape. There is a general consensus that the post-Cold unipolar moment has ended and that the US is in relative decline. Domestic factors also played a major role in this decline of the US. More importantly, Washington's strategy to set parameters for China's economic growth and its global economic engagement as it did so successfully with Japan and South Korea has failed. In fact, China is now not only wealthier but politically stable.

Nevertheless, despite calls for a "decoupling" of the two countries economies,  the overall US policy goal remains the same, which is to pursue a cooperative relationship with China while also maintaining US primacy in geo-political terms. In pursuing such a policy, the US anxiety about its relative decline is also driving its reflexive efforts to undermine China's rise and that underpins the US strategy to encircle China.

President Biden's recent visit to Asia was primarily focused on stepping up the US-led confrontation with China to economically weaken it. The New York Times commenting on the trip wrote "to demonstrate that the United States remained focused on countering China, even as his administration stage-managed a war against Russia in Europe".

In response China, to break Washington's encirclement strategy, is attempting to strengthening its ties with its neighbours, deepening relationship with Russia and encouraging the EU's continued movement towards strategic autonomy. The Chinese strategy to counter the US strategy to encircle China is also profoundly shaped by its perception of American power which has been outlined earlier.

The US-China rivalry, the Russia-Ukraine conflict, the Covid pandemic, increased volatility in financial markets and continuing threat of climate change have diminished the trust in the rule based global trading system. In fact, tensions over trade, technology and security have been growing for years undermining the current global system. As such increasingly countries are becoming inward looking which is likely to lead to the increased risk of geo-economic fragmentation. But it is the US economic sanctions that are having a very discernible effect on this fragmentation process because such sanctions also affect non-targeted countries and their international transactions and financial flows.

The likely outcome will be greater protectionism with highly localised manufacturing and value chains at the mercy of political or strategic rivalry. Increasing number of countries are restricting trade in food, energy and many other commodities. The US drive toward security over efficiency could also contribute to the fragmentation of global supply chains, especially goods considered to be strategically important.

The US dollar's centrality to the system of global payments increases the power of US financial sanctions. Also, the US and the EU removed Russian banks from SWIFT (Society for Worldwide Interbank Financial Telecommunications) which is the world's leading provider of a secure financial messaging service used to execute international transactions among banks. Therefore, countries to deal with US economic sanctions also develop parallel payment systems such as France, Germany and the UK developed an alternative, dollar free system to continue to trade with Iran in the wake of Trump imposed sanctions against Iran. In recent times Russia and China have reduced the use of dollar in their trade with each other and developed their own payment system. Russia also has introduced payments for its oil and gas in the Russian ruble. Such disconnected parallel payment systems further add to the fragmentation.

But it is to be noted that banning Russian banks from SWIFT poses significant risk for the global economy, in particular for the Global South because such a ban will disrupt energy supply and commodity exports to global markets, triggering further increases in energy and food prices. Therefore, the development of alternative global payment systems other than in the US dollar will be beneficial for countries in the Global South.

The overall impact of such a fragmentation is wide-ranging economic slowdown to stagnation. According to the IMF, global growth is projected to slow from an estimated 6.1 per cent in 2021 to 3.6 per cent in 2022 and 2023. Since the Russia-Ukraine conflict began, about 30 countries have restricted trade in food, energy and other important commodities. Food price inflation and supply shortages in many developing countries, particularly those with increasingly depreciating currencies with a heavy reliance on food imports will have a major impact on the purchasing power of the poorest households.

The US Federal Reserve's tightening of monetary policy is already impacting on the global economy. Rising interest rates bring economic stagnation while the fall in the value of domestic currencies vis-à-vis the US dollar increases debt burdens.

According to the World Bank President David Malpass 60 per cent of low-income countries are already in debt distress or at high risk of it. The Institute of International Finance which is the global association of the financial industry (with close to 450 members from 70 countries) have already warned that the global economy would at best flat-line this year with the recession risk elevated with a 'disorderly tightening of financial conditions' underway.

The geopolitical turbulence and the impact of Covid-19 and the resultant economic crises have turned countries’ attention inward leading to a more fragmented world. IMF chief economist Pierre-Olivier Gourinchas warns of a world fragmented into "distinct economic blocks with different ideologies, political systems, technology standards, cross-border payment, trade systems and reserve currencies".

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