Rising geopolitical tensions are increasing fragmentation of the global financial system and pose a risk to both global prosperity and human progress, according to a report from the World Economic Forum.
The economic costs of global fragmentation could potentially be more than the Covid-19 pandemic, as well as the 2008 global financial crisis (GFC), according to the recently released World Economic Forum (WEF) report, entitled Navigating Global Financial System Fragmentation. The report has been developed in partnership with US management consulting firm Oliver Wyman.
This is mainly because of an increasing number of countries using worldwide trading and financial systems to strengthen their geopolitical positions, primarily through a mix of industrial policies, sanctions and other economic measures.
There has already been a 370% rise in sanctions since 2017, according to the London Stock Exchange Group (LSEG), along with a marked increase in the number of subsidies seen across the globe during this time.
Threat to global GDP from increased fragmentation
This has resulted in increasing fragmentation across the world. Global gross domestic product could potentially be cut by anywhere between $0.6 trillion and, in cases of very high fragmentation, up to $5.7tn (€5.47tn), or 5%, due to this.
Decreased cross-border capital flows and falling trade are expected to be the main drivers of this potential loss in GDP. A reduction in economic efficiency is likely to exacerbate this situation.
Similarly, worldwide inflation is estimated to grow by more than 5%, in cases of very high splitting.
However, the WEF report emphasises the importance of implementing economic statecraft that focuses on sustainable development, cooperation and resilience on a global level.
As a result, nationals are expected to be able to protect their sovereignty and national security in a more sustainable way, while also reducing the economic impact of fragmentation.
Matthew Blake, head of the World Economic Forum’s Centre for Financial and Monetary Systems, said in a press release: “The potential costs of fragmentation on the global economy are staggering. Leaders face a critical opportunity to safeguard the global financial system through principled approaches.”
How could fragmentation impact the global economy?
The effect of a break up on global GDP growth and inflation is heavily influenced by the policies implemented by individual country leaders.
In the worst fragmentation situation, there could be a complete economic separation of Eastern blocs, which could include Russia, China and more countries, and Western blocs, which could include the US and its allies.
However, in a lower fragmentation situation, trade flows and capital are only likely to be monitored closely in areas important to national competitiveness and security.
Model trade relations have outlined four potential fragmentation situations: low, moderate, high and very high.
In the low situation, the Western bloc could see a GDP fall of 0.6%, whereas in a medium fragmentation scenario, this may worsen to a decrease of 1.8%. In a high situation, the Western bloc may potentially see its GDP drop by 2.8%, while in the worst case scenario, it could plunge by 3.9%.
Coming to the Eastern bloc, in the low fragmentation situation, GDP could inch lower by 1.4%, while in the medium scenario, it could fall by 3.2%.
If there is a high fragmentation situation, the Eastern bloc GDP could potentially plummet by 4.6%.
However, in an extreme fragmentation situation, the Eastern bloc’s GDP is expected to fare somewhat better, with a fall of 3.5%.
Fragmentation restricts trade
In the worst scenario, countries which do not fall within either Eastern and Western blocs may be compelled to trade only with whichever bloc is most important to them economically.
This includes countries like Brazil, Turkey and India, along with other countries in southeast Asia, Latin America and Africa. These countries could potentially experience a GDP plunge of more than 10% in the very high fragmentation situation.
Matt Strahan, private markets lead at the World Economic Forum, said: “Fragmentation not only fuels inflation, but also negatively impacts economic growth prospects, particularly in emerging markets and developing economies that depend on an integrated financial system for their continued development.
“By protecting the integrity and functionality of the global financial system, including through ensuring that actors maintain their right to engage with counterparts across the geopolitical spectrum, leaders can deliver a more effective financial system for all stakeholders.”