IMF: Geopolitical Tensions Divide Global Economy into Three Blocs

Gita Gopinath, Deputy Managing Director of the International Monetary Fund, called for a renewed dialog between competing countries to stop dangerous processes that threaten the global economy

Gita Gopinath

The world economy has divided into three major blocs, two revolving around the USA and China, and the third consisting of non-aligned countries. This was stated by Gita Gopinath, First Deputy Managing Director of the International Monetary Fund (IMF), at a conference at the Stanford Institute for Economic Policy Research (SIEPR).

“After years of shocks – including the COVID-19 pandemic and Russia’s invasion of Ukraine – countries are reevaluating their trading partners based on economic and national security concerns. Foreign direct investment flows are also being re-directed along geopolitical lines. Some countries are reevaluating their heavy reliance on the dollar in their international transactions and reserve holdings,” Gopinath said.

“The fragmentation of the global economy is getting worse every year. Trade between China and the US is declining. Over the past six years, China’s share of US imports has fallen by 8%, and the US share of Chinese imports has fallen by 4% due to trade disputes,” Gopinath said. She recalled that trade exchange between Russia and the West “simply collapsed” after the Russian military operation in Ukraine and sanctions against Moscow.

Moreover, trade fragmentation is costing the world economy far more in the 21st century than it did during the Cold War. According to Gopinath, at that time, trade in goods accounted for only 16% of global GDP, but now that share has jumped to about 45%.

The role of the World Trade Organization must be restored

In her speech at the Stanford Institute, Gopinath also recalled that at the time, the world was dominated by a movement to abolish trade restrictions: “Now we are in an environment of growing protectionism,” the IMF economist said. At the moment, the situation is not entirely dramatic, as some neutral countries – most notably Mexico and Vietnam – play an important role as a “connector” between the United States and China, which was not the case when America’s main adversary was the Soviet Union. “Today, these countries have greater diplomatic heft and can help attenuate some of the costs of fragmentation,” Gopinath said, stressing that global fragmentation can reduce the positive effects of specialization, as well as limit competitiveness. “Less trade would also imply less knowledge diffusion, a key benefit of integration,” Gopinath said, pointing an accusatory finger at Brexit, the United Kingdom’s exit from the European Union.

Gopinath said fragmentation threatens a number of financial risks, including greater market volatility, higher vulnerability to shocks, and difficulty for a separate world to share risks. “In a mild scenario with low adjustment costs, losses could be as low as 0.2% of world GDP, while in an extreme trade fragmentation scenario with limited ability of economies to adjust, losses could be as high as 7 percent of global GDP,” the IMF Deputy Managing Director said.

In this context, Gopinath called on the international community to work towards “strengthening the multilateral and multipolar system to attenuate the fragmentation of world trade.” This process, paralyzed since 2019, requires the implementation of the World Trade Organization (WTO) dispute settlement mechanism.

According to Gopinath, countries around the world should strive to improve their systems for managing subsidies and trade restrictions, ostensibly dictated by national security concerns, and develop standards for the proper use of industrial policy. However, the foundation’s deputy director acknowledged that these are “complex measures.” First, some pragmatic steps need to be taken, including “keep open the lines of communication” between competing countries. “A renewed constructive dialogue between the U.S. and China can help prevent the worst outcomes from occurring,” she said, adding that “countries around the world must find areas where, despite tensions, they can still work together, from combating climate change to regulating digital commerce.”