The Turning Point of Trade: Avoiding a New Cold War

The fragmentation of trade as a result of various nations closing their markets to foster "friendshoring," security, and self-reliance has led us to an inflection point. Though appealing in the short term, if this behavior continues we could see a new cold war emerge, costing the world peace, security, and prosperity.

This is not the first time that geopolitical considerations have impacted global trade and capital flows. The two previous periods of global crisis and economic hardship were followed by a rise in nationalist and authoritarian leaders, resulting in a plunge into war. A bipolar world emerged with two superpowers, the United States and the Soviet Union, resulting in a Cold War marked by trade and investment flows shaped by geopolitical considerations. A period of globalization is when trade and investment flows were shaped by geopolitical considerations.

Today, threats to the free flow of capital and goods have intensified as geopolitical risks have grown. Around 3,000 trade-restricting measures were imposed in 2023, nearly triple the number imposed in 2019.

Though deglobalization is not yet occurring, there are signs of increased fragmentation. Amid slower global growth and the rotation of spending from goods to services, trade has slowed everywhere. However, trade between blocs has slowed much more than trade within blocs, and especially in strategic sectors.

Estimates of the economic costs of fragmentation vary and are highly uncertain. However, the International Monetary Fund (IMF) suggests that these costs could be large and weigh disproportionately on developing countries. For example, if the global economy were to fragment into two blocs based on the initial 2022 Ukraine resolution, and if trade between the two blocs were eliminated, estimated global losses would be about 2.5 percent of GDP.

There are three general principles to ensure that the world does not descend into its worst-case economic scenario. These are:

1. The first is to seek a multilateral approach at the very least for areas of common interest, such as guaranteeing the international flow of minerals critical for the clean energy transition, food commodities, and medical supplies. These are not lofty policy goals but are grounded in work currently being done.
2. If countries deem some reconfiguration of trade and FDI flows necessary, a nondiscriminatory, plurilateral approach can help them deepen integration, diversify, and build resilience.
3. Countries can restrict unilateral policy actions—such as industrial policies—to addressing externalities and market distortions. These policies should be time-bound.

Policymakers face difficult trade-offs between minimizing the costs of fragmentation and maximizing security and resilience. But at the same time, the three general principles can ensure the world does not descend into its worst-case economic scenario.