## sdnea2023001 — Geoeconomic Fragmentation and the Future of Multilateralism

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### Key findings on geoeconomic fragmentation (GEF)
- After decades of increasing global economic integration, the world is facing the risk of fragmentation described as geoeconomic fragmentation (GEF).
- GEF is a policy-driven reversal of integration across trade, capital flows, migration, international payments, and multilateral cooperation to provide global public goods.
- Recent shocks and policy shifts contributing to fragmentation:
  - The post-GFC era has seen a leveling-off of global flows of goods and capital, and a surge in trade restrictions.
  - The COVID-19 pandemic and Russia’s invasion of Ukraine have increased skepticism about globalization.
  - National-security-motivated trade and capital restrictions surged in 2020 (IMF AREAER) and export restrictions on food and fertilizer were imposed by more than 30 countries in 2022.
- Aggregate and distributional consequences:
  - Unraveling trade links would most adversely impact low-income countries and less well-off consumers in advanced economies.
  - Restrictions on cross-border migration would reduce host economies’ skills and remittances for sender economies.
  - Reduced capital flows, especially FDI, would hinder financial deepening and technological diffusion in destination countries.
  - A decline in international cooperation would endanger provision of global public goods (climate, pandemic preparedness).

### Quantitative estimates and scenarios of economic costs
- Modeling estimates vary widely and depend on assumptions and adjustment costs.
- Reported illustrative ranges:
  - Cost to global output from trade fragmentation: 0.2 percent (limited fragmentation / low-cost adjustment scenario) up to 7 percent of GDP (severe fragmentation / high-cost adjustment scenario).
  - With technological decoupling, loss in output could reach 8 to 12 percent in some countries.
- Box 1 reported scenario ranges (percent of GDP):
  - Strategic decoupling: 0.2-1.0%
  - Trade frag. (trade fragmentation): 1.9-6.9%
  - Trade frag. + NTBs in other sectors: 0-4.5%
  - Decoupling only in electronic sector: 0.4-1.9%
  - Trade frag. + sectoral misallocation + lower knowledge diffusion: 0-8.5%
  - Full technological decoupling: 8-12%
- Specific study highlights preserved verbatim:
  - IMF (2022a): baseline output losses of about 1.2 percent of world GDP; with escalating NTBs losses rise to 1.5 percent; trade-intensive Asia-Pacific countries face losses of about 3.3 percent in the more severe scenario.
  - Bolhuis, Chen, and Kett: limited fragmentation scenarios reduce long-run output by 0.2 to 1 percent and by 1.9 to 6.9 percent globally in more severe scenarios.
  - Cerdeiro and others (2021): severe scenarios imply output losses on the scale of 8.5 percent for the most severely affected countries when accounting for all three layers of fragmentation.
  - Goes and Bekkers (2022): limited decoupling scenarios show losses as little as 0.4 percent of GDP for some countries; full technological decoupling shows losses as much as 12 percent for the most affected countries.
- Collective literature conclusions:
  - Depth of fragmentation matters; technological decoupling amplifies losses; EMs and LICs are most at risk; adjustment/transition costs are likely large; existing estimates omit several channels and are not upper-bounds.

### Transmission channels and amplification mechanisms
- Trade:
  - Trade has driven catch-up incomes, poverty reduction, productivity, and technology diffusion; GVCs expanded technology diffusion and reduced prices for consumers (benefiting low-income consumers in AEs).
  - Fragmentation would reduce trade-led income convergence, raise import prices, segment markets, and could produce temporary supply shortages and inflationary pressure during reconfiguration.
- Technology diffusion:
  - Openness fosters innovation, adoption, and skills; reduced knowledge diffusion under decoupling lowers productivity and raises long-term costs.
  - Domestic policies (targeted fiscal measures, retraining, infrastructure, labor market reforms, financial inclusion) are crucial to share gains from trade and technology.
- Labor flows:
  - Barriers to migration reduce host-country human capital and innovation, weaken diaspora networks, and reduce remittances — an important income stabilizer.
- Capital flows:
  - GEF could hinder cross-border capital flows and FDI, increasing capital misallocation and reducing multinational linkages and technology spillovers.
- Uncertainty and policy uncertainty:
  - Heightened uncertainty delays investment and R&D and raises precautionary savings. Examples cited include a 2-5 percent reduction in productivity of UK firms over three years after the Brexit referendum and a one percentage point decline in world trade growth during 2018-19 after increased trade policy uncertainty.
- Global public goods:
  - Reduced cooperation could impede climate mitigation and pandemic prevention; COVID-19 responses show benefits of cross-country cooperation (medical equipment, technology transmission).

### International Monetary System (IMS) and Global Financial Safety Net (GFSN) implications
- Financial globalization may give way to “financial regionalization,” reducing international risk-sharing, increasing macroeconomic volatility, and producing more severe crises.
- Payments and reserve implications:
  - Geopolitical actions (e.g., post-February 2022 SWIFT ban on key Russian banks) increase risk of payment system fragmentation and parallel systems with limited interoperability.
  - All G20 members are exploring a CBDC, with 16 already in development or at pilot stage.
  - The US dollar remains dominant; freezing of about USD 300 billion of the Russian Central Bank’s FX reserves may influence reserve management.
  - Central bank purchases of gold increased dramatically in Q3 2022: 399 tons in Q3 2022 vs. 119 tons quarterly average since 2010.
- GFSN structure and risks:
  - GFSN four layers: central banks’ FX reserves; central banks’ bilateral swap arrangements (BSAs); Regional Financing Arrangements (RFAs); and the IMF.
  - As of end-2021, BSAs and RFAs ($2.65 trillion) were much smaller than global reserves ($14.96 trillion).
  - GEF could reconfigure BSAs and RFAs along geopolitical lines, fragment liquidity provision, and challenge adequacy for large shocks.
  - Sovereign debt crisis resolution could become more challenging as creditor bases shift (Paris Club share declined since the 1990s; share of China, India, and other non-Paris Club creditors increased).

### Adjustment risks, distributional impacts, and self-insurance
- Aggregate costs and winners:
  - Fragmentation may produce strategic advantages for some countries in selected cases but is likely to involve significant aggregate economic costs: higher import prices, segmented markets, reduced access to technology and labor, lower productivity, and lower living standards.
- Debt reduction as self-insurance (Annex 1 illustrative simulation):
  - Sample: seventeen EMs.
  - Average reduction in the public debt-to-GDP ratio required to preserve risk exposure: about 3.4 percentage points over a five-year period.
  - Heterogeneity: for half the sample reduction is at most one percentage point; two-thirds up to 6 percentage points; top quartile between 6 and 15 percentage points.
  - Historical frequency: in the past 20 years the sample had 36 episodes (about 13 percent of all cases) where debt fell by at least 3.4 points of GDP during a five-year period; four countries account for ½ of the cases.
  - Synchronized deleveraging across several large EMs could have tangible global effects and be particularly painful under limited international risk sharing.

### Policy recommendations and pragmatic engagement framework
- Overarching goal:
  - Preserve benefits of globalization and multilateralism while addressing fairness and fitness of current rules-based systems.
- Three-pillar framework for engagement:
  - I. Areas of common interest: pursue multilateral approaches (examples: climate change mitigation, food security, pandemic preparedness).
  - II. Areas where multilateral negotiation stalls: pursue open and non-discriminatory plurilateral initiatives with safeguards.
  - III. Areas with unilateral actions: deploy credible “guardrails” (multilateral consultations, commonly agreed norms such as “safe corridors”).
- Guardrails components and examples:
  - Multilateral consultations with ex ante notification, explanation of rationale, discussion of cross-border spillovers, and exploration of alternatives.
  - Internationally agreed norms on “safe corridors” to ensure minimum cross-border flows of critical goods and services (example: exemption of World Food Program purchases from export restrictions).
  - Proposed consultation framework on subsidies: improved data sharing, deeper analysis of subsidy impacts and spillovers, and inter-governmental dialogue to develop rules on subsidy design and use.
- Strengthening institutions and data:
  - Focus multilateral reforms where preferences align; use plurilateral approaches for critical areas with safeguards; deepen RTAs to reduce trade costs and regulate frontier issues while supporting multilateral integration.
  - Data gaps identified: subsidies (no comprehensive data), local content requirements (partial), trade in services regulations (partial), competition laws (partial).
- Strengthening the IMS and GFSN:
  - Enhance crisis prevention and adjustment mechanisms, global cooperation on stability-affecting policies, and ensure a larger, more coherent GFSN.
  - Explore a new digital global cross-border payment system via multilateral or plurilateral cooperation embedding guardrails to mitigate capital flow risks.
  - Increase scrutiny of restrictions justified on security grounds and consider multilateral processes for assessment.
- Role of the IMF:
  - Convene members, bridge plurilateral initiatives or blocs, monitor and analyze global spillovers through surveillance, spearhead multilateral platforms for sharing information on strategic restrictions, provide evenhanded policy advice, lending, and capacity development.
  - IMF should remain representative of its global membership and at the core of a reinforced GFSN; completing the 16th General Review of Quotas noted as important.

### Key preserved statistics and data points
- Internet users reached nearly 66 percent of the world’s population in 2022.
- AEs (EU, Japan, the United Kingdom, and the United States) accounted for 74 percent of global GDP in 1995 and about 50 percent by 2019.
- China accounts for roughly one-third of the global manufacturing value added (based on World Bank data).
- Export bans accounted for about 90 percent of trade restrictions at the height of the COVID-19 pandemic.
- During 2022, export restrictions on food and fertilizer exports were imposed by more than 30 countries.
- Mentions of reshoring/near-shoring/onshoring in corporate presentations and calls increased significantly (figures and time series reported in original charts).
- Freezing of about USD 300 billion of the Russian Central Bank’s FX reserves cited as a factor influencing reserve management decisions.
- Central bank purchases of gold: 399 tons in Q3 2022 vs. 119 tons quarterly average since 2010.
- GFSN sizing as of end-2021: BSAs and RFAs ($2.65 trillion) versus global reserves ($14.96 trillion).
- Illustrative debt reduction result: average reduction about 3.4 percentage points of public debt-to-GDP over five years for a sample of seventeen EMs.
- Historical episodes: 36 episodes (about 13 percent of cases) where debt fell by at least 3.4 points of GDP during a five-year period; four countries account for ½ of the cases.

*Staff Discussion Notes — Geoeconomic Fragmentation and the Future of Multilateralism (sdnea2023001)*

### EXECUTIVE SUMMARY_______________________________________________________ 4

### EXECUTIVE SUMMARY

### Key findings
- After decades of increasing global economic integration, the world is facing the risk of fragmentation described as geoeconomic fragmentation (GEF).
- The post-GFC era has seen a leveling-off of global flows of goods and capital, and a surge in trade restrictions.
- The COVID-19 pandemic and Russia’s invasion of Ukraine have further tested international relations and increased skepticism about the benefits of globalization.
- GEF is a policy-driven reversal of integration across trade, capital flows, migration, international payments, and multilateral cooperation to provide global public goods.
- The benefits of globalization propagate through multiple channels; the adverse consequences of GEF would be felt in many areas including trade, migration, capital flows, technology diffusion, and provision of global public goods.
- The unraveling of trade links would most adversely impact low-income countries and less well-off consumers in advanced economies.
- Restrictions on cross-border migration would deprive host economies of valuable skills and reduce remittances in migrant-sending economies.
- Reduced capital flows, especially foreign direct investment (FDI), would hinder financial deepening and technological diffusion in destination countries.
- A decline in international cooperation would put at risk the provision of vital global public goods.

### Quantitative estimates and scenarios of economic costs
- Estimates of the costs of GEF from economic modeling vary widely and depend on modelling assumptions and adjustment costs.
- Depending on modeling assumptions, the cost to global output from trade fragmentation could range from 0.2 percent (in a limited fragmentation / low-cost adjustment scenario) to up to 7 percent of GDP (in a severe fragmentation / high-cost adjustment scenario).
- With the addition of technological decoupling, the loss in output could reach 8 to 12 percent in some countries.
- Available studies suggest:
  - the deeper the fragmentation, the deeper the costs;
  - technological decoupling significantly amplifies losses from trade restrictions;
  - adjustment costs are likely to be large;
  - emerging market economies and low-income countries are likely to be most at risk due to the loss of knowledge spillovers.
- More work is needed to assess and aggregate the costs through multiple channels.

### Implications for the international monetary system and global financial safety net
- GEF could strain the international monetary system (IMS) and the global financial safety net (GFSN).
- Financial globalization could give way to “financial regionalization” and a fragmented global payment system.
- With less international risk-sharing, GEF could lead to higher macroeconomic volatility, more severe crises, and greater pressures on national buffers.
- Facing fragmentation risks, countries may look to diversify away from traditional reserve assets — a process that could be accelerated by digitalization — potentially leading to higher financial volatility, at least during transition.
- By hampering international cooperation, GEF could weaken the capacity of the GFSN to support crisis countries and complicate the resolution of future sovereign debt crises.

### Drivers and definition of GEF
- GEF refers to policy-driven reversals in economic integration motivated by strategic considerations, national security objectives, efforts to enhance autonomy, strategic economic rivalry, or domestic policy objectives.
- GEF excludes fragmentation arising from autonomous shifts in preferences or technology and excludes prudential policies undertaken in an internationally coordinated manner.
- The motivation behind policies driving GEF varies and can include:
  - national strategic objectives such as security considerations or enhancing autonomy;
  - strategic economic rivalry among nations or groups of nations;
  - domestic policy objectives such as incentivizing domestic production or reacting to perceived unequal distribution of gains from trade.

### Adjustment risks and distributional impacts
- Fragmentation may produce strategic advantages for some countries in selected cases but is likely to involve significant aggregate economic costs.
- Costs include higher import prices, segmented markets, diminished access to technology and skilled and unskilled labor, reduced productivity, and lower living standards.
- GEF is likely to complicate multilateral cooperation in areas such as climate change mitigation and pandemic preparedness.

### A way forward: multilateralism, plurilateralism, and guardrails
- To avert runaway fragmentation, the rules-based multilateral system must adapt to the changing world, including the international trade and monetary systems.
- Given current geopolitical realities, progress through multilateral consensus may not always be possible; trust may need to be rebuilt gradually through differential engagements depending on countries’ preferences and willingness to work together.
- Where preferences are broadly aligned, multilateral cooperation remains the best approach to address global challenges (for example, climate change and pandemics).
- When multilateral efforts stall, open and non-discriminatory plurilateral initiatives (fewer countries wanting to do more) could be a practical way forward.
- When countries opt for unilateral actions, credible “guardrails” may be needed to mitigate global spillovers and protect the vulnerable (such as “safe corridors” for food and medicine).
- Addressing these challenges requires a joint effort of all international organizations, including the IMF.
- To be effective in a more shock-prone world, the IMF should remain representative of its global membership and at the core of the reinforced GFSN.

*Staff Discussion Notes — Geoeconomic Fragmentation and the Future of Multilateralism*

### Chapter 5 summarizes key takeaways, makes recommendations, and discusses some open questions

### Chapter 5 — Key takeaways, recommendations, and open questions

### The State of Global Economic Integration — Looking back and current structure
- Globalization measured by trade openness (sum of exports and imports of all countries relative to global GDP) has gone through distinct phases: Industrialization (1870–1914), Interwar era (1914–45), Bretton Woods era (1945–80), Liberalization (1980–2008), and “Slowbalization” (2008–21).
- Features of the current system shaped by the Liberalization era:
  - The network of linkages across countries has become highly complex: trade in services has grown dramatically over the past two decades; cross-border financial flows and cross-border movement of people and information have expanded; the number of internet users reached nearly 66 percent of the world’s population in 2022.
  - Supply chains are highly internationalized; trade in intermediate goods now slightly exceeds trade in final goods.
  - Production of many critical commodities is highly concentrated, creating fragility in global value chains (GVCs). Examples given:
    - The United States dominates the supply chain for oil and gas (upstream, refining, and consumption).
    - China is the dominant player in clean energy minerals.
  - Emerging market economies (EMs) have risen in importance:
    - The EU, Japan, the United Kingdom, and the United States accounted for 74 percent of global GDP in 1995 and about 50 percent by 2019.
    - China accounts for roughly one-third of global manufacturing value added (based on World Bank data).
    - Major EMs have become an increasing source of outward FDI.

### Signs of fragmentation and recent shocks
- Globalization slowed after the GFC; the slowdown differed across types of flows:
  - The bulk of the slowdown in cross-border capital flows was due to cross-border lending as banks deleveraged.
  - The slowdown in trade was partly cyclical (lower demand) and partly structural (changes in GVCs, including China’s growing production of intermediate goods replacing imported inputs).
  - Services trade held up well, aided by internet deployment and growth in cross-border services.
- Rising discontent with globalization:
  - Concerns stem from distributional effects, including the decline in the labor share of income and rising skill-related inequality; surging incomes among the top 1 percent have amplified concerns.
  - A 2021 Ipsos-World Economic Forum survey across 25 countries showed support for globalization and trade declined: half the respondents unsure of its benefits and a third advocating for trade barriers.
- Political and policy responses increasing fragmentation risks:
  - U.S.–China trade tensions in 2018 increased global trade policy uncertainty and contributed to paralysis of multilateral trade dispute mechanisms.
  - The COVID-19 pandemic and the war in Ukraine deepened strains:
    - At the height of the pandemic, export bans accounted for about 90 percent of trade restrictions.
    - During 2022, export restrictions on food and fertilizer exports were imposed by more than 30 countries.
  - Increased use of national-security-motivated trade and capital restrictions:
    - The IMF AREAER documents that restrictions motivated by national security considerations surged in 2020.
    - Global Trade Alert data show a rising number of trade restrictions, notably in high-tech sectors.
  - Recent policy examples that may raise fragmentation risks include the U.S. Inflation Reduction Act, the European “Chips Act,” “Made in China 2025,” and U.S. measures restricting sales to China of certain high-tech goods and activities of “US persons” supporting certain technologies in China.
- Firms’ responses:
  - Firms are increasingly focusing on supply-chain resilience; mentions of “reshoring,” “near-shoring,” and “onshoring” have increased significantly in company earnings calls and annual reports.
  - Evidence suggests supply-chain resilience to shocks is better built by diversifying across sources of inputs (IMF, 2022b), though firms may opt for reshoring or friend-shoring driven by policy incentives.

### Transmission channels of Geoeconomic Fragmentation (GEF)
- GEF impacts operate through changing patterns of trade, technology, labor, capital, and the provision of global public goods; these channels interact across national borders and geographic blocs and can be amplified by uncertainty.

Trade
- Historical benefits of trade:
  - Trade has been a catalyst for catch-up in incomes, reductions in global poverty, higher productivity, and faster technology diffusion (citations: Frankel and Romer 1999; Rodrik 2007; Dornbusch 1992; Dollar and Kraay 2004, 2002; Dollar 1992; Bhagwati and Srinivasan 2002).
  - GVCs have promoted technology diffusion across firm networks and pulled many countries closer to the technological frontier.
  - Trade liberalization reduced prices on imported inputs and consumer goods and disproportionately benefited low-income consumers in AEs (Jaravel and Sager 2019; Fajgelbaum and Khandelwal 2016).
- Distributional and environmental concerns:
  - Gains from trade have often been distributed unequally; in many AEs the labor share of income has fallen as gains accrued disproportionately to capital and skilled workers (IMF 2017a, 2017b).
  - GVCs have in some cases contributed to environmental deterioration (World Bank 2020b).
- Recent restrictive measures and costs:
  - Evidence from the 2018–2019 US-China trade dispute shows significant welfare costs of protective measures: tariffs were fully passed on to domestic consumers and importers via higher input costs; U.S. export growth was dampened and employment lowered.
  - Temporary U.S. trade barriers produced negligible long-term protection for industries but persistent negative effects on domestic employment in affected sectors.
- Potential costs of trade fragmentation:
  - Increased fragmentation would reduce economic opportunities, especially for developing economies; impede global poverty reduction; and lower living standards.
  - Reduced trade-led income convergence will have significant welfare costs for low-income countries (LICs); in AEs low-income consumers would be disproportionately harmed by higher prices.
  - A shift to near- or “friend”-shoring may reduce vulnerability to geopolitical developments and global shocks but involves sizable costs and disruptions as markets segment across national borders.
  - Transition periods could produce deep output losses, particularly in EMDEs with higher reliance on trade and thin buffers.
  - Reconfiguration of supply chains could create temporary supply shortages, push up commodity prices, and accelerate inflation.
  - Quantitative estimates of trade-fragmentation impacts vary widely depending on scope and scenario assumptions.

Technology diffusion
- Openness and knowledge diffusion:
  - Openness stimulates innovation via increased domestic competition, improved technology adoption, and knowledge transfer; it also enhances workforce skills (citations: Buera and Oberfield 2020; Branstetter, Glennon, and Jensen 2018; Bloom and others 2016).
  - The shared digital economy has extended the global technology frontier, built data intelligence, and boosted digital trade (Acemoglu, Robinson, and Verdier 2017; UNCTAD 2018b).
  - Diffusion of ideas facilitates innovation to address global challenges such as climate change (Barrett 2021).
- Distributional concerns from technological change:
  - Technological progress can disrupt existing processes and produce uneven distributional effects; automation and intangible capital use raise concerns for wages and employment, especially low-skilled workers.
  - Historical evidence suggests technological diffusion has overwhelmingly expanded productive capacity and living standards when accompanied by policies that facilitate sectoral reallocation (Aghion and others 2020; Artuc and others 2022).
- Policy implications noted in the literature:
  - Domestic policies—carefully targeted fiscal policies, job counseling and retraining, productive infrastructure investment, labor market reforms, and greater financial inclusion—are crucial to ensure gains from trade and technology diffusion are shared more broadly.

### Key statistics and data points (preserved exactly as in source)
- Internet users reached nearly 66 percent of the world’s population in 2022.
- AEs (EU, Japan, the United Kingdom, and the United States) accounted for 74 percent of global GDP in 1995 and about 50 percent by 2019.
- China accounts for roughly one-third of the global manufacturing value added (based on World Bank data).
- Export bans accounted for about 90 percent of trade restrictions at the height of the COVID-19 pandemic.
- During 2022, export restrictions on food and fertilizer exports were imposed by more than 30 countries.
- Mentions of reshoring/near-shoring/onshoring in corporate presentations and calls increased significantly (figures and time series reported in original charts).

### Policy-relevant findings and implications (from the chapter)
- The existing complex global economic network delivers large aggregate gains from trade and technology diffusion but also creates vulnerabilities via concentration of production and interconnected financial and trade networks.
- Rising geopolitical tensions, policy responses motivated by national security or economic security, and firm-level adjustments (reshoring, friend-shoring) risk fragmenting trade and technology flows, with adverse aggregate and distributional consequences.
- Mitigating adverse distributional effects of integration or fragmentation hinges on domestic policies: targeted fiscal measures, retraining and job-transition support, infrastructure investment, labor market reforms, and financial inclusion.
- Supply-chain resilience is better achieved through diversification across sources of inputs (IMF, 2022b) rather than solely through reshoring measures that may be costly and disruptive.
- Quantitative impacts of fragmentation are scenario-dependent and vary widely; transition dynamics matter and could produce particularly deep output losses during reconfiguration.

*Staff Discussion Note: Geoeconomic Fragmentation and the Future of Multilateralism — Chapter 5 summary*

### Box 1. Quantitative Estimates of Output Losses from GEF

### Box 1. Quantitative Estimates of Output Losses from GEF

### Overview
- Recent studies show that GEF is likely to be costly.
- Due to the recent nature of fragmentation, there remains limited work on the quantitative costs of fragmentation and most analyses focuses on modeling exercises as opposed to empirical estimation.
- The box summarizes and compares four such studies which all find significant costs to fragmentation despite different assumptions and methodology.
- The papers focus primarily on trade and technology barriers, with a variety of assumptions regarding trade restrictions as well as technological decoupling in some cases.
- Box Figure 1.1 summarizes the main results from the four papers considered, showcasing the long-term GDP losses for two scenarios in each paper, although the papers look at different regions so results cannot be directly compared across papers.

### IMF (2022a) — Key findings
- Looks at the effect of elimination of trade in high-tech manufacturing and energy across rival blocs.
- Countries are assigned to different blocs depending on how they voted on the motion to condemn Russia’s invasion of Ukraine at the United Nations General Assembly (UNGA) in March.
- Baseline results suggest sizeable output losses of about 1.2 percent of world GDP.
- When escalating non-tariff barriers (NTBs) in other sectors are added, the losses rise to 1.5 percent.
- Trade-intensive countries in the Asia-Pacific region are disproportionately affected, with losses of about 3.3 percent in the more severe scenario.

### Bolhuis, Chen, and Kett (forthcoming) — Key elements
- Construct a new dataset of production and trade in a large number of sectors, with particular emphasis on commodities, that underpins the modelling of two scenarios.
- A limited fragmentation scenario looks at partial trade restrictions between different blocs while a more severe fragmentation scenario features two rival blocs with zero inter-bloc trade.
- Depending on trade elasticities, which determine the cost of adjustment, long-run output is reduced by

*Source: Box 1. Quantitative Estimates of Output Losses from GEF (sdnea2023001).*

### 0.2 to 1 percent and by 1.9 to 6.9 percent globally in these scenarios with greater restrictions again

### sdnea2023001 - 0.2 to 1 percent and by 1.9 to 6.9 percent globally in these scenarios with greater restrictions again

### Estimates and scenarios of losses from geoeconomic fragmentation
- Reported estimated loss ranges in Box Figure 1.1 (percent of GDP):
  - Strategic decoupling: 0.2-1.0%
  - Trade frag. (trade fragmentation): 1.9-6.9%
  - Trade frag. + NTBs in other sectors: 0-4.5%
  - Decoupling only in electronic sector: 0.4-1.9%
  - Trade frag. + sectoral misallocation + lower knowledge diffusion: 0-8.5%
  - Trade frag. + sectoral misallocation + NTBs in other sectors: (upper-bound depicted)
  - Full technological decoupling: 8-12%
- Specific study findings preserved verbatim:
  - Cerdeiro and others (2021): mild scenarios show limited global losses; severe scenarios imply output losses on the scale of 8.5 percent for the most severely affected countries when accounting for all three layers of fragmentation.
  - Goes and Bekkers (2022): limited decoupling scenarios show losses as little as 0.4 percent of GDP for some countries; full technological decoupling shows losses as much as 12 percent for the most affected countries.
- Note: Numbers refer to GDP losses that are not directly comparable across papers as some refer to global GDP while others refer to specific regions or countries. Numbers in brackets represent ranges of losses based on assumptions about the severity of fragmentation and trade elasticities, and /or geographical ranges.

### Key collective findings from the literature
- Depth of fragmentation matters:
  - Costs rise with deeper fragmentation and with scenarios that place more barriers and fewer trading choices on countries.
  - Example: losses increase when NTBs broaden from select sectors to all goods sectors.
  - Example: losses increase if third-party countries are forced to trade exclusively with one dominant bloc rather than with multiple blocs.
- Technological decoupling amplifies trade effects:
  - Reduced knowledge diffusion is a powerful amplifier because productivity depends on access to technologies, knowledge, and processes.
  - Papers that model dynamic effects of technological decoupling find larger impacts than those modeling only trade barriers.
- Emerging Markets (EMs) and Low-Income Countries (LICs) are most at risk:
  - EMs and LICs lose disproportionately when access to embodied technology and R&D is lost, as they are further from the technological frontier.
- Transition costs are likely large:
  - Short-run elasticities of substitution in trade are considerably smaller than long-run elasticities; short-term costs can be much greater than long-term costs.
  - Productivity losses from less knowledge diffusion could take time to accumulate, increasing long-term costs of technological decoupling.
- Estimates are not upper-bounds:
  - Available studies omit several GEF transmission channels (reductions in labor and capital flows, deterioration in global public goods provision).
  - Interactions among channels and political economy factors (outsized retaliation, policy uncertainty) could multiply potential losses.

### Other channels amplifying GEF impacts
- Labor flows:
  - Rising barriers to cross-border labor flows could reduce efficiency, hinder innovation and technological diffusion, and worsen adverse demographic trends.
  - Reduction in skilled migration would reduce effective human capital stock in host countries and stifle innovation; loss of diaspora network effects would reduce cross-border diffusion of technology.
  - Less emigration would tend to reduce remittance flows, an important source of income stabilization.
- Capital flows:
  - GEF could hinder cross-border capital flows, reducing options for external financing and impeding economic development.
  - Retrenchment in FDI flows likely to increase capital misallocation, reduce multinational linkages and technology spillovers.
  - Volatile capital flows can be beneficial if risks are mitigated by robust macroeconomic frameworks; introduction of new barriers would fragment capital markets and reduce financing choices.
- Uncertainty and policy uncertainty:
  - GEF likely to lead to heightened uncertainty, delaying investment, weighing on productivity and R&D, increasing precautionary savings and demand for risk-free assets.
  - Estimates of policy uncertainty effects cited: 2-5 percent reduction in productivity of UK firms over three years after Brexit referendum; one percentage point decline in world trade growth during 2018-19 after increased trade policy uncertainty.
- Global public goods:
  - Lack of international cooperation could impede provision of global public goods (climate mitigation, pandemic prevention, regulatory practices, scientific sharing).
  - Successful aspects of the COVID-19 response (cross-country access, technology transmission, trade in medical equipment) illustrate benefits of cooperation.

### International Monetary System (IMS) implications
- Core IMS objectives reiterated:
  - (1) facilitating international risk sharing through effective oversight of capital flows;
  - (2) promoting smooth global adjustment to shocks, crisis prevention, and resolution;
  - (3) ensuring sufficient global liquidity and robustness of the GFSN.
- International risk sharing:
  - Financial integration has yielded welfare gains via greater international risk sharing but can create new cross-border risk channels.
  - Under GEF, financial globalization could evolve into “financial regionalization,” reducing diversification and consumption smoothing; shocks may be more correlated within blocs.
  - Reduced international risk-sharing could lead to greater domestic macroeconomic volatility and higher crisis severity.
- Crisis prevention, mitigation, and resolution:
  - Early stages of GEF: macro-economic volatility, swings in cross-border financing, and policy uncertainty likely to raise crisis risks for vulnerable countries.
  - In a fragmented steady state, crises could be less frequent but more severe due to lower risk-sharing, higher financing costs, reduced policy coordination, and fragmented global liquidity backstops.
  - Sovereign debt crisis resolution may become more challenging as creditor bases shift (Paris Club share declined since the 1990s; share of China, India, and other non-Paris Club creditors increased).
- Global payment system and digital money:
  - Geopolitical events (e.g., post-February 2022 SWIFT ban on key Russian banks) increase risk of payment system fragmentation and emergence of parallel systems with limited interoperability, raising transaction costs.
  - All G20 members are exploring a central bank digital currency (CBDC), with 16 already in development or at pilot stage; diversity in technology could increase fragmentation in regulation/supervision.
  - Fragmented payment systems could reinforce GEF via trade and capital flow effects.
- Global reserves and currency configuration:
  - US dollar remains dominant; freezing of about USD 300 billion of the Russian Central Bank’s FX reserves is likely to influence reserve management for countries without friendly relations with the US and Europe.
  - GEF could shift transactional demand and invoicing away from the US dollar as trade reroutes toward geopolitically aligned partners.
  - Over time, GEF could induce shifts in FX reserve composition, but significant moves require viable alternatives to dominant currencies; central bank purchases of gold increased dramatically in Q3 2022 (399 tons in Q3 2022 vs. 119 tons quarterly average since 2010).
- Global Financial Safety Net (GFSN):
  - GFSN four layers: central banks’ FX reserves; central banks’ bilateral swap arrangements (BSAs); Regional Financing Arrangements (RFAs); and the IMF.
  - As of end-2021, BSAs and RFAs ($2.65 trillion) were much smaller than global reserves ($14.96 trillion).
  - GEF could reconfigure BSAs and RFAs along geopolitical lines, increasing fragmentation of liquidity provision and possibly causing disruptions in the near term.
  - Bloc-specific pooling of resources may lead to inadequate supply of liquidity for large shocks; heterogeneity in oversight could test RFAs’ response capacity.
  - GEF could increase demand for GFSN resources through transition risks: capital flow volatility, bank disintermediation, higher incidence of currency substitution.
  - Multilateral institutions dominated by blocs may lose perceived neutrality, credibility, and legitimacy, hampering coordinated responses.

### A way forward — pragmatic, multipronged approach
- Overarching principles:
  - Preserve benefits of globalization and multilateralism while recognizing concerns about fairness and fitness of current rules-based system.
  - Rebuild trust through different types of engagement depending on alignment of countries’ preferences (three-pillar framework).
- Three pillars of engagement (Figure 16):
  - I. Areas of common interest: use multilateral approaches (examples: climate change mitigation, food security, pandemic preparedness).
  - II. Areas where preferences are not aligned and multilateral negotiation stalls: use open and non-discriminatory plurilateral initiatives with safeguards.
  - III. Areas with unilateral actions: deploy credible “guardrails” (multilateral consultations, commonly agreed norms such as “safe corridors”).
- Guardrails — components and examples:
  - Multilateral consultations with ex ante notification, explanation of rationale, discussion of cross-border spillovers, and exploration of alternatives.
  - Internationally agreed norms on “safe corridors” to ensure minimum cross-border flows of critical goods and services (example: exemption of World Food Program purchases from export restrictions).
  - Proposed consultation framework on subsidies with (1) improved data and information sharing, (2) deeper analysis of subsidy economic impacts and spillovers, (3) inter-governmental dialogue to develop rules on subsidy design and use.
- Data gaps and measurement issues:
  - Coverage and data availability vary by measure (selected examples):
    - Tariffs: yes (World Integrated Trade Solution)
    - Non-tariff barriers: World Integrated Trade Solution
    - Capital Flow Management Measures: yes (IMF's Annual Report on Exchange Arrangements and Exchange Restrictions)
    - Subsidies: no (WTO, IMF, OECD, GTA)
    - Local content requirements: partial (Peterson Institute, Global Trade Alert, European Commission, USTR, World Bank)
    - Trade in services regulations: partial (OECD Services Trade Restrictiveness Index, World Bank Services Trade Restrictions Database)
    - Competition laws: partial (George Washington University's World Competition Database)
- Strengthening the global trade system:
  - Focus on selected high-impact multilateral reforms where preferences align to rebuild trust.
  - Use plurilateral approaches for critical areas where coordination is currently infeasible, with safeguards to ensure openness and non-discrimination.
  - Deep Regional Trade Agreements (RTAs) can help reduce trade costs and regulate frontier issues while supporting multilateral integration.
- Strengthening the IMS:
  - Enhance mechanisms for crisis prevention and adjustment, global cooperation on stability-affecting policies, and ensure larger, more coherent GFSN.
  - Explore a new digital global cross-border payment system via multilateral or plurilateral cooperation, embedding “guardrails” in system design to mitigate capital flow risks.
  - Greater scrutiny of current and financial account restrictions justified on security grounds; existing multilateral processes may be insufficient.
- Role of the IMF:
  - Convene members to discuss common approaches; bridge between plurilateral initiatives or blocs; monitor and analyze global spillovers through surveillance.
  - Spearhead multilateral platforms for sharing information on cross-border restrictions motivated by strategic considerations, analyze spillovers, and support deliberations.
  - Support members with evenhanded policy advice, lending, and capacity development; remain representative and adequately resourced (noting importance of completing the 16th General Review of Quotas).

*STAFF DISCUSSION NOTES Geoeconomic Fragmentation and the Future of Multilateralism, INTERNATIONAL MONETARY FUND*

### Annex 1. Debt Reduction as Self-insurance

### Annex 1. Debt Reduction as Self-insurance

### Context and approach
- In a more shock-prone world, policy makers may choose to self-insure by reducing public debt due to higher uncertainty and/or reduced capacity of the GFSN to effectively insure against shocks if international payment systems, swaps lines, or IMF’s lending operations are impaired.
- Illustrative shocks are applied to the IMF Debt Sustainability Analysis (DSA) framework.
- The uncertainty shock is calibrated as one-half the standard deviation of either the World Uncertainty Index or the Geopolitical Risks Index to avoid possible non-linearities at larger shocks.
- Higher uncertainty is modeled in the DSA by scaling up the variance-covariance matrix of debt drivers (primary balance, growth, interest rate, and exchange rate) in each country’s latest Article IV report by the assumed shock and a new distribution of debt paths is computed.
- Risk exposure is estimated before and after the shock as the difference between debt under the baseline and at a given percentile. For illustrative purposes the debt path at the 75th percentile is used as reference.

### Illustrative simulation findings
- The simulations show a substantial debt reduction is required to preserve countries’ current level of risk exposure.
- Sample and central outcome:
  - Sample: seventeen EMs.
  - Average reduction in the public debt-to-GDP ratio: about 3.4 percentage points over a five-year period.
- Heterogeneity across countries:
  - For half of the sample, the reduction in debt is at most one percentage point.
  - For two-thirds of the sample, the debt reduction is up to 6 percentage points.
  - Countries in the top quartile display a debt reduction between 6 and 15 percentage points.
- Historical frequency and concentration:
  - During the past 20 years, countries in the sample had only 36 episodes (or about 13 percent of all cases) where debt fell by at least 3.4 points of GDP during a five-year period.
  - Four countries account for ½ of the cases.

### Implications and risks of large-scale deleveraging
- Large and rapid debt reductions—especially if they occur simultaneously in several countries—could affect the global economy.
- A synchronized debt reduction by several large EMs would likely have a tangible impact on the global economy.
- While lower debt may be positive for some countries, a forced synchronized deleveraging would have implications for future output and social protection and would be particularly painful in the context of limited international risk sharing.

*Prepared by Tohid Atashbar and Sergio Rodriguez — IMF staff calculations.*

### References

### sdnea2023001 - References

### Major thematic clusters in the references
- Global trade, trade policy, and value chains
  - Baier, Scott, and Jeffrey Bergstrand. 2001. “The Growth of World Trade: Tariffs, Transport Costs, and Income Similarity.” Journal of International Economics 53 (1): 1–27.
  - Handley, Kyle, Kamal, Fariha, and Ryan Monarch. 2020. “Rising Import Tariffs, Falling Export Growth: When Modern Supply Chains Meet Old-Style Protectionism.” NBER Working Paper Series No. 26611.
  - Mattoo, Aaditya, Alen Mulabdic, and Michele Ruta. 2022. Trade Creation and Trade Diversion in Deep Agreements. Canadian Journal of Economics/Revue canadienne d'économique 55: 1598–637.
  - Fajgelbaum, Pablo D., and Amit K. Khandelwal. 2016. “Measuring the Unequal Gains from Trade.” Quarterly Journal of Economics 131 (3): 1113–80.

- Geoeconomic fragmentation, decoupling, and protectionism
  - Cerdeiro, Diego A, Johannes Eugster, Dirk Muir, and Shanaka Peiris. 2021. "Sizing Up the Effects of Technological Decoupling.” IMF Working Paper 2021/069.
  - Gacia-Macia, David and Rishi Goyal. 2020. “Technological and Economic Decoupling in the Cyber Era”. IMF Working Paper No. 2020/257.
  - Barattieri, Alessandro, and Matteo Cacciatore. Forthcoming. “Self-Harming Trade Policy? Protectionism and Production Networks.” American Economic Journal: Macroeconomics.
  - Evenett, Simon J., and Johannes Fritz. 2021. “The 28th Global Trade Alert Report: Subsidies and Market Access: Towards an Inventory of Corporate Subsidies by China, the European Union and the United States.” Global Trade Alert.

- International monetary and financial integration; reserve currencies; payments
  - Arslanalp, Serkan, Barry Eichengreen, and Chima Simpson-Bell. 2022. “The Stealth Erosion of Dollar Dominance and the Rise of Nontraditional Reserve Currencies.” Journal of International Economics 138: 103655.
  - Bank for International Settlements (BIS). 2021. “Central Bank Digital Currencies for Cross-Border Payments. Report to the G20.” Joint report, BIS Innovation Hub, IMF, World Bank.
  - International Monetary Fund (IMF). 2011. “Strengthening the International Monetary System: Taking Stock and Looking Ahead.” IMF Policy Paper, Washington, DC.
  - Perks, Michael, Yudong Rao, Jongsoon Shin, and Kiichi Tokuoka. 2021. “Evolution of Bilateral Swap Lines.” IMF Working Paper No. 2021/210.

- Technology, automation, and innovation diffusion
  - Acemoglu, Daron, and Pascual Restrepo. 2020. “Robots and Jobs: Evidence from US Labor Markets.” Journal of Political Economy 128 (6): 2188–44.
  - Bloom, Nicholas, Mirko Draca, John Van Reenen. 2016. “Trade Induced Technical Change? The Impact of Chinese Imports on Innovation, IT and Productivity”. The Review of Economic Studies, 83(1): 87–117.
  - Amiti, Mary, Stephen J. Redding, and David E. Weinstein. 2019. "The Impact of the 2018 Tariffs on Prices and Welfare." Journal of Economic Perspectives 33 (4): 187–210.
  - Agarwal, Ruchir, and Patrick Gaule P. 2022. “What Drives Innovation? Lessons from COVID-19 R&D.” Journal of Health Economics 82: 102591.

- Risk sharing, capital flows, and crisis/financial history
  - Bracke, Thierry, and Martin Schmitz. 2011. “Channels of International Risk-Sharing: Capital Gains versus Income Flows.” International Economics and Economic Policy 8: 45–78.
  - Kose, M. Ayhan, Eswar S. Prasad, and Marco E. Terrones. 2009. “Does Financial Globalization Promote Risk Sharing?” Journal of Development Economics 89 (2): 258–70.
  - Reinhart, Carmen M., and Kenneth S. Rogoff. 2008. “This Time is Different: A Panoramic View of Eight Centuries of Financial Crises.” NBER Working Paper Series No. 13882.
  - Laeven, Luc, and Fabian Valencia. 2018. “Systemic Banking Crises Revisited.” IMF Working Paper no. 2018/206.

- Migration, labor markets, and remittances
  - Clemens, Michael A., Ethan G. Lewis, and Hannah M. Postel. 2018. "Immigration Restrictions as Active Labor Market Policy: Evidence from the Mexican Bracero Exclusion." American Economic Review 108 (6): 1468–87.
  - Abramitzky, Ran, Philipp Ager, Leah Boustan, Elior Cohen, and Casper W. Hansen. Forthcoming. “The Effect of Immigration Restrictions on Local Labor Markets: Lessons from the 1920s Border Closure.” American Economic Journal: Applied Economics.
  - Balli, F., and F. Rana, 2015. “Determinants of Risk Sharing Through Remittances.” Journal of Banking & Finance 55: 107–16.

- Climate policy, green energy supply chains, and international diffusion of mitigation policies
  - Barrett, Philip. 2021. “Can International Technological Diffusion Substitute for Coordinated Global Policies to Mitigate Climate Change?.” IMF Working Paper No. 2021/173.
  - Leruth, Luc, Adnan Mazarei, Pierre Régibeau, and Luc Renneboog. 2022. “Green Energy Depends on Critical Minerals. Who Controls the Supply Chains?” Peterson Institute for International Economics Working Paper 22-12.
  - Linsenmeier, Manuel, Adil Mohommad, and Gregor Schwerhoff. 2022. “The International Diffusion of Policies for Climate Change Mitigation.” IMF Working Paper No. 2022/115.

- Institutions, multilateralism, and WTO/agreements
  - Hoekman, Bernard M., and Petros C. Mavroidis. 2015. “ WTO ‘À La Carte’ or ‘Menu Du Jour’? Assessing the Case for More Plurilateral Agreements.” European Journal of International Law 26 (2): 319–43.
  - Hoekman, Bernard M., Petros C. Mavroidis, and Douglas R. Nelson. 2022. “Geopolitical Competition, Globalization and WTO Reform.” Unpublished, European University Institute.
  - Irwin, D., Mavroidis, P., and Sykes, A. 2008. The Genesis of the GATT. Cambridge, UK: Cambridge University Press.

### Representative IMF and multilateral contributions cited
- IMF policy papers and staff notes
  - International Monetary Fund (IMF). 2016a. “Strengthening the International Monetary System: A Stocktaking.” IMF Policy Paper.
  - International Monetary Fund (IMF). 2016b. “Adequacy of the Global Financial Safety Net,” IMF Policy Paper.
  - International Monetary Fund (IMF). 2020a. “Toward an Integrated Policy Framework.” IMF Policy Paper.
  - International Monetary Fund (IMF). 2021. “The Rise of Public and Private Digital Money – A Strategy to Continue to Deliber on the IMF’s Mandate.” Policy Paper No. 2021/055.

- Joint reports and G20-related outputs
  - Bank for International Settlements (BIS). 2022. ”Options for Access to and Interoperability of CBDCs for Cross-Border Payments. Report to the G20.” Joint report, Bank for International Settlements, BIS Innovation Hub, IMF, World Bank.
  - Financial Stability Board (FSB). 2020. “G20 Roadmap for Enhancing Cross-Border Payments: Priorities for the Next Phase of Work.”

### Cross-cutting methodological and empirical approaches represented
- Use of working papers and NBER series for macro, trade, and financial history analysis (examples: NBER Working Paper Series No. 27997; NBER Working Paper Series No. 26218; NBER Working Paper Series No. 24453).
- Empirical case studies and natural experiments (examples: Feyrer 2019; Feyrer 2021; Clemens et al. 2018).
- Modeling and conceptual frameworks for policy coordination, international risk sharing, and integrated policy frameworks (examples: Adam, Subacchi, and Vines 2012; Basu et al. 2020; Obstfeld 1994a and 1994b).

*Geoeconomic Fragmentation and the Future of the Multilateralism — Staff Discussion Note No. SDN/2023/001 — References*

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_Source: https://www.imf.org/-/media/files/publications/sdn/2023/english/sdnea2023001.pdf_