Geopolitical Fragmentation: Navigating Global Economic Divides

October 10 2024 Nada Bedir

Blog,Economics

Navigating Geopolitical Divides: An Overview

Geopolitical fragmentation refers to the increasing division and divergence in political, economic, and social policies and actions among countries and regions worldwide. This fragmentation can manifest in various forms, including trade disputes, regional conflicts, sanctions, and divergent policy directions on international platforms.

Table of Contents

In recent years, the pace of globalization has slowed, a direct result of geopolitical fragmentation, a phenomenon often called “slowbalization.” This shift, which began after the global financial crisis, has reversed decades of expanding cross-border flows of goods, services, and capital that had been ongoing since the mid-20th century.

This trend was already in motion before the Covid-19 pandemic and the war in Ukraine, but both events have further strained international relations and contributed to the diversion of capital flows.

Geopolitical fragmentation poses significant risks to the global economy, potentially driving inflation and disrupting supply chains. This article explores how geopolitical fragmentation is manifested through trade wars and military conflicts, prompting countries to implement various mitigation strategies, such as supply chain adjustments and trade protectionism, to navigate the resulting economic disruptions and maintain stability in an increasingly fractured global landscape.

Geopolitical Fragmentation Manifestations

The world has recently witnessed three major manifestations of geopolitical fragmentation:

Trade Barriers

The U.S.-China trade war, which began in January 2018, is a significant economic conflict characterized by the imposition of trade barriers between the two largest economies in the world. China, which became the world’s largest exporter over a decade ago, surpassed the U.S. as the largest economy in purchasing power parity terms around 2016. Concurrently, the decline in U.S. manufacturing jobs, partly due to rising Chinese imports, has fueled growing dissatisfaction with globalization and altered American perceptions of China. In 2018 and 2019, the Trump administration levied tariffs on a wide range of products worth about $380 billion, marking one of the largest tax increases in recent decades. In continuation, the Biden administration has largely maintained these tariffs and, in May 2024, introduced increases on an additional $18 billion of Chinese goods, including steel and aluminum, semiconductors, electric vehicles, and rare earth metals. In response, China quickly retaliated by initiating an anti-dumping investigation into chemical imports from the U.S., European Union, Japan, and Taiwan.

Sanctions

Another manifestation of geopolitical fragmentation are the sanctions imposed on Russia following its invasion of Ukraine which have significantly disrupted global trade, fueled energy & food inflation, weakened the currencies for import-reliant countries and impacted economic stability worldwide. This has resulted in a global economic slowdown, with many countries, especially in Europe, facing recession risks due to energy shortages and rising costs of living. Additionally, the geopolitical landscape has prompted shifts in trade patterns and investment strategies as nations seek alternatives to Russian supplies, highlighting the far-reaching consequences of the sanctions on the international economy. In addition, Russia’s exclusion from SWIFT has led some nations to consider diversifying away from the US dollar and euro, potentially favoring currencies like the Chinese Renminbi, Russian Ruble, or Indian Rupee for international trade. This had an impact on the US dollar index & global trade prices.

Disrupting Maritime Routes

More recently, the recent geopolitical tension in the MENA region that escalated in October 2023, has significantly contributed to geopolitical fragmentation, resulting in severe disruptions to global trade. From December 2023 up to mid-February 2024, the conflict has caused a significant rise in attacks on commercial shipping in the Red Sea, leading to a decline of approximately 90% in container shipping. This disruption is particularly concerning as the Red Sea is a crucial maritime route, facilitating about 12% of global trade and 30% of container traffic. As a result, businesses are facing higher logistics costs, which are likely to be passed on to consumers, further exacerbating inflationary pressures in the global economy.

Mitigating the Impact of Geopolitical Fragmentation

To effectively address the challenges and overcome the negative economic consequences posed by geopolitical fragmentation, countries have implemented various mitigation strategies as follows:

Supply Chain Rerouting

The war in Ukraine has severely affected long-standing containership routes in the Black Sea, forcing companies to seek alternative shipping methods through land or sea with neighboring countries like Poland, Romania, Turkey, and Bulgaria. Similarly, drone and missile attacks by Houthi rebels on vessels in the Red Sea have led to significant disruptions along major containership routes connecting Asia and Europe. As a result, many ships that would typically transit through the Suez Canal are now being rerouted around the Cape of Good Hope, despite the longer journey time and higher shipping costs.

Nearshoring, Friendshoring, and Reshoring

Companies are increasingly adopting nearshoring, friendshoring, and reshoring as essential strategies to manage supply chain risks. In nearshoring, companies move production closer to their primary markets to reduce transportation costs and geopolitical risks. For example, Foxconn Technology Group, a Taiwanese multinational electronics contract manufacturer, is expanding its manufacturing operations in Mexico to have easier access to the US market amid the on-going trade war.

Friendshoring is an increasingly popular trade approach that prioritizes supply chain networks in nations viewed as political and economic partners. For example, Apple, the tech giant, has recently taken steps towards friendshoring by shifting part of its iPhone production from China to India. Currently, only 5% of Apple’s products are manufactured outside China, but a recent analysis by JP Morgan suggests that this figure could increase to 25% by 2025.

As for reshoring or onshoring, these strategies involve relocating offshore production back to the company’s domestic market. An example of onshoring can be seen with Intel’s investment of over $100 billion over 5 years in the U.S. to expand chipmaking capacity and capabilities in Arizona, New Mexico, Oregon and Ohio. This significant move will enable Intel to produce the world’s most advanced chips domestically, reducing reliance on foreign suppliers and strengthening the U.S. semiconductor supply chain.

Rise in Trade Protectionism

Trade protectionism is a manifestation & a mitigation strategy for geopolitical fragmentation. Trade protectionism encompasses government policies designed to create barriers such as tariffs, import quotas, and subsidies that make imported goods more expensive or less accessible compared to local products. For example, The Indian government has levied high tariffs on various imported goods, particularly in the information and communication technology (ICT) sector, with duties ranging from 7.55% to 20% on products like mobile phones and integrated circuits since 2014. This has led to disputes with the EU at the World Trade Organization (WTO), where the EU argues that these tariffs hinder its exports and violate global trade norms.

A further illustration is the Carbon Border Adjustment Mechanism (CBAM) implemented by the EU imposes charges on carbon emissions associated with imported goods, effectively increasing their costs compared to domestically produced items that are subject to the EU’s stringent carbon regulations.

In-Country Value Initiatives (ICV)

ICV initiatives have emerged as a strategic response for countries to enhance economic resilience and reduce dependency on foreign entities. For instance, Petroleum Development Oman (PDO), which is state-owned, has initiated its In-Country Value (ICV) program to boost the procurement of local goods and services, and foster the development of local suppliers that contribute to the energy industry. Similarly, major companies like Abu Dhabi National Oil Company (ADNOC), Saudi Arabian Oil Company (Aramco), and Qatar Petroleum (QP) have adopted comparable initiatives to promote localization within their energy and industrial sectors.

Alternative Payment Options

In response to geopolitical tensions affecting traditional financial systems, countries are exploring alternative payment methods. For example, Russia has increasingly utilized the Chinese renminbi for international transactions post-sanctions, while several nations are considering digital currencies as a means of bypassing traditional financial systems dominated by the U.S. dollar.

Conclusion

Geopolitical fragmentation has been prominently manifested through various events all of which have disrupted global trade, energy supplies, and financial systems. To mitigate these challenges, nations and businesses have adopted strategies such as supply chain rerouting, nearshoring, friendshoring, trade protectionism, in-country value initiatives, and alternative payment options. While these strategies are fueling the “slowbalization” of the global economy, it was viewed as a strategic solution for some countries to reduce dependence on global supply chains during turbulent times, foster economic resilience, and navigate rising geopolitical risks.