By Guest Economist Joseph Joyce Capital Ebbs and Flows The disruption of the global economy caused by the COVID pandemic in 2020 had begun to be overcome when the Russian invasion of Ukraine in 2022 led to new fissures. Sanctions were placed by the United States and European nations on trade and capital transactions with Russia. Before the pandemic, tariffs and other trade measures had been imposed by the United States and China on each other, and these restrictions were continued under the Biden administration. How far has the reversal of the measures designed to promote international trade and finance gone, and has globalization been set back? Jesús Fernández-Villaverde, Tomohide Mineyama and Dongho Song in a new NBER working paper, “Are
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by Guest Economist Joseph Joyce
Capital Ebbs and Flows
The disruption of the global economy caused by the COVID pandemic in 2020 had begun to be overcome when the Russian invasion of Ukraine in 2022 led to new fissures. Sanctions were placed by the United States and European nations on trade and capital transactions with Russia. Before the pandemic, tariffs and other trade measures had been imposed by the United States and China on each other, and these restrictions were continued under the Biden administration. How far has the reversal of the measures designed to promote international trade and finance gone, and has globalization been set back?
Jesús Fernández-Villaverde, Tomohide Mineyama and Dongho Song in a new NBER working paper, “Are We Fragmented Yet? Measuring Geopolitical Fragmentation and Its Causal Effect,” devise an empirical measure of geopolitical fragmentation using a dynamic factor model. They selected 14 indicators, including economic measures such as FDI/GDP, the number of trade restrictions, and migration flows as well as political indicators, such as the number of international conflicts. The data begin in 1975 and include 61 countries, 34 advanced and 27 emerging markets. Their measure shows a high degree of stability between 1975 through the early 1990s, when political events led to a decline in fragmentation, as the Soviet Union dissolved, the World Trade Organization was formed, and the euro was created. This trend began to reverse during the time of the 2008-09 financial crisis, and the estimated fragmentation index has steadily risen.
The authors then use their index to examine its impact on economic outcomes, including the impact on GDP per capita, industrial production and fixed investment. They find that a rise in fragmentation affects the global economy adversely, with emerging economies suffering more of an impact. They also find asymmetries in the timing of the effect of an increase in fragmentation vs. a decline, with the negative effects of a rise in fragmentation taking place more quickly than the positive impact of a decline in fragmentation.
A different view of the extent of fragmentation has been presented by Steven A. Altman and Caroline R. Bastian in “The State of Globalization in 2023”, which appeared in the July 2023 issue of the Harvard Business Review. Both authors are affiliated with the DHL Initiative on Globalization at NYU’s Stern Center. They used the DHL Global Connectedness Index, which measures the growth of trade, capital, people and information relative to the growth of the domestic economy. The first three measure declined in response to the COVID pandemic, but trade and capital have recovered. International travel has not returned to pre-pandemic levels, although migration has. Flows of information, on the other hand, increased during the pandemic and afterwards as people turned to the Internet after shutdowns limited public activity.
The authors did find evidence of a drop in U.S.-China economic flows, although the two economies still have substantial linkages. Moreover, they report that allies of each country have not reduced trade with the other country. Regionalization has not succeeded globalization, and the authors claim that firms that retreat from globalization may lose a firm’s competitive position.
An analysis of one country’s response to fragmentation is presented in “Germany’s FDI in Times of Geopolitical Fragmentation”, a 2024 IMF working paper by Kevin Fletcher, Veronika Grimm, Thilo Kroeger, Aiko Mineshima, Christian Ochsner, Andrea F. Presbitero, Paul Schmidt-Engelbertz and Jing Zhou’s. Germany is sensitive to external shocks, such as the rise in energy prices that followed the Russian invasion and the authors sought to determine how geopolitical risk and energy prices could affect FDI flows. Among their findings they report that the post-pandemic recovery in both inward and outward FDI have been slower in Germany than in the U.S. or the rest of Europe. They also find that Germany’s outward FDI linkages with geopolitically distant countries have been weakening, in particular FDI to China-Russia-bloc nations.
Measuring and analyzing fragmentation and its consequences will remain an active area of research. Compounding the challenges of obtaining relevant data is the uncertainty of the future. The pace and extent of globalization will be driven in part by political decisions. By the end of this year there will be executive changes in many of the largest economies. Consequently, the political landscape will change and new restrictive policies could impede the integration of markets. National leaders will assess the challenges they face and the responses they choose may diminish global, welfare.