IMF says trade fragmentation can cost global economy up to 7% of GDP

The International Monetary Fund (IMF) says trade fragmentation could cost the global economy up to 7 percent of GDP and warned that the developing world would fall further behind during the process.

In a new report, the IMF noted that the longer-term cost of trade fragmentation varies from 0.2 percent of global output to almost 7 percent, which is roughly the combined annual output of Germany and Japan.

However, the document published Sunday, which outlines a “Gordian knot of challenges” that policymakers face, doesn’t state how long the fragmentation could take to impact growth of this magnitude.

Depending on the definition of “fragmentation,” some forecasts by the IMF are even bleaker. Estimates that include technological disconnect between regions suggest that countries could lose up to 12 percent of GDP.

The term fragmentation refers to a supply chain that is broken up into different parts. Companies spread the production process across different suppliers and manufacturers when they fragment. As such, companies use separate suppliers and component manufacturers to produce their goods and services.

In its report, the IMF has listed a number of factors contributing to increasing global fragmentation, including Russia’s invasion of Ukraine and the Covid-19 pandemic.

Both situations have caused international disruption to financial, food and energy supplies, with additional trading restrictions adding to the discord between regions.

“The risk is that policy interventions adopted in the name of economic or national security could have unintended consequences, or they could be used deliberately for economic gains at the expense of others,” the report says.

It also notes restrictions on cross-border migrations, reduced capital flows and a decline in international cooperation as different types of fragmentation.

Effects on the developing world

The IMF does not expect all countries to feel the impacts of fragmentation equally. Lower-income consumers in advanced economies would no longer have access to cheaper imported goods, leaving small open-market economies particularly vulnerable.  “Most of Asia would suffer due to its heavy reliance on open trade,” the report says.

Emerging and developing economies would also cease to benefit from “technology spillovers” from more advanced economies, which in the past have helped to boost growth and living standards.

“Instead of catching up to advanced economy income levels, the developing world would fall further behind.”

The IMF recommends three approaches to tackling fragmentation: strengthening the international trade system, helping vulnerable countries to deal with debt and stepping up climate action. These topics are likely to feature heavily in discussions at the World Economic Forum in Davos, Switzerland, starting Monday, which this year named “cooperation in a fragmented world”

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