Measuring the economic impact of geopolitical fragmentation
Fernández-Villaverde et al., in this paper, provide a comprehensive measure of fragmentation and quantify its causal effects on aggregate economic variables. The authors develop an index of geopolitical fragmentation using a dynamic factor model (DFM) with time-varying parameters and stochastic volatility. They compile 14 widely used indicators of geopolitical fragmentation, categorized into four areas:
- Metrics of economic integration (e.g., trade openness, FDI ratio)
- Policy implementation gauges (e.g., number of trade restrictions, capital control measures)
- Text mining-derived indicators (e.g., geopolitical risk index, trade policy uncertainty)
- Political reflections (e.g., number of international conflicts, UN General Assembly voting patterns)
Main findings:
- The estimated fragmentation index reveals three distinct phases:
– Relative stability from 1975 to the early 1990s
– Decreased fragmentation following the collapse of the Soviet Union
– Increased fragmentation to highest levels in the sample after the 2007-2008 financial crisis - A positive one-standard-deviation shock to the fragmentation index has a detrimental impact on the global economy, with more pronounced negative effects in emerging economies compared to advanced economies.
- There is an asymmetry in the effects: fragmentation has an immediate negative impact, while the benefits of reduced fragmentation unfold gradually.
- Sectoral analysis within OECD economies shows that industries closely linked to global markets (e.g., manufacturing, construction, finance, wholesale and retail trade) are more adversely affected by fragmentation.
- The impact of fragmentation varies across different geopolitical blocs:
– Fragmentation shocks in the U.S.-EU bloc lead to more pronounced global effects than those in the China-Russia bloc.
Are We Fragmented Yet? Measuring Geopolitical Fragmentation and Its Causal Effect
Authors: Jesús Fernández-Villaverde, Tomohide Mineyama, Dongho Song
From: University of Pennsylvania, IMF, Johns Hopkins University
Economic coercion and global fragmentation
Clayton et al. present a theoretical model of economic coercion and fragmentation in the global economy, focusing on how hegemonic powers like the United States and China can exert influence over other countries through threats of altering financial and trade relationships. The authors develop a model of the world economy with input-output linkages among productive sectors in different countries. The model incorporates production externalities, strategic complementarities, and geopolitical spillovers. They use a Stackelberg timing structure where countries first set domestic policies, then the hegemon makes demands on foreign entities. Finally, the model allows for revenue-neutral wedges (taxes/subsidies) as policy instruments for governments.
Key findings:
- Uncoordinated attempts by multiple countries to limit dependency on the hegemon lead to inefficient fragmentation of the global financial and trade system.
- The model demonstrates a “fragmentation doom loop” where countries breaking away from the integrated system make it less attractive for others, increasing incentives for further fragmentation.
- In the financial services application, the authors show that each country finds it optimal to fully fragment from the hegemon, leading to Pareto inefficient outcomes.
- Financial services are a key source of American geoeconomic power, while China’s power stems more from manufacturing trade.
- The model suggests that measures of coercive powers based only on goods trade likely underestimate the power of the United States due to its dominance in financial services.
A theory of economic coercion and fragmentation
Authors: Chris Clayton, Matteo Maggiori, Jesse Schreger
From: BIS
