A Fragmenting World

IN LATE NOVEMBER, US PRESIDENT-ELECT Donald Trump threatened to impose an across-the-board 25 per cent tariff on all imports from Mexico and Canada. He cited concerns about illegal imports of narcotic substances like fentanyl and the waves of illegal immigrants who cross from these countries into the US. He also promised to impose an additional 10 per cent tariff on imports from China.

In no time Canada’s Prime Minister Justin Trudeau met Trump at the latter’s Mar-a-Lago residence in Florida. He described the meeting as “very productive”. Trump, however, had a very different take. Posting on his social media site Truth Social, he said: “It was a pleasure to have dinner the other night with Governor Justin Trudeau of the Great State of Canada. I look forward to seeing the Governor again soon so that we may continue our in depth talks on Tariffs and Trade, the results of which will be truly spectacular for all! DJT.”

If this were not enough, he went on to say that Canada should become the 51st state of the US. Separately, he said that US ownership and control of Greenland— currently a part of Denmark—was an “abso­lute necessity”.

Seen in isolation, these statements are ex­amples of Trump’s quirky, even whimsical, way of ‘negotiating’ with recalcitrant allies, partners and even non-friendly countries. But viewed together—along with his idea Make America Great Again (MAGA)— the picture that emerges is one of a world increasingly fragmented along economic and political lines.

There is nothing unusual in countries using their political clout to secure a “good deal”—to use a Trumpian expression—for that is an end goal of all countries. But geoeconomic fragmentation—the restriction of economic relations: trade, capital flows and flow of technology to politically aligned countries—is very different from the pursuit of individual economic interests.

Will 2025 see the end of global economic integration wit­nessed for the last 34 years? Will this trend merge with rising geopolitical tensions? The short answer is yes. The question is the form this will take: Will this just halt at immiseration or will it lead to wars breaking out between rival camps?

The exact costs of such fragmentation are not known well. Economic integration as seen since 1991 has been a complicated process. Earlier rounds of global economic liberalisation (for example from 1870 to 1914 and from 1945 to 1980) were largely about reducing tariffs on tradable goods and manufactures. Reducing friction on capital flows, a more complicated process, was also undertaken partially during the later stages of this pro­cess of integration. But since 2000, economic integration has proceeded by the building up of increasingly complex supply chains that span the entire world. If fragmentation sets in, those chains will break and estimating the resulting costs is not easy.

In 2023, the International Monetary Fund (IMF) sum­marised a number of studies that estimated the costs of geoeco­nomic fragmentation (GEF). These ranged from 0.9 per cent of global GDP under mild assumptions to as high as 8.5 per cent of global GDP under severe assumptions. There are no exact estimates to be had. These estimates should be contrasted with its biannual global economic forecast, the World Economic Outlook (WEO). The latest edition, of October 2024, penned global growth in 2025 at 3.2 per cent, unchanged from the 2024 estimate and a sliver less than the 3.3 per cent estimate in 2023. With latest economic data from the UK showing no growth and Germany faring equally badly, it is not surprising that global economic output has stagnated. Even if one were to filter out cyclical factors behind such fluctuations in output, the geoeconomic factors loom large in this story. In Britain’s case, growth has nosedived ever since Brexit and Germany’s economic travails are largely due to exorbitant costs of en­ergy. The later phase of Germany’s Wirtschaftswunder was as much about sound economic management as it was about cheap energy, most of it from Russia. Once those taps shut, the German economy caught a chill.

Among the bright spots in this bleak scenario are China and India with estimated growth rates of 4.5 per cent and 6.5 per cent respectively in 2025. There are other economies with faster growth but they do not matter for global output as their share of output in the world economy is very small.

Two very different processes have led to the present situa­tion where economic integration across the world has ground to a halt. The first shock came in 2008 during the global financial crisis. It put the management of the global economy to a severe test. By that time there were powerful voices that highlighted the adverse distributional consequences of global economic integration. Contrary to the early 1990s when developing countries expressed fears about globalisation, the adverse con­sequences in the 21st century were felt in the advanced econo­mies. While outsourcing of production—largely along lines prescribed by the theory of comparative advantage—made goods available cheaply and abundantly, the distributional costs emerged later. The combination of skewed distributions of income and wealth—with the top 1 per cent gaining the most and leaving the bottom to stagnate—had its own costs: If one does not have either a job or money then what are cheaply produced goods worth? It is this class of the ‘left behind’ that has powered Trump’s return. America’s propensity to under­take ‘endless wars’ that have exacted a huge cost on its econ­omy—the Iraq and Afghan wars cost $4.4 trillion and these costs do not include the continuing expenses from those mis­adventures—and if one adds the support to Ukraine, the toll on America is very heavy. Under a huge pile of debt—$35.46 trillion in 2024 according to the US Treasury—the US is no longer the ‘buyer of last resort’ for the world that enabled the miracle of export-led growth economies in Asia. That idea is long past its expiry date.

AGAINST THIS BACKDROP, three trends are quite likely in 2025.

One, America is certain to turn protectionist as soon as Trump takes office on January 20. The use of tariffs— a blunt instrument at the best of times—is likely to get accelerated. The possibility that the US presidency will micro­manage the process of tariffs and “good deals” directly is very real now. It will be the antithesis of market forces allocating capital, determining incomes and dictating the spread of tech­nology. If one asks any economist, their response to these de­velopments is certain to be negative. But if one turns back and asks them whether they thought there would ever be adverse consequences to unchecked globalisation, one is likely to meet with a stony silence. Only two well-known economists, Dani Rodrik and Branko Milanović—both of very differ­ent economic persuasions—made any noise about what was happening.

Two, these geoeconomic trends are likely to go hand-in-hand with existing geopolitical conflicts—in Ukraine and the Middle East to cite two existing conflicts—and more are likely to be added to the list. Asia alone has two-to-three such potential hotspots. These processes are different but also linked. In case of more wars, the costs to the global economy will only rise. The Ukraine war, for example, cost anywhere from $1.6 to $2.8 billion in a single year (2022). Many of these shocks are likely to persist for a number of years.

Three, the process of friend-shoring and on-shoring—of relocating key production processes to territories where one has control—is already underway but likely to take an un­predictable course in the coming years. In a world where na­tionalism has returned as a moving force, friend-shoring is likely to be limited to a very small set of ideologically and ma­terially aligned countries, mimicking the end of the World War II situation, and on-shoring is the more likely course. This is especially true for products like semiconductors and rare earths (used in manufacturing electric vehicles). Under globalisation, the production of these goods was based, at least partially, on economic grounds even if countries like China had ‘strategic’ industrial policies to locate them in their territory. This trend will accelerate with a vengeance.

Where does this leave a country like India? Unlike export-dependent countries in Asia and elsewhere which are likely to bear the brunt of GEF, India will be better-placed. But this ad­vantage will be slight at best. Trade accounts for a significant chunk of India’s economic gains since 1991 and just about the time when it began to reap the rewards of growth from trade, the world has started becoming more protectionist. While not a manufacturing powerhouse like China—India is least likely to be a threat like China is seen by Western coun­tries—the costs of GEF are unlikely to leave it unscathed. For example, while India is close to being a $4 trillion economy soon, its target of achieving the $5 trillion mark—already de­layed—is likely to take more time. Going beyond $5 trillion will take progressively longer. Had the world been more open, this process would have been quicker.

What saves and costs India at the same time is that it has never been a fully market-driven economy at any point since Independence. With a very high inequality of income and wealth, redistribution has always been a part of the political agenda. A large portion of the annual Budget of the Centre and the states goes towards meeting redistributive needs. This ensures social stability but reduces what is available for investment for key productive requirements. In an increas­ingly difficult world, this is both a blessing and something less than that.

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