The Price of Fragmentation | Foreign Affairs 2023-08-24, 2:28 PM

!e Price of Fragmentation
Why the Global Economy Isn’t Ready for the Shocks
Ahead
BY KRISTALINA GEORGIEVA September/October 2023

Published on August 22, 2023

KRISTALINA GEORGIEVA is Managing Director of the International Monetary Fund.

We are living through turbulent times, in a world that has become richer
but also more fragile. Russia’s war in Ukraine has painfully demonstrated
that we cannot take peace for granted. A deadly pandemic and climate
disasters remind us how brittle life is against the force of nature. Major
technological transformations such as arti!cial intelligence hold promise
for future growth but also carry signi!cant risks.

Collaboration among nations is critical in a more uncertain and shock-

prone world. Yet international cooperation is in retreat. In its place, the
world is witnessing the rise of fragmentation: a process that begins with
increasing barriers to trade and investment and, in its extreme form, ends
with countries’ breaking into rival economic blocs—an outcome that risks
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reversing the transformative gains that global economic integration has

produced.

A number of powerful forces are driving fragmentation. With deepening

geopolitical tensions, national security considerations loom large for
policymakers and companies, which tends to make them wary of sharing
technology or integrating supply chains. Meanwhile, although the global
economic integration that has taken place in the past three decades has
helped billions of people become wealthier, healthier, and more productive,
it has also led to job losses in some sectors and contributed to rising
inequality. "at in turn has fueled social tensions, creating fertile ground for
protectionism and adding to pressures to shift production back home.

Fragmentation is costly even in normal times and makes it nearly

impossible to manage the tremendous global challenges that the world now
faces: war, climate change, pandemics. But policymakers everywhere are
nevertheless pursuing measures that lead to further fragmentation.
Although some of these policies can be justi!ed by the need to ensure the
resilience of supply chains, other measures are driven more by self-interest
and protectionism, which in the long term will put the world economy in a
precarious position.

"e costs of fragmentation could not be clearer: as trade falls and barriers
rise, global growth will take a severe hit. According to the latest
International Monetary Fund projections, annual global GDP growth in
2028 will be only three percent—the IMF’s lowest !ve-year-ahead forecast
in the past three decades, which spells trouble for poverty reduction and for

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creating jobs among burgeoning populations of young people in developing

countries. Fragmentation risks making this already weak economic picture
even worse. As growth falls, opportunities vanish, and tension builds, the
world—already divided by geopolitical rivalries—could splinter further into
competing economic blocs.

Policymakers everywhere recognize that protectionism and decoupling

come at a cost. And high-level engagements between the world’s two
largest economies, the United States and China, aim to reduce the risks of
further disintegration. But broadly speaking, when it comes to trying to
turn back the tide of fragmentation, there is a troubling lack of urgency.
Another pandemic could once again push the world into global economic
crisis. Military con#ict, whether in Ukraine or elsewhere, could again
exacerbate food insecurity, disrupt energy and commodity markets, and
rupture supply chains. Another severe drought or #ood could turn millions
more people into climate refugees. Nonetheless, despite widespread
recognition of these risks, governments and the private sector alike have
been unable or unwilling to act.

A more shock-prone world means that economies will need to become

much more resilient—not just individually but also collectively. Getting
there will require a deliberate approach to cooperation. "e international
community, supported by institutions such as the IMF, should work
together in a systematic and pragmatic manner, pursuing targeted progress
where common ground exists and maintaining collaboration in areas where
inaction would be devastating. Policymakers need to focus on the issues

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that matter most not only to the wealth of nations but also to the economic
well-being of ordinary people. "ey must nurture the bonds of trust among
countries wherever possible so they can quickly step up cooperation when
the next major shock comes. "at would bene!t poorer and richer
economies alike by supporting global growth and reducing the risk that
instability will spread across borders. Even for the richest and most
powerful countries, a fragmented world will be di$cult to navigate, and
cooperation will become not only a matter of solidarity but of self-interest,
as well.

A FRAGILE WORLD
Two world wars in the twentieth century revealed that international
cooperation is critical for peace and prosperity and that it requires a sound
institutional foundation. Even as World War II was still raging, the Allies
came together to create a multilateral architecture that would include the
United Nations and the Bretton Woods institutions—the IMF and the
World Bank—together with the precursor to the World Trade
Organization. Each organization was entrusted with a special mandate to
address the problems of the day requiring collective action.

What ultimately followed was an explosion of trade and integration that

transformed the world, culminating in what came to be known as
globalization. Integration had accelerated in previous historical eras,
especially in the wake of the Industrial Revolution. But during the world
wars and the interwar period, it had sharply retreated, and in the immediate
postwar era, the fragmentation of the Cold War threatened to prevent it
from recovering. "e international security and !nancial architecture the
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Allies built, however, allowed integration to come roaring back. Since then,
that architecture has adapted to massive changes. "e number of countries
in the world has grown from 99 in 1944 to nearly 200 today. In the same
period, the earth’s population has more than tripled, from around 2.3 billion
to around 8.0 billion, and global GDP has increased more than tenfold. All
the while, the expansion of trade in an increasingly integrated global
economy has delivered substantial bene!ts in terms of growth and poverty
reduction.

"ese gains are now at risk. After the 2008 global !nancial crisis, a period
of “slowbalization” began, as growth became uneven and countries began
imposing barriers to trade. Convergence in living standards within and
across countries has stalled. And since the pandemic began, low-income
countries have seen a collapse in their per capita GDP growth rates, which
have fallen by more than half, from an average of 3.1 percent annually in
the 15 years before the pandemic to 1.4 percent since 2020. "e decline has
been much more modest in rich countries, where per capita GDP growth
rates have fallen from 1.2 percent in the 15 pre-pandemic years to 1.0
percent since 2020. Rising inequality is fostering political instability and
undermining the prospects for future growth, especially for vulnerable
economies and poorer people. "e existential threat of climate change is
aggravating existing vulnerabilities and introducing new shocks. Vulnerable
countries are running out of bu%ers, and rising indebtedness is putting
economic sustainability at risk.

In a more fragile world, countries (or blocs of countries) may be tempted to

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de!ne their interests narrowly and retreat from cooperation. But many
countries lack the technology, !nancial resources, and capacity to
successfully contend with economic shocks on their own—and their failure
to do so will harm not only the well-being of their own citizens but also
that of people elsewhere. And in a less secure world with weaker growth
prospects, the risk of fragmentation only grows, potentially creating a
vicious downward spiral.

Should this happen, the costs will be prohibitively high. Over the long
term, trade fragmentation—that is, increasing restrictions on the trade in
goods and services across countries—could reduce global GDP by up to
seven percent, or $7.4 trillion in today’s dollars, the equivalent of the
combined GDPs of France and Germany and more than three times the
size of the entire sub-Saharan African economy. "at is why policymakers
should reconsider their newfound embrace of trade barriers, which have
proliferated at a rapid clip in recent years: in 2019, countries imposed fewer
than 1,000 restrictions on trade; in 2022, that number skyrocketed to
almost 3,000.

As protectionism spreads, the costs of technological decoupling—that is,

restrictions on the #ow of high-tech goods, services, and knowledge across
countries—would only add to the misery, reducing the GDPs of some
countries by up to 12 percent over the long term. Fragmentation can also
lead to severe disruption in commodity markets and create food and energy
insecurity: for example, Russia’s blockade of Ukrainian wheat exports was a
key driver behind the sudden 37 percent increase in global wheat prices in

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the spring of 2022. "is drove in#ation in the prices of other food items
and exacerbated food insecurity, notably in low-income countries in North
Africa, the Middle East, and South Asia. Finally, the fragmentation of
capital #ows, which would see investors and countries diverting investments
and !nancial transactions to like-minded countries, would constitute
another blow to global growth. "e combined losses from all facets of
fragmentation may be hard to quantify, but it is clear that they all point to
lower growth in productivity and in turn to lower living standards, more
poverty, and less investment in health, education, and infrastructure. Global
economic resilience and prosperity will depend on the survival of economic
integration.

A GLOBAL SAFETY NET

In a world with more frequent and severe shocks, countries have to !nd
ways to cushion the adverse impacts on their economies and people. "at
will require building economic bu%ers in good times that can then be
deployed in bad times. One such bu%er is a country’s international reserves
—that is, the foreign currency holdings of its central bank, which provide a
readily available source of !nancing for countries when hit by shocks. In the
aggregate, reserves have grown tremendously over the past two decades, on
par with the expansion of the world economy and in response to !nancial
crises. But those reserves are heavily concentrated in a relatively small group
of economically stronger advanced and emerging market economies: just
ten countries hold two-thirds of global reserves. In contrast, reserve
holdings in most other countries remain modest, especially in sub-Saharan
Africa, parts of Latin America, oil-importing states in the Middle East, and

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small island states—which, taken together, account for less than one
percent of global reserves. "is uneven distribution of reserves means that
many countries remain highly vulnerable.

No country should rely on its reserves alone, of course. Consider how a

household, which cannot save enough money for every conceivable shock,
purchases insurance for a home, a car, and health care. Similarly, countries
are better o% if they can complement their own reserves with access to
various international insurance mechanisms that are collectively known as
“the global !nancial safety net.” At the center of the net is the IMF, which
pools the resources of its membership and acts as a cooperative global
lender of last resort. "e net is buttressed by currency swap lines, through
which central banks provide one another with liquidity backstops (typically
to reduce !nancial stability risks), and by !nancing arrangements that allow
countries within speci!c regions to pool resources that can be deployed if a
crisis hits.

Protecting countries and their people against shocks contributes to stability

beyond their borders: such protection is a global public good. A global
safety net that pools international resources to provide liquidity to
individual countries when they are struck by calamities is thus in the
interest of individual countries and the world. "e COVID-19 crisis
provides a good example. With the pooled resources of the IMF, member
countries received liquidity injections at an unprecedented speed and scale,
helping them !nance essential imports such as medicines, food, and energy.
Since the pandemic, the IMF has approved over $300 billion in new

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!nancing for 96 countries, the broadest support ever over such a short
period. Of this, over $140 billion has been provided since Russia’s invasion
of Ukraine to help the fund’s members address !nancing pressures,
including those resulting from the war.

Although the global !nancial safety net helped manage the fallout from
COVID and the e%ects of Russia’s invasion, it is sure to be tested again by
the next big shock. With reserves unevenly distributed, there is a pressing
need to expand the world’s pooled resources to insure vulnerable countries
against severe shocks. "e IMF’s nearly $1 trillion in lending capacity is
now only a small part of the overall safety net. Although self-insurance
through international reserves has sharply increased for some countries,
pooled resources centered on the IMF have increased far less than self-
insurance and have shrunk markedly relative to measures of global !nancial
integration. "at is why the international community must strengthen the
global !nancial safety net, including by expanding the availability of pooled
resources in the IMF.

DEALING WITH DEBT

Even if the global !nancial safety net is strengthened, some countries might
exhaust their bu%ers in the face of global economic shocks and accumulate
economic imbalances over time—notably, higher !scal de!cits and rising
debt levels. Although debt is up everywhere, the problem is particularly
acute for many vulnerable emerging-market and low-income countries as a
result of recent economic jolts, rising interest rates, and, in some cases,
policy errors on the part of governments. By the end of 2022, average debt
levels in emerging-market countries had reached 58 percent of GDP, a
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signi!cant increase from a decade earlier, when that !gure stood at 42

percent. Average debt levels in low-income countries had increased even
more sharply over that period, from 38 percent of GDP to 60 percent.
About one-quarter of emerging-market countries’ bonds are now trading at
spreads indicative of distress. And 25 years after the launch of a broad-
based international debt relief initiative for poor countries, about 15 percent
of low-income countries are now considered to be in debt distress, with
another 40 percent at risk of ending up in that situation.

"e costs of a full-blown debt crisis are most keenly felt by people in debtor
countries. According to one analysis by the World Bank, on average,
poverty levels spike by 30 percent after a country defaults on its external
obligations and remain elevated for a decade, during which infant mortality
rates rise on average by 13 percent and children face shorter life
expectancies. Other countries are a%ected as well. Savers lose their wealth.
Borrowers’ access to credit can become more limited.

To ensure debt sustainability in a world of more frequent climate and

health calamities, individual countries and international organizations must
do everything they can to prevent the unsustainable accumulation of debt
in the !rst place—and failing that, to support the orderly restructuring of
debt if it becomes necessary. If debt crises multiply, the gains that low-
income countries have made in recent decades could quickly evaporate. To
prevent that from happening, international institutions can help countries
focus on economic reforms that would spur growth, improve the
e%ectiveness of budgetary spending, enhance tax collection, and strengthen

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debt management.

Reducing the costs of debt crises means resolving them quickly. Doing so is
not easy. "e creditor landscape has changed signi!cantly over the past
several decades, with new o$cial creditors such as China, India, and Saudi
Arabia entering the scene and the variety of private creditors expanding
dramatically. Quick and coordinated action by creditors requires mutual
trust and understanding, but the increase in the number and type of
creditors has made that more challenging, especially since some key
creditors are divided along geopolitical lines.

Consider the case of Zambia, Africa’s second-biggest copper producer.

Over the past decade, it ramped up spending on public investment !nanced
by debt, but economic growth failed to follow, and the country ran out of
resources to meet its debt repayments, defaulting in 2020. Its o$cial
creditors took almost a year to agree to a deal to restructure billions of
dollars of loans. "is milestone required the mostly high-income group of
creditors known as the Paris Club to cooperate with the new creditor
countries. But the job will be fully complete only when private creditors
also come forward and agree to a comparable deal with Zambia—work that
is already underway.

Although reaching an agreement for Zambia took time, o$cial creditors

have been learning how to work together, in this case under a Common
Framework established by the G-20. "e technical discussions taking place
through the new Global Sovereign Debt Roundtable—initiated in
February 2023 by the IMF, the World Bank, and the G-20 under India’s

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presidency—are also helping build a deeper common understanding across

a broader set of stakeholders, including the private sector and debtor
countries. "is development holds promise for highly indebted countries,
such as Sri Lanka and Ghana, that still need the international community
to decisively follow through on commitments to provide critical debt relief.

But creditors and international !nancial institutions must do

more. Debtors should receive a clearer road map of what they can expect
from creditors in the timing of key decisions. Creditors also need to !nd
ways to more quickly clear hurdles to reaching consensus. For instance,
earlier information sharing can help creditors and debtors resolve debt
crises in a more cooperative fashion, with help from institutions such as the
IMF. And if private creditors demonstrate that they can do their
part and provide debt relief on terms comparable to those o%ered by o$cial
creditors, it will reassure the o$cial creditors and give them the con!dence
to move faster.

International !nancial institutions and lenders must also develop

mechanisms to insure countries against debt crises in the event of major
shocks. Such mechanisms play a crucial role in ensuring that a liquidity
crunch does not tip countries into more costly debt distress. One promising
idea would be to take a contractual approach to commercial debt. "is
could involve including clauses in debt contracts that would automatically
trigger a deferral of debt repayments if a country experienced a natural
disaster such as a #ood, drought, or earthquake.

Debtors must do their part, too, starting by being more proactive when it

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comes to risk mitigation, and better coordinating their debt management

strategy with !scal policy. Governments must also show a willingness to
tackle the underlying policy mistakes at the heart of more fundamental
debt challenges. For instance, Zambia’s strong commitment to undertaking
necessary economic reforms, such as removing fuel subsidies that mostly
bene!ted wealthier households, meant that the IMF could move forward
with its own !nancial support and that o$cial creditors were more willing
to provide debt relief.

THE FIGHT AGAINST FRAGMENTATION

"e IMF has long played a central role in the global economy. It is the only
institution empowered by its 190 members to carry out regular and
thorough “health checks” of their economies. It is a steward of
macroeconomic and !nancial stability, a source of essential policy advice,
and a lender of last resort, poised to help protect countries against crises
and instability. In a world of more shocks and divisions, the fund’s universal
membership and oversight are a tremendous asset.

But the IMF is just one actor in the global economy and just one among
many important international !nancial institutions. And to keep up with
the pace of change in a fragmenting world, the fund’s !nancial model and
policies need a refresh. An important !rst step would be completing the
16th General Review of Quotas. "e IMF’s quota resources—the !nancial
contributions paid by each member—are the primary building blocks of the
fund’s !nancial structure, which pools the resources of all its members.
Each member of the IMF is assigned a quota based broadly on its relative
position in the world economy, and the IMF regularly reviews its quota
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resources to make sure they are adequate to help its members cope with
shocks. An increase in quotas would provide more permanent resources to
support emerging and developing economies and reduce the fund’s reliance
on temporary credit lines. It is essential that the IMF’s membership come
together to bolster the institution’s quota resources by completing the
review by the December 2023 deadline.

"e IMF’s better-o% members need to make a concerted e%ort to urgently

replenish the !nancial resources of the Poverty Reduction and Growth
Trust. "e trust, which is administered by the IMF, has provided almost
$30 billion in interest-free !nancing to 56 low-income countries since the
onset of the pandemic, more than quadruple its historical levels. "is
funding is critical to ensure that the IMF can continue meeting the record
demand for support from its poorest member countries. And to address the
economic risks created by climate change and pandemics, the fund’s better-
o% members should also scale up their channeling of Special Drawing
Rights (an IMF reserve asset, which it allocates to all its members) to more
vulnerable countries through the fund’s newly created Resilience and
Sustainability Trust.

"e IMF must also continue working to enhance representation inside the
organization. It is important that the fund re#ect the economic realities of
today’s world, not that of the last century. Decision-making at the fund
requires a highly collaborative approach and inclusive governance. "is
would support more agility and adaptability in the IMF’s policies and
!nancing instruments to better serve the needs of its members.

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Finally, the IMF cannot be truly e%ective in today’s fragmented world

unless it continues to deepen its ties with other international organizations,
including the World Bank, other multilateral development banks such as
the African Development Bank, and institutions such as the Bank for
International Settlements and the World Trade Organization. All those
international !nancial institutions must join forces to foster international
cooperation on the most pressing challenges facing the world.

In 1944, the 44 men (and zero women) who signed the Bretton Woods
agreement sat at one table in a modestly sized room. "e small number of
players was an advantage, as was the fact that most of the countries
represented were allies !ghting together in World War II. Today, !nding
consensus among 190 members is much more di$cult, especially as trust
among di%erent groups of countries is eroding and faith in the ability to
pursue the common good is at an all-time low. Yet the world’s people
deserve a chance at pursuing peace, prosperity, and life on a livable planet.

For nearly 80 years, the world has responded to major economic challenges
through a system of rules, shared principles, and institutions, including
those rooted in the Bretton Woods system. Now that the world has entered
a new era of increasing fragmentation, international institutions are even
more vital for bringing countries together and solving the big global
challenges of today. But without enhanced support from higher-income
countries and a renewed commitment to collaboration, the IMF and other
international institutions will struggle.

"e period of rapid globalization and integration has come to an end, and

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the forces of protectionism are on the rise. Perhaps the only thing certain
about this fragile, fragmented new global economy is that it will face
shocks. "e IMF, other international institutions, creditors, and borrowers
must all adapt and prepare. It’s going to be a bumpy ride; the international
!nancial system needs to buckle up.

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