The world economy is on the brink of a second cold war that could “annihilate” progress made since the collapse of the Soviet Union, a senior International Monetary Fund official has warned.
Gita Gopinath, the IMF’s first deputy managing director, said the accelerating fragmentation of the world economy into regional power blocs – centred around the US and China – risked wiping out trillions of dollars in global output.
“If we descend into cold war two, knowing the costs, we may not see mutually assured economic destruction. But we could see an annihilation of the gains from open trade,” she said.
Warning that the world was at a “turning point” as tensions mounted between the planet’s most powerful nations, Gopinath urged governments to pull back from the brink and work together on shared economic priorities where possible.
Her intervention comes amid a slowdown in international trade since Russia’s invasion of Ukraine in February 2022 inflamed preexisting tensions between the US and European nations in the west and China and Russia in the east.
“While there are no signs of broad-based retreat from globalisation, fault lines are emerging as geoeconomic fragmentation is increasingly a reality. If fragmentation deepens, we could find ourselves in a new cold war,” she said.
Setting out the potential damage from a collapse in trade between the two blocs – divided along the lines of the UN vote on the 2022 Ukraine resolution – Gopinath said the world economy could expect to see losses worth about 2.5% of gross domestic product (GDP), or about $2.5tn (£2tn) if trade was eliminated entirely.
However, depending on economies’ ability to adjust to the new divisions in world trade, losses could reach as much as 7% of world GDP. The fragmentation of foreign direct investment into two blocs centred around the US and China – with some countries remaining non-aligned – could also result in long-term global losses of about 2% of GDP.
International trade and investment flows have stumbled in recent years amid a breakdown in relations between some of the world’s most powerful economies, with a rise in protectionist policymaking since the 2008 financial crisis.
In response, companies have pushed to “de-risk” supply chains after years of previously unchecked globalisation since the fall of the Berlin Wall. Disruption to lengthy supply chains during the Covid pandemic has accelerated the process, amid a wave of “reshoring” and “friendshoring” – firms sourcing key materials from domestic suppliers or those in politically aligned nations.
Governments are also making billions of dollars available to kickstart domestic economic growth and job creation, while nurturing green industries to combat the climate emergency.
While acknowledging that there were benefits for countries from this playbook, Gopinath warned that failure to manage the process could “easily overwhelm these benefits, and potentially reverse nearly three decades of peace, integration, and growth that helped lift billions out of poverty”.
In a speech in Colombia on Monday, she said there could be some benefits for politically non-aligned countries acting as “connecters” between the largest rival economic powers.
Gopinath highlighted how some large electronics manufacturers were relocating production from China to Vietnam because the US had imposed tariffs on Chinese goods. However, Vietnam sources most of its inputs from China.
Latin American countries could also benefit, including South American commodity exporters and Mexico – which eclipsed China as the biggest exporter of goods to the US this year. She said many manufacturers opening plants in Mexico were Chinese firms targeting the US market, with the Mexican association of private industrial parks expecting one in five new businesses in the next two years to be Chinese.
“They can benefit directly from trade and investment diversion in a fractured global economy and cushion the negative effect of fragmentation on trade, therefore reducing its costs,” she said.
However, these countries could also lose out from a worsening breakdown in international trade, Gopinath added. “If fragmentation worsens, even those who benefit from fragmentation in its mild forms could be left with a larger slice of a smaller pie in an extreme scenario. In short, everyone could lose.”
