10.10.23 Review

Radical Deglobalisation: The IMF has built a model of the world economy divided into two warring blocs

With the start of Russia’s full-scale invasion of Ukraine, restrictions on the trade of energy resources and other commodities have been wielded as geopolitical weapons, marking a significant departure from the trends of the past few decades. The idea of a world divided into hostile blocs, which will radically reduce or minimise trade with each other, is no longer seen as a far-fetched notion. Experts at the IMF have modelled the most extreme scenario: countries that have condemned Russia's aggression against Ukraine cease trading with those that have not. While the immediate consequences for the global economy may not be dire, this fragmentation will undeniably slow down the pace of the energy transition and inflict considerable damage on the world's poorest nations, which heavily rely on food exports. To mitigate these negative consequences, the IMF experts urge countries to proactively establish 'green corridors' now, ensuring that critical resources such as minerals and grain can flow freely even in the context of radical deglobalisation.

Since the end of the Cold War, free trade in commodities, energy resources, minerals, precious metals, and food have played a pivotal role in global economic growth, particularly in developing countries. However, for the first time in decades, restrictions on the trade of commodities are being increasingly employed as instruments of geopolitical pressure. In the autumn issue of their World Economic Outlook, experts at the IMF have modelled the most extreme path forward: a world divided into two warring blocs that almost completely stop trading with one another. They consider such a scenario entirely realistic, and governments are being called upon to prepare for its eventuality.

The discussion of commodities is particularly important in the context of a fragmented world because a significant portion of their gross output is intended for international trade, the IMF experts explain. This is around 30% for agricultural products and energy commodities, and approximately 45% for minerals. Additionally, many countries rely on just a few major suppliers. For example, over 50% of the countries that purchase minerals rely on a maximum of three exporters, and for those that purchase energy resources, nearly 30% of countries do the same.

The first bloc in the IMF's model consists of the countries that have condemned Russia's aggression against Ukraine ('USA-EU+'), while the second bloc is made up of those that did not ('China-Russia+'). The cessation of trade between these groups will most severely impact metal and mineral prices, as these are extracted by countries in the first bloc and consumed by those in the second. For the former, prices would be expected to drop significantly, while for the latter, prices would rise just as significantly or even more severely. This primarily concerns metals like cobalt, lithium, and nickel, which are used in the production of electric vehicles, wind turbines, solar panels, and other green equipment. According to the International Energy Agency (IEA), over the past five years, global demand for lithium has tripled, demand for cobalt has seen a 70% increase, and nickel demand has risen by 40%. China is the largest producer of such equipment. At the same time, countries in the first bloc will face comparable increases in the prices of gold, silver, and platinum, which they import.

Energy resources and agricultural product prices would be expected to see less dramatic changes, according to the IMF experts, as the production and manufacturing of these goods are more evenly distributed across the planet. The rare exceptions to this include palm oil and soybeans, which are primarily produced in the first bloc and consumed in the second. However, prices for these products will become more volatile. A single global market absorbs shocks more efficiently than two isolated ones. The model constructed by the IMF experts shows that, in the same shock scenario, grain prices in the countries of the first bloc would increase significantly less in a fragmented market (about 4%) than in a global market (almost 9%). Another source of volatility would be the transition of individual commodity exporters from one bloc to another.

It may still be premature to estimate the level of losses for global GDP, the authors of the report caution. Different estimates place it between a fraction of a percent to over ten percent. The model built by the IMF experts predicts a 0.3% decrease. At the same time, the 'China-Russia+' bloc will suffer slightly more than the 'USA-EU+' bloc. Nonetheless, for individual countries, the consequences of total deglobalisation could be devastating. It will hit low-income countries, which buy more than 80 per cent of their wheat needs abroad, particularly hard. As a result of Russia’s invasion of Ukraine, hundreds of millions of people in these countries could face the most significant drop in living standards in the 21st century. For developed countries, restrictions on the trade of minerals and metals pose a threat to the pace of the energy transition. The IMF model demonstrates that, in the case of deep self-isolation by the two blocs, investments in 'green' energy and electric vehicles will fall short by 30% of what is required to meet the goals required by the Paris Climate Agreement.

Despite the fact that fragmentation might not spell immediate collapse for developed countries, the IMF experts urge them to take steps to prevent such a scenario in order to avoid slowing down the energy transition and to mitigate humanitarian issues in impoverished regions. At the very least, they should work on establishing 'green corridors' for minerals and food that could continue to function in a more fragmented world. Simultaneously, it is imperative to invest in the extraction and processing of critical and scarce resources and diversify the supply of goods that cannot be extracted or produced domestically.