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A new World Economic Forum report released on Thursday highlights significant economic risks from increasing geo-economic fragmentation as countries are increasingly using the global financial and trading systems to advance geopolitical objectives through sanctions, industrial policies, and other economic measures. 

The Navigating Global Financial System Fragmentation report estimates that fragmentation resulting from statecraft policies could cost the global economy $0.6 trillion to $5.7 trillion – up to 5 per cent of global GDP – due to reduced trade and cross-border capital flows as well as lost economic efficiencies.

It could also increase global inflation by more than 5 per cent in a very high fragmentation scenario.

The report, developed in collaboration with Oliver Wyman, shows that the economic impact of rising geo-economic fragmentation could surpass the disruptions caused by the 2008 financial crisis or the Covid-19 pandemic.

As countries increasingly use the financial system to advance their geopolitical objectives – evidenced by a 370 per cent rise in sanctions since 2017, along with subsidies, industrial policies and discussions about the creation of parallel financial architectures – the report calls on policy-makers to adopt economic statecraft that fosters cooperation, sustainable development and resilience in the global economy.

"The potential costs of fragmentation on the global economy are staggering,” says Matthew Blake, Head of the World Economic Forum’s Centre for Financial and Monetary Systems. “Leaders face a critical opportunity to safeguard the global financial system through principled approaches."

The impact of fragmentation on inflation rates and GDP growth depends heavily on the policies adopted by global leaders. With a principled approach, policymakers can advance appropriate policies for their economies and societies while mitigating unintended effects on areas like cost of living and GDP growth.

For example, modelling trade relationships shows that GDP growth could decrease nearly 10 times more in a scenario involving a full decoupling of Eastern (i.e., China and Russia) and Western (i.e., the US and its allies) blocs compared to a lower fragmentation scenario where capital and trade flows are only restricted in sensitive areas related to national security and competitiveness.

Similarly, inflation would be nearly nine times higher in this same comparison, the report added.