Divided we fall: Differential exposure to geopolitical fragmentation in trade

Abstract

This paper assesses differences in countries' macroeconomic exposure to trade fragmentation along geopolitical lines. Estimating structural gravity regressions for sector-level bilateral trade flows between 185 countries, we find that closer geopolitical ties are associated with lower barriers to trade, with the largest effects concentrated in a few sectors (notably, food and high-end manufacturing). Consequently, countries' exposure via trade to geopolitical shifts varies with their market size, comparative advantage and foreign policy alignments. Introducing our estimates into a dynamic many-country, many-sector quantitative trade model, we show that geoeconomic fragmentation—modelled as an increased sensitivity of trade costs to geopolitics and greater geopolitical polarization—generally leads to lower trade and incomes. However, emerging markets and developing economies (EMDEs) tend to see the largest impacts: real per-capita income losses for the median EMDE in Asia are 80% larger, and 120% larger for the median EMDE in Africa, than for the median advanced economy. This suggests that the costs of trade fragmentation could fall disproportionally on countries that can afford it the least.