Does the war in Ukraine mean the end of economic integration?

The economic consequences of the war in Ukraine are already severe. And beyond the immediate shocks lies a more far-reaching effect: a descent into economic rivalry on the global stage. But the conflict is not the cause of this – instead, it is accelerating a trend that has been growing for some time. How did we arrive at this more fragmented world and what, if anything, can be done to reverse it?

From integration to fragmentation

For decades, global economic relations were based on interdependence between countries: the rules-based system. This emerged in the aftermath of the two world wars, with an aim to contain rivalries that led to beggar-thy-neighbour policies and military conflict.

This system reached its high watermark in the 1990s. The Uruguay Round of trade negotiations led to the creation of the WTO in 1995, and strengthened the enforcement of trade rules. Later that decade, China’s accession to the WTO was finalised, and Russia was integrated into the IMF.

But the late nineties was also the point at which the tide began to turn on integration. Anti-WTO riots reflected perceptions that trade and technological progress were worsening inequality. These concerns were amplified by the global financial crisis of 2008–2009. And this led to an increase in protectionist interventions.

These tensions reflected the success of trade rules in interacting with technological progress. The rise of global value chains meant that countries began to specialise in particular tasks in those chains. This incentivised policies that allowed countries to capture a higher level of value added, with more gains for first movers.

The stage was set for greater rivalry – in part, ironically, because of the very rules designed to promote interdependence.

The lessons of China and Russia

It might have been possible to contain this trend had geopolitics and economics not combined in particularly potent ways.

When developed countries normalised trade relations with China, and then agreed to its accession to the WTO, they thought deeper economic integration would steer China to a more liberal growth model.

But twenty years after accession, there’s a sense of ‘buyers’ remorse’. China, if anything, has become more authoritarian, and its industrial policy is highly interventionistic. Meanwhile, China’s believes its partners have unfairly used WTO rules to constrain its growth.

Similarly, when Russia acceded to the WTO, the then Director-General, Pascal Lamy, portrayed it as a ‘“win-win deal”. Like the accession of China, it was meant to drive political change – but it’s clearer than ever that this hasn’t happened.

A change in mindset

The presumption had been that economic interdependence would drive geopolitical convergence. But thinking is now based on a presumption of geopolitical divergence: and this is driving greater fragmentation. Policies are now being enacted to reflect this new reality. The EU’s proposal for an anti-coercion policy instrument is one such example, since it is based on the premise that countries will use interdependencies to exercise political pressure.

Integration has been further weakened by the rise of technology, as nations diverge on matters of digital governance, now fundamental to economic organisation.

Multilateralism had helped to create a common mindset in policy making: abiding by principles like non-discrimination might be painful at times, but was ultimately beneficial. But that mindset has now disappeared in western countries, and arguably never really took root in emerging nations.

The effect of war

The trend towards a more regionalised approach to trade and investment began prior to the war, but it is accelerating forces already in motion.

The forecast economic costs of the conflict are high. The World Bank estimates that Ukraine’s economy could shrink by over 45% this year, and that Russia’s will shrink by more than 11%. The OECD estimates that global growth will be cut by a full percentage point in 2022.

Resultant surges in the prices of food, fuel and other commodities are likely to cause unrest, especially in low and middle-income countries. And all this will empower political forces with a reflexive aversion to trade and international cooperation.

A way forward?

Hopes for a more benign form of ‘re-globalisation’ therefore seem fragile. But could re-globalisation be managed in a way that slows the march towards conflict?

We should start with the recognition that geopolitical rivalry is here to stay, and that countries have ‘written down’ the idea that interdependencies can mitigate it.

Forces for rivalry must be channelled into more benign modes. Here the old GATT/WTO logic can come in handy: price-based measures are better than quantitative measures, and subsidies are better than trade restrictions.

Subsidy rules in particular must be reformed. Current rules seem at times to prevent subsidies that are welfare-enhancing, while allowing ones that are distorting.

Rules on trade defence measures need attention too. They should be targeted more at the issues raised in level playing field discussions, including environmental distortions,  rather than acting as a fig leaf for protectionist interests.

There is a natural rejoinder to all this: if countries have demonstrated a preference for rivalry, why should we expect them to cooperate on mitigating the forms and costs of that rivalry?

The optimistic view is that there remains a degree of clear-sightedness regarding the value of tying one’s own hands. But the more realistic view is that willingness to cooperate will need to be re-learned via some painful lessons of experience. We can only hope it will not be too late by then.