The world is edging towards a “new Cold War” that risks “annihilating” free trade as we know it, the deputy managing director of the International Monetary Fund (IMF) has warned.
Gita Gopinath said “growing fault lines” in the global economy, such as tensions between the US and China and Russia’s invasion of Ukraine, had created permanent shifts in the way countries do business.
Ms Gopinath warned that the “costs of fragmentation” were higher than ever after decades of globalisation brought closer trade links between countries.
Speaking at an economic forum in Colombia, Ms Gopinath warned of costs amounting to trillions of dollars if the global economy split into two blocs – one dominated by the US and Europe in the West and the other led by China and Russia in the East.
This risked repeating the decades-long struggle for supremacy between the US and the Soviet Union during the Cold War, which sparked a nuclear arms race.
Ms Gopinath said: “Fault lines are emerging as geo-economic fragmentation is increasingly a reality. If fragmentation deepens, we could find ourselves in a new Cold War.
“The economic costs of Cold War Two could be large. The world has become much more integrated, and we face an unprecedented breadth of common challenges that a fragmented world cannot tackle.”
She urged countries to protect the basic tenets of free trade, warning that escalating global tensions could threaten net zero or food security.
Ms Gopinath said: “We can look for blueprints from the last Cold War. Throughout that period, the US and Soviet Union made several agreements to avoid nuclear catastrophe. Both superpowers subscribed to the doctrine of mutually assured destruction, knowing that an attack by one would ultimately lead to total annihilation.”
While a broad-based retreat from globalisation remained unlikely, Ms Gopinath warned that losses could amount to between 2.5pc and 7pc of global gross domestic product (GDP) if the world split into two trading blocs.
She said direct trade links between the world’s biggest economies were already “being severed”.
Mexico replaced China as America’s top trading partner earlier this year, while around 3,000 trade restrictions were imposed globally in 2022 - almost three times the number imposed in 2019.
Ms Gopinath said: “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.
“Ultimately, policymakers must not lose sight of those gains. It is in their – and everyone’s – best interest to advocate strongly for a multilateral rules-based trading system and the institutions that support it.”
Rising geopolitical tensions, the impact of lockdowns during the pandemic and Russia’s war with Ukraine have sparked a wave of protectionism across the global economy.
Ms Gopinath said: “The US calls for ‘friend-shoring’, the EU for ‘de-risking’ and China for ‘self-reliance’. National security concerns are shaping economic policy worldwide.”
She suggested that “industrial policies”, such as President Joe Biden’s Inflation Reduction Act in the US could lead to a rise in tat-for-tat policies that heighten global tensions.
President Biden’s flagship policy provides nearly $400bn in subsidies and tax credits for green projects and initiatives.
While Ms Gopinath did not mention any subsidy schemes by name, she said industrial policies should be “carefully evaluate[d] ... both in terms of their effectiveness in achieving stated outcomes and associated economic costs, including cross-border spillovers”.
She added: “Domestically, industrial policies may be hard to limit or roll back given their concentrated benefits and diffused costs. Internationally, such policies may lead to retaliation, which would deepen fragmentation.”
Estimates from the IMF show that when China introduces a subsidy, there is a 90pc chance that the EU will impose retaliatory trade restrictions within 12 months.
She also signalled that the current system to resolve trade disputes through the World Trade Organisation was no longer fit for purpose.
“The global rules-based system was not built to resolve national security-based trade conflicts,” she said. “So, we have countries strategically competing with amorphous rules and without an effective referee.”
Ms Gopinath warned that the stakes were higher than ever before amid a backdrop of weaker global growth.
She said: “The degree of economic interdependence between countries now is higher, as economies have become much more integrated into the global marketplace and through complex global value chains.
“Global trade to GDP is now 60pc compared to 24pc during the Cold War. This will likely raise the costs of fragmentation. In short, everyone could lose.”