Geoeconomics and Fragmentation
Paper Session
Friday, Jan. 3, 2025 10:15 AM - 12:15 PM (PST)
- Chair: Pierre-Olivier Gourinchas, International Monnetary Fund
A Theory of Economic Coercion and Fragmentation
Abstract
Hegemonic powers, like the United States and China, exert influence on other coun-tries by threatening the suspension or alteration of financial and trade relationships.
Mechanisms that generate gains from integration, such as external economies of scale
and specialization, also increase the hegemon’s power because in equilibrium they make
other relationships poor substitutes for those with a global hegemon. Other countries
can implement economic security policies to shape their economies in order to insulate
themselves from undue foreign pressure. Countries considering these policies face a
tradeoff between gains from trade and economic security. While an individual coun-
try can make itself better off, uncoordinated attempts by multiple countries to limit
their dependency on the hegemon via economic security policies lead to inefficient frag-
mentation of the global financial and trade system. We study financial services as a
leading application both as tools of coercion and an industry with strong strategic com-
plementarities. We estimate that U.S. geoeconomic power relies on financial services,
while Chinese power relies on manufacturing. Since power is nonlinear and increases
disproportionally as the hegemon approaches controlling the entire supply of a sectoral
input, we estimate that much economic security could be achieved with little overall
fragmentation by diversifying the input sources of key sectors currently controlled by
the hegemons.
Hegemonic Globalization
Abstract
What is the relationship between hegemonic power and globalization? We propose a model of action-driven globalization with alignment around a hegemon and construct the first systematic dataset on the history of international cooperation and alignment over the past 200 years, based on almost 100,000 international treaties that we collect since 1800. In the model, the rise of a hegemon prompts a convergence in political actions, resulting in more trade and higher world welfare. In contrast, a shift to a multipolar world causes an unraveling of globalization. Our data across two centuries are consistent with these findings. Using the rich bilateral and multilateral treaty data, we show how hegemons create a network of international agreements that results in military alliances, a dominant global currency, and major international organizations. Our concept of “hegemonic globalization” is in line with Kindleberger (1973): hegemons actively build globalization through international agreements and this fosters trade in goods and assets.Liquidity, Debt Denomination, and Currency Dominance
Abstract
The international monetary system of the last four centuries has experienced the rise, persistence, and fall of specific currencies as the dominant unit of denomination in global debt contracts. We provide a liquidity-based theory to explain this pattern. Firms issue debt that can be extinguished by trading their revenues for financial assets of the same denomination. When asset markets differ in their liquidity, as modeled via endogenous search frictions, firms optimally choose to denominate their debt in the unit of the asset that is most liquid. Equilibria with a single dominant currency emerge from a positive feedback cycle whereby issuing in the more liquid denomination endogenously raises the benefits of that denomination. This feedback mechanism has historically been seeded by governments that created the largest pool of liquid assets in the same denomination. Once dominance is established, a country's costs of investing in the ability to create liquid assets, such as by increasing fiscal capacity, are lower while the incentives to do so are higher, thereby entrenching dominance. We explain the historical experiences of the Dutch florin, the British pound sterling, the US dollar, and the transitions between them. Our theory highlights normative features of liquidity provision in the international monetary system through the lens of the Bretton Woods arrangement, and we discuss the implications of modern policy tools such as central bank swap lines. We rationalize the current dollar-dominant international financial architecture and provide predictions about the potential rise of the Chinese renminbi.Changing Global Linkages: A New Cold War?
Abstract
Global linkages are changing amidst elevated geopolitical tensions and a surge in policies directed at increasing supply chain resilience and national security. Using granular bilateral data, we provide new evidence of trade and investment fragmentation along geopolitical lines and compare it to the early years of the Cold War. Gravity model estimates point to significant declines in trade, FDI, and portfolio flows between countries in geopolitically distant blocs since the onset of the war in Ukraine, relative to flows between countries in the same bloc. While the extent of fragmentation is still relatively small, the decoupling between the rival geopolitical blocs during the Cold War suggests it could worsen considerably should geopolitical tensions persist and trade restrictive policies intensify. Different from the early years of the Cold War, a set of nonaligned ‘connector’ countries are rapidly gaining importance and serving as a bridge between blocs.Discussant(s)
Matteo Iacoviello
,
Federal Reserve Board
Pablo Ottonello
,
University of Maryland
Matteo Maggiori
,
Stanford University
Laura Alfaro
,
Harvard University
Sebnem Kalemli-Ozcan
,
University of Maryland
JEL Classifications
- F3 - International Finance
- F4 - Macroeconomic Aspects of International Trade and Finance