Trade fragmentation

India must adjust to emerging trends

Following a contraction of 1.2 per cent in 2023, global merchandise trade volume is expected to grow 2.6 per cent this year, and 3.3 per cent next year. Yet, deepening fault lines and growing tensions between trading blocs have put cross-border trade relations at risk. Multilateral bodies like the International Monetary Fund (IMF) and the World Trade Organization (WTO) have thus rightly underscored the issue of restrictions in trade flows in the post-pandemic world, and the need to preserve the gains from economic openness. The latest World Economic Outlook of the IMF notes that since the start of the Russia-Ukraine war, countries are finding themselves comfortable trading with other members of the trade blocs they are part of, rather than those of politically distant blocs.

Total merchandise trade has slowed by 2.4 percentage points more between countries that are not in the same bloc, indicating that the extent of trade flows is increasingly being determined by the economic positioning of different countries and their possible trading partners. The relationship is even stronger for trade in strategic sectors, such as machinery and chemicals. Economic and ideological rivalry between the US and China has led to a weakening of trade links between the two largest economies of the world. As a result, countries in the West are moving towards “friend-shoring” and “near-shoring” policies to de-risk their trade flows, while China calls for self-reliance. The position taken by emerging-market economies (EMEs) and developing countries like India in this context remains crucial. For countries that are non-aligned and not particularly associated with any trade bloc, things could become more difficult in the future.
 

Disruptions on two of the most important shipping routes — the Panama and Suez canals — further elevate risks to the trade outlook. Shortage of fresh water in the Panama Canal and the diversion of shipping traffic away from the Red Sea led to supply-chain delays and higher shipping costs. Signs of fragmentation are not just confined to merchandise trade but are also being seen in services trade and data flow policies. This can especially affect countries like India which specialise in the services sector. For instance, the US’ import of information, communication and technology (ICT) services from its Asian trading partners (mostly India) fell from 45.1 per cent in 2018 to 32.6 per cent in 2023. By comparison, the US’ imports from its North American trading partners increased from 15.7 per cent to 23 per cent during the same period, a clear evidence of nearshoring.
 

Trade fragmentation is fraught with danger owing to reduced competition and efficiency loss from lack of specialisation. A study by the WTO shows that a decoupling of the global economy into geopolitical blocs could reduce world gross domestic product (GDP) by 5 per cent in the long run, while fragmentation of dataflow policies along geopolitical lines can reduce global real exports by 1.8 per cent and global real GDP by about 1 per cent. Reduced portfolio and foreign direct investment flows induced by trade disruptions could also reduce capital accumulation in EMEs. Given the emerging trends in global trade, which are unlikely to reverse in the near term, trade policy in India needs to be calibrated to remain relevant in global markets.