The IMF says US-China tensions might value the world about 2% of its output

WASHINGTON DC, UNITED STATES – DECEMBER 26: The International Monetary Fund (IMF) building is seen on December 26, 2022 in Washington DC, United States. (Photo by Celal Gunes/Anadolu Agency via Getty Images)

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The International Monetary Fund said in a Wednesday report that global tensions could disrupt foreign investment and eventually lead to a long-term loss of 2% of world gross domestic product.

Businesses and policymakers around the world are looking for ways to make their supply chains more resilient by “moving production home or to trusted countries,” the IMF warned in its report, adding that this is leading to fragmentation of foreign direct investment become.

The IMF pointed to recent legislation passed amid rising US-China tensions, such as Washington’s Chips and Science Act. Japan recently imposed its own restrictions on 23 types of semiconductor manufacturing plants, joining US efforts to curb China’s ability to manufacture advanced chips.

A recent survey by the American Chamber of Commerce in China similarly showed a shift in foreign direct investment away from China. Less than half of respondents ranked China as one of the top three investment priorities for the first time in 25 years.

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IMF economists said money is now flowing to what are considered “geopolitically close” countries. The rise of friend-shoring could hurt less developed markets the most, the organization said.

“Emerging and developing countries are particularly affected by limited access to investment from advanced economies, reflecting reduced capital accumulation and productivity gains from the transfer of better technologies and know-how,” wrote IMF economists, including Jae-bin Ahn, in the Report.

This comes as tensions rise between China and the United States. Following a recent meeting between US House Speaker Kevin McCarthy and Taiwanese President Tsai Ing-wen in California, Beijing issued veiled threats and vowed to take “decisive action” in response to the “provocation.”

Tsai Ing-wen, Taiwan’s President, left, and US House Speaker Kevin McCarthy, a Republican from California, during an event at the Ronald Reagan Presidential Library in Simi Valley, California, on Wednesday, April 5, 2023 .

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The IMF economists added that developing countries are more vulnerable to this shift in foreign direct investment because “they are more reliant on inflows from geopolitically more distant countries.”

Even if more powerful countries reap the benefits they hope to derive from heightened tensions, those gains could be partially offset by spillovers from weaker foreign demand, the IMF warns.

“A fragmented world is likely to be a poorer one,” the IMF economists wrote.

Vulnerable to shocks

The IMF argues that while “reconfigured” supply chains according to geopolitical alliances can benefit a country’s national security interests and gain the upper hand against competitors, there are consequences.

“Friendshoring with existing partners will often reduce diversification and make countries more vulnerable to macroeconomic shocks,” IMF economists wrote in a statement. The organization argued a year ago for more supply diversification in global trade, saying that “a more diversified global value chain could help mitigate the impact of future shocks.

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The organization echoed that argument, saying that even in developed economies, foreign firms that increase competition “spur domestic firms to be more productive.”

It warned that political uncertainty should be minimized as it “intensifies losses through fragmentation”.

“In a fragmented world with heightened geopolitical tensions, investors may fear that non-aligned economies will be forced to choose one bloc or another going forward, and such uncertainty could compound losses,” the IMF wrote.

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