Mitigating the risks of geopolitical fragmentation: regulation, oversight, and good corporate governance
On Our Radar, 12 April 2023
Two reports released by the International Monetary Fund — on global financial stability and the world economic outlook — echo findings from an earlier report from the World Bank about the weak prospects for sustainable economic growth. Like the World Bank report (which we covered here, asking “Is Global Growth Doomed?”), the IMF points to geopolitical risks as a major driver of suppressed growth potential. While the IMF is sceptical about reversing the trend of geopolitical fragmentation anytime soon, it emphasises the importance of risk monitoring and strengthening oversight to improve the resilience of banks.
What it’s about: The IMF’s April 2023 Global Financial Stability Report and World Economic Outlook paint a picture of a global economy strained by high inflation, fiscal tightening, a looming sovereign debt crisis, and uneven post-pandemic recovery. Added to that, and exacerbating these downside risks, is a persistent trend of geopolitical fragmentation — a deliberate reversal of global economic and financial integration, driven by strategic considerations, especially of major powers.
Why it matters: Geopolitical fragmentation, according to the IMF, has a negative impact on global trade flows, foreign direct investment, labour mobility, and technological advancement. It affects developing economies more, and more negatively, than advanced economies but also limits the ability of the international community as a whole to tackle global challenges like climate change and future pandemic threats. In a context in which many people are already severely exposed to the consequences of the energy and food crises, reduced capacity to support the most vulnerable populations is likely to contribute to more, and spreading, social unrest. This, in turn, has increased the risk, and cost, of doing business for many companies, according to a recent study by Allianz.
Our take: Geopolitical fragmentation is not a new trend, but it has accelerated since the beginning of Russia’s invasion of Ukraine. It is likely to continue as competition between the US and China increases. In fact, US-style decoupling is a prime example of geopolitical fragmentation. It also indicates that fragmentation will become more pervasive as countries will have few options but to choose between a US-led western bloc and a China-led bloc. That choice will be shaped by ideology as much as geography, evident in terms like ‘friend-shoring’ and ‘near-shoring’ that have been added to the vocabulary of geoeconomic strategies and that complement the trend of ‘re-shoring’ which became popular as a result of the COVID-19 pandemic.
While the most obvious countermeasure to geopolitical fragmentation would be strengthened multilateral cooperation, this is, for the time being, also the most unlikely path to be chosen by the world’s major powers. Consequently, other mitigation measures are required. These might not treat the root causes of fragmentation, but they can increase the capacity of national and international financial actors to deal with some of the symptoms.
Both policy makers and the private sector need to rise to this challenge. As the IMF points out, risks need to be more systematically monitored. This can improve early warning, which is important, and needs to be followed with early, and decisive action. Decisive action, in turn, requires that resources be available, and are made available, for targeted interventions. This can be aided by strengthening oversight of the banking and non-bank financial sector to ensure that financial regulations are not only in place but adhered to when it comes, for example, to capital and liquidity requirements.
It is important to note, that oversight is not merely a question for financial regulators but also goes to the heart of the short- and long-term health and governance of all organisations. Nor does it only impact traditional multinational companies. Any organisation buying or selling abroad or operating in sectors that could be impacted by local, regional, and global upheaval — from sovereign debt crises and expanding sanctions regimes, to cyber threats, currency fluctuations, and protectionist trade policies — must have a system of risk assessment and monitoring in place. Public or private, profit or not-for-profit, no-one is immune, and as a matter of corporate governance, boards must keep a finger on the pulse of how the shifting winds of policy in myriad areas impact their organisations.
At a time when multilateralism is unable to provide more than at best minimal guardrails against a prolonged global economic downturn, the public and private sectors need to work more closely together nationally and across politically like-minded economies to put in place mitigations against the negative impacts of geopolitical fragmentation. This requires a sense of common purpose in which regulation and oversight go together with good corporate governance. The more resilient national economies emerging from this will be better able to weather continuing fragmentation and be better placed to re-engage globally when the time comes.