FIGURE 7 Short-run impact of financial fragmentation on gross domestic product across geopolitical blocs -0.6% -1.4%0.0% -0.6%0% -2% -4% -6% -8% -10% -12%Scenario 1 Low fragmentationMarginal change in GDP growth (deviation from baseline in %) Scenario 3 High fragmentationScenario 2 Moderate fragmentationScenario 4 Very high fragmentation -1.8% -3.9%-3.5% -10.5%-5.5%-3.2%-2.8%-2.3% -2.8% -4.6%-4.5%-3.6% Similar GDP decrease as/uni00A0the/uni00A0Great Recession’s impact/uni00A0on/uni00A0the US in 2009 Over 2x larger GDP decrease than the global impact of the COVID-19 pandemic in 2020 Neutrals East World West Source: NERA analysis based on the multi-country, multisector model of Baqaee & Farhi (2024).32 Data from 2013 World Input–Output Database and Asian Development Bank’s 2023 Input–Output Tables. Short-run impact is defined as the impact measured one year after the shocks and is based on applying the one- year to 10-year trade elasticity ratio found in Boehm et al. (2023)33 to the elasticities in Baqaee & Farhi (2024), as in Bolhuis et al. (2023)34assumes that three distinct economic blocs emerge based on today’s geopolitical environment: the “West” (the US, the EU, Australia, Canada, Japan, South Korea and the United Kingdom), the “East” (China and Russia) and “Neutrals” (Brazil, India, Indonesia, Mexico, Taiwan, Türkiye and a composite of additional remaining countries). Scenario 1 – Low fragmentation: In this scenario, countries restrict capital and trade flows only in certain sensitive areas and encourage unimpeded activity in all other parts of the economy. The model envisions a ban on trading sensitive technology between the Eastern and Western blocs similar to the “small yard and high fence” approach, which limits investment restrictions to sensitive industries or technologies without impeding capital flows to other parts of the economy.35 The overall impact on global output is notable, but moderate, at -0.6% after one year. Inflation increases by 0.6% globally.Scenario 2 – Moderate fragmentation: This scenario introduces economic statecraft restrictions on all economic exchanges between the three blocs, with less severe measures between Neutrals and the other two blocs. Accordingly, the model shows that there are more significant tariff and financial productivity losses, driving a 2.3% decline in global economic growth in the short run. The effect on inflation is also more significant in this scenario, with a projected increase of 2.3%. Navigating Global Financial System Fragmentation 18

Navigating Global Financial System Fragmentation 2025