| Hello and a big welcome to our new friends from Cofco International, EU-LATIN Business Forum, Japan Business Council in Europe, and others. To tariff or not to tariff... that might be the wrong question if one goes by a new analysis published by the European Stability Mechanism on Tuesday (9 October). In its new report, the ESM – the eurozone backstop mechanism born out of the financial crisis years to shore up the 20-country bloc’s systemic resilience – takes stock of the increased global geopolitical divergence as a matter-of-fact secular trend that Europe needs to wake up to and safeguard its economic and policy toolkit against. Well beyond the issue of trade tariffs, one might add. “Geoeconomic fragmentation is on the rise amidst heightened geopolitical tensions and a surge in inward-looking policies to strengthen economic and national security,” the study warns. In terms of trade openness, it shows that, globally, around 3,000 “harmful interventions” on goods and services trade and investment occurred in 2023 alone – almost five times the number in 2017. That is, before the Trump administration reshaped global trade patterns by igniting one of the more consequential and multipolar trade wars of contemporary economic history. Against this backdrop, however, the report highlights that the eurozone has consistently and “sharply” continued to grow its financial exposure to “geopolitically distant countries” over the last two decades – with linkages with countries that hold “divergent political views,” heightening risks for both trade and capital flows, the ESM says. “The euro area has deepened its financial ties with countries whose foreign policies are now increasingly at odds with Europe’s own, such as China and Russia,” it says. Aggregate eurozone financial-sector ties with these 'geopolitically distant countries' “more than doubled since 2008, peaking [to a value of] 60% of euro area GDP in 2020,” the ESM notes – although it also saw the trend subsidising starting from 2020, dropping to below 50% of GDP by mid-2023. Within this, the value of euro area financial assets held by geopolitically distant countries climbed above 8.3% of GDP as of mid-2023 – a number that inches higher to almost 10% based on European Central Bank estimates, the ESM report shows. In particular, the ESM highlights that about one-third of euro area government debt held by non-euro area investors is in the hands of non-politically aligned countries. Overall, the eurozone region “exhibits high degrees of trade openness that expose them to repercussions from geoeconomic fragmentation,” the ESM says. “Our analysis points to the vulnerability of capital flows to geopolitical risks.” On aggregate, “these trends could threaten macro-financial stability, especially in the absence of appropriate buffers to mitigate the shock,” it further warns. The costs of economic and financial fragmentation, the report says, could translate into “global output losses ranging from 0.2% to almost 7%.” In the most extreme scenario of a “full technological decoupling of the global economy” – where the breakup of trade ties results in a deep retrenchment of the global circulation of technology – the study cites figures that see total production losses reach 12% of GDP in some cases. “While the likely economic costs are largely unknown, it is expected that countries will be impacted differently depending on such factors as their degree of trade and financial openness, level of development, and availability of policy buffers to mitigate any potential geoeconomic shock,” the ESM says. Among the practical implications, “an increasingly divided international trade and financial system could lead to significant welfare costs, impair our ability to tackle international challenges, and pose risks to global and regional financial stability.” This outlook is far from rosy. | 
