Global trade patterns are undergoing reconfiguration with two potential pathways on the horizon, according to McKinsey Global Institute’s Geopolitics and the Geometry of Global Trade report (pdf). One route sees global economies concentrating on trade with geopolitically aligned partners while another sees trade diversifying. The report looks at these dynamics via four measures: trade intensity, geographic distance, import concentration, and geopolitical distance.

The two scenarios: One pathway sees trade fragmenting as economies shift to engaging with partners within a geopolitically-aligned bloc, boosting trade concentration and limiting risk from geopolitical disruptions, but presenting a drawback in terms diminishing globalization and economic growth. The other route sees diversification in trading partners, shoring up resilience to some shocks, but presenting the drawback of dependencies between geopolitically disparate partners. Pros-and-cons for each pathway can also vary considerably between economies, McKinsley says.

A fragmentation route “deglobalizes” trade and limits transactions within geopolitical blocs, the report said. While having the upshot of reduced interdependence between opposed geopolitical camps, this scenario also increases supply concentration and reduces supply chains’ resilience to non-geopolitical disruptions such as natural disasters. Trade fragmentation also limits global economic growth. Such an outcome would be a continuation of decoupling seen today in the declining shares of China-US trade, and Russia-EU trade, the report added.

The diversification pathway ensures that no economy is overly reliant on another for products, McKinsley explained. This outcome would see global supply chains more resilient to a wider range of shocks, while still retaining exposure to geopolitical shocks, the report says. Trade diversification may also relieve “acute points of interdependence” for critical goods and products that can only be sourced from a small set of suppliers, such as rare earth metals, but requires coordination and links between geopolitically distant trade partners. This scenario is inline with the concurrent boost in greenfield investments seen across a wide range of developing economies, the report explained.

A trade fragmentation outcome would be starkly different from the trade patterns seen today, which more broadly resemble diversification. A trade diversification outcome “would remain quite similar to today, with shifts occurring across specific value chains,” the report said.

Multinational Companies (MNC) affect changing trade patterns: Upwards of two-thirds of global exports are attributable to MNCs, McKinsley said. Decisions MNCs take with respect to their supply chains, operations, and markets guide paths towards trade fragmentation or diversification. A fragmented outcome will see MNCs matching their sourcing and production within a narrow set of suppliers and end-markets, with diversification permitting MNCs greater flexibility with respect to their supply chain decisions.

MNCs can be prepared for trade pattern shifts: Businesses need to develop better insights by developing more visibility into their supply chains and tracking indicators for shifts in geopolitics, trade, regulation, and labor markets that can cause an impact, McKinsley says. Contingency plans for handling shocks can include shifting supply chains, production sites, and end-markets. MNCs must also develop “core capability” in terms of assessing geopolitical risks and cultivate cooperations with a broad network of diverse stakeholders, the report added.

Tags: