The Fragmentation Paradox: De-risking Trade and Global Safety

We develop a model of international trade and geopolitical disputes, embedding a diplomatic game of escalation to conflict within a quantitative model of trade. Bilateral disputes arise exogenously, and rival countries engage in negotiations to avoid war. In equilibrium, negotiations may fail, resulting in conflict. All welfare-relevant geoeconomic factors, such as the realized costs of war, the concessions to prevent it, and the probability of escalation, depend on the opportunity cost of war, itself shaped by observed trade flows. We provide a simple procedure to estimate these factors in a model of trade calibrated to current data. This approach is then used to quantify the geoeconomic factors characterizing the US-China relationship, both historically and under various ``decoupling'' scenarios. We find that the growing US dependence to Chinese products and markets over the past thirty years has increased the cost of geopolitical disputes with China for the US. In this context, decoupling from China through increased tariffs may offer geopolitical benefits. Yet, the analysis highlights a fundamental security dilemma: because export and import dependencies influence bargaining power in negotiations, decoupling may reduce the diplomatic concessions needed to maintain peace but can paradoxically raise the risk of escalation by weakening incentives for restraint.