Are We Fragmented Yet? Measuring Geopolitical Fragmentation and Its Causal Effect

After decades of rising global economic integration, the world economy is fragmenting. To measure this, we introduce a geopolitical fragmentation index based on a dynamic hierarchical factor model with time-varying parameters and stochastic volatility. We then use structural vector autoregressions and local projections to assess the causal effects of fragmentation. Increased fragmentation negatively impacts the global economy, with emerging economies suffering more than advanced ones. Notably, fragmentation has an immediate negative effect, while the benefits of reduced fragmentation unfold gradually. A sectoral analysis shows that industries closely tied to global markets are more adversely affected. Finally, we highlight significant differences in the effects of fragmentation across geopolitical blocs.