Trade relationships are continuing to reconfigure, and changing geopolitics is a major reason. Sven Smit, Senior Partner of McKinsey & Company and Chair of the McKinsey Global Institute, discusses how shifting geopolitics are reshaping trade relationships.
Interviewed by Klara Marie Schroeder
We do not engage in predictions, however, there are many possible futures, and today's geopolitical context is particularly uncertain. We did look at investment flows as a forward indicator that may tell us whether trade reconfiguration is likely to continue. And we also developed two broad scenarios for the future.
While roughly 60 percent of greenfield cross-border investment has flowed to developing economies each year since 2010, its destination is shifting. Announced investment into Africa, India, Central Asia, and the Middle East, as well as developing economies in Europe, has risen markedly relative to pre-pandemic averages. However, announced investments in China and Russia have declined substantially—by 67 percent for Greater China (70 percent for Mainland China) and 98 percent for Russia. And advanced economies in Asia, Europe, and North America have experienced increases, too.
Developing economies that have experienced recent increases in investment announcements are often sourcing investment from economies across the geographic and geopolitical spectrum. For example, ASEAN economies have witnessed increases in investment announcements from China, Europe, and the United States. Both China and Europe have announced meaningfully increased investment into Africa, Central Asia, the Middle East, and developing economies in Europe. And while India has seen declining investment announcements from China, total investment announcements into India have surged, driven by economies spanning Asia, the United States, and Europe.
The two broad scenarios are fragmentation and diversification. Each has trade-offs:
Fragmentation. One possibility is an increasingly fragmented "deglobalized" world in which trade reorients toward flowing between geopolitically aligned economies. This could be a continuation of the slight decrease in the geopolitical distance seen in global trade over recent years that has, for instance, been linked to the decreasing share of US-China trade or the rapid reduction in EU-Russia trade. Broadly, this approach may reduce interdependence between geopolitically distant partners but increase supply concentration, which, therefore, potentially lowers resilience to other types of risk, such as natural disasters. It also risks materially lower growth. In our modeling, the average concentration of trade increases by 13 percent, and economic growth suffers.
Diversification. Another form of reconfiguration could involve diversifying trade relationships so that no economy is overly dependent on any other for the products it imports. This kind of trend could be consistent with increased greenfield investment in a diversity of developing economies. Diversification may reduce acute points of interdependence for specific goods but will require continued linkages and cooperation among geopolitically distant economies. In our modeling, the geopolitical distance of trade increases by 3 percent.
In our research, we looked at whether these buzzwords reflect the reality on the ground and the picture is nuanced.
Nearshoring and reshoring are not yet happening on a global scale. Some nearshoring is happening, but it is a strategy largely deployed by the United States, which is shifting some trade toward geographically closer partners. For instance, Mexico has also gained US import share—in large part from Japan in transportation equipment and ASEAN in agriculture. This seems indicative of nearshoring. But it is an outlier in this. The other economies we analyze show no substantial evidence of nearshoring of trade patterns—rather, their trade has often been traveling further on average.
De-coupling is difficult because certain key products are so concentrated in terms of where they can be sourced. No region of the world is close to being self-sufficient. Every region has been importing 25 percent or more (in value-added terms) of at least one important type of resource or manufactured good that it needs, and often much more. Making the ties that bind economies even stronger is the fact that around 15 percent of global goods trade flows between more geopolitically distant economies, and that trade is skewed toward products that are highly concentrated in their sourcing—around one third of trade in "globally concentrated products" is between geopolitically distant economies. Examples of such products include laptops and iron ore—three or fewer economies provide at least 90 percent of global exports.
Friendshoring is happening to some degree. We can see this from the decline in the geopolitical distance of trade. What is this new measure? We used votes at the UN General Assembly between 2005 and 2022 as a proxy for alignment on global issues. Then, we defined a one-dimensional spectrum of geopolitical positions based on votes. We mapped each country on a voting spectrum from zero to ten. We then took the geopolitical distance between any two economies to be their difference on this scale.
The average geopolitical distance of trade fell by 7 percent between 2017 and 2024. Economies at each end of the geopolitical spectrum have been trading less with one another—large economies such as China, Germany, and the United States have seen sharp reductions in the geopolitical distance of their trade. However, not all economies are realigning their trade along geopolitical lines. Between 2017 and 2024, the geopolitical distance of trade for ASEAN, Brazil, and India was stable or increased, reflecting their growing trade ties across the geopolitical spectrum.
We suggest five priorities for consideration:
First, establish an insights edge. In the ever-evolving landscape of trade, business leaders need to elevate their baseline insight to gain a competitive edge, developing a granular view of their own company, of other companies, and of the global context in which they are operating, monitoring the world for tremors that may signal shifts.
Second, anticipate and adapt with scenario planning. Business leaders should consider developing detailed scenarios with implications for what and where they invest in, where they locate upstream and downstream businesses, and what shifts could influence competitive opportunities.
Third, develop a portfolio of strategic actions. A clear information baseline and a suite of scenarios provide the groundwork for action. A proactive set of actions can be pursued in anticipation of shifts, while others can be planned and set in motion by specific trigger points. Actions might include shifting supply chains, production locations, or end markets; establish options; and taking "insurance" actions.
Fourth, build muscle and bone for navigating geopolitics. Understanding of geopolitical realities is becoming a core capability for the MNC leaders and their teams whose firms face uncertainty in global trade—the "muscle". Executives should develop a grasp of context, nuance, and business implications well beyond what they can learn from news headlines. Companies also need the "bone" of processes and systems that support geopolitically informed decision-making, such as digital early-warning systems and risk dashboards. Strategic planning processes can formally incorporate geopolitical considerations into strategy and capital allocation.
And fifth, embrace cooperation. Even while acting within their own organizations, business leaders can actively seek to shape the future path of trade, identifying how best to navigate some of the potential trade-offs across different regions and sectors, potentially in concert with other stakeholders.
For many years, global connections have been formed largely as international players have sought fruitful markets and cost efficiency. Those were the factors that drove the development of global supply chains.
But a new agenda is now emerging, and national security, competitiveness, and supply chain resilience are key drivers. As a result, the use of industrial policy has been increasing, especially in support of sectors that are perceived to be of critical strategic importance. Semiconductors and energy are two prominent examples.
In an uncertain world, international cooperation is arguably even more important, but such cooperation has stalled. McKinsey teamed up with the World Economic Forum to develop a Global Cooperation Barometer that can help leaders understand and act on broad global trends that have a direct impact on the lives and livelihoods of billions of people. The barometer takes the pulse of five pillars of global cooperation—trade and capital flows, innovation and technology, climate and natural capital, health and wellness, and peace and security. The first barometer, which we published in February 2024 found that after trending positively for much of the past decade, global cooperation has stalled.
Absolutely. Let's have a look at all five pillars.
Trade and capital. Although some trade relationships have clearly come under strain, others have strengthened. For instance, the United States has been trading more with Vietnam, and China has increased trade and investment across Southeast Asia and India. But there is no doubt a major question about whether leaders will bolster cooperation to rebuild global connections that have been frayed as well as new connections.
Innovation and technology. Given recent increased friction, global leaders will need to address (at least) two critical areas of cooperation to return to the levels of cooperation we saw from 2012 to 2020. The first is to commit to greater cross-border collaboration through foundational R&D, international student exchanges, and cross-border patent applications. The second area is harmonizing and simplifying approaches to global regulation of frontier technologies.
Climate and natural capital. Solving the climate and nature challenge requires more cooperation not less. Even with a multitude of climate commitments from countries, development banks, private sources, and philanthropists and an increase in funding flows in recent years, there remains a cumulative funding gap for climate mitigation alone of $41 trillion between 2020 funding levels and what is needed through 2030.
Health and wellness. During the pandemic, cooperation increased, but since that peak in 2020, cooperation has dropped. Both national governments and private companies can learn from their experience during the COVID-19 pandemic. Two examples of efforts to improve cross-border pandemic preparedness and response are the G-20's new $1.4 billion Pandemic Fund and the WHO's Pandemic Preparedness Treaty. There is also bandwidth to use international partnerships to coordinate and deepen basic research on a variety of health conditions, from chronic disease to accelerating approaches to clinical trials on frontier conditions, to tackle the proliferation of synthetic drugs; and to coordinate on emerging best practices to support improved outcomes in mental health in the working-age population.
Peace and security. We suggest that the public and private sectors focus their energies on two important areas: supporting vulnerable populations and finding new mechanisms of collaboration to respond to the evolving challenge of cyberattacks.
Trade configurations are quite complex, and it is hard to discuss clearly in winner and loser terms. We look instead at trade-offs and those vary depending on the economy.
Broadly, fragmentation may reduce interdependence between geopolitically distant partners but increase supply concentration and therefore potentially lower resilience to other types of risk, such as natural disasters. It also risks materially lower growth. Diversification may reduce acute points of interdependence for specific goods but will require continued linkages and cooperation among geopolitically distant economies. These broad findings vary substantially by economy groups and within economies. However, the fact of trade-offs holds generally.
In a fragmentation type of reconfiguration, geopolitical divides deepen. There are significant tensions between Eastern and Western economies. Overall, intra-Western trade increases while China strengthens ties with economies that are somewhere in the middle of the geopolitical distance spectrum, mid-aligned. In a diversification reconfiguration path, the overall might be broadly unchanged, but substantial shifts would occur within and among sectors. The most material shifts occur in relation to China. China loses share of its trade partners' imports in sectors where it is currently a concentrated supplier, particularly in electronics and textiles, but gains share with other partners and in other sectors.
There are certainly opportunities in both a fragmentation and diversification scenario. However, in both scenarios, most mid-aligned economies do not experience increased trade participation or accelerated growth in either case, without continued investment.
In a fragmentation scenario, mid-aligned economies reorient their trade toward the Eastern group. This reorientation is particularly marked in some sectors where Western group economies had been a major destination for Eastern group exports. For example, mid-aligned economies' share of electrical equipment imports from the Eastern group rises from 34 percent today to nearly 50 percent. As a result, China remains a major global exporter across sectors and the largest trade partner for economies representing one-third of the world by value of trade in both Eastern and mid-aligned groups. Indeed, it remains the world's largest exporter in 16 out of 43 sectors, as it is today.
In a diversification scenario, mid-aligned economies gain share when they have existing substantial supply relationships, offering an opportunity to scale in diversification. However, mid-aligned economies with less established global supply relationships, such as those in Africa or Latin America, do not experience substantial trade increases. To shift this calculus, which is grounded in existing production capabilities, more mid-aligned economies would need continued differential investment of the sort that our analysis of recent investment announcements suggests may have started.
As global trade continues to reconfigure, there is an opportunity for mid-aligned economies to play a connecting role. For instance, as US trade has reoriented away from China, Vietnam has become a trade intermediary between the two.
Investment flows suggest that mid-aligned economies may find a new place in the global trading system. ASEAN economies have witnessed increases in investment announcements from China, Europe, and the United States. Both China and Europe have announced meaningfully increased investment into Africa, Central Asia and the Middle East, and developing economies in Europe. And while India has seen declining investment announcements from China, total investment announcements into India have surged, driven by economies spanning Asia, the United States, and Europe.
This is not an easy question to answer. There are so many variables and so much uncertainty.
What we do think, however, is that there is huge value at stake for MNCs. For instance, should a typical manufacturing multinational in the automotive sector experience simultaneous shocks that prevent it from securing the global flows it needs, as much as 40 to 60 percent of its enterprise value could be at risk.
Sven Smit is a Senior Partner at McKinsey and Chair of the McKinsey Global Institute (MGI). Sven works with leading companies to develop strategies for growth and serves all industries, analyzing the success factors required for business growth, examining the way megatrends influence it, and defining the lessons of diversified growth. As chair of MGI, he leads research and authors MGI reports on global economic trends and topics. Sven's previous roles within McKinsey include leading the firm’s work in Western Europe and the global Strategy & Corporate Finance Practice.
