5 transformational trends shaping global finance

The global economy is very different now compared with even just a few years ago. Thanks to tectonic shifts since COVID-19, major structural changes are underway. Deglobalization, decarbonization, demographics, surging debt, and digitalization are all shaping the world’s economy and financial markets.

These five fundamental forces – the “Five D’s” – establish a multi-dimensional decision space for policymakers and investors. They require careful evaluation, as they have the potential for transformational impacts.

The retreat from globalization is accelerating as trade tensions, geopolitical rivalries, and a reassessment of supply chain vulnerabilities catalyze resurgent economic nationalism and trade regionalization. According to the IMF, the number of trade restrictions imposed annually worldwide increased from about 1,000 in 2019 to more than 3,000 in 2023. In anticipation of the new Trump Administration’s stated policy of increasing reliance on US tariffs, that number looks set to rise further.

Deglobalization presents significant challenges to economic growth, and meaningfully increases inflationary impulses. Trade fragmentation reduces efficiency gains from specialization and competition, and limits economies of scale -- while financial fragmentation constrains cross-border capital flows and increases macro-financial volatility. Research by the IMF and BIS show that open economies tend to experience lower inflation rates, even after accounting for other inflation determinants.

The effects of deglobalization will not be uniform. Emerging and developing economies are likely to be disproportionately impacted due to their dependence on foreign direct investment, and exposure to energy and commodity supply risks. Given the hegemonic role of the dollar in invoicing, continued dollar strength is likely to further impact these economies. Importantly, deglobalization may impede efforts to tackle global challenges such as climate change.

At the same time, some countries or regions may benefit -- as established trading relationships disintegrate, and new relationships form. Southeast Asia is seeing new trading patterns emerge as US and China ties falter.

Renowned climate scientist Veerabhadran “Ram” Ramanathan warns that global warming will happen faster than we think, and climate change could get its COVID-19 moment as early as 2030, if emissions go unchecked. The impacts of climate change manifesting through extreme weather events are already a stark reality, from increasing wildfires in Australia, to extreme rainfall in Dubai, floods in Europe, and the growing intensity of hurricanes in the US. These realities are inflationary, as they require fiscal support to restore normal operations. Adaptation is an urgent necessity to protect against weather events. Irrespective of the pace of climate change, adaptation requires grants and fiscal support, which is inflationary since there is no concomitant increase in productivity or tax base. While green bonds and sustainable loans are growing, they are not yet at a sufficient scale to meet these challenges; some form of fiscal support will be inevitably required to fill the gap.

Demographics (including ageing populations) is driving declines in workforces. Greater longevity and falling birth rates further increase the fiscal burden of provisioning medical care and retirement benefits to an ageing population. As was noted recently at the Federal Reserve’s Jackson Hole meetings, financial markets have become highly sensitive to fiscal strains and their implications for monetary policy. Since rewriting social contracts is an uncertain option, ageing populations and increasing dependency ratios lower productivity and increase inflationary impulses, while worsening fiscal strains.

Heightened government expenditures will increase government obligations, which are already at record levels. According the World Economic Forum, global debt recently reached a record $307 trillion largely driven by developed countries. Global fiscal support during the COVID-19 pandemic era alone lifted government debt to a record $50 trillion among developed economies. This, and higher interest rates than experienced in the past two decades, is likely to lead to higher risk premium for additional debt issuance -- and higher debt servicing costs. In the US, for example, the debt servicing costs will exceed the defence budget in 2025, a trend that is likely to worsen.

Elevated debt limits a government’s capacity to invest in infrastructure, education, and research, which are key drivers of long-term economic growth. This crowding-out effect may also emerge if sustained government borrowing leads to higher interest rates, raising the cost of capital for the private sector. This is especially an issue as companies in the US with high-yield debt face an imposing maturity wall with about $200 billion due in 2024-25 and about $1.1 trillion in 2024-28.

Against this backdrop of significant challenges to global growth, the trend towards greater digitalization stands in sharp contrast. Digitalization, artificial intelligence (AI), and tech innovation more broadly promise to provide an uncertain but much-needed counterweight to the forces holding back growth. Take the economic potential of generative AI (GenAI), for example -- some estimate related productivity growth of about 1.5% per year, and total economic benefits ranging from $2.6 trillion to $4.4 trillion across industries resulting from a wide adoption of GenAI . While past tech disruptions offer reasons for caution, the key characteristics of GenAI, namely accessibility and versatility, may help the technology overcome hurdles that blunted the benefits of previous innovation.

The interactions between these forces are complex. Reduced economic activity resulting from increasing tariffs would diminish tax revenues and exacerbate fiscal deficits. At the same time, funding decarbonization and addressing shifting demographics will also intensify fiscal demands. These are inflationary, and limit the efficacy of monetary policy. Meanwhile advancements in digital technologies, particularly GenAI, could optimize energy consumption and accelerate the development of clean technologies, potentially mitigating any inflationary impacts and delivering broader productivity gains from widespread adoption.

While these fundamental forces present significant challenges for economic growth, they also offer unique opportunities in many industries -- not least the financial industry. Large flows of capital will have to be sourced and managed to meet changing demands. And the shifting dynamics of markets from the interplay of these forces could provide opportunities for the wealth and asset management industry, liquidity providers and dynamic risk management tools. Being nimble enough to handle the shifting dynamics of markets, while being integrated front to back, would be helpful for handling the multi-faceted challenges of these transformational trends.