Australia risks being caught in no man’s land as the world divides into rival economic blocs in what the International Monetary Fund describes as a new cold war.

Trade has been falling everywhere since Russia’s invasion of Ukraine, but it has been falling twice as fast between the blocs of nations centred on the United States and China as it has between nations within those blocs.

The IMF’s latest World Economic Outlook shows that trade between the rival blocs of nations is falling faster than was the case between the US and Soviet blocs in the late 1940s.

The US presidential election victory of Donald Trump, who has vowed to impose steep increases in tariffs on China and its proxies, will deepen the cleavage in both global trade and foreign direct investment.

IMF Deputy Managing Director Gita Gopinath has warned, ‘Policymakers need to get ready to navigate a more volatile world whose key features are increasingly being shaped by fragmentation and conflict.’

Australia’s political leaders, like most of their regional counterparts, reject the notion that they face a choice between the two superpowers and instead emphasise opportunities that await in commerce with counterparts across the Indo-Pacific and beyond.

However, Australia’s dependence on China as its principal market and supplier is both an economic and geopolitical fact.

The tension in Australia’s position is shown by the different attitudes towards trade, where the government has sought to rebuild Chinese exports, and foreign investment, where national security concerns are now paramount.

Where Australia sits in a division of the world between rival blocs is not clear. An IMF analysis of the impact of global fragmentation on commodity markets earlier this year assigned Australia to the ‘China-Russia’ bloc, rather than the ‘US-Europe’ bloc.

The IMF estimates that trade between blocs aligned with either the United States and China has fallen 5 percent since 2022, or twice the 2.5 percent decline of trade among nations within those blocs.  A similar dynamic is evident in foreign direct investment.

US and Chinese companies have been shifting supply chains away from each other.  One result has been a surge in the trade of what the IMF terms ‘connector countries’ such as Vietnam and Mexico. Trump has said he will impose punitive tariffs on imports that attempt to evade his restrictions on China by being routed through third countries.

A study by the Organisation for Economic Cooperation and Development, exploring the impact of a hypothetical 10 percent fall in trade between advanced and emerging nations, found that Australia and South Korea would be the most severely affected, facing falls in GDP as much as 1.4 percent.

It is not simply a matter of geopolitical forces upsetting otherwise mutually profitable trading arrangements. Depending on other nations for traded goods and services can carry intrinsic geopolitical implications. The OECD comments:

Up until recently, interdependence was generally seen in a positive light, principally involving mutually beneficial commercial exchanges, allowing better specialisation and bringing higher productivity and access to a wider pool of capabilities and ideas. However, recent global events disrupting international markets and supply chains have increased concerns about the supply chain resilience and the risks that might be transmitted through international trade linkages.

Global production of products has become increasingly concentrated, and it tends to be increasingly clustered around some countries and regions, notably China and Asia. This is not only due to natural or organic economic factors, such as natural endowments, comparative advantage, economies of scale, or global value chain fragmentation, but also policies.

There is a growing interest in identifying commercial links that could cause high economic or societal damage in case of unexpected disruptions, or those that could be used as a tool of coercion or might create national security risks or weigh on countries’ sovereignty.

Countries are dependent on a trading partner when it accounts for a large share of exports or imports of a particular product or service and there are few alternative suppliers or markets.

When China blocked Australian coal imports, mining companies could divert their exports to other markets. But there was no such remedy for lobster producers, because China accounted for 90 percent of Australia’s exports and a large share of global imports.

The OECD says that many products that appear on lists of ‘critical’ or ‘strategic’ goods are not particularly concentrated. Strategic sectors where OECD countries do have high dependence on China include manufacturing refractory and ceramic products, tools for cutting stone (essential for quarries), pharmaceuticals, lifting and handling equipment and electronic components.

An important conclusion from the OECD study is that China is much more dependent on advanced countries than vice versa. ‘Trade dependencies of OECD economies on China also need to be put in the context of China’s dependencies on OECD economies, which appear even larger.’

While the tensions may become more acute, both US and Chinese blocs retain strong vested interests in each other.