Connector Economies in a Fragmenting World

By Chuan Han Cheng, Oleg Konovalov and Alexander Plekhanov

Connector economies, those not strongly aligning themselves with the US or China, play an increasingly important role in intermediating trade and investment against the backdrop of rapid geopolitical fragmentation. FDI between geo-politically distant blocs fell by 30% relative to within-bloc flows after Q1 2022, while flows to connector economies kept up with within-bloc investment. In a triple-differenced setting, we show that connector economies benefiting most from shifting investment patterns enjoy one or more distinct competitive advantages related to: (i) manufacturing capabilities; (ii) indirect access to major markets; (iii) geographical, cultural and political proximity to major geopolitical rivals; and (iv) the use of special economic zones (SEZs). With rising geopolitical fragmentation, investors make greater use of SEZs and we show that cross-bloc investment in SEZs did not decline relative to within-bloc investment.