INTERDEPENDENCE BITES BACK / PROJECT SYNDICATE

Interdependence Bites Back

In today’s interconnected global economy, geopolitical shocks cascade through trade, production, and financial networks that were built for efficiency, not resilience. As disruptions hit critical supply chains, temporary price spikes can evolve into sustained inflationary pressures, raising the risk of stagflation.

Şebnem Kalemli-Özcan

PROVIDENCE – As the Iran war entered its fourth week, financial markets finally began to price in the possibility that the conflict was rapidly turning into a global macroeconomic crisis.

Many investors had initially treated the war as a temporary disruption with limited spillovers. Ç

But this view carried little weight with economists and political scientists, who knew all too well that in a global economy characterized by deep trade, finance, and production interdependencies, it is only a matter of time before a geopolitical shock becomes a macroeconomic one.

Paradoxically, this interdependence has also been a source of resilience. 

Over the past five years, it has helped the global economy absorb four stagflationary shocks: the COVID-19 pandemic, Russia’s invasion of Ukraine, US President Donald Trump’s trade war, and the ongoing war in the Middle East.

Even if one reserves the term “stagflation” for the oil shocks of the 1970s, the pattern of slowing growth alongside sticky inflation in the United States and elsewhere is hard to deny. 

This raises a critical question: How much stronger might global and US growth have been without those four shocks, particularly the three avoidable, man-made ones?

Economic theory offers one way to approach this question. 

In an interdependent global system in which trade, production, and financial networks are layered on top of each other, countries hold varying degrees of leverage over one another. 

Some choke points – such as the Strait of Hormuz and the Suez Canal – are geographic, while others reflect monopoly power, as in China’s dominance of the rare-earth sector. 

Then there are what I call “persistent chokeholds”: disruptions rooted in misguided domestic policies or wars that affect global networks’ most vulnerable nodes. 

Tariffs, which often act as stagflationary shocks, are a prime example. 

While the US economy appeared to absorb the initial market turbulence that followed the “Liberation Day” announcement of reciprocal tariffs on April 2, 2025, that resilience may have been overstated. 

As tariff-related uncertainty persists, recent data point to underlying weakness and early signs of labor-market deterioration.

Meanwhile, tariffs are already feeding into inflation. 

Headline US inflation was running at an annualized rate of 2.4% in February, with core inflation at 2.5%. 

More tellingly, the producer price index – often regarded as a leading indicator of upstream price dynamics – rose to 3.4% in February from 2.9% the previous month, well above expectations. 

Taken together, these higher-than-expected readings suggest that inflationary pressures were already working their way through US supply chains even before the latest oil-price surge.

This is consistent with economic theory. 

In a world of tightly integrated supply chains – where countries import not only finished goods but also key inputs such as steel, aluminum, and fertilizers – tariffs raise costs across multiple stages of production. 

At the same time, the US trade deficit reached $901 billion in 2025, partly driven by the AI boom, which itself depends on integrated supply chains to build data centers at scale.

The Return of Stagflation

While the US economy grapples with the effects of Trump’s tariffs, the Iran war has introduced another stagflationary shock. 

Wars destroy productive capacity, making them inherently inflationary, yet markets initially expected the conflict and the resulting supply shocks – including shipping disruptions and strikes on oil infrastructure – to be short-lived.

They fell into a familiar trap. During the COVID-19 pandemic, global inflation rose sharply from around 2% to nearly 9%, and by 2022, both advanced and emerging economies were facing double-digit price increases. 

Then, as now, markets assumed the stress would pass and that vaccine rollouts would ease supply-chain bottlenecks. 

Instead, inflation surged, underscoring the importance of production capacity, factory operations, and the physical location of assets.

The pandemic showed, once again, that trade elasticities are time-varying and shaped by supply networks. 

This lesson was reinforced by Russia’s 2022 invasion of Ukraine, when Germany managed to substitute away from Russian gas only by rapidly building liquefied natural gas (LNG) terminals to receive US imports, a process that took more than a year. 

It also highlighted the risks of demand-and-supply mismatches, as vaccines led to an unprecedented recovery in demand while supply remained limited, fueling global inflation.

Geographic choke points – most notably the Strait of Hormuz but also the Panama and Suez canals and key shipping lanes like the Malacca Strait and the South China Sea – have few, if any, substitutes. 

The current supply shock extends well beyond oil and gas to encompass fertilizers, metals, aluminum, helium, and sulfur. 

Roughly 10-15% of trade in these commodities passes through the Strait of Hormuz, while the region accounts for 20-45% of the world’s supply of some of them.

Trade, production, and financial networks are not necessarily constrained by geography: they can adapt, and so can the elasticities that determine how easily suppliers, inputs, and financial assets can be substituted. 

But when domestic and global policies create new obstacles, adjustment slows and becomes more costly.

Tariffs, in particular, are a poor tool for strengthening supply-chain resilience. 

The long-discussed but never-realized Iran-Turkey-Europe natural-gas corridor would have done far more to enhance energy security than Trump’s efforts to compel insurance companies to cover ships unwilling to sail through the Strait of Hormuz or the diversion of scarce military resources to protect them.

Markets understand the link between financial-asset prices and physical supply; policymakers, it seems, do not. 

As the gap between the pricing of oil futures and the underlying fundamentals that determine costs of energy across the economy widens, attempts to manage supply through emergency releases from strategic reserves – and, more controversially, by easing sanctions on adversaries like Russia and Iran – only deepen the disconnect.

Such measures are unlikely to prevent what could become the largest surge in global inflation since the pandemic. 

While there is no reason for 2026 to follow the pattern of 2022, the scale of the current supply shock is already significant, with some experts drawing comparisons to the 1970s. 

One lesson from the past several years is that in today’s global economy, the supply of energy is tightly linked to that of other inputs like chips and fertilizers through global networks. 

As a result, seemingly unrelated events can pose systemic financial threats.

Ultimately, the key variable is asset prices, which in turn hinge on US monetary policy. 

Faced with the enormous uncertainty caused by the Iran war, policymakers are once again forced to rely on a data-dependent, wait-and-see approach.

The Price of Fragmentation

Against this backdrop, all monetary authorities find themselves in a bind. 

The US Federal Reserve, for its part, has paused its interest-rate cuts as it struggles to fulfill its dual mandate of price stability and maximum employment. 

But even single-mandate institutions like the European Central Bank cannot afford another bout of double-digit inflation. 

Nor can they print their way out of a downturn when capital, physical assets, and production are under threat.

At the same time, temporary price spikes are threatening to fuel persistent inflation through integrated production networks. 

Higher inflation and inflation expectations tend to move together. 

As short-term US Treasury and UK gilt yields make clear, markets are not pricing in rate cuts anytime soon. 

Investors remember that pandemic-era inflation had been on a downward trajectory until it was knocked off course by two inflationary shocks of the Trump administration’s own making: first the trade war and now the war against Iran. 

Consequently, only consistently tight monetary policy can put the inflation genie back in its bottle.

To be sure, some things have improved since 2022. 

Europe has significantly expanded its LNG import capacity, cut gas consumption, and eliminated logistical bottlenecks. 

US LNG exports rose by 65% between December 2021 and December 2025, reducing the risk of extreme energy vulnerability.

But broader vulnerabilities remain. 

As long as the world is interconnected, markets remain globalized, and supply chains are optimized for efficiency, persistent choke points will continue to fuel inflationary pressures. 

Consider, for example, semiconductors: the Taiwan Semiconductor Manufacturing Company (TSMC), the world’s leading chip manufacturer, relies on sulfur and helium supplied by Gulf countries and shipped through the Strait of Hormuz.

Some may argue that Global South economies with solid fundamentals and a broad commodity export base, particularly in Latin America, will benefit from these trends. 

The Brazilian real and the Colombian peso are among the few currencies still appreciating against the dollar. 

Other economies, however, have come under pressure. 

Turkey’s central bank, for example, burned through roughly 15% of its foreign-exchange reserves in the first week of the Iran war in order to stabilize the lira, while foreign investors in South Africa and Hungary have suffered significant losses amid market volatility and capital outflows.

These pressures, in turn, are likely to encourage energy hoarding, further tightening global supplies and driving up domestic inflation. 

With economic sovereignty increasingly understood as hoarding natural resources, reshoring manufacturing, and expanding domestic energy production, containing global inflation could become far more difficult.

No Going Back

Protectionist leaders may see the unwinding of supply-chain interdependence as the solution, but the data show that this is neither simple nor costless. 

A fragmented global order cannot simply be willed into existence.

To understand why, it is worth returning to the founding text of modern capitalism. 

As composer David Lang’s new musical adaptation reminds us, Adam Smith’s The Wealth of Nations remains as relevant today as it was in 1776, and so does its core insight: even when individuals act in their own self-interest, the gains from exchange and interconnection make everyone better off. 

The global economic system was designed to harness those gains through free trade and the division of labor. 

We dismantle it at our peril.

In a highly interconnected global economy, coercive statecraft that relies on economic pressure inevitably leads to slower growth and higher inflation. 

No hegemon can exert such pressure without paying a price, because interdependence creates mutual leverage. 

Aspiring global hegemons and regional powers must therefore work to preserve international stability and predictability rather than undermine it.

This is particularly true for the US, which derives its power from economic interdependence, not in spite of it. 

In a fragmented world, no power can be truly hegemonic, and both physical and financial assets become highly sensitive to shifts in sentiment, as recent volatility in gold prices and technology stocks has shown.

Ultimately, today’s global supply chains were built for efficiency, not resilience, leaving them vulnerable to geopolitical upheavals. 

In this sense, the stagflationary pressures now bearing down on the world economy are neither an accident nor an aberration. 

They are the price of underestimating global interdependence and taking it for granted.

Şebnem Kalemli-Özcan, Professor of Economics at Brown University and Director of the Global Linkages Lab, is a former senior policy adviser at the International Monetary Fund and former lead economist for the Middle East and North Africa at the World Bank.