Quantifying economic vulnerabilities induced by interdependent networks

Abstract

Under economic globalization, countries are linked through trade and investments. This economic interdependence creates vulnerabilities. The indirect vulnerability induced by interdependent networks of trade and investments can put a country’s economy at risk, but this risk has yet to be systematically quantified and investigated. In this paper, we developed the novel Potential Indirect Vulnerability Index (PIVI) to capture how interdependencies between networks of trade and foreign direct investment (FDI) may induce economic vulnerabilities. The model consisted of three main components: a target country (the importer of goods), an investing country (the exporter of FDI), and the intermediary countries that export commodities to the target country and receive FDI from the investing country, serving as conduits of the vulnerabilities caused indirectly by the investing country. The PIVI quantifies the indirect vulnerabilities based on the product of two fractions: 1) the dependency of the target country on commodities from each intermediary country; and 2) the dependency of each intermediary country on FDI from the investing country. We demonstrated the utility of PIVI by examining the US economy’s vulnerability to China using 2019 trade and FDI data. Several Asian countries and a mix of agricultural products and raw materials were identified as conduits through which China could potentially influence the US economy. Vietnam was a sizeable risk because, while it has been a primary source of many US imports, it also received about 30% of its FDI from China. The US policy makers might opt to increase diversity in trade partners or to promote investment in countries such as Vietnam. We also applied the PIVI analysis to critical minerals, identifying cobalt, tungsten, and copper as the most vulnerability-inducing among them. PIVI is a flexible metric than can be aggregated and modified to provide a more nuanced and focused assessment of an economy’s vulnerability.