Editor’s Letter: Technology, Payments, and the Rise of Stablecoins
THREE YEARS AGO, Finance & Development devoted a full issue to anticipating “The Money Revolution,” driven by innovations in finance, such as crypto assets. That revolution is now unfolding.
This issue of F&D looks at the new frontiers of finance, where technology, data, and changing societal values are reshaping how people and institutions move money and trade financial assets, who provides liquidity, and where new risks are brewing. We bring together academics and policymakers to assess this complex and politically charged landscape, one that generates excitement and anxiety in equal measure.
Stablecoins are one of these frontiers, a form of digital asset backed by currencies or government bonds. Stablecoin companies have racked up millions of users globally, transacting across borders 24/7 at very low cost. New legislation in the US and other countries may further boost their growth.
Hélène Rey, a professor at the London Business School, assesses the macroeconomic and geopolitical implications of widespread adoption of US dollar–denominated stablecoins around the world. On the positive side: faster and cheaper cross-border payments. On the negative: risk of dollarization, capital flows and exchange rate volatility, potential weakening of the banking system, money laundering and other financial crimes. While it’s hard to forecast how the use of this technology will play out, it’s “likely to create major financial stability risks,” she writes.
Yao Zeng of the University of Pennsylvania Wharton School identifies one potential source of risk: “The global financial landscape has changed, yet the rules remain largely unchanged.” He puts stablecoins in the context of broader changes in financial markets. For example, lightly regulated nonbanks are providing more liquidity. And lenders are increasingly relying on AI and big data to speed loan approvals, reduce collateral requirements, and reach borrowers traditional banks often overlook. One thing is clear, he writes. “Stablecoins may function well in good times, but they can falter under stress.”
Stablecoins are only one facet of the revolution. The public and the private sector alike are driving innovation. Some governments and central banks have responded to private payment initiatives by sponsoring systems that respond to consumer demand for fast, efficient payments. IMF researchers examine the case of India’s Unifed Payments Interface, which interconnects hundreds of banks, platforms, and apps and carries out more than 19 billion transactions a month.
“New entrants like fintechs and big techs, and new products like crypto and stablecoins, are challenging incumbent financial institutions.”
At the same time, central banks and supervisors must contend with disruptive innovation. New entrants like fintechs and big techs, and new products like crypto and stablecoins, are challenging incumbent financial institutions. Iñaki Aldasoro, Jon Frost, and Vatsala Shreeti, from the Bank for International Settlements, explore how competition among the new entrants and incumbents might unfold. They conclude that forward-looking public policies must accompany radical innovation to achieve the most impactful breakthroughs.
Preventing crime is another area in which public authorities need to stay alert. Criminals, unfortunately, were among the earliest adopters of crypto, and all payment systems need to balance privacy and speed with the need to stop tax evasion, money laundering, and terrorism financing. Stanford’s Darrell Duffie and coauthors lay out a practical approach to getting ahead of the curve.
Clearly, there is a lot of room for innovation in payment systems and financial markets in general. Users demand it. The key is to balance the risks and benefits through clear regulation that protects consumers and investors and limits spillovers. Who knows what new possibilities such innovations will unlock along the way? F&D
Kaleidoscope: A global view, in brief
THE BIG PICTURE: Gita Gopinath, the IMF’s first deputy managing director, has stepped down from her position to return to Harvard University. She was formerly the IMF’s chief economist. “Gita has been an outstanding colleague—an exceptional intellectual leader, dedicated to the mission and members of the Fund, and a fabulous manager,” the IMF’s managing director, Kristalina Georgieva, said in announcing the move. Above, Gita Gopinath speaks at an IMF event. IMF Photo/Lewis Joly.
Trade and Tensions
GLOBAL GROWTH is projected at 3.0 percent for 2025 and 3.1 percent in 2026, according to the IMF’s July 2025 World Economic Outlook Update. This upward revision from the April forecast reflects front-loading in anticipation of higher tariffs, lower effective tariff rates, easier financial conditions, and fiscal expansion in some major economies.
Global inflation is expected to fall, but US inflation is predicted to stay above target, the flagship report notes. Downside risks from potentially higher tariffs, elevated uncertainty, and geopolitical tensions persist.
Restoring confidence, predictability, and sustainability remains a key policy priority, according to the report.
Pierre-Olivier Gourinchas, the IMF’s economic counsellor and Research Department director, noted that “projections remain about 0.2 percentage points below our pre-April forecasts, indicating that the trade tensions are hurting the global economy.”
“A breakdown in trade talks, or renewed protectionism, could dampen growth globally and fuel inflation in some countries,” Gourinchas said. However, he added that “on the upside, breakthroughs in trade negotiations could boost conf-dence, and structural reforms could lift long-term productivity.”
Financial conditions have eased, but they could tighten abruptly, especially in the case of threats to central bank independence.”
—–Pierre-Olivier Gourinchas,
“The needs of the poorest and most fragile countries, in particular— who are often hit hardest by global shocks— demand our attention, and for these countries concessional financing remains of critical importance.”
—Nigel Clarke, deputy managing director of the IMF, speaking at the Fourth International Conference on Financing for Development
“The IMF plays a central role in casting a rigorous and independent eye over the economic and financial systems of individual countries, and the world as a whole, providing timely warnings of where problems are being stored up for the future and giving its members sound advice on how to mitigate risks.”
—Andrew Bailey, governor of the Bank of England, speaking at Mansion House, London
IN THE NEWS: Mauritius recovered from the pandemic on the back of buoyant tourism, social housing construction, and financial services, but is facing high public debt, significant public investment needs, low productivity, and an aging society. The IMF’s recent annual economic health check of the island nation offers policy options to achieve fiscal sustainability. Above, locals and tourists gather on the beach to watch the sunset. AbdulKarim/iStock by Getty Images.
Back to Basics: Tokens Are Finance’s Newest and Oldest Innovation
DALE CROSBY-CLOSE
Tokens Are Finance’s Newest and Oldest Innovation
Money has taken many forms over millennia; digital tokens are the latest
Itai Agur
THOUSANDS OF YEARS AGO, long before coins, paper money, credit cards, and banking apps, our ancestors bought and sold goods using cowries, a type of seashell. These shiny physical tokens were humankind’s first financial innovation. What made them especially useful was that they were easy to verify: When someone handed you a cowrie shell, you could see it, feel it, and trust that it had value. You didn’t need a middleman to verify the transaction.
Cash still works this way today. When you pay someone with a banknote, the deal is done—no delays. But when it comes to digital transactions, payments only seem instant. Behind the scenes, banks and credit card networks take over as intermediaries, approving and settling the transaction later. They take on the settlement risk—the danger that one party will renege on its end of the bargain. Intermediaries ensure that both parties keep their promises.
It takes time to manage settlement risk through intermediaries. This matters in cases where settlement delays are costly, especially when trading stocks, bonds, or other securities in financial markets. A clearinghouse collects the seller’s asset and the buyer’s payment and exchanges them one or two days later. In places like Wall Street, time is money. J.P. Morgan estimates that asset management costs could be cut by about a fifth if the settlement of trades and the reinvestment of sale proceeds were immediate.
Financial innovators aim to cut intermediation costs by bringing the immediacy of exchanging physical tokens to the digital world. The challenge is that when transacting parties don’t meet face-to-face, they cannot see the assets they are trading before completing an exchange. Programmability provides a solution—a piece of code that ensures the buyer’s money and the seller’s asset are locked in and then exchanged at the same moment. The funds received can be reinvested automatically, saving valuable time and money.
Digital intermediaries
Tokenization creates assets on a programmable ledger, a recordkeeping system for financial transactions that market participants can trust and share access to. Assets such as a stock or bond can be issued directly on the ledger, or they might be a representation of an asset that exists outside the ledger, such as stock on the New York Stock Exchange. In the latter case, an intermediary still needs to hold the represented asset safely in the background.
Tokenization can spur competition between intermediaries. To trade in financial markets, investors are often required by regulation to use brokers. Switching assets from one broker to another is a hassle that requires the services of a specialized clearinghouse. Alternatively, an investor can sell all assets owned through one broker and repurchase them through another, but that comes with a trading cost. Tokenization, however, allows data to be transferred among brokers with the click of a button. It makes it simpler for investors to shop around and switch between brokers for the best price.
Tokenization does not cut out all middlemen, but it is reshaping the financial industry and reducing the need for certain roles. Registrars are intermediaries that manage asset ownership records and transmit payments such as dividends or interest from a firm to the asset owners. On a token ledger such payments are made directly to the token holders, automating the role of registrars and putting them out of a job.
Tokenization works best when money and assets flow smoothly. If different companies build their own token ledgers that don’t work together, the financial system could fragment into silos. It is possible to design ledgers so that they can talk to each other, but this
Tokenization works best when money and assets flow smoothly. If different companies build their own token ledgers that don’t work together, the financial system could fragment into silos. It is possible to design ledgers so that they can talk to each other, but this interoperability requires planning and coordination. This is why policymakers want to make sure that tokenized systems stay open, connected, and stable.
Flash crashes
Tokenization’s greater efficiency does not come without risk. Faster driving can save time, but it also makes crashes more likely to occur and more serious when they do. The same is true for financial markets. Faster, automated trading has already led to sudden crashes, known as “flash crashes,” such as the 2010 Wall Street flash crash, when an estimated $1 trillion was briefly wiped off the value of stocks listed on the exchange. By making it easier to program and instantly execute automated trading rules, tokenized markets can be riskier and more volatile.
Financial crises often unfold like falling dominoes, with one failure setting of the next, as occurred during the 2008–09 crisis, when global giants Bear Stearns, Lehman Brothers, and AIG all collapsed within the space of six months. On a token ledger, chains of programs can be written on top of each other, acting like a programmed set of falling dominoes during a crisis.
Tokenization and programmability also make it easier to create complex financial products, with risks regulators may not understand fully until it’s too late. This was true of the nonprogrammable assets that soured during the 2008–09 crisis and led the Financial Crisis Inquiry Report to conclude that a “complexity bubble” burst at the same time as the real estate bubble. “The securities almost no one understood, backed by mortgages no lender would have signed 20 years earlier, were the first dominoes to fall in the financial sector,” it says. Programmability adds to an already complex financial landscape and makes it harder for regulators to keep tabs on potential risks.
“Financial crises often unfold like falling dominoes, with one failure setting of the next.”
How much debt participants in a financial market owe each other has often made the difference between a financial ripple and a tsunami. Debt amplifies shocks because it implies a promise to repay—and nothing rocks confidence like broken repayment promises. Tokenization can make it easier to build up debt, because investors or institutions can use tokens as collateral to borrow and then invest that money elsewhere. If one part fails—if a token loses value, say—it could trigger losses across the system.
Hybrid technology
Financial assets started off as paper records and evolved into digital ledgers and programmable tokens. This trend is now expanding to nonfinancial assets such as real estate and potentially even agricultural collateral like farmland and livestock. But physical assets cannot be fully digitalized—they still require physical care to maintain their value, as a farmer tends to a herd of cattle or the pasture where they graze. The tokenization of nonfinancial assets is best seen as a hybrid between physical and financial technology.
From the ancient world’s cowrie shells to today’s digital tokens, human society has come to accept different mediums of exchange. The latest innovations offer clear rewards by speeding transactions and making trading cheaper. But there are risks, too. Speed, complexity, and risky debt have all contributed to previous financial crises— and tokenization adds to all of them. As with any innovation, digital tokens should be handled with care. F&D
ITAI AGUR is a senior economist in the IMF’s Research Department.
Point of View: Why Europe Needs a Digital Euro
The digital euro project has a simple motivation: to ensure that people in a digital world retain the option to make or receive payments in central bank money. Supplementing physical cash with digital cash will support the modernization of the traditional two-tier monetary system that allows both cash and bank deposits as a medium of exchange.
The evolution of the two-tier monetary system over the past 300 years has provided a strong foundation for the operation of the broader financial system and has enabled central banks to deliver price stability effectively. While it is possible to theorize about alternative monetary systems in which central bank money plays only a wholesale role, prudence suggests that the retail role should be preserved, including through the introduction of a digital euro.
Central banks have a mandate to safeguard monetary stability in all circumstances. This calls for a cautious yet forward-looking approach that takes into account not only baseline scenarios but also tail risks of the future development of the monetary system. A digital euro will minimize the likelihood of adverse economic outcomes in the future and ensure the resilience of the monetary system in an increasingly digital world.
Cash issued by the central bank has historically played a critical role in maintaining trust in the convertibility of commercial bank money to central bank money. While convertibility is largely taken for granted, it’s not obvious that the two-tier monetary system would necessarily remain stable if ongoing digitalization meant that convertibility to physical cash lost relevance and a digital cash option was not made available.
Monopoly power
Compared with other services, payment instruments exhibit exceptionally strong network externalities—they gain value as more people use them. This is one reason using central bank money for payments improves economic efficiency: It limits the scope for commercial payment systems to exploit monopoly power by charging excessive fees. As the share of digital transactions increases, the option to make payments in digital euros can limit the potential monopoly power of the firms at the center of private sector payment networks.
In addition, public access to central bank money provides a reliable fallback option to using commercial bank money for some types of transactions if there is disruption of the commercial banking system, whether from technical problems or a cyberattack. This is one reason policymakers want a digital euro to work offline as well as online.
“If banks and other payment service providers carry out the necessary know-your-customer checks, maximum privacy will be maintained, and the central bank will not be privy to individual account details.”
Some argue that an alternative approach in adapting the monetary system to a digital age would be to promote stablecoins, issued and operated by private sector intermediaries. However, stablecoins are best understood as expanding the private money universe— as another substitute for bank deposits—rather than as a true substitute for central bank money. A stable value of a stablecoin in terms of currency is not intrinsic (unlike a liability of the central bank). Even a highly liquid backing portfolio does not guarantee convertibility under all scenarios.
By contrast, a well-designed digital euro promises to modernize the two-tier monetary system without destabilizing financial institutions or disrupting monetary policy implementation or transmission. Among other features, appropriately calibrated limits on digital euro holdings can provide people sufficient digital cash for transactions while preventing excessive outflows from commercial banks and outsize expansion of the central bank balance sheet.
Moreover, since people will set up digital euro accounts primarily via their banks (or other payment service providers), close interconnection will continue between central bank money and commercial bank money. If banks and other payment service providers carry out the necessary know-your-customer checks, maximum privacy will be maintained, and the central bank will not be privy to individual account details.
Unifying fragmented markets
For the euro area, a digital euro offers additional benefits in a multicountry monetary union. Among other factors, the euro area payment system is highly fragmented along national lines: Customers must typically rely on non-European card or e-wallet providers to make payments across the euro area. By mandating acceptance of a digital euro, instant network effects would help unify the currently fragmented market.
A digital euro would reduce costs for merchants and businesses by providing the network infrastructure for an area-wide payment system on a not-for-profit basis. It would increase bargaining power vis-à-vis international card networks for both in-person transactions and e-commerce. A digital euro thereby promises to enable an area-wide fast payment system at the point of interaction (POI) between customers and merchants. With conflicting incentives across operators of legacy national payment systems, such an area-wide POI fast payment system will not likely develop without a digital euro.
A digital euro would also provide an important foundation for fintech innovation across the continent. A standardized, pan-European platform would allow private providers to innovate while benefiting from the economies of scale of the underlying digital euro network, ultimately reducing costs for consumers and businesses alike.
In particular, by linking customers and merchants across the euro area via a system of digital euro accounts, card and e-wallet providers could focus on additional payment services while the underlying payments travel via the rails of a digital euro system. Separation of the basic plumbing of the payment system (the digital euro network) from the delivery of add-on services also lowers the risk of lock-in effects—when one private payment network with a transitory technological advantage suppresses subsequent innovation in order to keep the upper hand.
Symbol of unity
To sum up, a retail role for central bank money is arguably integral to the sovereign foundations of the monetary system. In particular, the singleness, effectiveness, and stability of the monetary system are ultimately underpinned by the sovereign (or, in the case of the euro area, the joint sovereignty of the European Union’s member states). The monetary role of the sovereign spans the institutional foundations of the monetary system (including the definition and enforcement of legal tender), the maintenance of the budgetary discipline required to ensure that monetary policy is insulated from fiscal dominance, and the delegation of various monetary tasks to the central bank.
A retail role for central bank money maintains the direct monetary relationship between the sovereign and the citizen. It reinforces public understanding that monetary stability is intrinsic to sovereignty. This consideration is especially relevant in a European context, with the common currency seen as a critical mechanism for greater economic and political integration among member countries. Beyond its economic and monetary roles, the euro is an important symbol of European unity. This must be maintained in a digital age. F&D
PHILIP R. LANE is chief economist and a member of the executive board of the European Central Bank.
Behind the Veil of Tariff Fixation
In the heated debates over trade policy in Washington and beyond, tariffs are often portrayed as the pri-mary—or even the sole—instrument by which governments intervene in global commerce. They are easy to quantify, easier to politicize, and readily wielded in bilateral negotiations.
But this focus on tariffs is misleading. It obscures the more fundamental mechanisms by which countries shape their trade relationships with the world. Because a country’s internal imbalances between consumption and production must always be consistent with its external imbalances, anything that affects the former must affect the latter, and vice versa. Tariffs are just one of many tools a government can use to change a country’s internal imbalance.
Like most such tools, tariffs work by shifting income from consumers to producers. But because of their visibility, they are often among the most politically contentious of these tools. By contrast, many of the most powerful trade interventions in today’s world occur not as tariffs but as policy choices that don’t appear to be related to trade at all. Fiscal decisions, regulatory structures, labor policies, and institutional norms can all affect how income is distributed, and how economies are balanced between consumption and production, with far-reaching implications for global trade.
To understand why tariffs receive such disproportionate attention, it helps to consider their visibility. A tariff is a line item in a trade negotiation affecting the price of an imported good. It’s easy to identify, easy to weaponize, easy to reverse, and very obviously linked to trade. But the very simplicity that makes a tariff politically salient also makes it a poor proxy for trade policy as a whole.
Income transfer
At its core, a tariff is a tax on imports. By making foreign goods more expensive, it gives domestic producers a pricing advantage. This can benefit certain industries and preserve jobs. But those benefits come at a cost: Consumers pay more for goods and services. The net effect is to transfer income from households to businesses, and it is this transfer that, by reducing the household share of GDP, reduces overall consumption relative to production.
This shifting of income from consumers to producers is the essence of trade intervention. Whether through a tariff, a tax subsidy, or a wage-suppressing labor law, the result is a change in the internal distribution of income that also has external implications. If consumption is taxed and production is subsidized, net exports are likely to rise. Conversely, if policies shift income from producers to consumers, net exports are likely to fall. In this sense, any policy that affects the balance between household consumption and total output will also affect the balance between domestic saving and domestic investment, and so is effectively a trade policy.
Consider currency policy. When a country intervenes in foreign exchange markets to keep its currency undervalued, it achieves the same goals as a tar-if. A weaker currency makes imports more expensive and exports cheaper, subsidizing production and taxing consumption. Like tariffs, this represents a transfer of income from net importers (the household sector) to net exporters (the tradable goods sector), but it occurs through exchange rates rather than in the form of tariffs.
Financial repression can have the same effect. In countries in which the banking system serves mainly the supply side of the economy, suppressing interest rates is effectively a tax on the income of net savers (the household sector) and a credit subsidy for net borrowers (the producing sector). By transferring income from the former to the latter, it creates a domestic imbalance— just like the one created by tariffs or an undervalued currency—between consumption and production. This shows up in the form of higher net exports.
Strategic subsidies
Tax and regulatory policies can work similarly. Governments might provide direct or indirect subsidies to strategic industries, including by building infrastructure tailored to manufacturing clusters. These measures may not violate international rules on trade intervention, but they change relative incentives within the economy in ways that mirror traditional protectionism. By making it cheaper or more attractive to produce than to consume, they achieve the same end: an internal shift that produces an external effect.
Even labor market structures and social institutions can function as tools of trade intervention. In China, for example, the hukou system—a household registration system that limits rural migrants’ rights in urban areas— has long served to depress wages and reduce household consumption. Although designed mainly to manage urbanization, the hukou system directly affects China’s trade balance by limiting the growth of domestic demand relative to domestic supply.
“As John Maynard Keynes argued at Bretton Woods in 1944, the fact that a diversified economy runs persistent trade surpluses is usually sufficient evidence of trade-distorting interventions.”
Similar effects can be seen in policies that encourage environmental degradation (by increasing business profitability at the expense of health care costs), restrict labor from organizing, hold down minimum wages, or reduce the bargaining power of workers. By suppressing wage growth and limiting consumption relative to productivity growth, these policies create the same kinds of imbalances as tariffs, but they do so far more quietly.
This broader perspective helps explain why some countries have run persistent trade surpluses even as they maintain relatively low tariffs. These economies have long emphasized production over consumption, whether through institutional structures, saving incentives, or export-oriented industrial policies. The result is the same: If domestic demand is too weak to absorb national output, these countries must externalize the cost of weak domestic demand by running trade surpluses.
The point is that trade imbalances are not just about what happens at the border. They are a consequence of how economies are structured internally— how income is distributed, how much households spend relative to what businesses produce, and how governments balance the competing demands of producers and consumers.
Implicit intervention
When governments pursue policies that favor investment over consumption, or capital over labor, they are engaging implicitly in trade intervention— whether they intend to or not. And as surplus countries implement domestic policies that prioritize producers over consumers, the deficit countries with which they trade are effectively prioritizing consumers over producers, whether they choose to or not.
A narrow focus on tariffs is misleading. It distracts from the underlying drivers of trade imbalances and invites counterproductive responses. As John Maynard Keynes argued at Bretton Woods in 1944, the fact that a diversified economy runs persistent trade surpluses is usually sufficient evidence of trade-distorting interventions. Whether or not these distortions are created by tariffs is largely irrelevant; in fact, to the extent that tariffs in deficit economies can force down trade imbalances, they may actually promote freer trade.
Rather than railing against tariffs, the world needs a broader conception of trade policy—one that moves beyond the surface-level debate over tariffs and looks inward at how economies allocate income. If trade imbalances are ultimately the result of internal choices about who gets what, then fixing them will require more than bilateral deals or protectionist gestures. It requires a change in how countries structure their economies. It requires power and resources to shift toward those whose spending drives sustainable demand. F&D
MICHAEL PETTIS is a senior associate at the Carnegie Endowment for International Peace and a lecturer at Peking University.
Multilateralism Can Survive the Loss of Consensus
Can adversarial nations work together for the common good? It’s natural to despair over prospects for international cooperation given the state of the world order. Geopolitical competition is straining the multilateral system, which has helped maintain global stability since the Cold War. The most powerful nations cannot seem to agree on how to solve urgent global problems, from the climate crisis to governing economic competition and international trade to regulating artificial intelligence.
Geopolitical competition doesn’t naturally advance international cooperation. The economic historian Charles Kindleberger showed how a lack of global leadership and international cooperation prolonged the Great Depression. Yet at other times geopolitical competition has, paradoxically, raised international cooperation. During the Cold War, for example, Presidents Dwight Eisenhower and John Kennedy advanced US leadership in open markets, free trade, and other global public goods to counter communism.
Multilateralism is splintering today— not because of geopolitical competition alone—but because it’s an expensive global public good. It benefits all humanity but distributes costs unevenly across nations.
Even in today’s polarized world, geopolitical rivals can still agree on common goals—the planet should be hospitable to human beings, the next pandemic should be controlled and confined through sensible public health safeguards, global economic policy should yield prosperity for all. Nations might disagree on how to achieve these goals—arguing that one approach or another unfairly benefits a rival—or they might accuse others of free riding by failing to contribute toward solving a common problem.
Carbon, for example, has been accumulating in the atmosphere for centuries. How should we divide the burden of tackling climate change between past and present emitters? Or how should we share responsibility for providing financial stability and restoring global growth? An advanced economy might expend considerable resources to ensure growth and stability while others fail to behave prudently.
Middle powers
If great powers refuse to support the international system, can others take their place? Global public goods are costly to provide. Small poor economies don’t have the resources to patrol the seas to keep shipping lanes safe for international commerce or to pump trillions into the world economy when markets fail. But middle powers—those with sufficient economic and financial firepower—may be candidates to take over the role of great powers. And middle powers that are not on the front lines of great rivalries and are committed to rules-based order are in fact playing an increasingly consequential role.
Without continuing US leadership, rules-based free trade agreements have already emerged. Consider the Comprehensive and Progressive Agreement for Trans-Pacific Partnership, the 12-member free trade pact that rolled out after the US failed to ratify its precursor, the Trans-Pacific Partnership. This new agreement even includes the United Kingdom, not a Pacific nation: Open economies appreciate arrangements built on a predictable rules-based system.
Middle powers can afford to provide global public goods more easily than can small states. But they are just as likely as great powers to be swayed by diminishing incentives and are just as unlikely to uphold multilateralism if they see no net benefit. Support for multilateralism must align with their self-interest. Their actions must, in other words, be incentive compatible.
If the international system is to endure, it must have more than just great- or middle-power leadership. Incentive compatibility must replace the idea that size matters and will add more to the resilience of the international system than explicit contractual collaboration agreements. All nations must contribute in a way that delivers visible gains for everyone. But how is this possible without goodwill or consensus between critical actors? I propose three pathways.
Inadvertent cooperation
First, policymakers should seek opportunities for inadvertent cooperation. Cooperation emerges naturally when countries agree on a common solution to a problem and can lay out explicit articles of collaboration. Inadvertent cooperation, however, means that countries cooperate even when they disagree: It’s about doing the right thing even if for the wrong reason.
Inadvertent cooperation is most evident when there are positive spillover benefits. During the COVID pandemic, nations raced to find a vaccine. Faster vaccine development was made possible by a combination of mRNA technology and competition between companies in different countries. The process meant building on what others had discovered, but competition yielded vaccines that benefited everyone.
Consider the energy transition. If one country considers that a competitor is unfairly subsidizing production of electric vehicles, it could subsidize its own production rather than slapping tariffs on its adversary. Such subsidies are a sharp riposte to its adversary but also increase the supply of affordable clean-energy vehicles, which reduces carbon emissions. It’s a good outcome for all, even though everyone is acting for the wrong reasons.
“If the international system is to endure, it must have more than just great- or middle-power leadership.”
Prisoners’ dilemma
Second, policymakers in smaller nations should nudge the international system out of gridlock. When all countries seek their own self-interest, a prisoners’ dilemma can result: Every country acts in ways that are individually optimal but mutually destructive when taken collectively. No country can free itself from the dilemma: If it tries to do so unilaterally, others take advantage. When great powers get caught this way, a small nudge can persuade them to change course and pursue a collectively preferred outcome.
Advanced economies, for example, often hesitate to grant emerging economies greater access to their markets. Instead they put up barriers to trade, depriving developing economies of opportunities to become richer, which in turn drives outward migration. This ratchets up political tensions on all sides. If developing economies can persuade advanced economies to act as a group, the impact of freer trade is minimized; imports are spread across the advanced economies, and rising incomes in developing economies reduce the incentive to migrate. Nudging can help great and middle powers do what they want to do but cannot for fear of losing out to adversaries.
Pathfinder multilateralism
Third, policymakers should strive for pathfinder multilateralism. When some nations turn their backs on multilateralism, subgroups of countries that favor it can still work together. The World Trade Organization’s Multi-Party Interim Appeal Arbitration Arrangement (MPIA) provides an independent appeals process to resolve trade disputes when the main appellate body can’t function for lack of a quorum. MPIA membership has tripled to more than 50 nations since 2020. In pathfinder multilateralism coalitions act together to overcome problems. While the focus is different, these arrangements resemble what the IMF has called “pragmatic multilateralism.”
The Regional Comprehensive Economic Partnership is another example. The 15-nation free trade agreement is committed to rules-based order; it’s an inclusive arrangement and, as well as members of the Association of Southeast Asian Nations (ASEAN), includes countries as politically diverse as Australia, China, Japan, New Zealand, and South Korea. Even as multilateralism is in retreat elsewhere, ASEAN countries continue to promote it in the Asia-Pacific region.
International cooperation through multilateralism may seem impossible now, with consensus falling, particularly between geopolitical rivals. Yet inadvertent cooperation, overcoming the prisoners’ dilemma, and pathfinder multilateralism can restore the best of the international system. F&D
DANNY QUAH is Li Ka Shing Professor in Economics at the National University of Singapore’s Lee Kuan Yew School of Public Policy.
Global Balances Widen|: Wider external gaps in key economies point to the need for policy adjustment at home
GLOBAL CURRENT ACCOUNT
GLOBAL CURRENT ACCOUNT balances—the surpluses and deficits arising from cross-border trade, income flows, and current transfers—are widening again after narrowing in recent years. They fell to a postpandemic low of 3 percent of world GDP in 2023, but widened to 3.6 percent last year. Adjusting for volatility from the pandemic and Russia’s war in Ukraine reveals a notable reversal of the narrowing since the global financial crisis. This may signal a significant structural shift.
As the table on this page shows, several major economies have seen their surpluses or deficits expand, contributing to the growing divergence in current account balances.
Excessive deficits and surpluses can be sources of risks. Large, persistent imbalances often signal vulnerabilities. They typically reflect distortions—for example, a mismatch between a nation’s saving and investment—that leave economies more exposed to shocks.
The IMF’s external assessment shows that current account balances were out of line with fundamentals in several major economies in 2024, underscoring the need for adjustment. History demonstrates that global imbalances can unwind abruptly and painfully. To avoid such a scenario, a gradual correction is needed through concerted domestic macroeconomic policies.
Deficit countries should curb excess spending and improve competitiveness to narrow their external gaps, while surplus countries should boost domestic demand and investment to better absorb their output. Such steps would gradually shrink imbalances and foster more balanced, resilient global growth. F&D
This article draws on the IMF’s 2025 External Sector Report.
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