The costs of geopolitical risk and the impact of the EU cohesion policy

Di Caro P., Arbolino, R., Fratesi, U. 2025 – Annals of Cooperative and Public Economics

Geopolitical risks-GPR originating from conflicts and wars as well as trade disputes have regained a prominent role at international level. In April 2024, when the United States-US administration announced new global tariffs, the Trade Policy Uncertainty Index (monthly average) peaked at the highest value since 1960, nine time higher than the value registered in April 2024. In a context featured by trade, financial, and institutional linkages among countries, raising GPR and trade wars produce consequences that spread beyond national borders. It is likely, moreover, that such consequences are distributed unequally between and within countries, as indicated by Antonio De Viti De Marco (‘Giornale degli Economisti, serie II, vol. 27, luglio 1903’).

Scholars have recently shown interest in studying the impact of variations in the geoeconomic environment. Nevertheless, evidence is limited on the relation between GPR and effectiveness of public expenditures funding investments. Therefore, analysing the impact of geopolitical tensions on the effectiveness of funds aimed at promoting development and cohesion in the European Union-EU countries is timely and relevant. This is particularly critical given that for the 2021-2027 cohesion funds are equal to 372 billion euro, about one third of total EU budget.

In the paper “The costs of geopolitical risk and the impact of the EU cohesion policy”, published in Annals of Cooperative and Public Economics, Paolo Di Caro, Roberta Arbolino and Ugo Fratesi analyse from an empirical perspective if and to which extent the effectiveness of the cohesion policy in the EU countries, in terms of economic growth, varies in the presence of GPR originating outside Europe. The authors measure the exposure of the EU countries to GPR at global level and for selected countries – US, China, Russia, and Israel – by combining information on trade linkages and GPR data. The selection of the four specific countries of origin of GPR is motivated as follows: the US and China play a pivotal role in global markets; Russia and Isreal strongly influenced the GPR at global level, particularly in recent years.

Using a panel-time series econometric model with heterogeneous coefficients applied to 27 EU countries for the period 2007-2020, the authors measure the costs of GPR as reduced effectiveness of cohesion policy on economic growth. One of the novelties of the work is the production of country-specific results, when significant, which are relevant to define context-specific shock-absorption policies. In the second step of the analysis, the authors show exploratory evidence on selected factors that can explain the uneven impact of GPR on the cohesion policy effectiveness: trade integration; participation to GVCs; quality of national institutions.

The analysis produces three key results. First, the raise of GPR by 1 percentage point (p.p.) contributes to reduce the effectiveness of cohesion policy funds on economic growth across the EU on average by 0.45 p.p. Second, the impact of GPR on cohesion policy effectiveness differs across EU countries. For instance, in case of high GPR variation of approximately 15%, the same change observed during the Taiwan dispute between the US and China and comparing the first semester of 2025 with the same period of 2024, EU countries show very different GPR costs. In Belgium, Germany and Italy we observe the higher (potential) growth reduction that, other things being equal, are due to the strong commercial and financial linkages of these countries with the nations where GPR originates. However, the most pronounced reduction of the growth impact of cohesion expenditures is registered in the Central and Eastern EU countries (Poland, Romania and Hungary), which are characterized by high exposure to risks coming from Russia and China and a high amount of cohesion funds received.

In a related work using the same data, published in Structural Change and Economic Dynamics in 2025, the authors document that the asymmetric impact of GPR depends on the specific origin of geopolitical tensions, by making a distinction between GPR coming from the US and China. In short, GPR from the US, which also incorporates global geopolitical tensions, produces major impact in countries like Italy that are strongly linked with the US. When geopolitical tensions originate from China, as in the case of the Taiwan dispute, the adverse consequences of GPR mostly influence Central and Eastern EU countries and Germany, by confirming the high economic and financial interdependence of this area with China.

Third, the high impact of GPR on public funds for cohesion policies is registered in countries with high trade distance from value added, in the form of GVCs downstream positioning, and low quality of national institutions. To study the explanatory factors, the authors combine different variables, including the Political Stability and Absence of Violence/Terrorism Index, part of the World Bank Governance Indicators, which measure the level of national political instability. Additionally, the authors employ the GVCs downstreamness Index in order to measure the distance of each EU country with respect to the place where factors with value added are produced.

Two main comments derive from the exploratory analysis on the explaining factors of the GPR costs. The first lies on the relationship between international and domestic political dimensions. In this respect, the authors emphasize the role of national political instability in explaining the greater impact of geopolitical risks in terms of reduced effectiveness of public spending (regression correlation of 0.10; Spearman’s rho coefficient of 0.42). In other words, more unstable and risky national institutions facilitate the propagation of external shocks. The second relates to the direct relation between GPR costs (in absolute value) and distance from origin of GVCs added value (regression correlation of 0.21; Spearman’s rho coefficient of 0.50). In other words, the adverse effects of international geopolitical tensions propagate in countries distant from the production of added value of GVCs.

The main merit of the analysis is to provide real-time evidence on a research area that is rapidly progressing. The main policy implications of the study can be listed as follows. To raise the resilience of the EU as a whole it is unavoidable to work for a coordination of the different macroeconomic (industrial, trade, territorial cohesion and development) and monetary policies, at European and national level, in order to create a context able to tackle geopolitical tensions. Additionally, the presence of asymmetric effects within the EU when looking at the costs of GPR for the cohesion policy, which will require further research effort at sector- and regional level, indicates that there are new challenges for unequal development paths that add to historical internal heterogeneities across the EU, with impact on European and national public finances.