Geopolitical Risks and Trade Conflicts: How Resilient is the Swiss Economy?

In their KOF Working Paper “Resilience of Small Open Economies to Geopolitical Shocks: The Case of Switzerland,” Hans Gersbach, Paul Maxence Maunoir, and Kieran James Walsh examine various scenarios concerning the risks to the Swiss economy arising from trade conflicts and its consequences. “The Swiss economy is both resilient and vulnerable,” summarizes Hans Gersbach, Co-Director of KOF Swiss Economic Institute, reflecting on the study's findings.

Although the Swiss economy is relatively resilient to the effects of geopolitical shocks, it is also quite vulnerable in the event of intense and prolonged trade conflicts. In such cases, permanent losses of around one percent of GDP per year are possible. In some scenarios, additional effects (so-called “second-layer” effects) can further amplify these losses. If severe trade conflicts were to arise between the U.S., Mexico, and Canada, as well as between the U.S. and Europe, there would be a clear risk of recession for several countries, including Switzerland.

Two-Stage Process for Analysis

To examine the resilience of the Swiss economy, the authors employed a two-step approach. The impact of geopolitical disruptions on international trade in goods and services for Switzerland and other countries is analyzed using the new “KOF Trade Model”. This model is a modern quantitative general equilibrium model of global trade networks. It captures the effects of relative price and demand changes resulting from tariffs, how companies respond in their production of goods and services, and feedback effects on all market participants.

However, a number of further effects—such as downward amplification, structural changes in investment activity, further nominal exchange rate fluctuations, or product-specific supply chain disruptions—are not included in the model. Depending on the scenario, these second-layer effects may have minor, significant, or major implications. They must therefore be considered for a comprehensive assessment.

In (Almost) All Scenarios, the Economy Suffers Losses

The Swiss economy is particularly vulnerable if the U.S. administration imposes tariffs on imports from all countries, including key sectors of the Swiss economy. These sectors would include the pharmaceutical industry, mechanical engineering, and precision instruments for instance. If this scenario were to occur, the Swiss economy would be the most affected of all countries on the European mainland. If the European Union (EU) responded to broad U.S. import tariffs with comprehensive countermeasures, also against Switzerland, significant losses could arise—potentially exceeding 1% of GDP.

However, in both scenarios, the economies of the U.S. and major countries in the EU would suffer similarly or even more. Therefore, such comprehensive tariff wars are difficult for these countries to sustain in the long term and are not considered the most likely scenario. Should critical raw materials or computer chips become unavailable due to geopolitical tensions, or if there were a rapid policy-driven decoupling between a Western sphere (including Switzerland) and a sphere centered around China, major disruptions would be expected. Such a decoupling could even lead to a global economic crisis.

Conclusion

Our results provide a foundation for discussion on how the economic resilience of Switzerland can be strengthened and what role the state should play in this process. Key policy levers include free trade agreements to promote diversification and risk mitigation, conditions to ensure supply security, and the government’s contribution to a resilient innovation system.