Global Reallocation of Capital in the Era of Geo-Economic Fragmentation and Artificial Intelligence

Fernando Toledo and Gabriel Montes-Rojas

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Abstract: This paper studies how geo-economic fragmentation affects the international allocation of capital in an economy where artificial intelligence (AI) relies on specialized, mobile investment. We develop a heterogeneous-agent open-economy model with AI-specific capital and geopolitical frictions in cross-border asset holdings. These frictions reduce capital mobility, raise the cost of AI adoption, and generate distributional effects across countries and households. The quantitative results show that fragmentation produces welfare losses that rise nonlinearly with geopolitical distance. These losses are larger for AI-lagging economies and for low-wealth households, mainly through reduced investment, weaker labor income, and tighter financial conditions. The paper also defines a so-called Fragmented-AI Trilemma: economies cannot simultaneously preserve monetary autonomy, maintain efficient AI-capital allocation, and insulate themselves from geopolitical shocks.

Date: 2026-07
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