The on-again, off-again US-Israeli war against Iran has underscored the growing disconnect between financial markets and real economic activity. It has also exposed how differently such shocks play out across the global economy.
Consider oil markets. While they have been extremely volatile since the war began, their fluctuations have largely reflected shifting perceptions and expectations—often shaped by US President Donald Trump’s erratic social media posts—rather than immediate changes in demand and supply.
To be sure, Iran’s closure of the Strait of Hormuz did disrupt global oil supplies. But shipping distances and transport lags meant that the effects were not immediately felt by consumers and producers.
Nevertheless, crude oil and natural-gas prices swung sharply as conflicting official announcements repeatedly shifted market expectations. By early July, following the initial ceasefire agreement between the United States and Iran, crude oil was trading below $70 per barrel—roughly where it stood in February, before the war began. Even the subsequent resumption of hostilities has so far produced only a modest price increase.
Despite the volatility in global energy prices, US stock markets recorded their best-performing quarter since 2020 between April and June and continued to rise in early July. The rally was led by AI stocks, buoyed by the belief that AI will deliver unprecedented gains in productivity and economic growth.
To some extent, this reflects the relatively limited impact of the war on economic activity in rich countries. The International Monetary Fund projects only a modest slowdown in GDP growth in advanced economies in 2026, from 1.9 per cent in 2025 to 1.7 per cent. The US, for its part, is expected to grow by 2.3 per cent, up from 2.1 per cent in 2025. Across OECD economies, the unemployment rate stood at 5 per cent in April, virtually unchanged since February 2022.
Advanced economies’ resilience can be largely attributed to the recent boom in AI and cryptocurrency investments. Several Asian economies—notably China, Taiwan, South Korea, and Malaysia—have also benefited from this trend. Financial markets’ current complacency is further reinforced by the widespread perception that the war with Iran is effectively over, despite both sides’ belligerence, or that it will persist only as a low-intensity conflict that allows at least partial movement through the Strait.
Yet this confidence overlooks the war’s longer-term economic consequences. Despite the ceasefire, oil exports from the Gulf remained well below pre-war levels. And even if exports recover completely, lower-income countries will continue to bear the costs of today’s energy crisis for years to come.
These countries lacked the means to carry out the extraordinary government interventions that limited the energy shock’s impact on advanced economies. Roughly 440 million barrels of crude oil and refined products were released from commercial and strategic reserves between April and June, mostly by the US. But with the US Strategic Petroleum Reserve now below half its capacity and approaching its operational floor of 33 per cent, and with total OECD inventories continuing to decline, there is far less scope for a similar intervention. Although prolonged uncertainty over the Strait is likely to accelerate the diversification of both energy sources and trade routes, those adjustments will require years of investment and new infrastructure.
Global attention has largely focused on crude oil, but modern production also relies heavily on petroleum derivatives. According to the International Energy Agency, Gulf exports of refined petroleum products and liquefied petroleum gas were still less than half their pre-war levels in June, partly because the war destroyed some of the region’s refining capacity.
Among the most economically significant petroleum derivatives are fertilisers, which are crucial for agricultural productivity. The Food and Agriculture Organisation of the United Nations projects a 15–20 per cent increase in global fertiliser prices in the first half of 2026. As a result, farmers—especially in lower-income countries—must now contend with rising fertiliser prices as well as higher fuel costs for irrigation and transport.
Even modest reductions in fertiliser use can trigger steep declines in crop yields, especially where application rates are already low. But food markets are unlikely to wait for the harvest, as oligopolistic firms typically raise prices in anticipation of tighter supplies, long before physical shortages materialise.
The consequences extend far beyond agriculture. More than 6,000 products rely on fossil-fuel derivatives and processing by-products such as helium, sulfur, methanol, polyethene, and polypropylene, many of which are supplied by Gulf countries. These inputs are essential for plastics, lubricants, waxes, tars, asphalt, synthetic textiles, and life-saving medical devices like MRI machines and pacemakers. Ironically, the green energy transition also depends on specialised petroleum products used to manufacture, maintain, and operate wind turbines and other renewable-energy infrastructure.
These disruptions will fall disproportionately on lower-income countries, particularly in Asia and Africa, which remain heavily dependent on the Middle East for both imports and exports. Worse still, they come as many emerging and developing economies are still recovering from the damage inflicted by the COVID-19 pandemic, the food and fuel price spikes that followed Russia’s invasion of Ukraine, and the interest-rate hikes that have driven up borrowing costs.
Against this backdrop, the World Bank estimates that the per-capita income gap between advanced and developing economies, excluding China and India, will not return to its pre-pandemic level until after 2028. For many countries in the Global South, the result could be a lost decade; for those already in debt distress, the economic toll could be catastrophic.
This raises a fundamental question: How will an increasingly fragmented global economy reshape geopolitics? Governments around the world have learned that ignoring rising inequality within their own societies fuels political instability. The same lesson applies to the widening economic divide between countries. Financial markets may be able to ignore it for now, but the rest of the world cannot.
— The writer, Professor of Economics at the University of Massachusetts Amherst, is Co-Chair of the Independent Commission for the Reform of International Corporate Taxation. ©Project Syndicate
