World economic challenges in 2026 

Geopolitical tensions top list of economic risks for 2026

By Kyriacos Lambrias and Nektarios Michail

In what follows, we offer our view on what the main economic challenges in the world economy are in the coming year. It is important to note that this is not an exhaustive list, and there are other important risks that can threaten the global economy. Those are increasing political polarisation, inequality, “fake news” and misinformation and climate change, to mention a few. Many of those are, nevertheless, slow-boiling risks with a potential of changing the current political and economic landscape in the medium-to-long-run. For the sake of brevity, we chose to concentrate on those that we believe are more relevant and imminent for the short term. 

1. Geopolitics

The clearest challenge for the world economy over 2026 is to navigate smoothly through geopolitical tensions. Developments in the Russia-Ukraine war, in the Middle East and a potential escalation over Greenland and/ or a fallout of NATO are important risks looming over the global economy. Whether we are in a new world order is probably more a question for political analysts than economists. What matters is that nations continue to collaborate as smoothly as possible in politics, economics and trade, to support a stable economic environment. The feeling of certainty and collaboration makes it easier for firms to expand production, invest in human and physical capital, banks to fund those investments and so on. It is generally believed that this collaboration, stability and trade openness have contributed to strong growth and increased prosperity as experienced over the last decades, especially in the Western world (the trend has been rather positive, despite occasional crises).  

The key challenge is thus to maintain the collaboration and stability as firmly as possible in the changing geopolitical environment. Admittedly, the signs are not too positive. To that we can add the associated policy uncertainty, especially on the side of the US, and the response of other nations particularly blurring the geopolitical picture. These are key reasons why we view geopolitical tensions as a prime challenge for the world economy in 2026 – together with its potential to literally affect the entire world. 

2. Trade and Protectionism

A related area of concern is increasing protectionism and generally the situation around world trade. While the tone from the US administration has generally softened, and few trade deals have recently been reached, it is important to not be complacent. It is noted that (i) tariffs imposed by the US are higher than they have been since the 1930s (even if threats were typically for higher levels than what was implemented) and (ii) the tension is not yet over. A major challenge is the final outcome of the US-China trade relations. It is of prime importance for the future of the trade between the two super-powers, as well as for the future of world trade, the kind of deal the two sides will eventually reach – be it in 2026 or later. It is noted that beyond the two economic super-powers, any bilateral trade deal reflects on other countries/ areas as well.  

On a somewhat positive note, the two above areas of geopolitical tensions and increasing trade protectionism – both heavily influenced by US policies and view of the world – have acted as a “wake up call” for Europe. As such, recently, decisive steps have been taken in envisaging, or at least planning, for a world that it is not so dependent on the US (for example, the trade deal between EU and India). The latter relates to trade, geopolitical and military relations across the two blocks.  This is an indication that trade protectionist policies have less potential to be beneficial particularly in the long-run as trade relations are reshuffled and production lines adapt.  

3. AI Adoption and Usefulness

Artificial Intelligence (AI) continues to gain ground and become an everyday aspect in many organizations, affecting how they work and operate. What the past few years have shown is that AI has moved from being a niche part of the tech sector to a mainstream application across industries. What is now changing is not just the availability of AI tools, but the confidence with which businesses, governments, and individuals are beginning to use them. 

While the usefulness of AI is unquestionable, emphasis remains on how the most impactful applications will likely be those that blend automation with judgment, in sectors such as healthcare, education, and finance. Systems will increasingly understand context, remember preferences when users allow it, and adapt to individual working styles. This shift toward proactive intelligence will make AI feel less like software and more like a collaborative partner.  

AI’s energy demands are rising quickly, and as adoption grows, the cost of running it will become a major constraint. Even small queries add up when millions occur daily, making electricity use an economic, environmental, and strategic concern. While attention often goes to new capabilities, the physical reality is unavoidable: AI consumes significant power. 

From 2026 onward, several shifts may ease this pressure. Smaller, task‑specific models will handle more workloads. Hardware will become more efficient, using lower‑precision math and reducing data movement. Data centres will adopt liquid cooling, on‑site renewables, and heat‑reuse systems to cut energy use. 

These trends deserve deeper study, but a broader question remains: will AI deliver the value many expect? Despite its growing presence, job postings requiring AI skills remain below 4 per cent, raising doubts about its immediate economic impact. Whether this reflects slow adoption or future job displacement is still uncertain but is something that will greatly affect the economy from 2026 onwards. 

4. Public Debt

Over the past two decades, public debt has expanded dramatically across major global economies. In the United States, public debt rose from roughly $8.5 trillion in 2005 to $35 trillion in 2024, pushing the debt‑to‑GDP ratio to around 120 per cent. While the U.S. once had ample fiscal space—such as in 2008, when it could respond forcefully to crisis conditions—the continued rise in debt after the crisis eroded that flexibility. With a fiscal deficit near 6 per cent, the U.S. now faces pressure to reduce its deficit in order to restore long‑term fiscal sustainability. 

China has experienced a similar trajectory. Its public debt surged from about $600 billion in 2005 to $16.5 trillion in 2024, driven by efforts to support domestic demand, stabilize the real estate sector, and strengthen its global influence. Although China’s debt‑to‑GDP ratio remains below that of the U.S., it has climbed above 95 per cent, narrowing its fiscal room.  

In Europe, debt patterns vary. Germany has kept its debt relatively stable, rising from $1.9 trillion to $3 trillion over twenty years. Other major economies—France, the United Kingdom, and Italy—have seen much sharper increases. All three now exceed 100 per cent debt‑to‑GDP, with France facing particularly severe challenges due to persistent budget deficits and difficulty implementing fiscal consolidation. 

Adding to these (admittedly self-induced) problems, are geopolitical tensions, which, along with a need for the modernization of military capabilities and commitments to collective security arrangements have pushed many countries to raise defence budgets. Fiscal policy in 2026 will be shaped by the tension between high debt levels and the need for continued public investment, especially as defence spending is becoming an increasingly important contributor to public debt dynamics. For governments already operating with limited fiscal space, higher defence outlays add pressure to budgets that are also strained by social programs, infrastructure needs, and demographic trends. More so, the limited fiscal space poses questions regarding the ability of governments to intervene in the case of a crisis, something that will be likely reflected in the bond yields of several countries. 

Thus, with fiscal space already constrained in many major economies, policymakers will have limited flexibility to respond to new shocks or fund ambitious initiatives without making difficult trade‑offs. Balancing consolidation with the need to support growth, social stability, and strategic priorities will remain a central challenge throughout the year. 

Kyriacos Lambrias, Economist, currently working as Risk Manager at UBS. Nektarios Michail, Chief Economist, Bank of Cyprus. Views are strictly personal. The article is republished from the Blog of the Cyprus Economic Society (https://cypruseconomicsociety.org/blog/blog-posts/)