By Alexander Jones, International Banker
The onset of the COVID-19 pandemic in early 2020 had profound consequences for the global economy, not least by exposing the fragility of global supply chains, which had to contend with restrictions that prevented goods and raw materials from reaching their end destinations. And while a host of stop-gap solutions have been proposed to counter these issues, the flare-up of geopolitical tensions over the last year has prompted key trading players to look to “friend-shoring”—the manufacturing and sourcing of components from countries with shared political values—to resolve this persistent supply-chain turbulence. But this potential solution is not without drawbacks.
Although companies are not quite resorting to wholesale shifts of their factory locations to allied nations, it does seem clear that, in many cases, they are allocating greater consideration and importance to geopolitical risks within their overall business models. And with the Ukraine war and China’s zero-COVID policy both massively derailing global supply chains over the last few months, this strategic shift is perhaps understandable. “It’s kind of a new era,” Harvard Business School professor and supply-chain expert Willy Shih told the New York Times in December. “Fifteen years ago, there weren’t these flashing warning signals saying unexpected things can happen.”
As such, a growing school of thought—particularly being pushed by the United States—contends that relying on potentially adversarial countries with whom one already faces elevated geopolitical tensions is a risky ploy, one that necessitates lessening supply-line exposures to those countries and instead shifting towards friendlier supplier nations. Friend-shoring means “that we have a group of countries that have strong adherence to a set of norms and values about how to operate in the global economy and about how to run the global economic system, and we need to deepen our ties with those partners and to work together to make sure that we can supply our needs of critical materials,” US Secretary of the Treasury Janet Yellen, who has been among friend-shoring’s most fervent cheerleaders, told an Atlantic Council audience in April 2022.
Yellen views friend-shoring as a means of securing global trading relations with countries that are friendly to the US while easing its exposure to geopolitical rivals. Over the last 12 months, this has frequently meant securing or reaffirming ties with various countries to ensure that the US is trading with as many trustworthy partners as possible, particularly with market-oriented democracies. “India’s membership in [the] Indo-Pacific Economic Framework [for Prosperity] (IPEF), in efforts to make our supply chains more resilient through what I call friend-shoring, are tightening those ties,” Yellen said in November when she met with Indian government officials and business leaders in New Delhi. “To do so, we are proactively deepening economic integration with trusted trading partners like India.”
Yellen also noted that the US is providing up to $500 million in debt financing to its biggest solar-manufacturing company to build a plant in South India to help diversify supply chains away from China. Other American multinationals are also opting for greater exposure to India—an ostensibly friendlier option than China—with tech behemoths Amazon and Google investing in India and Apple shifting some iPhone manufacturing from China to India. “The US and India are ‘natural allies’, in the words of a former Indian prime minister,” Yellen added. “People around the world are looking to us and asking: Can democracies meet the economic needs of their citizens? Can they stand up to bullies and cooperate on the most intractable global problems? I am confident that we will succeed.”
The European Union (EU) is also seemingly on board with friend-shoring as it strives to end its reliance on Russian exports. “To our friends in Ukraine, Moldova, Georgia, and to the opposition in Belarus. We should have listened to the voices inside our Union—in Poland, in the Baltics, and all across Central and Eastern Europe. They have been telling us for years that Putin would not stop. And they acted accordingly,” European Commission (EC) President Ursula von der Leyen said during her 2022 State of the Union address. “Our friends in the Baltics have worked hard to end their dependency on Russia. They have invested in renewable energy, in LNG terminals, and in interconnectors. This costs a lot. But dependency on Russian fossil fuels comes at a much higher price.”
The United Kingdom, meanwhile, proposed the creation of a “network of liberty” as early as December 2021. “The more freedom-loving countries trade with each other, build security links, invest in our partners and pull more countries into the orbit of freedom, the safer and freer we all are. New agreements between like-minded countries, even when you’re not part of them, are there to be celebrated,” then-Foreign Secretary Liz Truss remarked in a speech at Chatham House (the Royal Institute of International Affairs). “When the US works on a new economic partnership with Japan, as Ambassador Tai has been doing with Minister Hayashi, or when the EU announces its new Global Gateway scheme to invest in developing countries, we all benefit.”
But with friend-shoring seeking to confine the West’s trade to its allies more concretely—and with the likes of China and Russia likely to respond similarly—what does this kind of fragmentation across the world mean for global trade? While a recent report from the United Nations Conference on Trade and Development (UNCTAD) on the topic sees “no evidence of a mass exodus” away from offshoring trends at present, plans by the US and EU could potentially further fragment international commerce. “The trade system is a very complex system. If you try to get away from one part of the world, you create a huge disruption to the system. Everything changes,” according to Rebeca Grynspan, secretary general of UNCTAD. Grynspan added, however, that should trade flows maintain patterns of open rather than closed regionalisation, this could improve value chains and lead to more sustainable growth in the developing world.
That said, the economic argument would seemingly rule against friend-shoring, with a sizeable loss in global economic growth a likely consequence. A recent report from the World Trade Organization (WTO) warned of the heightened risk that trade “could become more fragmented in terms of blocs based on geopolitics”, which could reduce global gross domestic product (GDP) in the long run by about 5 percent, especially by “restricting competition and stifling innovation”. Other analysts warn that the implications friend-shoring has for de-globalisation could result in global supply shocks, as well as higher prices in the short term and lower growth in the long run. “While moving supply chains away from east Asia could increase security in the long run, an ill-conceived implementation of this friend-shoring strategy could result in price hikes and a stronger China over time,” wrote William Reinsch, Emily Benson and Aidan Arasasingham of the Center for Strategic and International Studies (CSIS) in a report addressing semiconductor supply chains.
There is also likely to be considerable debate over the methodology used to determine whether a country is a friend or foe. “Who is a friend? You’re not too sure they’ll be a friend tomorrow, we’ve seen examples of that,” World Trade Organization Director-General Ngozi Okonjo-Iweala recently explained to Reuters, while urging particular caution when dealing with vulnerable countries that have not consistently enjoyed the full benefits of global trade thus far. “Friends should not just be in Asia, there is Latin America, there is Africa. There are countries there that are places where you can perfectly de-concentrate manufacturing. You bring them into the supply chain, and that way, you also include them.”
Indeed, one of the biggest criticisms of friend-shoring is that it could boost the aligning of countries with similar income levels, further exacerbating global inequality by excluding poorer countries from the overall production process. “The benefits of a global supply chain stem precisely from the fact that it involves countries with very different income levels, allowing each to bring its comparative advantage to the production process—PhD researchers from one, for example, and unskilled assembly-line workers from another,” Raghuram Rajan, a former governor of the Reserve Bank of India (RBI), wrote in a June piece for Project Syndicate magazine. “Friend-shoring would tend to eliminate this dynamic, thereby increasing production costs and consumer prices. While some labour unions would welcome the reduced competition, the rest of us would regret it.”