That should worry us. Today’s global supply chains, made possible by lower tariffs and lower transport and communication costs, have transformed production by allowing companies to manufacture goods where it is cheapest . This generally means that while high value-added inputs come from advanced economies, manufacturing moves to emerging markets and developing countries. The advantages are obvious. The end products are significantly cheaper, so even the poorest people in rich countries can buy them. At the same time, developing countries participate in the production process by using their most precious resource: cheap labour. As their workers acquire skills, their own manufacturers adopt more sophisticated production processes, moving up the value chain. As workers’ incomes increase, they buy more products from rich countries. In 2017, for example, China had more iPhone users than any other country. Knowledge workers in rich countries then earn higher incomes as the market for high-value products expands.
Of course, even if the trade produces net benefits, the distribution of gains and losses is important. Trade is not simply “win-win”. The hollowed-out small towns of the American Midwest bear witness to the disadvantages of offshoring production. It has always been so: in advanced economies, today’s Rust Belt towns first grew by putting traditional craftsmen out of work elsewhere. With the right political support, however, trade should not leave people or communities behind. In Scandinavia, companies constantly focus on improving the skills of their workers so that they are ready for change.
These are the basic arguments in favor of free and fair trade. But in recent years, global supply chains have shown new vulnerabilities. In their desire to maximize efficiency, companies have sometimes overlooked resilience. Weather-related disasters (including floods, droughts, and wildfires) and shocks such as pandemic-induced lockdowns have highlighted many choke points for just-in-time supply chains.
As a result, businesses are now considering whether they should increase inventory as an additional buffer. They are also looking for ways to reduce bottlenecks by diversifying production sites across countries and to increase flexibility by making inputs more substitutable. Such private sector responses can keep global supply chains viable.
But resurgent protectionism, masked and augmented by new geopolitical rivalries, poses a more dangerous threat. The tit-for-tat tariffs between the United States and China during Trump’s presidency were opening salvos. The West’s subsequent restrictions on Chinese telecommunications giant Huawei’s sales and China’s restrictions on Australian imports have added more political uncertainty to the mix. Today, Russia’s war of aggression against Ukraine has introduced the possibility of an angry public expanding official sanctions beyond what policymakers intended.
If all of this isn’t enough to inspire business leaders to rethink the value of their global supply chains, the government’s advocacy of outsourcing friends certainly will. Of course, national security can never be taken lightly. It is legitimate for a country to ensure that the goods and services essential to its national defense are produced locally or by friendly neighbours. The problem is that “basics” is often expanded by protectionist interests to include even widely produced products like steel or aluminum.
If future friend-shoring mandates were to apply such a broad categorization, they would have devastating effects on international trade. After all, relocating friends usually means trading with countries that have similar values and institutions; and this, in practice, will mean dealing only with countries at similar levels of development.
The benefits of a global supply chain stem precisely from the fact that it involves countries at different income levels, allowing each to bring their comparative advantage to the production process – the doctoral students of one, for example, and unskilled assembly workers on the other. Friend-shoring would tend to suppress this dynamic, thus increasing production costs and consumer prices. While some unions would welcome less competition, the rest of us would regret it. Moreover, it is not even clear whether on-shoring or near-shoring generation contributes to increased resiliency or reliability of supply. In the United States, infant formula is supplied by a government-backed oligopoly of four domestic companies that are protected from foreign competition by high tariffs. But, right now, there is no formula milk in some US states, due to issues at a single facility. So much for inner resilience!
Similarly, the concentration of production within a closed community of advanced economies would not necessarily increase community security. As Brexit shows, friends don’t always stay friends. Even countries as close in temperament as the United States and Canada have had serious disagreements during Trump’s presidency. Specifically, existing economic interdependencies can make geostrategic rivals more reluctant to launch missiles at each other. Observers have noted that China will think twice before invading Taiwan now that it has seen the damage the sanctions are doing to Russia. But if China were to prepare for an invasion, it would start by reducing its dependence on Western economies, a process that the consolidation of Western friends would inadvertently advance. Economic entanglements can be messy, but they help keep the peace.
Finally, friend-shoring tends to exclude the poor countries which most need world trade to enrich themselves and become more democratic. This will increase the risk of these countries becoming failed states, fertile ground for nurturing and exporting terror. Mass emigration will become more likely as chaotic violence increases.
Friend-shoring is an understandable policy if strictly limited to specific matters directly affecting national security. Unfortunately, public reception of the term already suggests that it will be used to cover many other things. ©2022/Syndicate Project
Raghuram G. Rajan is a former Governor of the Reserve Bank of India and Professor of Finance at the University of Chicago Booth School of Business.
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