Friendshoring makes sense if done in the right way

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Container ships wait off the coast of the congested Ports of Los Angeles and Long Beach in Long Beach, California, U.S., October 1, 2021. REUTERS/ Alan Devall

LONDON, Dec 5 (Reuters Breakingviews) - The adage “don’t put all your eggs in one basket” applies as much to global trade as to a trip to the market.

China’s zero-Covid policies, and the backlash against them, provide a case in point. Apple (AAPL.O) may lose the production of 10 million iPhones because of disruption at a vast factory complex in Zhengzhou. Europe’s dependence on Russian gas is another cautionary tale. After President Vladimir Putin’s invasion of Ukraine, Russian gas supplies to the European Union have virtually ceased, causing economic damage which will last for years.

These examples explain the enthusiasm for “friendshoring”, an idea U.S. Treasury Secretary Janet Yellen is pushing. Her aim, which the EU also backs, is to build up suppliers of goods such as solar panels in friendly countries, so that Western buyers are less vulnerable to geopolitical blackmail or other disruptions. The People’s Republic, for its part, is trying to avoid relying too heavily on Western technology.

The risk of restricting trade to countries deemed friendly is that it could escalate into a full-blown Cold War – splitting the world into two trading blocs. That would damage prosperity at a time when the global economy is suffering. The World Trade Organization estimates it would knock global production by 5%.

So how to get the benefits of friendshoring while minimising the costs? There are two core principles: don’t use it to attack China; and have a big circle of friends.

PLAY DEFENCE NOT ATTACK

The policy could be used defensively or aggressively. In the former case, the aim is to protect a country against interruptions in supply chains, whether caused by another country’s aggressive actions or unforeseen events such as pandemics. This is the U.S. Treasury’s rationale, according to a senior official. Policies could involve dissuading companies from concentrating too much production in an unreliable country, or persuading allies to supply critical products by ensuring there is sufficient demand.

By contrast, using trade policy to damage China’s economy across the board would be a bad idea. First, it could provoke an all-out trade war – causing the kinds of disruptions that friendshoring is intended to prevent. For all the talk about diversifying supply chains, China’s economy is still tightly intertwined with the West, so cutting these links suddenly would be costly.

Second, it would heighten geopolitical tension with the People’s Republic – potentially spilling over into a hot war. Given the history of clashes between rising powers and ruling ones, the United States and others would be wise to avoid fanning the flames.

Things would be different if China was the West’s implacable enemy in the way that Putin’s Russia is. But last month’s summit between U.S. President Joe Biden and his Chinese counterpart Xi Jinping suggests that a wary détente may be possible.

David Dollar, a senior fellow at the Brookings Institution and a former official at the U.S. Embassy in Beijing, thinks America is right to take a different approach to the People’s Republic from Russia, though that may change if China invades Taiwan.

Using friendshoring in a defensive rather than aggressive way means focusing on strategic products. Hung Tran, a senior fellow at the Atlantic Council, listed five in a recent paper: semiconductors; telecommunications, including 5G infrastructure; green products, such as solar panels and batteries; active pharmaceutical ingredients; and strategic minerals, such as rare earths.

In many of these, Chinese companies have strong positions. For example, they control more than 80% of all solar panel manufacturing and over 95% of the production of polysilicon which goes inside the panels.

Yet even in these cases, the aim of the United States and its allies should be to ensure that there are enough alternative suppliers, not cut off Chinese ones completely. A targeted approach would limit the economic cost. Spreading production among several suppliers would also limit the risk that countries which are deemed friends today become less reliable in the future.

The same logic applies to companies. Apple, for example, is ramping up iPhone production in India. While it makes sense to cut its dependency on China, that doesn’t mean going all the way to zero.

WHO’S A FRIEND ANYWAY?

The term friendshoring might seem to imply that America should build up supply chains only where it has strong alliances – mainly other NATO countries and Pacific nations such as Japan, South Korea and Australia. That would mean avoiding India, which has refused to follow Western sanctions against Russia and has increased its purchases of Russian oil.

But this would be foolish. The more narrowly America and its allies define their club of friends, the more they will damage their own economies. Fortunately, the U.S. Treasury is taking a broad approach to what constitutes a friend. For example, last month Yellen was in India, touting the benefits of her policy.

Ideally, rich democracies would intensify trade with other parts of the world as they reduce their dependence on China. For example, they could negotiate ambitious trade and investment deals that increase production of green products – simultaneously advancing the energy transition and diluting China’s strong position.

Ngozi Okonjo-Iweala, the WTO’s director-general, rightly argues there is an “opportunity to use trade as an instrument of inclusion” for poorer countries. The snag is that America is extremely reluctant to agree new trade deals. The best it can probably do is squeeze more out of its new Indo-Pacific Economic Framework and the EU-U.S. Trade and Technology Council.

Protectionist sentiment in America was particularly aggressive when Donald Trump was in the White House. But Biden’s landmark Inflation Reduction Act includes protectionist subsidies for products like electric vehicles. Fortunately, the U.S. president seems to realise there is a conflict between this and friendshoring. When French President Emmanuel Macron complained during his state visit to the United States last week, Biden promised to “tweak” the rules so European allies aren’t excluded.

Protectionism won’t just undermine the geopolitical logic of friendshoring. It could be self-defeating. As the economist Richard Baldwin noted: “Putting all your production eggs in one basket doesn’t make sense, no matter where the basket is.”

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(The author is a Reuters Breakingviews columnist. The opinions expressed are his own.)

Editing by Peter Thal Larsen, Streisand Neto and Oliver Taslic

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