‘Friendshoring’ Could Have Some Not-So-Friendly Downsides

Under a push from the U.S. and others to trade more with friends and less with rivals, the world would be poorer, the International Monetary Fund reported.

In a report published on Wednesday, the IMF researchers noted that these trends towards ‘friendshoring’, which could lead to geopolitical fragmentation of global production networks, would result in a global hit to gross domestic product of 2 per cent. The most fragile effects, in terms of output foregone, would be felt in developing countries: those that would benefit from the increase in foreign investment.

“A fragmented world is likely to be a poorer one,” the researchers wrote.

Even before the Russian invasion of Ukraine in February 2022, US diplomats have been seeking to build up economic relations with friendly countries like India and Mexico as relations with China cool.

With the US Treasury Secretary Janet Yellen pointing to it during her trip to India in February, including updates from companies such as Apple and Google increasing their phone factory presence in the subcontinent as they seek to take production out of China, political leaders such as the US president Joe Biden have adopted policies aimed at increasing domestic manufacturing capacity, whether directly, such as the $250 billion CHIPS Act of 2022 that subsidises US computer-chip production, or indirectly, as was the case with the Bounced Back loan scheme in the UK meant to bail out domestic business testaments to friendshoring as they reward suppliers inside with expanded contracts. In effect, the traditional defence of the US position is based on its superior market power, while the logic of friendshoring is that foreign companies, in its case Europe or China, should come to ‘get away’ from the US.

The IMF focused on only one of the potential effects of greater trade autarky: the contraction of foreign direct investment as part of a larger wave of ‘rising trend of geoeconomic fragmentation’, or countries in general becoming more inward-looking and reluctant to supply each other.

US trade checked lower in February from January as the BEA reported Tuesday. Both exports and imports ticked down. The US imported $321.7 billion of goods and services in February, and exported $251.2 billion. Imports were well below where they had been last March. The fall in imports, according to economists at Wells Fargo Securities, resulted from ‘the weakening in demand as the US slows’. That slowdown doesn’t point to deglobalisation.

True enough, by targeting the forward-looking exchange rates not the spot ones, the effects could be minimal. ‘In the short term, the impact of many of these policies will be very modest,’ says Matthew Martin, a US economist at Oxford Economics. The strong dollar will probably serve to restrain exports for some time, and an economic recession could bring imports to a halt.

Though the longer-run picture is harder to judge – especially if international tensions ratchet up – Martin said he sees no evidence that globalisation is ‘unwinding in any serious way’.

‘Provided that there are no new shocks to global supply chains (such as those caused by COVID) producing goods in markets where labour and capital are cheaper will remain cheaper for certain manufacturing subsectors, and China and other emerging markets will remain good destinations for production and FDI,’ Martin said via email.

While some items, such as computer chips and electric cars, are currently made better here, ‘that’s a long way from a shift of all supply chains,’ Martin added.

‘On balance, I think the hype regarding deglobalisation is a bit too much, and we’re not expecting 180-degree pivoting of supply.’

Mark Hopkins, an economist with Moody’s Analytics, said that the re-shaping of friendshoring from the US was likely to shift what goods are created where so much as reduce the volume of trade – and if the IMF forecast becomes reality, the US will not even feel it much because the main casualties would presumably be developing countries.

As he put it in an email: ‘There seems little ground for thinking that friendshoring would be an economic shock to the US that is in any way meaningful. Best one could say is that it represents a (relatively minor) efficiency penalty one must incur as a kind of “insurance premium” to avoid the risk of an economically more devastating disruption in the future (in the absence of friendshoring).’

Yet if a deglobalisation trend – instead of being just a spike in a long cycle – turns out to be here to stay, the prospects for a concerted response are considerably bleaker. Last week, economists at the Brookings Institution took a broader look at what a truly deglobalising trend might mean for the US. In a ‘highly speculative’ paper, Yale’s Pinelopi Goldberg, a former chief economist at the World Bank, and the Bank’s Tristan Reed ran through what might unfold if friendshoring produces a return to the kind of deglobalisation of the 1970s.

Yes, an economy would be more resilient with regard to war, while being more brittle in the face of a pandemic – one of the few bright spots of that year was that the US could import the masks and so forth that it needed from China, and if it were less integrated in the world economy, such imports would probably have been much harder to get hold of.

Deglobalisation might also hamper technological progress to some extent, perhaps deliberately: last summer, the Biden administration blocked US companies from exporting chip-manufacturing technology to China for reasons of national security, a move that Reed and Goldberg both said would hurt the US and China in the end.

Or consumers could feel the pinch – there would be fewer imports, so prices would climb for goods. Globalisation has, for example, meant offshoring US jobs, as well as downward pressure on wages for US employees. Having cheaper imports has acted as a counterforce, the Reuters reporters said – this, too, could change if globalisation shrinks.

While a reversal of globalisation might be ‘almost inconceivable’, Hopkins said one of the key risks was that international trading patterns reshuffle to opposing blocs of countries, creating a similar pattern to the Cold War.

‘Think of the so-called “McDonald’s” theory of peace — the concept that two countries with a McDonald’s have never gone to war — which today [maybe literally no longer, but certainly in spirit] cannot possibly be less true.’ He continued: ‘As the US, China, Russia and probably several other BRIC countries start to circle their economic wagons, source their trade and direct their investment strictly to “friend” countries, there will be fewer and fewer “slack ties in the web” between the two groups that make up the global citizenry, and almost by definition their governments. That, I do believe, runs the risk of serious consequences if left to continue on its path.’