While the notion of friend-shoring is relatively new, the twin realities that supply chains face potential disruption and that governments favour allies in trade policy are not. In the third paper in this series on friend-shoring, I question whether the ends and means of friend-shoring have been sufficiently thought through.
Tamping down one risk is no guarantee of overall risk reduction
At its core, friend-shoring seeks to reallocate production and sourcing away from unreliable, geopolitical rivals towards allies thought less likely to cut off sought-after raw materials, parts, and technology. Essentially, friend-shoring seeks to reduce the risk of disruption. The flaw in the plan, however, is to focus on one specific form of disruption risk: foreign government-risk or, specifically, that arising from governmental control or influence over exports.
Friend-shoring—at least as currently outlined by its advocates—takes no account of producer specific risks (including risks arising from their own supply chain management decisions), region- or geographic-specific risks (including climate-related risks), or trade route-specific risks (recall the Suez canal blockage). Potential foreign suppliers can differ in respect of all of these risks, not just foreign government-risk. A foreign supplier could be located in an ally yet still at significant risk of disruption on account of non-governmental factors. Worse, in some sectors it may be that exposure to lower foreign government risk is negatively correlated with the exposure to other risks. Whether this is the case is an empirical question.
A second design flaw relates to the very notion of disruption. As far as supply chains are concerned, there are at least three dimensions to disruption: the probability that supplies are cut in the first place, the degree to which supplies are cut, and the length of time that supplies are not forthcoming/reduced during which alternative supplies cannot be found. Which dimension matters most may vary across supply chains—and, consequently, so might the optimal policy response.
It would seem that friend-shoring logic, such as it is, focuses exclusively on the first of the three dimensions—the probability of supply interruption. But even a cursory reading of the sophisticated supply chain literature—both practitioner and research-based—reveals that the optimal risk management in supply chains is no easy task. There are no silver bullets here and—equally important— it is far from clear why private sector suppliers don’t have strong profit-driven motives to limit disruption if buyers really value uninterrupted supply.
For sure, friend-shoring is relatively new policy proposal and maybe its proponents will raise their game and devise initiatives that take account of the nuances of twenty-first century supply chains and associated risk management. As the remarks made here imply, however, any such policy initiatives should be held to a high standard—and will require a level of expertise in design and execution on the part of officials not apparent to date.
Will friend-shoring carrots move the commercial needle?
The fact that firms are offered inducements to move their factories or labs doesn’t mean that they will be taken up. Short of compulsion, factory relocation is a voluntary commercial decision and the state largesse offered will have to cover the lifetime of cost and other disadvantages of moving production away from an efficient location. An important and unanswered question is whether the incentives offered to date are sufficient to sway commercial decision-making towards friend-shoring.
Here it is important not to be misled by headline billion-dollar budgets. The Japanese factory relocation scheme announced during the pandemic—and described in the second paper in this series—is a case in point. It’s $2.2 billion price tag garnered a lot of headlines. Turns out that, in one large tranche of subsidy awards to Japanese firms to bring production home from China, the average award was a mere $15 million. Awards that small could only make a difference if the gap between the lifetime profitability of a plant in China and its replacement in Japan was tiny. Or to put it differently, a $15 million subsidy won’t move the commercial needle when producing in China has a major cost advantage over producing at home or in an ally.
Some might retort that U.S. legislation has put tens of billions of dollars on the table to bolster semiconductor production. Again, the $52.7 billion headline number looks impressive until one realises that setting up an efficient semiconductor fab is a 10-digit dollar proposition. Similar considerations arise with the EU Chips Acts where the amounts involve pale when compared to the costs of establishing new plants. Furthermore, the more strings policymakers attach to these subsidies, the less likely they are to move the commercial needle towards friend-shoring.
Of course, one reaction to these concerns is to argue that governments should put more money on the table. But bear in mind that this is a discussion about friend-shoring. Few elected officials will relish explaining to voters why tens of billions of dollars or euros are being given to move factories from adversaries to foreign countries. State largesse that moves the commercial needle and induces friend shoring may be politically indefensible at home.
Once carrots have failed, are sticks next?
Once carrots have been tried and failed, proponents of friend-shoring may well resort to sticks. Already, the U.S. government has tightened up local content rules in recently enacted legislation associated with friend-shoring. But states could go much further—raising trade barriers against nonallies as part of a strategy to encourage production relocation towards friendly nations. Rather than being framed as a benign inducement to shift factories and labs, friend-shoring could mutate into another rationale for fragmenting the world trading system into rival blocks. Is this what the trade-friendly officials advocating friend-shoring really want?
Halit Harput is Senior Trade Policy Analyst at the St.Gallen Endowment for Prosperity through Trade. For the Global Trade Alert initiative he reports on trade-related policy changes by several nations, including the United States. Previously, Halit served as an official in the Turkish Ministry of Trade. He thanks Simon J. Evenett and Johannes Fritz for their comments and guidance on earlier drafts of this note.
Please send comments or suggestions to halit.harput@sgept.org. This is the last of three assessments of friend-shoring, the others being available here.
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