The tendency to move production and trade away from countries considered to be political rivals or national security risks and towards allies, so-called “friend-shoring”, is a hot topic among economists. The term popped up during the COVID pandemic, a time of significant disruption to supply chains, and gained further traction when Russia invaded Ukraine.
One of the most high-profile results of a friend-shoring policy is that Canada and Mexico have recently replaced China as America’s largest trading partners by total trade, while Mexico has overtaken China as America’s top importer. This followed the introduction of Donald Trump’s trade strategy, which aimed to reduce US dependence on Chinese goods – partly for political reasons and partly because of Trump’s perception of China as a rival power.
Joe Biden has also placed restrictions on trade with China in an attempt to strengthen US competitiveness with China and grow the US tech industry.
The US raised tariffs on imports from China significantly during the Trump administration. These levels remain high, making the costs of importing goods from China to the US more expensive.
In addition, the International Labor Organization Global Wage Report 2022-23 shows that China has experienced the highest rate of real wage growth among all G20 countries over the period 2008-22, also pushing up the price of Chinese goods.
The Biden administration continues to champion friend-shoring, which has further encouraged companies to shift production from China to Mexico as they weigh up geopolitical risks against differences in the costs of production.
While data on the number of firms relocating production is not available, the latest trade data suggests Mexico has managed to capitalise on the US-China rivalry.
Closer relationships with allies can be created by forming new trade agreements, for example, the US, Mexico, Canada Agreement (USMCA), which is more about geopolitics and friend-shoring than lowering tariff barriers as was the case of its predecessor, the North America Free Trade Agreement (Nafta).
But the USMCA was also a product of its time. US political will had shifted towards undermining political competitors and setting out anti-China political statements that resonated with voters.
Trump, a consistent critic of Nafta, had argued that it undermined American jobs and wages, a statement that undoubtedly played well in US industrial states experiencing manufacturing decline. A paper from the National Bureau of Economic Research suggested that far more US jobs were lost due to competition with China.
Doing business with your friends
Friend-shoring is a new term for something that has been around for a long time. Countries engaged in sanctions, blockades, and friend-shoring during the first and second world wars on a much larger scale.
In 1948, the US initiated economic sanctions against the Soviet Union, a 50-year-long strategy that started with export restrictions and was solidified by the Export Control Act of 1949.
These sanctions, intensified after the Battle Act of 1951, were aimed at limiting strategic goods to the Soviet bloc and became a permanent fixture of cold war policy following the escalation of the Korean war.
Data analysis shows how trade responds to political factors. For over sixty years, trade economists have made extensive use of the gravity model of trade, which has provided empirical evidence that countries tend to trade more with countries geographically closer to them as well as where there is a common language, common legal system, common exchange rate regime and shared colonial history.
Research also shows how political distance between countries and formal military alliances affects trade.
Governments can use trade policy to strategically support their own industries, so reducing trade with rivals can be part of a political agenda based on boosting domestic manufacturing (and jobs) rather than relying on imports. The US Chips and Science Act, and in the EU, the European Chips Act, are examples of policies that can inflict economic pain on adversaries while ensuring domestic production of this key component in high-technology manufacturing.
However, developing an industry takes time. By the time the industry is established, it may not pay off, either due to falling prices caused by increased supply or an economic slowdown that suppresses demand.
In the case of US chips, it is particularly interesting to note that the existing industry focuses on design and production of high-quality chips. Therefore, the latest policy will see low-cost microchips, the mainstay of the Chinese chip industry, start to be produced in the US and compete with the established US high-end suppliers.
The US has experienced the negative effects of these types of policies before. Just consider the US support for the steel industry, a popular choice among US presidents, including the current administration. Under the Trump administration, this saw 25% tariffs imposed on steel imports, which benefited the US industry but imposed costs on steel users.
Countries such as Australia were exempt from this policy, while other allies, such as the EU, were hit hard. Industrial policy can reduce dependence on rivals, but it’s not clear that friends always get special treatment.
Other policies can tie in with a friend-shoring agenda. The new generation of EU trade agreements deal with issues including labour rights and environmental protection, making it clear that third countries that want to do business with the EU need to meet the same standards. The EU has also been debating new anti-forced labour legislation, so this type of legislation may also start to get more serious consideration in the UK, for instance.
Friend-shoring policies aren’t new, but the slogan is. Self-sufficiency at the national level can inflict short-term pain on adversaries but may hold limited benefits in the medium term. However, there is broader acceptance that businesses need to have the certainty of trading bloc friends.
Half of all trade currently takes place between members of trade blocs, and recent trade data for the US and Mexico suggests that trade blocs may become more important over time as production moves.
To read the full article as it appears on The Conversation’s website, click here.