Since friend-shoring was added to the US trade policy lexicon, little has been revealed about what the term actually means. If governments seek to intervene in a supply chain, they must make the case that they observe the risks better than firms do. But it is unclear which market failure friend-shoring policies will fix without further fragmenting the world trading system.
Recently, in the US, there have been calls for onshoring production back to American soil to increase resilience and sustain US manufacturing jobs. A careful review of the statements shows that the pronouncements by senior officials of the Biden administration over friend-shoring are neither coherent nor a well-designed, rational, or evidence-based trade policy.
The proponents of friend-shoring have willed the ends—supply chain resilience—but they have not specified the means. Friend-shoring is not just a Biden administration buzzword. It has translated into policy actions, largely through a mixture of legislative and executive initiatives, not only in the US but also in other countries such as the EU and Japan. It remains to be seen whether these initiatives will motivate businesses to relocate, and if they are fiscally and politically sustainable.
About a year ago, the US added friend-shoring to the trade policy lexicon. A White House report [1] based on an Executive Order on supply chains drew attention to Covid-era supply shocks disrupting global value chains. Friend-shoring was proposed as an instrument to strengthen the resilience of those supply chains. Since then, senior US officials have been working to broaden the term’s scope.
US Treasury Secretary Janet Yellen described [2] friend-shoring as deepening relationships with allies and constructing supply chains among a group of “friendly” countries to reduce the risk of disruption. In her more recent statements [3], friend-shoring has become the Biden administration’s new approach to advance foreign trade policy.
The matter is framed differently by other US officials, who put more emphasis on translating the term into import substitution policies. For example, Commerce Secretary Gina Raimondo explained [4] that friend-shoring is “essential” for the US, but as part of a dual approach that also involves investing in domestic manufacturing. She emphasized[5] that “if it can’t be in America, it ought to be on our allied shores.” For supply chains in sectors deemed sensitive, an explicit emphasis is put on national security. Concerning “sensitive” semiconductor supply chains, Ms Raimondo said, “some things are more important than price. You can’t put a price on America’s national security.” And she offered full repatriation of chip production to the United States, arguing, “it is a huge national security issue and we need to move to making chips in America, not friend-shoring.”
After the Biden Administration first mooted the term, statements by senior US officials revealed little about what the term actually means. While some statements favored relocation of production, or shifts in sourcing arrangements to allies, others essentially promoted subsidy-induced import substitution.
Semiconductor policy offers a glimpse
The shoots of friend-shoring are evident in several sectors. The focus of many Group of 20 governments on the semiconductor industry offers a clear window into what friend-shoring might look like. The number of policy initiatives with a friend-shoring component is increasing. Yet, their mushrooming does not imply the existence of a grand friend-shoring strategy among Western allies.
In August, the US announced a multi-billion-dollar initiative, namely the CHIPS and Science Act [6] (CHIPS Act), with elements that could be termed friend-shoring, to advance chip manufacturing in the US. The CHIPS Act includes provisions prioritizing partnerships with allies as well as guardrails to weaken commercial ties with China. Specifically, federal funds under the CHIPS Act are offered contingent on halting the expansion of semiconductor manufacturing capacity in countries that present a national security concern to the United States. As a complement to the CHIPS Act, in October, the Commerce Department implemented [7] sweeping export controls on chip manufacturing components to China. Similar to the CHIPS Act, the new export control measures included restrictions on third countries to supply these items to China if any US technology is used in the supply chain of these items. With these two policies, the US is aiming to construct a semiconductor supply chain with allied countries while attempting to decouple China from advanced American technology.
Apart from the US, other countries are also announcing policy initiatives or actions that have a friend-shoring flavour. Recently, the EU announced the European Chips Act with a budget of more than €43 billion to strengthen semiconductor value chains within the EU. While targeting “excessive dependencies,” the European Chips Act included friend-shoring components by proposing “semiconductor international partnerships with like-minded countries.” In September, Japan offered [8] a $320 million incentive package to US chip-maker Micron to invest in Japan following negotiations with the US to expand cooperation in semiconductor production.
These initiatives are complemented by others including the US-EU Trade and Technology Council (TTC), the Minerals Security Partnership (MSP), the Indo-Pacific Economic Framework for Prosperity (IPEF), and the Americas Partnership for Economic Prosperity, to “engage with trusted partners” and “reduce dependencies on unreliable sources of strategic supply.”
For now, by and large, Western governments are using carrots rather than sticks to advance friend-shoring. But it remains unclear if carrots will be sufficient.
How realistic is friend-shoring?
The idea of friend-shoring is based on constructing value chains among allies and switching production and sourcing away from geopolitical rivals to insulate supply chains from disruptions. However, such logic has flaws.
First, it is not clear in this plan which market failure friend-shoring policies will fix. If governments seek to intervene in a supply chain, they must make the case that they observe the risks better than firms do. One of America’s leading international trade economists, Professor Gene Grossman of Princeton University, recently observed [9] that: “Firms have their own incentives to avoid disruptions, so it’s not obvious that their investments in resilience will be sub-optimal without government policy intervention.” Policies based on the assumption of the private sector’s under-investment in resilience is flawed. Grossman also concludes [10] in another paper with two co-authors that governments are very unlikely to observe the factors that optimal public policy for supply chains depends on. So, if governments cannot accurately observe market failures in supply chains, how can they be sure that friend-shoring policies won’t do more harm than good.
Another flaw of friend-shoring is that it focuses on only one dimension of supply chain risk: that offshore operations might run the risk of vulnerability to states that turn “unfriendly.” Such an approach assumes that sourcing from allies is less likely to be disrupted than sourcing from geopolitical rivals. However, as the recent baby milk powder shortage in the US illustrates, short-sighted friend-or onshoring policies may diminish one supply risk only to amplify another. Relying on a few domestic suppliers for its supply of baby formula didn’t increase the resilience in the US. Instead, a disruption in one of the facilities has caused significant supply shortages. In their location choices, companies must balance a series of risks beyond expropriation and IP theft. Advocates of friend-shoring should consult businesses to better understand how relocating supply chains interacts with other dimensions of supply chain security.
We must remember that supply chains are run by businesses. To date, Western governments have mainly relied on carrots to induce factories to move. But subsidy-induced production relocation away from an efficient location must be commercially viable for the company. Considering the additional costs and other disadvantages of relocating factories, government subsidies should sufficiently cover the costs of relocation over the lifetime of the relocated factories. The jury is out on whether government incentives offered to date are sufficient.
Governments’ multibillion-dollar subsidies may look tempting for factory relocation. But, in essence, most of the subsidies are provided in the form of conditional tax relief over long periods of time, and lump sum grants are usually insufficient to cover the relocation costs. For example, the $52.7 billion headline number for the US Chips Act looks impressive until one realizes that setting up a single efficient semiconductor fab runs into millions of dollars. The former chairman of the world’s largest contract chipmaker TMSC argued [11] that the US CHIPS Act is a wasteful and expensive exercise in futility and that US-based semiconductor fabs “will be non-competitive in the world markets.”
Similarly, Japan’s $2.2 billion proposal announced [12] during the pandemic to repatriate production and bring factories back home from China, or move them to other South East Asian nations, initially received significant welcome. But it turned out that the average subsidy amount to bring production home from China was only $15 million. Considering the lifetime profitability and cost advantage of producing in China over Japan or in an allied economy, this amount is unlikely to move the commercial needle.
To compound matters, the subsidy sufficient to sway commercial decision-making towards friend-shoring is not easy to determine. Furthermore, pouring billions of dollars into moving factories from geopolitical rivals back home or to allies means diverting those dollars from helping populations grappling with the rising cost of living. Will governments have to turn to sticks to spur companies to relocate as soon as voter willingness to pay for relocation fades in the light of cost-of-living worries?
The friend-shoring argument requires a similar perception of disruption risks and close cooperation among allies to reach agreement on how to relocate production and sourcing away from unreliable geopolitical rivals. Any perception of an imminent security threat, such as during the Cold War, would make it easier to unite against rivals under a security framework. But in today’s world, it is not clear whether every ally can be counted on to be a part of US friend-shoring initiatives. Even domestically, it is not clear whether businesses or consumers are willing to pay the higher costs associated with moving supply chains away from China.
Carrots seem unlikely to move the commercial needle towards friend-shoring. Domestic voters may force Western governments to bring out the sticks. How well will that work in a multilateral context? By raising trade barriers to economies deemed “unfriendly,” friend-shoring could mutate into a rationale for further fragmenting the world trading system.