Friend-shoring is the new hot button issue in international trade today, couple of months back when Janet Yellen mentioned the term in her Atlantic Council Lecture its far reaching implications were not clear immediately. International trade has been adversely affected in recent years by USA-China trade clashes, Covid-19 pandemic, Ukraine war and sanctions against Russia. Globalisation as a concept is slipping into a morass of decoupling, regionalisation and even re-shoring in certain cases. These developments have deeply affected the supply-chain issues confronted by the corporates across the world. Friend-shoring basically means that supply chains would run through countries which have a close political understanding. The idea is to make the supply chain resilient and not dependent on the “sourcing of critical goods” from countries about whom “USA has geopolitical concerns”. It is understandable that in the current context of Ukraine-Russia conflict, the dependence of a NATO country for critical items like fuel, food and fertiliser on Russia can be suboptimal. When safe-shoring becomes an integral part of supply chain networks then all kinds of trade-offs would enter the calculations, the first victim would be the consumer who has to pay higher prices due to cost inefficiencies that get built into the existing supply chain. When safe-shoring is at the core of friend-shoring then opportunities may open up for countries that can provide substitutes. For example, Taiwan is a major supplier of semi-conductors to USA, however if USA is worried about a Taiwan-China conflict then it will have to develop alternative sources for de-risking the operation. Re-shoring to USA is a straight forward option, but the cost could make the product less competitive. So it has to look for countries like Korea and Malaysia which can retain the competitiveness. For us the key issue is, can this development open up an opportunity for India. There are many such instances, where USA from the point of view of national security, risk mitigation and resilience could seek alternative sources of supply. One example that was quoted by Yellen herself recently was that of rare-earth materials, where currently 78% of the supplies come from China. Restricting the sourcing of critical inputs to ‘trusted countries’ is understandable. The problem arises when this de-risking concept goes overboard and becomes an alibi for protectionism.
In this context it is important for a country like India to study the emergence of Indo-Pacific Economic Framework (IPEF), it is not a full fledged regional free trade agreement. It is different from RCEP where China is a member or erstwhile Trans Pacific Partnership from which USA walked away during the Trump days. It is at best an economic alliance to take on China in Asia. The mechanism through which it would operate is still not very clear.
In this context, some of the suggestions made by Yellen should be taken seriously. It seems, the new alignments will end up becoming plurilateral networks and touch upon issues not considered by WTO or current free trade agreements; such as data protection, digital services, clean energy, environmental protection, etc.
India will have her own sensitivities in each of these areas and the scope for proper negotiation is important. It appears in a broad context Indo-Pacific Economic Framework which could include both trade and investments is intended to counter the Belt and Road Initiative of China. The current bipolarity in international relations which is affecting trade and investments is getting questioned. In the short run, some countries can find new opportunities opening up due to the USA-China clash of interests.
However, in the long run friend-shoring as an idea can create major difficulties, it will lead to the fragmentation of the trade and raise costs from a firm’s point of view, it will put the consumer under higher inflationary pressure. It is often pointed out that iPhones cost can go up by 2.5 times if it is reshored. Secondly friend-shoring could also lead decoupling of developing economies from the western world leading to a loss of output and GDP growth for developing economies. From a firm’s point of view the entire objective of cost efficiency and productivity gains would be lost. Bipolarity in international relationships can lead to a fragmentation in economic relationships. Some examples are decoupling, friend-shoring, regionalisation of trade, investments and currency blocks, restricted capital movements, etc. All these would lead to a loss of the gains from multilateralism and rule based economic governance. The current system consisting of WTO, FTAs and RTAs have their own shortcomings. That doesn’t mean friend-shoring and decoupling would provide a panacea for all the existing limitations.
Siddhartha Roy is the former Economic Advisor of the Tata Group. Currently he is the CEO of SR Associates an Economic Advisory and Strategic Consultancy enterprise.
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