By Peter Poliakov
World of Chaos
The past five years have seen historic disruptions to global trade. The US-China trade war, the COVID-19 pandemic, and Russia’s invasion of Ukraine have acted as three consecutive shocks to the global trading system. Each of these shocks sparked discussions on supply chains and their role in our economies. Up for debate is whether it is more advantageous to have manufacturing take place in foreign countries, where companies have invested billions of dollars in factories and labor is cheaper and abundant, or to bring manufacturing operations back to domestic shores, creating jobs and ensuring a country's national security interests in times of crisis. However, this tradeoff is illusory; both of these scenarios are possible through the relocation of supply chains to friendly countries to enjoy national security advantages while still retaining the economic benefits of offshoring.
Good Old Days
Global trade has been expanding since the end of World War 2 and the rise of the Bretton Woods System. However, growth has accelerated in the past 30 years as developing countries such as Brazil, India, and Russia have become integrated in the global trade regime. On top of this, China’s accession to the WTO in 2001 was seen as the "golden age" of international trade — the "factory of the world" had been accepted into the global community, and companies took advantage of this by expanding their production of consumer goods in China while cutting back in the US.
Policymakers have taken notice of hostile regimes exploiting their positions in the global economy to extract geopolitical gain. China’s abuse of economic regulations, more specifically its protectionist economic structure, and stringent capital movement policies, as well as its position as the world’s largest labor market, has allowed it to gain significant advantage within the global trade system and coerce other nations, if necessary, for political or economic gain. Russia, on the other hand, has used energy blackmail in order to dissuade Europe from supporting Ukraine, throwing the continent into an energy crisis not seen since the First Gulf War. On top of this, Russia is using its control over agricultural exports to pressure the rest of the world to remain neutral at the risk of incurring high wheat prices.
Treasury Secretary Janet Yellen is one of many individuals who is now proposing friend-shoring as an alternative to the current binary of onshoring vs. offshoring. Instead of sacrificing economic efficiency and subjecting consumers to higher prices, or leaving critical supply lines vulnerable to foreign interference, avoiding either outcome is possible. Friendly countries in Asia or South America are prime opportunities for investment by US companies, and for free trade agreements, whether multilateral or bilateral. Existing frameworks, such as the TPP (Trans Pacific Partnership), should be rejoined and new treaties should be explored (such as with India or Brazil). These agreements would allow for companies to invest safely, achieving higher profits while consumers retain the advantage of cheaper goods and services.
The benefits are apparent: cheaper goods and higher profits — a natural consequence of this scheme — would allow consumers to enjoy all the same baskets of consumption that they have enjoyed for the past few decades, while companies save on labor and other miscellaneous costs. These profits are returned to investors, who use them to fund other productive projects, resulting in higher long-run economic growth while consumption, the main driver of a healthy economy, remains stable. On top of this, governments that hold no hostility to the US, such as most of Latin America and Asia, would not exploit the economic leverage gained from this arrangement to the detriment of the US. These nations already retain positive relations with the US and would not gain any strategic advantage in trying to compete or otherwise disrupt supply chains as gains from American friend-shoring are mutual. US investment would create jobs and allow increased incomes and tax revenues, something that would not be afforded to these countries if they decided to be uncooperative. International trade in a free enterprise system is mutually beneficial by definition, and many of these countries would lack the desire to disrupt such an advantageous arrangement.
Many companies are already doing just that. Apple’s overreliance on China for the past two decades has finally come to hurt them with restrictive COVID lockdowns and an unfriendly technological environment. The company is now investing heavily in India and Vietnam, while also trying to scale down its production in China slowly over time. By doing this, Apple is already preparing itself for any new policy changes that might come from DC, and making itself a stronger and more resilient company as well. Tim Cook and Apple’s leadership quietly understand its exposure to geopolitical tensions between the US and China leave the company vulnerable — it would be wise for other China-dependent companies to come up with action plans on how to adapt to volatility in the US-China relationship.
Time Will Tell
However, these measures are not enough to protect the economies of the US and the West. Domination of certain resources, such as by Russia or Saudi Arabia, can also devastate the economy by creating supply shocks in globally-traded commodities. The past year has been extremely volatile with respect to food and energy prices, with oil and wheat prices reaching all time highs following Russia’s invasion of Ukraine. Add in the effect of Saudi Arabia’s enormous influence over OPEC, and it is clear how vulnerable Western and developing economies really are to these shocks. Unfortunately, with such commodities, there is little friend-shoring can do to help alleviate these issues. Although the US is the world’s largest oil producer, its pricing system is still at the whims of the international market, which is largely dictated by the Saudis and OPEC; the same applies to food prices and Russia. It is simply impossible to move oil fields from the Middle East or agricultural land in Eastern Europe to the jungles of South America or Southeast Asia. To counter these forces, policy makers have tried using the Strategic Petroleum Reserve to lower oil prices while still offering a minimum price for producers to drill, as well as imposing an oil price cap on Russian oil. Nevertheless, it will take many months to see the effects these policies have on the economy, and many years to properly build a resilient and strong economy that can withstand the constant shocks of a globalized economy.
Peter Poliakov is the director for the Economics & Business team and currently a fourth-year undergraduate at the University of Washington Department of Economics.