The hidden costs of friend-shoring

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.

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.

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.

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.”

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.

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[1] Building Resilient Supply Chain, Revitalizing American Manufacturing, and Fostering Broad-based Growth, The White House, https://www.whitehouse.gov/wp-content/uploads/2021/06/100-day-supply-chain-review-report.pdf
[2] US Treasury Secretary Janet Yellen on the next steps for Russia sanctions and ‘friend-shoring’ supply chains, Atlantic Council, https://www.atlanticcouncil.org/news/transcripts/transcript-us-treasury-secretary-janet-yellen-on-the-next-steps-for-russia-sanctions-and-friend-shoring-supply-chains/
[3] US Treasury Secretary Janet Yellen on the next steps for Russia sanctions and ‘friend-shoring’ supply chains, Atlantic Council, https://www.atlanticcouncil.org/news/transcripts/transcript-us-treasury-secretary-janet-yellen-on-the-next-steps-for-russia-sanctions-and-friend-shoring-supply-chains/
[4] Telephonic Press Briefing with U.S. Secretary of Commerce Gina M. Raimondo, U.S. Department of State, https://www.state.gov/telephonic-press-briefing-with-u-s-secretary-of-commerce-gina-m-raimondo/
[5] Davos Annual Meeting 2022 - A Conversation with Gina Raimondo, United States Secretary of Commerce – Original, World Economic Forum, https://www.weforum.org/videos/davos-annual-meeting-2022-a-conversation-with-gina-raimondo-united-states-secretary-of-commerce-original
[6] FACT SHEET: CHIPS and Science Act Will Lower Costs, Create Jobs, Strengthen Supply Chains, and Counter China, The White House, https://www.whitehouse.gov/briefing-room/statements-releases/2022/08/09/fact-sheet-chips-and-science-act-will-lower-costs-create-jobs-strengthen-supply-chains-and-counter-china/
[7] Commerce Implements New Export Controls on Advanced Computing and Semiconductor Manufacturing Items to the People’s Republic of China (PRC), BUREAU OF INDUSTRY AND SECURITY, Office of Congressional and Public Affairs, https://www.bis.doc.gov/index.php/documents/about-bis/newsroom/press-releases/3158-2022-10-07-bis-press-release-advanced-computing-and-semiconductor-manufacturing-controls-final/file
[8] Japan grants Micron $320mn in deepening US chip alliance, The Financial Times, https://www.ft.com/content/7c7cff55-5eb1-4a2d-8527-61d8788cea17
[9] Office Hours with Gene Grossman, Princeton Economics, https://economics.princeton.edu/news/office-hours-with-gene-grossman/
[10] Supply Chain Resilience: Should Policy Promote Diversification or Reshoring?, Princeton Economics, https://economics.princeton.edu/working-papers/supply-chain-resilience-should-policy-promote-diversification-or-reshoring/
[11] Can semiconductor manufacturing return to the US?, The Brookings Institution and Center for Strategic and International Studies, https://www.brookings.edu/wp-content/uploads/2022/04/Vying-for-Talent-Morris-Chang-20220414.pdf
[12] Japan wants manufacturing back from China but breaking up supply chains is hard to do, Reuters, https://www.reuters.com/article/us-health-coronavirus-japan-production-a-idUSKBN23F2ZO

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