Geopolitical tensions have exposed the risk of over-reliance on certain markets. Liberal democracies are reassessing whether free trade should be replaced by what US Treasury Secretary Janet Yellen has called “resilient trade.” This is defined as a form of trade where international value chains rely on “friendly” suppliers (read: not China).
Champions of this new trade architecture are not questioning David Ricardo’s comparative advantage theory. They continue to believe in the benefits of trade liberalization, but more so if it takes place among “friends.”
In their world, free trade is good but “friendshoring” is safer. Comparative advantages still count, but rather than chasing the cheapest suppliers, companies should factor in longer-term risks such as geopolitics, security and overconcentration in supply chains.
Governments, friendshoring advocates say, should play a critical role in strengthening national economic resilience by guiding private companies toward reliable comparative advantages. How can they do that?
Friendshoring proponents are not very specific on how governments should choose friends and whether friends can trade with other friends’ foes. But biases toward friends must be embodied in preferential trade agreements. Nor do advocates of the approach see a conflict with trade’s multilateral architecture. According to them, moving supply chains to like-minded countries can be done through a broad array of “multilateral engagements.”
This is peculiar. Friendshoring is not a multilateral engagement, as this is commonly understood, since only friends are invited to sit at the negotiating table.
Moreover, unless the scope of the trade preferences exchanged among friends is broad enough to meet the World Trade Organization’s (WTO’s) free trade agreements’ yardstick, such agreements would breach the “most favoured nation” clause. And it is very unlikely that nations shifting toward friendshoring will be willing to grant all WTO members the ability to specify trade preferences.
Beyond the foreseeable consequences of trashing the cornerstone of the entire postwar rules-based trading system, there is a technical detail that friendshoring advocates fail to consider. All trade preferences are necessarily based on rules of origin. Was a product made in a friendly country? What was the origin of the inputs used in its production? And how much value was added in the friendly country from where the final product was shipped?
Determining the “friendly origin” of industrial goods is complex yet possible. But what rules could be used to determine the friendly origin of digital flows?
Goods have a discrete existence because they are made of atoms. They can only be in one place at a time. But to an increasing extent, trade in goods or services is connected to cross-border data flows. As the Organisation for Economic Co-operation and Development notes, a smart fridge requires market access not only for the physical product, but also for embedded digital support and service.
Determining the origin of digital flows is difficult because bytes are not discrete items. They behave like waves, rather than like atoms. They can be in several places at the same time and can be reproduced multiple times (at almost zero marginal cost), stored and “shipped” from multiple sites.
Admittedly, governments could build firewalls to intercept bytes and determine their origin. Although it could be technically difficult, it is theoretically possible to create a barrier to entry for digital flows, scrutinize them to determine their origin and let in only those arriving from friendly places.
China already does some of this (although virtual private networks can make life difficult for the censor). The paradox is that in order to weed out China from their value chains, liberal democracies are creating a world that may end up looking more like China than one shaped by their values. Friendshorers should be careful what they wish for.
This article first appeared in the Financial Times.