Everything but offshoring

Since the end of the Cold War, globalization and off-shoring have served as the structuring principles of international economics and business. Infrastructure and technological development have consistently reduced the costs of transport and communication. An expanding network of bilateral and multilateral agreements had diminished tariffs and nontariff barriers, favouring cross-border trade and capital flow.

In 1993, over one hundred countries signed up to the World Trade Organization (WTO) charter, signalling a commitment to free and fair trade on a global scale. Since then, trade has increased as a proportion of GDP in most countries. Cross-border trade grew faster than the global output. Firms improved their efficiency by increasing the length and complexity of their value chains. Free trade and improved technology meant manufacturers could keep smaller inventories, thereby boosting efficiency. Global value chains, based on just-in-time manufacturing, increased profitability and lifted millions of people out of poverty worldwide.

Even politics became globalized, as demonstrated by the coordinated response from the United States, European Union, China, and Russia in the aftermath of the Great Recession of 2009. With trade volumes dropping more than GDP, global leaders collaborated to stave off the kind of protectionism and trade wars that had exacerbated the Great Depression in the 1930s.

However, since 2009, global trade stopped rising relative to global GDP (Figure 1). Some analysts attribute this to most firms having fully exploited opportunities in their traditional markets. Other markets, particularly in Africa, have been slow to integrate with the global economy. Recently, the COVID-19 pandemic delivered a massive blow to global trade from which a full recovery is still pending and may have altered how the global economy operates. The offshoring inspired by efficiency revealed a weakness as soon as lockdowns, port congestion, container shortages, and export controls kicked in. Many countries also realized the drawbacks of relying on cheap imports without the domestic capacity to produce essential low-tech products like facemasks, gloves, and medicines, which left us vulnerable to shortages.

FIRST STOCKPILE, THEN REDESIGN

In response to delays and shortages, firms resorted to stockpiling inventory. The justin-time model, which relied on slashed inventories with minimal margins for error, revealed its shortcomings and even proved fatal to many firms as global trade ground to a halt.

Along with stockpiling, firms began questioning the pre-Covid globalized design of their value chains, realizing that, in an uncertain world, they are only as strong as the weakest link. As if the pandemic was not proof enough of the vulnerability of the globalized economic model, the Russian invasion of Ukraine drove the point home. Europe’s dependence on Russian fossil fuels proved to be a dangerous chink in the continent’s armour as European firms struggled to keep the lights on, and consumers faced massively inflated bills for gas to heat their homes. With Ukrainian grain shipments blocked in port, food prices surged worldwide, posing the risk of unrest in poorer countries reliant on food imports. Knock-on inflation throughout the supply chain is hitting consumers hard. In May 2023, the price of pasta in Italy reached an all-time high, prompting an emergency cabinet meeting to discuss the dangerously high price of the national staple.

Responding to these challenges, a new vocabulary for global trade has emerged as firms scramble to redesign their supply and value chains. Diversification means enlarging the number of suppliers and countries involved in the value chain. Not putting all your eggs in one basket is a key financial principle to reduce risk. Nearshoring entails bringing operations nearer to the main production hub or the end customer, shortening the value chain and mitigating the risk of trade disruptions (e.g., an American firm switching from a Chinese supplier to a Mexican one). Reshoring refers to bringing productive activities back “home.” Reshoring has both an economic rationale (reducing the manufacturing cost of international trade disruptions) and a political one, as domestic firms are insulated from shocks caused by international events, export controls, or nationalization.

The political dimension has gained relevance for businesses as the rift between the US and its allies and China widened in the wake of the Russian invasion of Ukraine. Although China subscribed to the WTO in 2001, its political and economic models have not converged towards those in advanced economies based on democracy, rule of law, and a market economy. Rising concerns include China’s growing external assertiveness and its relationship with Russia.

The extreme reaction to this geopolitical clash is decoupling, the disconnection of the US-centred economy from the Chinacentred one. However, a full decoupling would be disastrous for both countries as their economies are highly intertwined, destabilizing the entire world. This is why de-risking, reducing the reliance on China, especially for national security products, is more palatable.

Friendshoring involves strengthening trade relationships with allies and trusted countries. It is diversification with a political inflection that is aligned with the proposal made in April 2022 by US Treasury Secretary Janet L. Yellen. This is not a silver bullet, as it comes with a cost. Manufacturing in developed economies, which are in general democracies (thus “allies and trusted countries”), is more expensive than in developing ones. Moreover, limiting the geographical reach of firms to friends and allies reduces the opportunity to exploit economies of scale, further increasing the cost of production. Even other reorientations of value chains come with a price tag as they move away from the cheapest options, and overordering to stockpile is expensive due to its impact on working capital. All this at a time when inflation is a growing concern for most developed economies.

Cover image: Global trade relative to global GDP