'Friendshoring' Could Have Some Not-So-Friendly Downsides

A push by the U.S. and other nations to trade more with friends and less with rivals could make the world poorer, according to a report from the International Monetary Fund. 

The IMF researchers said in a report on Wednesday that said “friendshoring” trends could lead to a more fragmented global trade network and the loss of 2% of the world’s gross domestic product. Developing countries, which would otherwise benefit from more foreign investment, are most vulnerable to losing economic output. 

“A fragmented world is likely to be a poorer one,” the researchers wrote.  

Since the Russian invasion of Ukraine in February 2022, U.S. diplomats have sought to strengthen economic ties with friendly countries like India and Mexico as relations with China grow frosty. 

Treasury Secretary Janet Yellen touted friendshoring when she visited India in February, noting that Apple and Google have expanded phone factories there as they move production out of China. President Joe Biden has also pursued policies encouraging U.S. manufacturing to replace imported products, including the $250 billion CHIPS Act of 2022, which subsidizes domestic computer chip production. Other countries, including the European Union and China, have taken similar steps. 

The IMF’s analysis focused on just one possible consequence of the rise of inward-looking trade policies: a reduction in foreign direct investment as part of a broader “rising trend of geoeconomic fragmentation,” or countries generally becoming more insular and less willing to trade with adversaries. 

U.S. trade did indeed dip in February from January, data from the Bureau of Economic Analysis showed Tuesday, with both exports and imports declining slightly. The U.S. imported $321.7 billion of goods and services in February and shipped out $251.2 billion. Imports were solidly below the peak they hit in March 2022. Economists at Wells Fargo Securities attributed the downtick in imports to weak demand as the U.S. economy slows, however, rather than a broad deglobalization trend.

Indeed, Matthew Martin, U.S. economist at Oxford Economics, said the recent wave of policies is unlikely to make much of an impact on trade in the short-term. In the near future, the strong dollar is likely to restrict exports, while an impending recession could slow imports. 

While the longer-run outlook is uncertain, especially if international tensions get worse, Martin said there are few signs of globalization unwinding in a serious way.

“Barring any renewed challenges to supply chains similar to those COVID brought on, it will be cheaper for certain manufacturing subsectors to produce goods abroad where labor and capital are cheaper—and China and other emerging markets will continue to be attractive destinations for production and FDI,” Martin said in an email.

Certain products, like computer chips and electric cars, could be produced more here, but that’s “far from a total reorientation of supply chains,” Martin said.

“Overall, the speculation and claims regarding deglobalization seems to be somewhat overdone, and we don’t expect a complete reorientation of supply,” he said. 

Mark Hopkins, an economist at Moody's Analytics, said the friendshoring maneuvers were more likely to change which products were made where rather than reduce the overall volume of trade, and noted if the IMF prediction holds true, the U.S. would be little affected since developing countries would bear the brunt.

"There is little reason to fear that friendshoring would have a negative economic impact on the U.S. of any consequence," Hopkins said in an email. "It can be at best thought of as a small efficiency cost paid as an 'insurance premium' to avoid the risk of a much more costly economic disruption in the future (without such friendshoring)."

However, if a reduction in trade proves to be a long-term trend rather than a temporary blip, the consequences could be severe. Last week, researchers at the Brookings Institution took a broader look at the possible impact on the U.S. of a “deglobalization” trend. In what they said was a “highly speculative” paper, Yale economics professor Pinelopi Goldberg and World Bank economist Tristan Reed laid out what could happen if the friendshoring trend accelerated into full-blown deglobalization. 

The economy would hold up better in the face of war, but would be more vulnerable to shocks like the pandemic—the researchers noted that the U.S. was able to import crucial supplies like facemasks from China in 2020, something that would be harder to do if deglobalization took hold. 

Deglobalization could also slow the pace of innovation, in some cases deliberately so—for example, last year, the Biden administration banned U.S. companies from sharing computer chip technology with China for national security reasons, a move that Reed and Goldberg said could ultimately hurt both countries. 

Consumers could be squeezed—fewer imports would mean higher prices for products. While globalization has meant outsourcing U.S. jobs and lower wages for American workers, it’s also kept prices down, the researchers said—a process that could go into reverse if globalization is in decline.

While Hopkins said a reversal of globalization was "almost unfathomable," he saw a major risk in the reshuffling of trade to opposing blocs of countries, which could recreate a pattern similar to the Cold War.

"Consider the so-called 'McDonald’s' theory of peace–the notion that two countries with a McDonald’s have never gone to war—which may no longer hold true anymore in a literal sense, but is almost certainly as true as ever in spirit," he said. "As the U.S., China, Russia and possible other BRIC countries being to circle their economic wagons, sourcing trade and directing investment only to 'friend' countries, there will be fewer and fewer “loose ties that bind” among the global citizenry, and by extension their governments. This I do believe has the risk of serious consequences if left unchecked to continue in its current direction."