The era of hyper-globalization ended with the trade war that began in 2017. In its place, global trade flows have fragmented to the point that by November 2022, U.S. trade with Mexico and Canada had surpassed China.
This evolution of trade has been driven in part by national security concerns as the U.S. has sought to protect its technological base.
In addition, as political risk has increased around the world, including the recent attacks on ships in the Red Sea, and inflation has taken hold, free trade and economic ties have deteriorated.
Now, a new era of friend-shoring, or fostering trade ties with friendly nations, has emerged.
This evolution of trade has been driven in part by national security concerns as the United States has sought to protect its technological base and increase the reliability of global supply chains.
While U.S. trade overall has been drifting lower since last February, the decline is particularly notable with China, dropping at rates approaching 18% per year by the third quarter.
The global slowdown in trade was spurred in part by two years of monetary tightening, but there is more to the story with China, which is experiencing a realignment of the global supply chain.
As a result, U.S. trade with close offshore allies like the euro area, England, Japan and South Korea now amounts to nearly five times U.S. trade with China.
Through this transition, though, risks continue to emerge. The deteriorating situation in the Red Sea has already disrupted supply chains pushed prices higher. Absent a wider escalation, though, the consequences will be manageable and it is unlikely to deter major central banks from cutting rates this year.
Reliability
There are advantages to dealing with private market participants in the West as opposed to the government-decision making of China or authoritarian governments in the Middle East.
Recent geopolitical fragmentation and the experience of the pandemic have provided the catalyst for corporations to diversify their suppliers.
Read more of RSM’s insights on the economy and the middle market.
For example, while private businesses in the West worked in concert to develop vaccines during the pandemic, China’s government went it alone. It dictated the use of a domestic vaccine that was effective until it wasn’t.
According to an analysis reported in Forbes, China’s managers were well aware of the super-spreader risks inherent in their densely populated production and living centers. And while they more or less navigated the COVID outbreak in 2020, the shutdown of Shanghai in early 2022 was a turning point, particularly for the tech sector.
The report continues that the heavy-handedness and unpredictability of government policies were cause for a loss of confidence in manufacturing in China. If you hadn’t been serious about diversifying your supply base before, the Shanghai shutdown changed everything.
Cost
If the sudden unreliability of China suppliers wasn’t enough, the enormous increase in shipping costs in 2021 and into 2022, as well as the more recent increase in shipping costs because of hostilities in the Red Sea all provide the impetus for diversification.
Price instability in the global supply chain, and particularly the jump in energy prices, made it obvious that it was time to shorten supply routes.
Shipping costs from Europe certainly moved higher during the pickup in demand in 2021. And those costs stayed high throughout 2022, which we attribute to the energy shocks coming out of the war in Ukraine.
But shipping costs from Rotterdam to New York are now lower than they were in 2019 and are 45% lower than the Shanghai to Los Angeles route.
Corporate security and national security
A big reason to move production from Asia to North America is national security. China’s aggressive behavior toward Taiwan and its repression in Hong Kong are disconcerting at best, but it is difficult to put a hard number on how that aggression is affecting the near-term profitability of U.S. firms.
Still, it will be increasingly difficult to separate economic issues from broader considerations of national interest. As Treasury Secretary Janet Yellen put it in 2022, after Russia invaded Ukraine, the modernization of our trade policy, the deepening of economic integration and increasing efficiency all favor the friend-shoring of supply chains.
The geopolitical events of the past two years suggest that economic integration with trusted countries would lower the risks to our economy.
We have long seen the benefits of integration in the North American production of automobiles, where it’s said that cars move back and forth across the Canadian border five times during production. And we suggest that further integration with Mexico and Central America would help solve the immigration problem.
Recent trade data indicates a shift toward friend-shoring. U.S. trade data confirms efforts by the government and private industry to further integrate and diversify the economies and therefore strengthen supply chains. In the long run, however, friend-shoring will be sustained only if it proves to be cheaper and more reliable than supply chains originating in China.
The takeaway
Fragmentation of economic, financial and trade relationships is now the norm as trading and security blocs continue to form around the world. Near-shoring or friend-shoring will likely play a larger part in shaping the narrative around global economic competition and collaboration.
Firms that operate in the global economy will now have to manage normal supply chain, financial and economic challenges in addition to emerging political risks.
This will almost certainly result in globally active firms following the flag and organized redundancy to hedge risk against international economic and financial volatility driven by geopolitical instability.
After several generations of international economic integration, regional trade driven by security concerns and a new era of political risk is taking shape.
