Economies across the world have been strained by the events of the last three years. The COVID-19 pandemic claimed millions of lives and brought the world economy to a standstill. Russia’s brutal war has taken a devastating toll on lives and infrastructure in Ukraine, generating seismic repercussions for oil and food prices at a time when the global economy was finding its footing.
Looming above these crises has been climate change. Severe droughts and floods have disrupted agricultural capacity and exacerbated energy shortages around the world. These disruptions have resulted in severe shortages of key goods, from lumber to microprocessors to food and fuel, that have in turn slowed global growth and contributed to high inflation in many economies. In the developing world, we have seen a rise in poverty for the first time in decades.
Over the past year, US President Joe Biden’s administration has advanced a historic economic plan to strengthen America’s resilience against costly supply disruptions like the ones we have experienced. Here at home, we have built on our work to ease bottlenecks in ports with ongoing monitoring of our supply chains and a historic investment in our physical infrastructure. And we have passed legislation that will expand domestic manufacturing capacity in core twenty-first-century sectors like semiconductors and clean energy.
But I believe that the success of our plan also depends on our economic policy abroad. The traditional conception of free trade emphasizes the efficiency of trade governed by comparative advantage. That is the economic theory that suggests that each national economy should produce what it is comparatively best at. Comparative advantage explains the efficiency gains of international trade and specialisation. But we have learned that we must also account for the reliability of trade.
In today’s world, I believe that any economic agenda must consider the potential for regional and global shocks to impact our supply chains, including those shocks driven by the policies of certain foreign governments. We are concerned about vulnerabilities that result from over-concentration, geopolitical and security risks, and violations of human rights. Through an approach called “friend-shoring”, the Biden administration aims to maintain the efficiencies of trade while promoting economic resilience for the United States and its partners.
The importance of secure trade
Let us start with the fundamentals. No country can, or should, produce every good its economy needs. Trade brings significant economic benefits to all countries involved.
We can export goods that we produce more efficiently. And we can import goods produced more efficiently by other countries. For businesses, trade boosts production by providing a larger market for exports. It enables our most productive firms to expand and create good jobs for more people. For consumers, it means lower prices and greater choice in the products we purchase. Trade also encourages the global flow of ideas that is essential for scientific discovery and technological advancement.
We must vigorously protect global economic integration. As we do so, we need secure trade that reaps the benefits of economic integration while providing greater reliability of supply for the goods we depend on. Three key risks are of particular concern.
The first risk is over-concentration. The US and its partners have a strong interest in creating redundancies in our supply chains. We must avoid over-concentration of the production of critical goods in any particular market. Concentration of sources for key components can sometimes lower costs. But it leaves supply chains vulnerable to cascading disruptions that hurt workers and consumers.
Take the example of semiconductors. Microchips are essential building blocks of the modern economy. Yet virtually all manufacturing of the most advanced chips is located in East Asia.
We have seen firsthand the consequences of a shortage which, according to one estimate, has affected at least 169 industries. For the automotive industry alone, the pandemic chip shortage was estimated to have cost $210 billion in lost revenue in 2021, with manufacturers like Ford and General Motors forced to shut down several of their plants temporarily.
Concentration risks can manifest most acutely during a crisis. These events introduce sudden supply or demand shocks; they can also prompt countries to turn inward. Prior to the pandemic, the US imported nearly half of its personal protective equipment from China. When global demand surged in early 2020, this concentration contributed to drastic shortages of PPE for American frontline workers.
We must never again force our health-care professionals to resort to using trash bags for protection during a public-health emergency. And that requires reshaping our supply chains.
Second, we must protect against geopolitical and security risks. Not only is Russia waging a brutal war against the Ukrainian people; it has also weaponised commodity exports against the world. For too long, much of the world was too willing to believe Russia’s claim that it was a reliable supplier of cheap and convenient energy.
The consequences are clear. In the first five months following Russia’s invasion of Ukraine, the price of natural gas in Europe jumped by 170 per cent. Russia’s destruction of grain storages and blockade of Ukrainian ports have also driven up food costs. The World Food Programme estimates that Russia’s war could push up to 70 million additional people into acute food insecurity.
Third, we must shift away from supply chains that violate core human rights. For decades, the US has prohibited the import of goods made with forced labor. One area of particular concern are imports from the Xinjiang region in China, where the Chinese government has perpetrated human-rights abuses against Uyghurs and other ethnic and religious minority groups. It has subjected detainees in its internment camps to forced labour, using threats of violence, physical and sexual abuse, and torture. The Biden administration is restricting imports of goods produced with forced labor from Xinjiang, including cotton, tomatoes and certain silica-based products. The US will always stand up for human rights. And we must continue to do so, including through our supply-chain decisions.
The future is friend-shoring
Supply-chain risks are a cause for urgent concern. In the past two years, these risks have hampered our economic growth and hiked costs for our families. They have also harmed our national security. It is time for a systematic approach to address these vulnerabilities.
We first need to recognise that the private sector does not internalise the right level of economic resilience by itself. Some firms are highly incentivised to focus on lowering costs in the short term and may not factor in longer-term risks like over-concentration in supply chains. Even when companies pursue a privately optimal level of resilience through insurance policies and inventory build-up, they will often not consider national-security concerns or how an interruption in their production could affect other firms or consumers. Governments play a critical role in strengthening economic resilience at a national level.
The Biden administration’s friend-shoring approach aims to deepen our economic integration with a large number of trusted trading partners that we can count on. And it seeks to build in supply-chain redundancies to lower risks for our economies.
We believe that it is important to shift away from trade that only chases the cheapest supply chains without considering other factors like concentration, geopolitics and security and human-rights risks. By doing so, we will create greater certainty and reliability for key goods and critical inputs for our consumers and businesses.
At the same time, friend-shoring is a rebuttal to those who argue that economic security can be achieved only through protectionism. Friend-shoring aims to achieve economic resilience and realise trade’s economic efficiencies simultaneously.
We do not seek to produce everything ourselves. Nor do we seek to limit trade to a small group of countries. That would substantially harm the efficiency gains of trade and hurt US competitiveness and innovation. Rather, our core goal is to diversify away from risky countries and concentrated supply chains.
The Biden administration is pursuing our friend-shoring agenda through a broad array of bilateral and multilateral engagements. Through the US-EU Trade and Technology Council, we are working together to create secure supply chains in the solar, semiconductor, and rare-earth magnet sectors.
The US is creating similar partnerships in the Indo-Pacific region through the Indo-Pacific Economic Framework and in Latin America through the Americas Partnership for Economic Prosperity. The countries in the IPEF, representing 40 per cent of global GDP, have committed to establishing early-warning systems and coordinating with one another on efforts to diversify supply chains.
Of course, in any discussion of friend-shoring, it is natural to ask: Who are our friends?
Friend-shoring is not for a closed group of countries. It is open and inclusive of our partners in emerging markets and developing countries, in addition to advanced economies. In fact, a key part of our agenda is to deepen the integration of the US and our partners with developing countries.
For example, the US International Development Finance Corporation has invested billions in developing countries, funding projects such as one that connects small-scale rural fishers in Indonesia with the global market, or another to construct a supply-chain regional logistics center in Georgia. Broader programs, like the new World Bank Financial Intermediary Fund for pandemic prevention, strengthen the capacity of developing countries to respond early to public-health threats and other risks. That, in turn, helps protect the resiliency of our supply chains.
Friend-shoring will be gradual. But we are already seeing the development of new supply chains. The European Union, for example, has worked with Intel to facilitate an investment of nearly $90 billion to build up a regional supply chain for semiconductors over the next decade.
The US is also doing its part. We are working with our trusted partners to develop a full semiconductor ecosystem here in the US. Our efforts have received a significant boost through the domestic semiconductor manufacturing incentives enacted by the Biden administration this summer.
Moreover, we are working with Australia to build rare-earth mining and processing facilities located in both of our countries. China traditionally holds a dominant market share in the global production of magnets and rare-earth elements, which are critical inputs for consumer electronics, clean-energy capacity, and military technologies.
More broadly, many businesses are diversifying their supply chains as a response to the recent crises. In one survey, 81 per cent of supply-chain managers worldwide said that they now source raw materials from two suppliers rather than one, up from 55 per cent in 2020. American businesses show growing interest in moving segments of the supply chain out of China, including to Southeast Asia or Mexico.
We know that, over the longer term, climate change will pose increasingly severe risks to the reliability of critical supplies. Countries need to work together to develop climate resilience, particularly for the most vulnerable communities. They must also work together to avoid the worst effects of global warming by achieving the goals of the 2015 Paris climate agreement.
In the US, we recently enacted our nation’s most aggressive domestic action on climate change, putting us on a promising path to achieve our emissions goals. We will also continue to help developing countries move decisively toward more resilient, low-carbon futures. Beyond the effect on the climate, our collective movement away from fossil fuels will also reduce our vulnerability to oil- and gas-price shocks and our exposure to autocratic regimes, which often control much of the world’s reserves of fossil fuels.
As we pursue these initiatives, we will remain focused on friend-shoring for sectors and products that are critical to our national and economic security. We will coordinate with our trading partners on high standards for human rights, labour, and the environment. And we will continue to support trade integration, which has yielded significant benefits for the global economy.
When we look back decades from now, I believe that the past three years will be viewed as a uniquely volatile period in our modern history. We have all been subject to enormous disruptions in our collective lives: the pandemic, a terrible war in Europe, and increasingly destructive natural disasters. But I also believe that it will be viewed as a moment when the US and its partners advanced a new pillar of our economic agenda, one focused on resilience. I am confident that this agenda will strengthen our economic dynamism while providing greater economic stability for our people.
Janet L. Yellen is US secretary of the Treasury. Copyright: Project Syndicate, 2022.
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