Commentary: Derisking, friendshoring no replacement for fixing your own economic problems

A goal that may come at a price.

The pursuit of security within the supply chain is understandable, especially with geopolitical tensions, particularly the rivalry with China, and international supply chain disruptions stemming from the COVID-19 pandemic and the war in Ukraine.

The key is how it’s done. There’s a right way, and a wrong way—and most countries are choosing the latter.

The U.S.–and imminently Europe’s–decision to use tech export controls on China is clearly on the wrong path. They are self-defeating, perversely accelerating the development of China’s own technological capacity, starkly evident in the cutting-edge Kirin semiconductor used in Huawei’s latest smartphone. Such controls also deny U.S. firms, like Intel, the opportunity of growing through exports to China. And they force countries such as Indonesia, Thailand, and Vietnam to make the invidious choice between U.S.- and China-centric supply chains.

Massive state subsidies are just as problematic, distorting international competition at the expense of poorer developing countries. They disrupt the international trading system while running the risk of regulatory capture as the companies that benefit from subsidies become dependent on them.

Nor is friend-shoring a clear path forward. The ultimate logic of trading with friends, however defined, would split the world into rival trade blocs. Recent research from the International Monetary Fund and the World Trade Organization highlights that such a split would entail serious financial fragmentation and major losses in GDP, as high as 12% in some regions.

So what is the right path to dealing with supply chain disruption and vulnerability? There are two pointers.

The first is recognizing that the World Trade Organization, despite efforts by governments in the West and elsewhere to hobble it, is still the best place to tackle supply concerns over China’s practice of state capitalism. Within the auspices of the WTO, Beijing could agree to end subsidies for state-owned enterprises operating in overseas markets, in exchange for more tolerance for those supplying public services within China.

Countries can also build on the cooperation within the WTO negotiations on e-commerce, covering issues such as data protection, that brings together key players, including the U.S. and China, offering a welcome opportunity for constructive engagement between Washington and Beijing. (We might expect progress at the WTO’s ministerial conference, which starts Feb. 26)

The second and perhaps most critical pointer is the need for overall national policy frameworks that generate genuine resilience to shocks by fostering innovation and export diversification.

The scope to get domestic policies right can usefully be demonstrated by taking the countries engaged in the Supply Chain Resilience Initiative (SCRI), a trilateral endeavor by Japan, India, and Australia—and prospectively the United States—to secure supply chains and reduce dependence on China.

Rather than picking winners, the SCRI countries need to get the basics right. For Japan, this includes rebuilding fiscal space by increasing the consumption tax while improving productivity—lowest of all G7 economies—via enhanced corporate governance; for India, improving health and education infrastructure, modernizing labor laws to remove disincentives for firms to create jobs and further reducing restrictions to trade; for Australia, avoiding over rigid production systems based on the worst and most infrequent of predicted events; and for the United States, returning to more open policies of technological development, enabling it to “run faster” rather than seeking to hobble the opposition.

What these policies share is their focus—not narrow, in trying to defy comparative advantage through misplaced targeted trade-distorting interventions in the name of self-reliance, but broad, addressing economic fundamentals to foster genuine resilience.

In other words, countries seeking greater security within the global value chain should concentrate, above all, on putting their own economic house in order.

Ken Heydon is a former Australian government and OECD official and visiting fellow at the London School of Economics. He is the author of The Trade Weapon: How Weaponizing Trade Threatens Growth, Public Health and the Climate Transition.

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