A Two-Bloc World Carries Risks

"As geopolitical tensions rise, Western governments have urged international companies to shift more business to friendly countries. Some critics think that could split the global economy into hostile camps, hurting growth and worsening inflation.

Advocates think "friend-shoring," as the trend is nicknamed, can protect access to vital raw materials and components, drawing on lessons learned during the Covid-19 pandemic that saw shortages of semiconductors and some other components threaten vital industries.

But many economists fear restricting trade and direct investment to political allies could undo decades of gains from globalization, including raised incomes for hundreds of millions in the developing world and lower prices in the West.

They worry that it could place security and political concerns above those of economic efficiency for a much wider range of goods than are necessary for security. And they think it could require countries around the world to choose sides as the global system of low tariffs and rules-based trade that was built in the aftermath of the Cold War fragments into closed bubbles.

"This to me rings alarm bells," said Beata Javorcik, chief economist at the European Bank for Reconstruction and Development. "I worry that we may be on a path to a world that is split into blocs."

The EBRD was founded in 1991 to help countries in Eastern Europe and the former Soviet Union participate in globalization. For Ms. Javorcik, friend-shoring carries an echo of the Cold War.

"It reminds me of Comecon," said Ms. Javorcik, referring to the trading bloc led by the Soviet Union and open to countries that shared a Communist worldview.

The potential slide into a world economy characterized by two antagonistic blocs -- one centered on the U.S., the other on China -- has also occupied the thoughts of economists at the World Trade Organization, the institution most closely associated with globalization.

They calculate that the creation of a two-bloc world would lead to a 5% loss of global economic output over a 10- to 20-year period -- equivalent to roughly $4.4 trillion. While friend-shoring could lead to higher prices and lower profits in the West, the WTO economists believe that cost would be borne disproportionately by poorer countries, which gain most from the transfers of technology that globalization brings.

The European Union's embargo on Russian oil illustrates the problem. By in effect confining Europeans' oil purchases to friendly countries, it has artificially boosted what they pay.

The impact of friend-shoring on global growth and inflation would depend on how friends and enemies are defined.

Since divisions around sanctions on Russia have played a big part in the new focus on the geopolitical aspects of supply chains, economists at Italian bank UniCredit have used an April 7 vote on whether to suspend Moscow from the U.N. Human Rights Council as an indication of how countries might align.

The "non-friendly" countries -- those that voted against Russia's suspension or abstained -- include China, India, Brazil and Mexico. In total, they account for 35% of all goods imported by members of the Organization for Economic Cooperation and Development, the group of rich countries that includes the U.S. and most of its closest friends.

Shifting so many imports to friendlier countries is probably further than advocates of friend-shoring would want to go, but that figure does emphasize how big an impact it might have.

For central bankers, any shift in that direction would tend to keep inflation higher than in the run-up to the pandemic, even after energy and food prices ease.

In a recent speech, European Central Bank President Christine Lagarde argued that while sanctions on Russia "may prove to be a tipping point, causing geopolitics to become more important for the structure of global supply chains," that need not spell the end of globalization, just a smaller range of options for businesses looking to lower costs.

But even in that relatively benign environment, prices would be higher.

"In this context, it looks increasingly unlikely that the disinflationary dynamics of the past decade will return," Ms. Lagarde said.

Advocates of friend-shoring, who include U.S. Treasury Secretary Janet Yellen, argue that it merely seeks to account for geopolitical changes that are already under way -- including China's efforts to become much more self-reliant -- and that not responding to those changes would also risk slower growth and higher inflation if key raw materials and goods were to be withheld by hostile powers.

"I believe that we need to consider how to incentivize the 'friend-shoring' of supply chains to a greater number of trusted countries for a variety of products, so we can continue to securely extend market access, with lower risks to our economy, as well as to those of our trade partners," Ms. Yellen said at a Brussels conference organized by the European Commission last month.

But finding the right balance between allowing businesses to produce where costs are lowest, and ensuring that supplies of essential goods will always be available, is likely to be difficult.” [1]

Communist-shoring saves many Western companies some cash. It also reduces the level of skills needed for innovation in the West. We risk to become Third world region in a long run.

1.  U.S. News --- THE OUTLOOK: A Two-Bloc World Carries Risks
Hannon, Paul. 
Wall Street Journal, Eastern edition; New York, N.Y. [New York, N.Y]. 06 June 2022: A.2.