Friendshoring: the new not normal

In this series of articles, we explore the evidence for a US-led trend of friendshoring away from China and towards other major emerging markets (EMs).

In the first blog, we looked at the friendshoring trend as manifested in global goods trade. In the second, we examined the evidence for friendshoring with regard to flows of foreign direct investment (FDI) between countries.

In this last blog, we review the effects of friend-shoring on Sino-US competition, major EMs and the global growth-inflation mix.

A Game of Factories

Evidence for friend-shoring is mounting, with implications for Sino-US competition. The location of manufacturing is central here, more so than during the Cold War. But US and Chinese strategy differ.

In the US, both the Biden and Trump administrations sought to repatriate manufacturing of high-end or strategically important products, particularly autos, semiconductors and steel. Yet policy has stopped short of trying to revive New York’s Garment District – low-value manufacturing such as apparel and furniture has been left untouched. That leaves an opportunity for other EMs to develop these low-margin industries, starting their journey up the manufacturing value chain.

China, by contrast, has emphasised a ‘secure’ or ‘comprehensive’ domestic supply chain, maintaining a grip on low-margin manufacturing as it deepens expertise in advanced products. Yet China is happy to import commodities to supply its manufacturing sector. For EMs, future exposure seems split between commodity exporters supplying China, and aspiring manufacturers aligning with the US.

Trade and investment, but development?

Aspiring EM manufacturers are the chief beneficiaries of supply-chain re-ordering. Countries such as Mexico, Indonesia and Vietnam benefit from strengthening inward investment, favour in US markets and boosted external balances. As global supply chains disperse, EMs could accelerate their growth, potentially using friend-shoring to power a ‘development miracle’ like Japan or South Korea.

Exploiting that opportunity is possible, but not a sure thing. Many EMs still need labour market reform, looser rules on investment and greater focus on advancing up the manufacturing value chain. Investors remain watchful for a good growth story, but so far a big winner similar to pre-COVID-19 China remains elusive.

Supply chain 2.0: more secure, less efficient

For rich countries, friend-shoring’s effects are nuanced. Since 2020, the world economy has transitioned from an environment of broadly low rates and inflation to higher rates for both. As rates volatility is elevated, markets are anxious for a return to the norm pre-COVID-19.

The friend-shoring trend suggests at least some of this hope is misplaced. Ever-greater concentration of manufacturing in China, which shaved 20 basis points off goods inflation each year from 2004-15, is over. This complicates the job for central banks, who now must tolerate less growth and higher inflation.

For developed markets (DMs), the end of the stable, China-based manufacturing supply base worsens the growth-inflation mix, where rates must be kept higher for longer to achieve a return to the inflation target. This is reflected in our negative view on corporate credit, particularly in investment grade, which we expect has further to fall as rates remain elevated and macro conditions worsen. We remain constructive on duration among DMs as supply chain resilience improves and long-term yields decline.

This concludes a series of blog posts covering global ‘friendshoring’; previous instalments examined changes in goods trade and reviewed changes in investment flows.