Friend-Shoring Security Trumps Economics? : A European perspective

The return of geopolitics and geoeconomics

In recent years, using friend-shoring as a means of increasing economic security has been widely discussed by academics, think tanks, and governments. The multilateral order based on the World Trade Organization (WTO) is not functioning as had been hoped and we are observing a change of government attitudes as they turn back toward industrial policy by getting more involved in markets, for example by using subsidies.

It has also become apparent, especially through the COVID-19 pandemic, that world trade is not the engine of growth which it used to be. People talk about the heyday of globalization being over as a new system is in the making. Whenever one order is changing and another order is developing, insecurity in the system occurs. Economic and political insecurity can lead to protectionism. In geopolitics, we experience the instrumentalization or weaponization of trade, investment, and technology.

All of these developments combined can lead to fragmentation, which is the opposite of what the multilateral trading system was intended to establish. Policies that center on de-risking, near-shoring, friend-shoring, and similar measures seem to me to be indications of increased fragmentation. Given the fact that geoeconomics and geopolitics have returned to the forefront, one important idea in the political discourse nowadays is like-mindedness. If value chains, supply chains, and sea routes are managed by like-minded “friends,” there will be less risk. However, these approaches are also a sign of fragmentation, and therefore, they are not viable concepts upon which entire trade policies can be built, because if non-democratic countries are excluded, basically half of the world trade will be lost.

Challenges to the WTO-centered multilateral order

A static approach will not suffice in building a new order. Cooperation, setting of rules, and regulation of data are needed. Data, in particular, is a new challenge. The EU has implemented a digital partnership agreement, the General Data Protection Regulation (GDPR), which Japan has also joined. Our ever-growing digital infrastructure is a primary security concern.

Another topic is the procurement of rare minerals, which are needed for emerging technologies. The creation of dependencies—such as Europe’s dependency on Russia for fossil fuels—should be avoided; however, exchanging one dependency for another is not desirable. The sustainable development sections of free trade agreements are also becoming more important, including those related to human rights, and this is where the ILO Conventions and regulations about forced labor come into play. To tackle climate change, green financing is required and agreeing on a taxonomy including a definition of “green” is necessary to avoid misuse of “green” for protectionist purposes which could erode our very important goal of fighting climate change.

To achieve this, some form of multilateralism needs to be preserved and an improved WTO would be desirable, because its rule-setting function is essential. Plurilateral agreements can have positive effects as long as they are not enshrined as permanent solutions. Furthermore, caution regarding use of frameworks and platforms below the level of free trade agreements is required because they are not within the control of the rules set by the WTO so we must make sure they are not used to escape WTO control.

Toward building a new order: The EU Economic Security Strategy

Without having the WTO to resort to, there is a tendency to take the creation of laws and their implementation in national hands, resulting in trade defense, anti-coercion law and economic security strategy. The EU formulated a proposal for a European Economic Security Strategy, which is an addition to the Strategic Compass, which is the security doctrine of the EU. This strategy outlines an approach to identifying four major risks, such as risks to supply chains, physical and cybersecurity, weaponization of economic dependencies and economic coercion, and risks based on technology. Technology is of particular importance. Years ago, the phrase “It's the economy, stupid” was coined, but nowadays we would probably say “It's the technology, stupid.” Once the risks are identified, it is possible to take action.

The first part of the strategy is the promotion of the EU's competitiveness by strengthening the European Single Market, supporting a strong and resilient economy, investing in skills, and fostering the EU's research technology and industrial base. It is often said that “foreign policy starts at home” and this also applies to trade policy. From a European perspective, a strong Single Market leads to better economic policy abroad.

The second part of the strategy is the protection of the EU's economic security. Unfortunately, not every country is playing according to the rules. When taking measures to address such countries, it is very important that these measures are proportionate and precise, to limit any negative, unintended spillover effects, especially on like-minded countries.

Economic security also requires economic diplomacy. Therefore, the third part of the strategy focuses on partnering with as many countries as possible by making use of traditional elements, such as trade agreements and partnerships. There are also new developments in this regard, such as connectivity partnerships, including one with Japan. Strengthening the rule-based economic order and multilateral institutions, such as the WTO, is also crucial. At the same time, investing in sustainable development through the EU’s Global Gateway program and ensuring appropriate reform are important in keeping the Global South on board.

Economic security starts at home. This includes robust economic performance, leadership in terms of technology, and financial stability. On the other hand, there is the external dimension of engaging bilaterally and multilaterally and not taking an isolationist stance.

As with any strategy, first of all goals need to be defined. Economic Security strategy needs to be defensive, offensive, and creative. Defensiveness comes from strength as I mentioned earlier. Offensive measures are countermeasures against those who want to exercise economic statecraft, similarly to preventive diplomacy. Creativity is necessary in meeting new challenges instead of turning toward renationalizing and protectionism, even though this might be the first reflex. Multilateralism should not be replaced by bilateralism, as it tends to devolve into “right is might” which is obviously unfavorable, and especially in the case of smaller countries.

However, there is need for reform of the existing multilateral order as there is no point in defending the status quo at all costs. Updated rules for intellectual property and investment are needed, taking data, e-commerce, artificial intelligence, and health into consideration.

The possibilities and limitations of friend-shoring

At first glance, friend-shoring has a certain appeal as various problems might be avoided by interacting primarily with “friends.” Looking at philosophy, the underlying thought is similar to Immanuel Kant’s concept of eternal or perpetual peace and the idea that “liberal democracies do not engage in wars against each other,” which is not necessarily true.

Friend-shoring covers a middle ground between decoupling and de-risking. Decoupling is the more radical approach of severing relationships and building new ones to reduce dependencies. De-risking is a more gradual process of mitigating risks through broadening relationships. It is important to keep in mind that these ideas are not meant to be applied across the board. Instead, certain areas such as strategic goods and technologies should be singled out. Careful consideration and foresight are needed to identify which sectors are appropriate to which level of mitigation.

In the realm of politics, friend-shoring can certainly deepen relationships with partners. In the realm of economics, on the other hand, it is an interventionist action of industrial policy targeting the market. Obviously, there are shortcomings because not all goods or services can be obtained through “friends.” To achieve goals such as climate change, the green transition, and procurement of necessary raw materials, there will be times when cooperation with non-friends is inevitable. There is also a systemic issue because friend-shoring may cause problems in a competition-based market economy. Such actions often end in losing a market for goods or a supplier in the long term.

Furthermore, the big question of how to define “friends” remains. Are “friends” forever? Is a “friend” above any suspicion? Looking at examples such as the Inflation Reduction Act, certain policies based on the America First principle during the COVID-19 pandemic, and the U.S. stance on the acquisition of U.S. Steel by Nippon Steel, may provide answers to these questions.
The issue of how to deal with China plays a big role in the discussion about reshoring, near-shoring, and friend-shoring. Maintaining a level playing field is one of the major problems we face, and to achieve this, it is essential that rules and regulations are applicable to all parties. Burgeoning bilateral trade deficits are also a problem if they are the result of one partner not playing in line with the rules.

According to a study by the European Bank for Reconstruction and Development (EBRD), many countries are considering regionalization and friend-shoring as a way to minimizing exposure. But this comes with a significant cost, estimated at about 4.6% of total GDP in simulations by the EBRD and the WTO.

The potential impact of friend-shoring in the area of technology

Reshoring and friend-shoring is not just limited to trade: there is also a strong technology element involved. The current friend-shoring trend can lead to exclusion of others from state-of-the-art technology by limiting cooperation to “friends” through export controls and limitations on investment, whether inbound or outbound. Technology plays an important role, especially in terms of renewable energy, e-mobility, defense, and space. The European Commission Recommendation on critical technology areas includes risk assessment based on three criteria: “the enabling and transformative nature of the technology”; “the risk of civil and military fusion”; and “the risk of misuse of the technology for human rights violations.” In line with this Recommendation, four technological areas have been selected: advanced semiconductors, artificial intelligence, quantum technologies, and biotechnologies.

All of this is part of an active industrial policy. One important question is which tools to use for policy implementation--a stick or a carrot? How can supply chains, production chains, and value chains be reorganized? It is important to keep in mind that every individual company has a vested interest in ensuring that supply chains are organized in a manner that allows continued production and import/export of products.

One of the areas chosen to make a big push forward is microchips, as evidenced by the European Chips Act which entered into force in 2023. The EU has a share of 10% of the global microchip market and aims to increase production capacity to 20%. To achieve this target quicker, many measures must be taken on a European level. The European Chips Act is a framework for increasing resilience in the field of semiconductor technologies within the EU, including training and research.

It is also important to engage in chip diplomacy but to do so effectively, it is necessary to establish a leadership position in the industry. Cooperation on early warning systems and ensuring that inputs are monitored are important, and strong defensive elements to address infringement of intellectual property rights, unauthorized disclosure of trade secrets, and leakage of sensitive emerging technologies are also needed.

Presently, as we are facing political instability and an international trade system that is not functioning as expected, ensuring as much cooperation as possible is key, because confrontation only leads to increased tensions, which is not in anyone’s interest. Cooperation among like-minded “friends” is of course a possibility, but trade policy, investment policy, and technology cannot be advanced by cooperating only with “friends,” as there are many areas where “friends” cannot provide what is necessary. Last but not least, summarizing the statements on allies, enemies, and interests made by Lord Palmerston in the 19th century: states have interests, and not friends.

Comments & Q＆A

URATA Shujiro:
In summary, security policy—just like foreign policy—starts at home. Likewise, economic security and robust economic performance are essential. To achieve this, good leadership in critical technology is needed. And, of course, financial stability and the avoidance of isolationism are necessary. Regarding friend-shoring, while having “friends” is important, their level of friendliness is never guaranteed and may waver in terms of specific issues or overall.

All of my questions center on the EU’s economic security strategy. The point about protecting the EU’s economic security in a “proportionate and precise way that limits any negative unintended spillover effects on the European and the global economy” caught my attention, because this observation is very similar to what U.S. National Security Advisor Jake Sullivan has said about the “small yard, high fence” approach to protect the economic security of the United States. What exactly do you mean by “proportionate”? And also, how can an economic security policy that limits any negative unintended spillover effects be implemented?

Regarding the EU's relationship with other countries, such as Japan, the U.S., and China, what specific policies are the goal? Are there plans to update the EU-Japan Economic Partnership Agreement, for example finalizing trade agreements or reinforcing collaboration in the fields of connectivity and digital technology (i.e. WTO digital trade rules), to contribute to economic security? And what about strengthening the international rules-based economic order and other institutions, such as the WTO? A Multi-Party Interim Appeal Arbitration Arrangement (MPIA) has been established on the initiative of the EU and Canada. Would that be one example that we can think of?

Finally, Global Gateway was mentioned as the infrastructure program vis-à-vis the Global South. Could you elaborate on that? Regarding EU policy toward the U.S., how will the EU achieve their objectives if Donald Trump becomes the next president? Also, do you think that President Biden's trade policy is different from Donald Trump's policy or not? What is the EU’s policy toward China?

Michael REITERER:
Regarding the definition of “proportionate and precise,” a clear understanding of the effects of policy measures is required. For example, when President Trump implemented the tariffs on aluminum, a lot of partners, including Japan, the EU, and Korea, were hit. This was neither precise nor proportionate and caused economic and political damage. Reshoring, near-shoring, and friend-shoring should not be applied across the board. Instead, specific products and sectors should be singled out.

Regarding Global Gateway, it is an important sequel to the EU-Indo-Pacific Strategy and provides the specific and necessary means for actions to be taken in addition to the regular development aid the EU provides. Concerning Japan, the EU-Japan Economic Partnership Agreement and the EU-Japan Strategic Partnership Agreement are already in place. One common interest is cooperation in third markets, particularly the ASEAN countries.

Regarding the U.S., the Biden Administration’s trade policy has not changed that much compared to the Trump Administration and the EU has adapted to this situation. The EU and Japan have a common interest to pass on a message to future U.S. administrations that measures implemented by the U.S. need to be more precise and proportionate.
On China, neither the EU nor Japan aim for a decoupling from China since it would not make sense politically or economically. China can be a partner and China’s cooperation is needed, for example regarding climate change. China is also a competitor and a systemic rival.

In the realm of climate change, there are new challenges involving China. One example are solar panels which China produced at very low cost, giving rise to suspicions about subsidies, and many companies in Europe, the U.S. and Japan could not withstand this competition. We are now facing a similar situation with batteries, electric cars, and also wind power facilities, which seem to be cases of dumping, but they are also related to fighting climate change, which is allied with the interests of the EU. This year, European Parliament elections will take place. I am sure that the next European Commission will put high priority on the EU’s China policy.

Q:
Regarding EU bureaucracy, are industrial policy and economic security policies implemented integrally or are they pursued by separate departments?

Michael REITERER:
Primarily, the European Commission, which is organized similarly to a government, is in charge. There are no ministries, but Directorates-General. One of them is in charge of industrial policy, including cybersecurity as there is an economic link. But since it is a security issue at the same time, it is also part of foreign policy. The president of the European Commission, Ms. von der Leyen, is very much aware of the importance of the economic strategy and has taken a great interest in securing supply chains. But the decision for a proposal and the implementation is made by the College of Commissioners. If legislation is required, a proposal has to be made to the European Parliament and Member States. If something can be done administratively, the European Commission or the External Action Service can facilitate it.

Q:
Based on your experience as a diplomat in South Korea and Japan, what kind of projects would you suggest for both countries to collaborate on in the future?

Michael REITERER:
In my opinion, cybersecurity would be a top priority since the cybersecurity situation for Japan and Korea is very similar. Cyberspace is the best example for international cooperation because no one can clearly say where the cyber world begins, where it ends, or where it is located. I think this is an area for cooperation and political issues should not play any role. Hopefully the thawing of ties between Japan and Korea will continue as this is in the interest of geopolitics.

Q:
Please provide some final remarks.

Michael REITERER:
The idea of friend-shoring lies in cooperation and showing solidarity to improve the international trading system and the political system. This is certainly something we should pursue, and I think that this value is shared between the European Union and Japan. On the other hand, sometimes good intentions do not lead to the intended results. Therefore, equating friend-shoring with near-shoring and de-risking is something to be careful about. We should not be blinded by the term “friend,” as Lord Palmerston pointed out.

URATA Shujiro:
Overall, this seminar was valuable for understanding the undertakings of the EU and the EU’s stance regarding economic policy and security policy. Close and active communication between two parties is very important. Likewise, something RIETI could do is to give a presentation in Europe on Japan’s economic security policy. Increasing mutual understanding in order to formulate desirable policy for both parties is of great importance.