The price of relocating factories to ‘friendly countries’

The growing geopolitical conflicts continue to produce a retreat into blocks of global trade. The war in Ukraine and tensions with Beijing have driven Western multinationals to seek security through the supply of raw materials and the installation of production centers in ‘friendly countries’. Washington and Brussels have promoted these tendencies by advocating the search for “reliable” and “like-minded” partners to control the risks for their companies, which are looking to scale back their ties with China to head for Indonesia, Malaysia or even India. According to the European Central Bank (ECB), 42% of the large companies in the Old Continent that it has recently surveyed have resolved to produce in allied countries as a means of reducing risks. However, this relocation carries economic consequences, and international institutions — such as the IMF and the ECB — warn of its impact on growth and soaring prices.

The zero covid policy, which put the global supply chain in turmoil, compelled Apple to decide to move production from China to India. This was not a one-off occurrence: this summer the multinational began manufacturing the iPhone 15 in Sriperumbudur (India) as a result of Washington’s growing mistrust of Beijing. This is just one example, as the United States and the EU look to countries with similar ideas and policies, in other words, ones that are less likely to engage in conflict, in order to protect their companies. This is what is known as ‘friend-shoring’. U.S. secretary of the treasury, Janet Yellen, was the first to advocate a shift in production to allied states as early as September 2022. “We cannot allow countries to use their market position in key raw materials, technologies, or products to have the power to disrupt our economy or exercise unwanted geopolitical leverage. Let’s build on and deepen economic integration and the efficiencies it brings,” she argued.

Brussels, which prides itself on its status as a standard-bearer for free trade in times of economic downturn, approved a new economic security strategy this summer that involves the bloc forging closer ties “with countries that share” its “economic security concerns” as well as “those that have common interests.” Indeed, the European Union has established a mechanism to control foreign investments in strategic companies or instruments to guarantee reciprocity in economic relations.

The World Trade Organization (WTO) maintains that it does not perceive an underlying trend of “widespread de-globalization,” but it has been warning of “signs” of such a retreat of geopolitical blocs. The agency’s director general, Ngozi Okonjo-Iweala, recently admitted that companies are in pursuit of a policy to minimize the risks of political and military crises, yet warned that a generalization of that trend would be “costly and probably ineffective.”

For the time being, international institutions are backing the WTO’s warning. The latest to do so has been the European Central Bank (ECB), which in this month’s Economic Bulletin makes several observations on the impact of global trends on inflation in the euro zone. The monetary authority, to take one example, calculates that the fall in the prices of products imported from China has subtracted four tenths of a percentage point from the CPI in the euro zone. However, it also provides an in-depth analysis of the behavior of European companies in the new global environment, which multilateral organizations define as “prone to economic shocks.” Furthermore, the monetary authority also perceives a change in large European companies, which say that over the next five years they will be “more active” in relocating their activities to “make their businesses more resilient.” Forty-two percent are relocating their production, up from 11 percent in the last five years.

According to the document, European companies attribute “geopolitical risk” as the main factor behind their decision to relocate their business. “That highlights a shift in companies’ priorities from just focusing on cutting costs or improving efficiency to also bringing resilience into their decisions,” the report says. When asked how they were going to do this, they gave three answers: by moving production closer to the country of the parent company, by diversifying suppliers geographically and by choosing countries that are close to them politically. Moreover, the ECB indicates that this strategy will result in greater use of European suppliers.

The risk of China

Following the sanctions placed on Russia, China has become the country that business leaders believe entails the greatest risks. However, 55% of companies rely on supplies from the Asian powerhouse. Most of them believe that it is “very complicated” to replace it with other countries. However, in the ECB survey, the majority of companies say they are working to “reduce their exposure” to countries they believe to be a threat. Indeed, 20% say they are searching for those same products within the European Union.

These developments, which began at the peak of the inflationary spike, are of concern to the ECB because of their impact on prices. And its results support this concern. “60% of those contacted said that changes in the location of production and/or cross-border sourcing of supplies had pushed up their average prices over the past five years, compared to only 5% who said their prices had fallen as a result,” according to the report, which adds that 45% believe that pressure will remain high in the next five years.

The ECB’s warnings fall in line with other reports from institutions such as the European Bank for Reconstruction and Development (EBRD). A document published by this institution concludes that the policies adopted by companies can indeed “undo” globalization, which has been “the force that has shaped international trade in recent decades, meaning that this ‘era’ of relocating to friendly territories” will involve “economic costs”.

The IMF, which at its recent annual meetings in Marrakesh warned about the retreat into blocs, has pointed out in several studies that geopolitical tensions have led to a reconfiguration of investment flows. The pattern reflects a reduction in capital and loans between countries of opposing blocs and an increase between allies, which points to a reversal of global integration. Although the advantages of relocating this capital could afford greater security to companies, the fund also believes that this relocation could be detrimental to growth, specifically in a proportion equivalent to 2% of GDP. And this in a world whose economic growth for the coming years already promises to be “mediocre”, in the words of the institution itself.

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