Friend-shoring vs. "Buy American"

Cold War 2 won't be won with a go-it-alone strategy.

"Buy American!" by srqpix, CC BY 2.0.

The pro-free-trade consensus is dead. Although some of Donald Trump’s specific protectionist policies have been reversed, the Biden administration has shown no sign of going back to the days when Presidents worked hard to sell a reluctant public on the benefits of open markets. Biden has kept the tariffs on China, while intensifying export controls and inbound investment restrictions on that country, and is even considering outbound investment restrictions as well.

It’s important to note that all of these measures are specific to China. That makes sense, because these trade restrictions are not “protectionist” in the traditional sense of the word — instead of being designed to protect American jobs or profits, they’re designed to prevent an increasingly aggressive China from being able to militarily overwhelm the world’s developed democracies. National security, not economic protectionism, is what really destroyed the free-trade consensus.

But you know what else is important for preventing China from being able to militarily overwhelm the world’s developed democracies? Strong alliances. Thus, Biden administration officials have been emphasizing the idea of friend-shoring — moving supply chains out of China and into friendly countries. Treasury Secretary Janet Yellen has been emphasizing this concept on her recent trips to Asia.

Friend-shoring is a great idea. Economies never really worked as isolated units where each country makes everything for itself, but in the modern day, imagining that America can or should make everything it consumes, and consume everything it makes, is pure fantasy. We need international supply chains, period.

And given that we need international supply chains, we ought to have them in countries that are either our allies (like South Korea, Japan, Mexico, and France), or our de facto quasi-allies (like India, the Philippines, and Taiwan), or countries that are generally wary of Chinese power and might become our de facto quasi-allies in the future (like Vietnam, Indonesia, and Thailand). In practice, China has few friends that are not either petrostates like Russia or basket cases like North Korea, so “friend-shoring” really just means “almost anywhere but China”.

Relocating our supply chains to these countries from China has obvious diplomatic benefits, but it’s also strategically important — in the event of a conflict with China, even one that falls far short of full-scale war, China could simply threaten to shut down any U.S.-owned factories or key U.S. suppliers within its borders. Friend-shoring isn’t just a way to be a good friend to other countries; it’s a way of hardening our economy against a potential attack.

On top of all that, in the long run, investing in friendly nations will help build up their economies, making them more effective allies and quasi-allies decades down the line. The U.S. successfully did this with Japan in the first Cold War; as documented in the excellent book Chip War, one reason the U.S. complained little about Japanese semiconductor manufacturing in the 1970s was that Japan was an important U.S. ally and we knew that a strong and technologically advanced Japanese economy was in our best interests. So it is with India, Vietnam, Indonesia, and so on today — as well as old allies like Japan and South Korea who still need to keep their economies strong.

So it’s very good news that some big-name U.S. companies like Apple are moving some of their production out of China and into friendly countries like India and Vietnam. The U.S. should encourage this with subsidies for any company that moves out of China to any country on a “friends” list. And in practice, that “friends” list needs to be basically any country other than China.

But even though national security is what forced both Democrats and Republicans to accept a pivot away from free trade, it’s not the only thing on politicians’ minds. Many on both sides of the aisle still think about trade in terms of A) America versus the world, and B) jobs lost overseas. Here’s just one example of this attitude, from a politician who generally has many good ideas and whose heart is in the right place:

Ro Khanna @RoKhanna

The off-shoring experiment left 70,000 factories shut down and countless families devastated. It’s time to bring those factories back home and help heal America.

I’m not going to lambast people for thinking like this. In fact, it’s true that offshoring to China did devastate U.S. manufacturing jobs and regions and workers’ careers in the 2000s — an event economists now call the China Shock. And in general it is good to incentivize high-tech manufacturing in the U.S., and this will produce some jobs. I’m very happy about the new factories that TSMC and Samsung are building new semiconductor plants in the U.S.

Khanna’s way of thinking, however, misses some very important changes that have happened between the 2000s and now. The technologies that made global supply chains cheap — especially the internet — are still here, meaning that the kind of cheap, labor-intensive manufacturing of furniture, toys, clothing, etc. that the U.S. still did a bit of 20 years ago is just not coming back. Meanwhile, the kind of high-tech, capital-intensive manufacturing that produces the greatest economic benefits for America — think of semiconductor fabs and robotic auto plants instead of shoe factories — creates only a modest number of jobs. In order to be competitive in the modern globalized high-tech manufacturing sector, the U.S. needs to do most of the work with robots.

But the most important thing that’s changed over the last two decades is the strategic calculus. In 2003, it wasn’t yet clear whether China would become a “responsible stakeholder” in the global order, or would see that order as something that it needed to overthrow. We now have our answer. And China is so much bigger than the U.S. that there’s just no way we can balance it, economically or militarily, without a large coalition of allies and friends.

And if we try to bring everything onshore, not only will it fail, it will prevent us from building that large coalition of allies and friends. Already, key U.S. allies — the EU, South Korea, and Japan — have bristled at the provisions of the Inflation Reduction Act that subsidize cars and batteries made in the U.S. over cars and batteries made in allied nations. South Korea’s President even called the provisions a “betrayal”.

Nor is the urge to go it alone limited to the Bernie-aligned Left or the Trumpian Right. In 2021 the Biden Administration proudly trumpeted its “Buy American” policies. “Buy American”, unfortunately, also means “Don’t buy from allies”, and this policy understandably angered European allies, as well as others.

Now, some jostling of this sort is inevitable. Allies are not perfectly aligned, and there will always be some amount of friction between them — there definitely was plenty of friction in both the Cold War and WW2. And those other countries can and should offer their own matching subsidies for batteries and EVs — this will speed the green transition along, and help move production away from China. But at this early stage of Cold War 2 — or whatever you want to call it — it makes sense to err on the side of deference to our allies, especially those that are in the same geographic neighborhood as China and Russia.

Remember that Japan and South Korea are locked in their own battles with China for battery and EV manufacturing — and Europe soon will be. With their small domestic markets and high labor costs, they’re at a distinct disadvantage against their giant neighbor. We need to negate that advantage by offering Japan and Korea full access to the U.S. market, including all the same tax credits that we give to domestic producers. Otherwise it will look like the U.S. is the kind of country that hangs its key allies out to dry. And that is an image we absolutely can’t afford.

The same is also true when it comes to exchange rate policy. In the 2000s, one of the ways China was able to take U.S. manufacturing industries away so fast was that it kept its currency artificially cheap, making U.S. exports more expensive and Chinese exports cheaper. It wasn’t until many years later, when the damage had already been done, that the Trump administration branded China a currency manipulator. We should have done that a decade and a half earlier.

But some of the people who rightfully got mad about our failure to do anything about China’s currency shenanigans in the 2000s are still mad, and seem to want to close the proverbial barn door after the horse has already bolted. For example, Brad Setser is an economist I deeply respect, who has done excellent and very detailed work analyzing international financial flows and identifying the sources of exchange rate distortions. But I think he makes a grave error when he lumps allies like India, Japan, Korea and Taiwan in with China:

Brad Setser @Brad_Setser

Talk of a new Plaza agreement is wildly premature. The conditions for a global agreement aren't in place. But Asian countries worried about the weakness of their own currencies could do more on their own. My take for @CFR_org 1/x

cfr.orgAs Global Recession Looms, a Perilous Moment for Central BanksMany central banks are navigating turbulent waters as they battle inflation, a strengthening dollar, and an energy crunch. Should they coordinate policy?

First of all, China is far more important than these others in terms of sheer size. The U.S.’ bilateral trade deficit with China is about half of our total trade deficit, meaning that our financial imbalances with China dwarf all others. Second of all, the cheap currencies of the Asian allies Setser is upset about are often due to factors other than currency manipulation — for example, Japan’s yen is weak because the Bank of Japan has been reluctant to raise interest rates and cause a recession, not because the BoJ wants Japan to run a current account surplus. Even in the cases when allies are intervening to keep their currencies cheap, they’re often doing it in order to stay competitive with China.

We should want our allies and friends to stay competitive with China. That strategic concern should override worries about the small current account imbalances that we have with small allies like South Korea and developing-country friends like India.

This goes for the semiconductor industry as well. Setser argues that forcing small allies and friends like South Korea and Taiwan to appreciate their currency against the dollar will allow the U.S. to win chipmaking market share from those countries:

Brad Setser @Brad_Setser

I am a bit of a broken record on this topic. But the economics of semiconductor production in the US relative to Taiwan and Korea (or Singapore for that matter) cannot be entirely divorced from discussions about these countries' exchange rate policies over time. 1/x

But is that really a top priority? Obviously we need to move some of TSMC and Samsung’s semiconductor fabs to U.S. soil or nearby, just so that we won’t be suddenly cut off from chips in the event of a Chinese blockade or missile strike. But Setser — who advised the Biden administration on trade in its first year — seems unconcerned with this or any other strategic consideration; instead, his seems laser-focused on reducing financial and trade imbalances between the U.S. and its smaller Asian allies.

This seems like a counterproductive way of thinking. Taiwan and South Korea aren’t just smaller than the U.S. — they’re also poorer, and more dependent on a few big companies like Samsung and TSMC. Forcing them to give up policies that sustain those industries, even if the policies are slightly unfair, would be stingy and selfish. But worst of all, it would be penny-wise and pound-foolish, because it would show the world that the U.S. is the kind of country that pushes around its own allies and hurts their economic development.

I worry that after decades of losing out to unfair Chinese competition, Americans might be looking for a trade “win” anywhere they can find one. Democrats might not use the same phrasing, but Trump’s complaint that “we just don’t win anymore” probably resonates widely after our experience with China. The problem is that the easiest “wins” here would be to punch down against our own weaker allies — to vent our frustrations on targets of opportunity, even if those targets are our own friends.

That’s no way to fight a Cold War. The economic benefit of “Buy American” provisions, America-only tax credits, and other protectionist policies would be miniscule to nonexistent, while the strategic losses of looking like a country that punks its own allies would be enormous. In the first Cold War, we wisely realized that when allies like South Korea and Japan and France got rich, it made the U.S. and the world more secure. We realized that every dollar of goods manufactured in South Korea and Japan and France represented a win for the free world. We should realize that again now.

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