Which Shoring Makes Best Sense for Globalised Business

Four decades after globalization of business began, I think we can all agree that it is widespread and well-entrenched. And while there is a lot of talk of deglobalisation, about which I wrote recently on my blog, I not only think that globalisation is here to stay, I think it has become much more complex in this millennium.

Thanks to the high level of specialization and the breaking up of value chains, the world is seeing a much higher level of complexity in manufacturing tasks. Of course, this has also come to mean a greater degree of fragmentation in supply chains. This is most visible in consumer electronics and automobiles, but it is growing in other categories as well.

This has its origins in the just-in-time manufacturing model that the Japanese pioneered, and it was quite revolutionary in the way that it cut companies’ need to maintain large inventories of parts and components. Now companies could just order and ship in components as and when required. In many ways, this was the precursor to the global supply chain system as it exists now.

The world suddenly faced problems with the global supply chain during the pandemic, as consumer demand surged and the global supply system could not cope with it. This was most felt in semiconductors, as these manufacturing units tend to be concentrated in China and East Asia, where the Delta wave of Covid-19 dealt a particularly hard blow in 2021. Huge bottlenecks developed where once supply was smooth, and this caused many to question the merits of offshoring and indeed, of globalisation itself, once again.

If we look at how globalization has evolved, it moved from offshoring to nearshoring, and now to friendshoring, as new terms and concepts are invented to help us deal with the problems and iron out inconsistencies. Actually, it would be more accurate to say that it is geopolitics that seems to be determining these shifts. Nearshoring came into common business parlance only in 2018, when Trump started a trade and tariff war with China. Many multinational companies as well as Chinese companies decided to shift their production to other countries in the region to gain advantages, while getting around the tariff restrictions. A lot of manufacturing shifted to Vietnam, Cambodia and Thailand, all countries that trade a lot with China, within the region, and now with the rest of the world.

Geopolitics can halt and interrupt trade; Image: Wikimedia Commons

Actually, the ideas of offshoring and nearshoring have been with us ever since the EU was formed, even if nobody used those terms then. It began first as the EEC (European Economic Community) and was designed to increase trade and cooperation in commodities, especially coal and steel. It later expanded to include a wide range of merchandise, services and even people movement across what was an attempt to create a single market. The American trade bloc, NAFTA, too was an attempt at offshoring and nearshoring where the US, Canada and Mexico invest and trade freely with each other.

Latin America has had several trading blocs or communities as well, though they probably trade more in commodities and less in finished goods, but that too could change, given how much the region has developed in recent years. From what I have read Mercosur, Latin America’s largest trading bloc comprising Brazil, Argentina, Paraguay, Uruguay and Venezuela (which was expelled from the bloc) trades most with Europe and it exports more commodities, while importing finished goods. The Pacific Alliance, a grouping of countries on the west coast of Latin America and Mexico, trades most with the US. In Africa too, there are groupings of nations, especially the ECOWAS, and they all perhaps trade significantly with each other, since some of the African countries are populous and large markets. This would be in addition to trading with China, Europe and the US though it appears that right now, the EU is its largest trading partner. In Asia, we have the ASEAN, a grouping of 10 countries that cooperate economically and trade with each other. Each of these has become trading hubs in themselves, that in turn trade with the rest of the world, and is now China’s largest trading partner. In many cases bilateral agreements seem to be becoming the order of the day, which undermine the role of the WTO.

Strangely, though, two industries that seem to have escaped the grip of these trading blocs or hubs, and as a result are truly global, are financial services and information technology. In fact, it would be quite accurate to say that it was financial services that led the boom in globalization, and took business to places previously not on multinationals’ maps. Perhaps this has occurred because these are considered essential services, but it is ironical that when services have not made much progress in trade agreements and even within the WTO, these two services have grown by leaps and bounds and are truly global in every sense of the word.

The newest and spiffy term, friendshoring, has been minted in the post-pandemic days and it owes its existence to Biden’s ratcheting up the rhetoric and the competition with China. In seeing China as the enemy and biggest competitor in the economic and technological space, America and its western allies now seek to base their manufacturing facilities in countries that share their world view and are aligned with their values and ways of doing business. I see this as a dangerous trend, and rather than jump to conclusions about it, I thought about what the merits and demerits of the various forms of shoring manufacturing and services might be. Since I am reading Michael Porter’s Competitive Advantage of Nations, I thought I might view this through his “Diamond Theory”. After all, it is in the globalized world of business that his competitive advantage theory makes most sense, even though this book was written more than three decades ago.

I tried analysing the features of each type of shoring and seeing how and in what ways they differ from each other. And indeed, if each was superior to the other, and if so, in what ways. I find that the most basic and fundamental form of offshoring corresponds to Porter’s diamond the most; its features map all the four dimensions of factor conditions, firm strategy, structure and rivalry, demand conditions and related industries/services. Most multinational companies will consider offshoring manufacturing or a part of it, if it meets the criteria of factor conditions, demand conditions, firm strategy at the very least. If related industries are already existent, or if their offshoring spawns them, even better.

A diagrammatic representation of the three forms of shoring and their salient features by the author

The core of what makes this offshoring model feasible and successful, however, is the presence of a large market, described by demand conditions in the Porter model. So much of the offshoring that we discuss nowadays which emanates from the global supply chains that exist across east and south-east Asia is the strong pull of the Chinese market. Similarly for the EU, it would be the large single market within the EU, as well as China and the US. For NAFTA, it is mainly the US market. For Latin America, it is the EU, China and the US. All important trading blocs serve at least one or two large markets.

On these counts, nearshoring – the more globalized supply chain system – works quite similarly to the original offshoring system. It too must fulfill at least the first three conditions of the diamond, and therefore, also serves a large market. For example, the nearshoring that took place after Trump’s tirade continues to serve the huge China market as well as the US and Europe.

Friendshoring, an idea that seeks to offshore based on alignment of values, political systems and ways of doing business operates on a different set of parameters, and I am not sure which companies would view business strategy in this manner. By introducing a set of conditions which are not purely business considerations, friendshoring can sever connections with the main market. It appears that by deciding to base manufacturing in different countries, all united in geo-political terms, friendshoring can then sell anywhere it pleases and by doing so, it is actually expanding the area of cooperation and trade. Not so. For this model of offshoring is missing that large single market to be primarily served. And I doubt many companies or businesses would buy into this, since it doesn’t serve business and economic interests.

The other danger with friendshoring is that it will further fragment and divide the globalized world, when in fact, greater cooperation and collaboration is needed. The current supply chain system is fragmented because of higher specialization and attempts to move up the value chain. This is desirable, as it works to help improve manufacturing, innovation and competition. The fragmentation that will come from friendshoring will be of a different kind: leading to atomization of manufacturing, but not based on factor conditions or demand conditions, less competition of the healthy kind and less innovation as well. As it is the eco-tech war between the world’s two great powers, US and China, has created two different world systems in technology and further competition in AI will only make things worse. This when the internet was always meant to be one system uniting and connecting the world, which explains why we need global standards and better regulation. Not to mention the problems that global finance and technology will have in navigating the new “friendshoring” world, when they were largely responsible for creating the globalized world of business in the first place.

There is a lot of talk suddenly about Biden’s IRA legislation and package affecting EU countries adversely, and even leading to the start of a new trade war between US and EU, as the fear is that European companies might prefer investing in the US now, over Europe. I don’t think European companies will invest in the US only to benefit from a subsidy, unless they are also assured of a large market there. It is true that the US is a large market in many areas, especially for new green technologies, including electric cars. However, the EU needs to formulate its own green technology policies and I read that Ursula von der Leyen even announced a policy at the World Economic Forum Summit in Davos recently. Besides, if as The Economist wrote some time ago, Biden’s subsidies are not available to Korean car companies in the US, what is to say that European companies will qualify for them. This is not merely protectionist, this is discriminatory, if true.

These are not the best ways for businesses and economies to stay competitive, innovative and dynamic. I would therefore conclude that the erstwhile offshoring system that has served the world economy well, with its hub and spoke kind of model is perhaps what we ought to stay with. Nearshoring that developed as a response to a trade war is a second-best option. Friendshoring brings other considerations besides business and economic issues into the discussion and would lead to greater fragmentation, cliques of countries from holier-than-thou western economies and autocratic nations to lawless, rogue states.

Globalisation began through companies seeking to grow their markets and their operations across the world, bringing growth to countries that both invested and those that were investment destinations. Of course, it could have been managed better, as economists like Joseph Stiglitz have pointed out. Now, we have countries trying to make business investment and global supply chains instruments of foreign policy which is never a good idea. The latter must serve the former, not the other way around. The globalized world of business can do without factionalism, especially of this kind.   

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