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Most Favoured Nation: Friend-Shoring
Supply chain resilience, trade gloom and the fifth mode of supply
Hello everyone. This week Sam’s away gallivanting around Italy. So you’re stuck with me, George Riddell (Director of Trade Strategy at EY), apologies in advance. Anyway, let’s get into it.
We need to talk about supply chain resilience
Last week, US Treasury Secretary Yellen gave a speech to the Atlantic Council which is worth a read in its entirety, but I wanted to pull out a paragraph which jumped out at me.
“[…] we need to modernize the multilateral approach we have used to build trade integration. Our objective should be to achieve free but secure trade. 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—on terms that work better for American workers. And let’s do it with the countries we know we can count on. Favoring the “friend-shoring” of supply chains to a large number of trusted countries, so we can continue to securely extend market access, will lower the risks to our economy, as well as to our trusted trade partners.”
Step aside on-shoring, off-shoring, and near-shoring, we now have friend-shoring. Kind of like what’s happening to MFN today – it has been friend-shored.
Silliness aside, what has really struck me is the continued and fundamental disconnect between the political rhetoric and the practicalities of how companies construct their supply chains, build relationships with suppliers, source alternatives, and organise logistics.
It’s not to say that some companies won’t look at the geopolitical risk factors around the world and de-risk their operations. Companies will also take advantage of government subsidies which are being used to incentivise such moves.
But there are limits … and supply chains look like they do for a reason.
If you’re interested in the topic, Michael Gasiorek has a new piece out Supply Chain Resilience: The dangers of ‘pick n mix’ where he finds that policy responses in many cases have been designed to protect domestic producers (quelle surprise!). Meanwhile, this recent paper on Global Value Chain Resilience: Understanding the Impact of Managerial Governance Adaptations in the California Management Review is a masterful overview of how companies make supply chain decisions (and how they can be improved post-pandemic).
As one grumpy supply chain manager told me at the beginning of the pandemic, if all of your eggs are in one basket, you’re not going to be resilient when it gets drop kicked. It doesn’t matter where that basket is in the world nor how pretty it is … something is always going to give it a kick.
Words to live by I guess.
Gloomy trade projections
Prospects for international trade are steadily ticking downwards due to the ongoing Russia-Ukraine war. This has led the folk over at the WTO to reassess their projections for world trade over the next two years.
The organization now expects merchandise trade volume growth of 3.0% in 2022 — down from its previous forecast of 4.7% — and 3.4% in 2023, but these estimates are less certain than usual due to the fluid nature of the conflict.
The most immediate economic impact of the crisis has been a sharp rise in commodity prices. Despite their small shares in world trade and output, Russia and Ukraine are key suppliers of essential goods including food, energy, and fertilizers, supplies of which are now threatened by the war. Grain shipments through Black Sea ports have already been halted, with potentially dire consequences for food security in poor countries.
The war is not the only factor weighing on world trade at the moment. Lockdowns in China to prevent the spread of COVID-19 are again disrupting seaborne trade at a time when supply chain pressures appeared to be easing. This could lead to renewed shortages of manufacturing inputs and higher inflation.
The IMF makes a similar point in its April World Economic Outlook (chapter 4 for those looking to skip ahead to the trade section).
Looks like all of us working in international trade are in for another bumpy period.
Is Mode-5 all it is really cracked up to be?
Now I should start off by saying that I’m a huge believer in the importance and changing role of services in the economy. Whether we’re talking the embedded services which are increasingly intertwined with every product we use (think internet of things) or the changing way that services are being delivered to consumers and businesses around the world.
Really exciting stuff and shout-out to the Swedish National Board of Trade for their trailblazing work on servisification (all the way back in 2010) and a shameless plug if you’re interested about it in a UK context – here’s something I prepared earlier.
Marc Busch published a piece this week on the bipartisan US Trading System Preservation Act which, if passed, would authorise the US to pursue plurilateral agreements. Yay plurilaterals, they’re definitely the future of progress for most issues at the WTO in my opinion. One of the avenues he suggests pursuing is an agreement on Mode-5.
Now Mode-5 has been around for a while and was the brain-child of Lucian Cernat while he was Chief Economist at DG Trade. In short, Mode-5 is a catch-all term used to capture services value-added embedded in traded good. Now, as a concept – I’m totally on board. But I have some fairly punchy concerns are around initiating a plurilateral negotiation focused solely on the fifth mode of supply. I’m not saying it’s impossible, but there are four substantive issues we’d need to cover off first:
What specific negotiating issues/concepts/market access barriers are unique to Mode-5 which aren’t already being covered in some way by the existing plurilaterals on domestic regulation, e-commerce and investment facilitation?
A Mode-5 agreement would undermine existing WTO GATS commitments. While the received wisdom is that most countries’ GATS commitments agreed back in the mid- to late-1990s are not very good and pre-internet is true, that doesn’t mean that some countries wouldn’t use the new negotiations to start unpicking the commitments they don’t like, particularly as the internet has de facto liberalised their Mode-1 (cross-border provision from jurisdiction a to jurisdiction b) commitments anyway. My experience in the WTO’s Committee on Specific Commitments, and hours wasted discussing bundled services, is a testament to this.
If we are integrating Mode-5 into bilateral FTA negotiations (or even something like a restarted Trade in Services Agreement negotiations) – which should already have modern services, investment and digital trade chapters – I wonder how this would be done in practice, given that most countries have already moved away from scheduling services commitments by modes of supply and instead do it via so-called negative lists.
Mode-5 will be used as an excuse to onshore stuff. Basically, the original Mode-5 work focused on customs valuation reform. The argument goes something like this: tariffs are only meant to be levied on goods, not services. Therefore, when valuing a product for the purpose of applying tariffs, you should subtract the services-value add. This would lead to a de-facto lowering of applied tariffs. Trade liberalisation — woo! Now this is the good outcome. A bad outcome would be that Mode-5, and services value add, is incorporated into rules of origin calculations. This could, for example, lead to explicit requirements for the services content of goods — for example the design and research – to be sourced locally in order for products to qualify for tariff-free trade. In short, are we really sure this is a good idea? Pandora’s box and all that …
Nonetheless, one thing we can do in the meantime is get better at measuring all of this. For anyone who’s had to delve into trade in services data, you know it’s a challenge. The OECD with their Trade in Value Added databases go a long way to bridge this data gap of where are we creating value in international trade through both goods and services but there’s some way still to go.
What I’m reading
The IRSG has a new report on the future of international data transfers.
The TESS Forum has a great backgrounder on what all the various trade and environment discussion at the WTO mean.
Chatham House’s new briefing paper looks at what the Russia-Ukraine war means for global food and energy markets.
Well thanks folks, its been great. If you have any complaints about your service today, please direct all emails to Sam.
Your regularly scheduled MFN will resume next week. Byyyeeee.