Why Freeland’s embrace of ‘friend-shoring’ is fraught with problems

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Luxembourg is open for business, provided you’re from a country it considers a friend.

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“I consider Canada to be a very friendly country, because we share so many values,” said Franz Fayot, economy minister of Luxembourg. “We share democracy, we share a strong attachment to human rights. We share pro-environmental policies.”

Fayot and other officials from the Luxembourgish government visited Montreal and Toronto in mid-June in an effort to encourage Canadians to do more business with their small nation. Not so long ago, representatives of a country with fewer inhabitants than New Brunswick might have struggled to get much attention. But the current geopolitical environment provided Fayot with an advantage: Luxembourg and Canada are friends.

At a time when Russia brazenly invades an independent neighbour and China repeatedly demonstrates that it has no issue using its economic clout to get its way, trading with “countries with shared values as well as economic sectors makes a lot of sense,” Fayot said.

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Since the time of David Ricardo, the early 19th century thinker who pioneered the theory of comparative advantage, it’s been generally understood that trade works best when its guided by who makes the best stuff for the lowest prices, and that all other considerations should be set aside in the name of maximizing prosperity.

The world seemed to approach the Ricardian ideal in the late 1990s, when the United States and its allies agreed to let China join the World Trade Organization. But that turned out to be the peak of globalization; from then on, it’s been in decline. Chinese President Xi Jinping’s nine years in power have signalled an authoritarian turn, reigniting a Great Power rivalry with the United States and enabling other like-minded regimes to test norms established by the winners of the Second World War. Meanwhile, the U.S.’s commitment to freer trade has wavered, as President Joe Biden has only partially stepped back from his predecessor’s use of punitive import tariffs and trade sanctions.

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So maybe it shouldn’t be a surprise that countries such as Luxembourg are embracing a policy of “friend-shoring,” a play on the term “near-shoring,” which refers to trading with countries that are near to you, geographically. It recognizes that China has become the primary source of an inordinate amount of important inputs in the production of telecommunications gear, vehicles, and other goods.

Friend-shoring, however, refers to trading only with countries you think you can count on, regardless of where they are located. So, in such a world, you might source iron blocks from Luxembourg (one of the country’s main exports) not because they are the cheapest, or the best, but because Luxembourg is a member of NATO.

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Critics of the policy argue that friend-shoring can easily become exclusionary and elitist. Countries run the risk of taking friend-shoring to the extreme, assuming a protectionist stance when it comes to choosing where to channel foreign investment and source imports. The notion runs counter to the free trade principles that underpin the current liberal international world order. According to Chrystia Freeland, Canada’s deputy prime minister and finance minister, such criticism is beside the point: the game has changed, and Canada needs to change with it.

“The world has not started to grapple with how big a deal this is,” Freeland said at an event hosted by Canada 2020 in Toronto on June 20.

The beginning of history

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Luxembourg wants to strengthen its trade relationship with Canada, primarily “because we see that we are living in a world that has changed dramatically as far as Europe is concerned,” Fayot said.

Trade between Canada and Luxembourg — a  landlocked European nation with a population of roughly 600,000 people — is not significant, but the two countries have a shared history. During the Second World War, Luxembourgish heads of government and members of the ruling party fled the Nazi invasion and took refuge in Quebec for a number of years, making Montreal the de facto headquarters of the Luxembourg government.

“It shows how like-minded we were already in the past, and this hasn’t really changed,” said the Crown Prince of Luxembourg Guillaume Jean Joseph Marie. “We have common values. We have a similar way of looking at business, but also of looking at our history and our past.”

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Fayot is all for friend-shoring. “I don’t see any cons in this approach,” he said, adding that the world appears to be reverting to various blocs. “Europe needs to do more with like-minded countries, and Canada is definitely one of them.”

Luxembourg knows how painful it is to be overly dependent on unfriendly trading partners, as the country is indirectly dependent on Russian gas. (Luxembourg does not get its gas directly from Russia, but from Belgium, which sources its energy from Germany, which is heavily dependent on Russian imports.)

This is precisely the sort of dependency that friend-shoring seeks to address, according to U.S. Treasury Secretary Janet Yellen, who introduced the idea in a speech in April.

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“Friend-shoring is the idea that countries that espouse a common set of values on international trade … should trade and get the benefits of trade,” Yellen said alongside Freeland at the Canada 2020 event. The idea is to ensure the U.S. and its allies have “multiple sources of supply and are not reliant excessively on sourcing critical goods from countries, especially where we have geopolitical concerns.”

Yellen, who previously led the U.S. Federal Reserve and is widely recognized as one of her country’s top economists, makes no attempt to describe her idea as optimal. However, according to Freeland, a former financial journalist who spent time in Central Europe at the end of the Cold War, the assumption that the world’s countries could come together and “all get rich together” through free trade proved to be overly optimistic.

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With the fall of the Berlin Wall in 1989, the world heaved a collective sigh of relief; the battle between the two competing world systems — communism and capitalism — had finally been settled. Capitalism and subsequently, liberal internationalism, had emerged as the victor.

This view was cemented by political scientist Francis Fukayama’s book The End of History, which argues that the decades-long squabble between great powers over which system was best had finally come to an end, and henceforth government by liberal institutions steeped in a tradition of democracy and co-operation would become the norm.

Leaders such as China’s Xi and Russian President Vladimir Putin apparently saw things differently.

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“I really believe that Putin’s illegal invasion of Ukraine has shown us all: it didn’t work,” Freeland said of the world’s attempt to embrace free trade. “That era is over. We need to figure out what replaces it.”

I really believe that Putin’s illegal invasion of Ukraine has shown us all: it didn’t work

Chrystia Freeland

Freeland said that friend-shoring must become the new norm. Canada should “deepen ties between the countries that share values,” she said. “The countries that really can trust each other to not throw citizens in jail when we get mad at each other, as a kind of diplomatic hostage taking. Can trust each other not to invade another country and commit war crimes in that country. It sounds kind of basic, but we need that.”

For years, countries have been turning inward. Friend-shoring is the culmination of that process; the interdependence that was once prized at globalization’s apex at the beginning of the millennium has proven detrimental in a world rocked by war and pandemics. Russia’s invasion of Ukraine was the tipping point, but the global order was already teetering due to widespread pessimism about the merits of freer trade and distrust between China, the U.S., and the EU.

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“We’re still going to have a relationship with countries outside this closest circle, but it’s going to be a different sort of relationship,” said Freeland. “It’s going to be a relationship that has less trust at its heart, that is more careful, where we’re careful not to have as much of a dependency.”

Then she made a comment that showed that friend-shoring was no longer just an idea, but a real thing: “I think it may require some new institutions, some new relationships, but I think this is where we really need to go.”

‘We should not draw the wrong conclusions’

Bessma Momani, senior fellow at the Centre for International Governance Innovation (CIGI), cautioned against taking Freeland’s comment too literally. “I don’t think anybody has any appetite to create yet another institution, or secretariat, or club,” she said. “Perhaps the intention there is a new framework, a new thinking,” said Momani.

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While friend-shoring won’t get rid of existing institutions like the WTO, it certainly runs counter to its mandate.

“There are moves to support re-shoring, near-shoring and friend-shoring,” Ngozi Okonjo-Iweala, the WTO’s director general, said in a speech in April. The war in Ukraine “has led many to conclude that global trade and multilateralism — two pillars of the WTO — are more threat than opportunity,” she continued. “But I believe we should not draw the wrong conclusions from these stresses.”

Okonjo-Iweala personifies how quickly friend-shoring can get complicated. She’s the former finance minister of Nigeria, Canada’s largest bilateral trading partner in Africa in 2021, with Canadian imports from the country totalling $2.1 billion. Nigeria provides Canada with mineral fuels and oils, rubber, cocoa, and lead; however, under a friend-shoring policy that prioritizes values like human rights, it’s not a guarantee that Nigeria would make its list of “friends,” given Nigeria’s political instability and inconsistent commitment to human rights.

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That’s why critics such as Okonjo-Iweala say countries should resist the urge to tear up the trade blueprint they’ve so carefully crafted over the past few decades. Instead of choosing to “retreat into ourselves, make as much as we can ourselves, grow as much as we can ourselves, we should reform the WTO that underpins it and upgrade its rules to deal with 21st century challenges,” she said.

Yellen also cautioned against the impulse for a country to become entirely self-sufficient. In fact, she characterized friend-shoring as a trade-friendly response to those who argue that the best way to counter China’s dominance in manufacturing is to make more things at home. She said that an effective friend-shoring group need not be small, or even overly restrictive.

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Still, smaller economies such as Canada do better in bigger groups, because larger countries such as the U.S. have a harder time using their heft to dictate the terms.

“Efficiency is still paramount,” said Peter Hall, a former chief economist at Export Development Canada. “To be sustainable, friend-shoring must pay. Not necessarily in the short run, but critically in the medium-to-long run. Failure to recognize and plan for this could ultimately be commercially fatal.”

To be sustainable, friend-shoring must pay

Peter Hall

​​Carolyn Rogers, senior deputy governor of the Bank of Canada, said at an event hosted by the Globe and Mail in Toronto on June 22 that Canada would need to resist the impulse to take a “protectionist stance,” adding, “that would not be a good outcome for a small economy like Canada.”

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The elitism trap

Whatever the flaws, the period of globalization that followed the Cold War lifted hundreds of millions of people out of poverty by giving poorer countries an opportunity to access wealthier markets. Friend-shoring would probably lift fewer boats.

“Friend-shoring would tend to exclude the poor countries that most need global trade in order to become richer and more democratic,” Raghuram Rajan, the former chief economist of the International Monetary Fund and former governor of India’s central bank, said in a recent commentary published by Project Syndicate.

In other words, instead of promoting democracy, friend-shoring might only serve to further entrench the unfriendly qualities showcased by some countries. “It will increase the risks that these countries become failed states, fertile grounds to nurture and export terrorism,” Rajan wrote. “The tragedy of mass emigration will become more likely as chaotic violence increases.”

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Regardless of who is admitted to the group, friend-shoring will come with a price tag, said Momani. If Canada plans to trade only with other developed economies, Canadians will need to pay the price for higher labour standards, and subsequently, higher-priced products. “It’s going to be a more expensive product in the long run,” she said.

The stricter the friend-shoring policy, the fewer goods we will be able to trade. Some things, like minerals, are mainly provided by “unfriendly” countries. “Can we do it? Can we solely depend on friends, and friends only?” Momani asked. “Probably not. Not for everything.”

Regardless of how carefully group members are selected, “thorny” ethical questions will inevitably arise, Momani said. India is a democracy, but the country’s ruling party has a history of inciting religious violence, and Prime Minister Narendra Modi so far has resisted becoming a full member of U.S.-led efforts to isolate Russia. Viktor Orbán leads a repressive regime in Hungary, and far-right parties have emerged as legitimate contenders for power in Italy and France.

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“Friends today may be foes tomorrow,” Momani said, noting that even Canada’s closest ally has an unfriendly side. “What happens if you have the return of a populist, Trumpian leader?” Momani asked. “Is the United States still a friend?”

Who makes the cut?

How will countries go about determining who is friendly and who is unfriendly? Former Canadian finance minister Paul Martin and his U.S. counterpart, Lawrence Summers, famously decided the membership for the G20 in a chat amongst themselves. Designing a new trading bloc won’t be so simple.

If it’s like choosing friends in real life, you’d want countries with similar “values” to yours, allies you can trust to stick by your side when times get tough. But countries are not human beings, said Carlo Dade, who studies trade policy at the Canada West Foundation, a think-tank.

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“This friend-shoring thing is kind of worrisome, Dade said. “You’re using the word ‘friend.’ You’re anthropomorphizing the institutional relationship,” he added. “So you’re giving human qualities to a political relationship. The U.S. ain’t our friend. We’re interest aligned. We’re allies.”

Friend-shoring is perhaps an attempt to humanize international relations at a time when the international sphere has become unrecognizable, veering away from the liberal norms to which Canadians have grown used to over the past few decades. Arguably, classifying world affairs into binaries — good versus evil or friend versus foe — removes important nuance. That’s why the “friend” classification should be multi-faceted, said Dade, and take into account the likelihood that the country might cut off trade during a crisis. He said he would emphasize countries Canada can trust, rather than those that are simply “friendly.”

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Dade noted that many countries cut off crucial exports during the pandemic, to Canada’s detriment. That’s why Dade prefers what he called “trade-bloc shoring,” where countries trade not with friendly countries, but with friendly blocs. “The idea of moving stuff to some random country that happens to be a friend doesn’t make as much sense as moving production back into a trade bloc,” he said. The benefit, he said, is that the bloc comes with “institutional architecture” so that trade isn’t based solely on a handshake alone.

To be sure, speculating on who would make Canada’s list of friendly countries could be moot. Yellen and Freeland make trade sound like it’s about politics, when it’s really based on commercial decisions made by companies, Dade said. In other words, if friend-shoring is too expensive, it just won’t happen. Short of imposing blanket trade bans and sanctions, governments can’t control whether businesses choose to trade with friends or foes.

“At the end of the day these are business decisions,” he said. “Near-shoring or friend-shoring will happen when it makes economic sense.”

• Email: mcoulton@postmedia.com | Twitter: marisacoulton