McKinsey report finds attempts at friend-shoring have done little to protect supply chains from geopolitical tensions

Wed 24 Jan 2024
Posted by: Phil Adnett
Trade News

Despite moves towards more ‘friendshoring’ amid deepening geopolitical divisions, a report into global trade released by consultancy McKinsey has found attempts to protect trade amid increasing geopolitical tensions have been largely ineffective.

Across many key goods and sectors, trade remains highly concentrated and is carried out between “geopolitically distant” nations – defined in the report as those which differ on global issues, quantified based on UN Assembly votes between 2005 and 2022 – leaving supply chains exposed to disruption in the event of worsening relations.

‘Arteries of vulnerability’

The report outlines how global trade is “deeply interconnected”, stating that every country derives at least 25% of its consumption of at least one type of critical resource, manufactured good or service from imports.

Trade between geopolitically distant economies accounts for nearly 20% of global goods trade, but this increased to almost 40% among highly concentrated products, where three or fewer countries provide over 90% of global exports. 

This interconnection between unfriendly countries creates additional precarity in global supply chains at times of heightened tensions, which the report terms: “the ties that bind and arteries of vulnerability”.

Limited impact of controls

The report also finds the number of new global trade restrictions each year has been steadily increasing, from around 650 new restrictions in 2017 to more than 3,000 in 2023.

However, despite such a substantial increase, the effect of these controls on global trade appears to be minimal. Since 2017, no economy has gained or lost more than one percentage point of annualised global export share in any given value chain. This figure is even less than the historic maximum of two-percentage-points lost by a single economy since 1995.

The report notes that the world’s largest trading economies tend to trade over wider geopolitical distances, regardless of misalignment. The US and China, the world’s largest and second-largest trading economies, both trade across a broad geopolitical spectrum.

Germany, the world’s third-largest, trades over a smaller geopolitical spectrum by virtue of intra-EU trade and the relatively close political alignment of the bloc.

Friendshoring over nearshoring

Countering the recent nearshoring trend, McKinsey finds that only the US has showed signs of relocating trade more closely, mostly through increased trade with Mexico. It also notes this has come at a significant cost, with sectors affected by this relocation seeing price rises of up to 9%.

Greater shifts have occurred via geopolitical distance, with countries redirecting trade through politically aligned partners.

Since 2017, China, Germany, the UK and the US have reduced the geopolitical distance of their trade by between 4 and 10% each.

Need for greater reconfiguration?

Increased dependency on geopolitically distant economies was identified as a source of vulnerability for both importers and exporters, illustrated with examples such as the economic repercussions faced by Australia when it lost China as an export market amid tensions over the South China Sea for products including wine, barley and iron ore. Iron ore is mainly exported by Australia, with more than 80% of its exports destined for China.

Conversely, nations relying on geopolitically distant trading partners for critical imports also face challenges at times of tension, such as when Russia turned off the taps on it exports of gas in the wake of its invasion of Ukraine. Many EU nations – notably Germany – came suddenly unstuck and energy prices across Europe soared.

A host of geopolitically aligned nations including the US, UK, Germany and Japan, rely on China for imports of electronic goods including laptops and mobile phones, which have become classic examples of a highly concentrated products.

The report concludes that reconfiguration in this area would be difficult, based on the lack of available alternative suppliers, and that such goods currently represent “a floor below which [many countries] can’t fall without leading to significant supply disruptions”.

Sliding trade corridors

The report also models two hypothetical future scenarios for the political trajectory of trade – one marked by greater fragmentation and division between China and ‘the West’,  the other by greater diversification among trading partners.

In the former scenario, the increasingly fragmented world is predicted to cost the global economy as much as 7% of global GDP, which is a greater contraction than that experienced during the Covid-19 pandemic (which was only 5%).

China comes out of this scenario as the biggest loser, with a loss of GDP up to 6%.

In the other scenario, a future marked by greater diversification, the report predicts that geopolitical patterns remain broadly similar with shifts seen within sectors.

For example, China could anticipate a fall in its share of Western trading partners’ imports, especially where it’s a concentrated supplier – such as electronics – but would potentially gain in other areas such as chemicals and services.

The report also predicts global average GDP impact would be significantly smaller in a diversified trading setup, with a drop of 0.5%.

Business readiness

The report suggests that businesses continue to prepare themselves for uncertainty by investing in increased supply chain data and comprehensive scenario planning.

Subscribing to the maxim that ‘knowledge is power’, McKinsey suggests companies build greater supply chain visibility to mitigate geopolitical exposure, warning that only 2% of companies have visibility into their supply chains beyond the second tier.

Scenario planning – building a detailed understanding of the business impact of potential risks – is another way of reducing exposure, especially when combined with actions plans to implement in the event of the worst happening.

Although potentially expensive, allocating money and minds towards this kind of planning can be cost-effective in the long term.