ECB warns that ‘friend-shoring’ will increase prices

According to a European Central Bank study, geopolitical tensions have prompted more multinational companies signaling plans to move production to countries that are closer to their final market.

The ECB discovered that almost four times more European multinationals have said they will shift production to countries with friendly political systems — a phenomenon called “friend-shoring,” — than in the last five years.

While 42 percent of the 65 companies surveyed by the ECB said they would produce more in politically-friendly markets, a larger number — 60 percent — indicated that changes to supply chains and production sites have pushed prices up over the last five years.

In a survey conducted this summer, 45% of respondents said that they expect greater inflationary pressures in the future.

Economists are concerned that the global trading system could fragment into competing blocks. This is due to the diplomatic rifts created by the Russian invasion of Ukraine, Israel’s war against Hamas, and the growing tensions in trade between the US, and China.

The IMF had warned in early this year that the trend was likely to reduce global economic output on a long-term basis by 2 percent. ECB President Christine Lagarde stated earlier this year that the fragmentation in the global trading system “contributed” to the steep increase in inflation during the past two years.

The ECB published a report on Monday that stated “Geopolitical Risk was the most commonly cited factor for decisions to (re-)locate production within the EU while cost and demand factors are the main reasons behind moves outside the EU.”

It is not easy to rework supply chains in order to reduce geopolitical risks, particularly when many companies depend on materials from China, which are difficult to obtain elsewhere, like those used to make batteries.

The ECB stated that “most analyses to date do not find any evidence of significant change in aggregate European trading patterns”. The ECB added that these shifts may take some time to manifest, due to the costs and challenges involved in changing business models, contracts, and supply chains.

Many businesses, whose aggregate value added is equal to around 5 percent of EU Gross Domestic Product, expressed concerns about their dependence on essential supplies sourced from China.

The ECB reported that more than half of companies said they were “at risk” when supplying critical inputs to a particular country or countries. In “a majority” of these cases, this was China.

The majority of companies stated that it would be “very difficult” to locate these essential inputs anywhere else. Many companies said that they were diversifying their supply, while others stated they held more inventory, changed their product composition, or closely monitored risks.

Due to a shortage of labour and high costs in the area, the ECB believes that changes in production locations and supply chain will likely reduce the number of jobs in the EU.

It also said that these changes appeared to be causing more companies to “use EU suppliers” in greater numbers.