Geopolitics is permanently changing trade flows

Geopolitical tensions are increasing, and the world is increasingly splitting into two blocs, something that is now also becoming visible in global trade flows. One bloc is led by the United States and its allies, which include the vast majority of highly industrial countries. The other bloc is led by China and its allies. We call the latter the CRINK Bloc after tits key members China, Russia, Iran, and North Korea.

The voting behaviour in the UN clearly shows the split between the two geopolitical blocs. Some countries have so far managed to strike a balance between the two and can be considered ‘neutral’, but in general, the major economies of the world are increasingly orienting themselves toward one of the two blocs.

UN voting similarities for select countries

Source: Bailey, Strezhnev and Voeten (2017)

In reaction to this geopolitical drift away from China, many businesses have been discussing the need to backshore manufacturing to their home countries or nearby neighbours. Alternatively, friendshoring, relocating manufacturing to potentially distant but geopolitically friendly countries, has been discussed as well.

In their analysis of the changes in trade flows between 2018 and 2023, Costanza Bosone and Giovanni Stamato from the ECB show that backshoring and nearshoring are not what is happening. Instead, there is now increasing evidence that businesses prefer friendshoring to keep labour costs low. The chart below shows the elasticity of trade based on geopolitical and geographical distance.

Elasticity of trade to changing geopolitical distance (left) and geographical distance (right)

Source: Bosone and Stamato (2024)

The main takeaway from the left-hand chart is that an increase in geopolitical distance by 10% - roughly what we experienced between the US and China since 2018 – leads to a c.2% drop in trade between the two countries while trade between geopolitical close and friendly countries rises by about 3%.

Meanwhile, the right-hand chart shows that there is very little if any nearshoring or backshoring. Instead, businesses re-orient their supply chains from some of the farthest suppliers (e.g. China) to far away but similarly low-cost suppliers in South East Asia, South Asia or Latin America. The winners of the increasing geopolitical tensions seem to be mostly countries like Malaysia, Thailand, and India, not Poland, Hungary or Turkey.