Are we still friends? The U.S. and EU approach to ‘friend-shoring’ of supply chains

On August 28, 2023 the Minister of Commerce of the People’s Republic of China (PRC) Wang Wentao and the U.S. Secretary of Commerce Gina Raimondo held talks in Beijing in light of a tense exchange of measures restricting bilateral trade. It is only a few weeks after the Chinese Ministry of Commerce (MOFCOM) imposed export licensing obligations for gallium and germanium, elements that are essential in the production of semiconductors and used in almost every modern electronic device. Based on the 2020 Chinese export control laws, the restrictions were justified on grounds of national security. Despite their general applicability, they could be viewed as a retaliation against the US Chips and Science Act of 2022 (CHIPS Act), which conditions research and development (R&D) subsidies for the development of high end semiconductors on the recipients being prevented to build production facilities in the PRC. The Chips Act also serves to improve national security. Moreover, the U.S. extended the number of Chinese and Russian entities towards which the export of certain semiconductor manufacturing items and chip design software is restricted.

The conflict could be interpreted as a classic trade dispute on the interpretation of WTO Agreements: export controls on advanced semiconductors and fabrication tools (U.S.) as well as on rare earths (China) conflict with the ‘most-favoured-nation’ principle foreseen in Article I:1 of the GATT 1994. As claimed by the PRC in a request for consultation regarding export restrictions of manufacturing equipment by the U.S. submitted last year, with respect to all rules and formalities in connection with exportation, the U.S. fails to accord immediately and unconditionally the advantage, favor, privilege and immunity granted to products destined for other WTO Members to like products. The same allegation could be made against the PRC with regards to export control on rare earth. Moreover, these measures are contrary to Article XI:1 of the GATT 1994, which provides for the general elimination of quantitative restrictions. In DS146, the panel clarified the broad scope and comprehensive coverage of Article XI:1 GATT, when stating that, although the title of Article XI refers to the elimination of ‘quantitative restrictions’, it intends to cover any type of measures restricting the entry of goods into the territory of a WTO member, other than those specifically excluded, namely, duties, taxes or other charge. Regarding subsidies included in the U.S. CHIPS Act, the PRC placed an item on the agenda at a meeting of the WTO’s Committee on Subsidies and Countervailing Measures (SCM) in May of this year. The issue at stake is whether the fiscal measures provided by the Act meet the requirements of actionable subsidies under Part III of the SCM Agreement. This is the case if a subsidy is specific and causally adversely affects the interests of other countries. In this respect, it is claimed that the fiscal measures of the Act negatively ‘affect the development process of China’s semiconductor industry’, since companies that currently have semiconductor plants in China and the U.S., including TSMC (Nanjing), Samsung (Xi’an), Hynix (Dalian), etc., will be restricted from building or expanding advanced process foundries in China’. However, this last aspect is an economic question that needs to be monitored.

Notwithstanding these clear lines of specific WTO law conflicts, the dispute is of broader relevance. It is exemplary of a trade policy U-turn under the headline of so-called ‘friend-shoring’ that the U.S. – and the EU – are undertaking in the aftermath of COVID-19 and in light of Russia’s war of aggression against Ukraine. Although, according to the MOFCOM press statement on the August meeting, the U.S. has supposedly reiterated that it has no intention of ‘decoupling’ from the PRC, the CHIPS Act can be seen as one of recent examples of this new approach. The concept of ‘state friendship’, which seemed to be forgotten with the advent of modern trade after the end of the Cold War, is experiencing a renaissance in international law. ‘Friend-shoring’, however, raises fundamental questions about the scope of the ‘national security’ exception in WTO law. We argue that friend-shoring creates a fundamental conflict with WTO law: While friendships are traditionally meant to last for a long, indefinite period, WTO exemptions are intended to be limited in time.

Friend-shoring of supply chains in the U.S. and the EU

As U.S. Secretary of the Treasury Janet L. Yellen proclaimed in April 2022, the Biden administration plans to build on and deepen economic ties with countries the U.S. ‘knows’ and can ‘count on’. She said: ‘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.’ China and Russia do not belong to these trusted countries. Especially COVID-19 has exposed dependencies in trade on a small number of countries. One of those is in the semiconductor production, which is essential to the electronics, automotive and defense sectors, as well as playing a role in the fight against climate change. The PRC exercises crucial control over the production of critical rare materials (CRM). Gallium and germanium are just two of the elements needed for semiconductor wafers, optical fibers, as well as photovoltaic cells. 80 % of the global output of these two elements is estimated as coming from the PRC.

After COVID-19 and under the influence of the economic impact of Russia’s war of aggression against Ukraine, the goal of reducing dependence become a fixture in trade policy around the world (see for example here, here, and there) and has led the EU, in particular, to adopt multi-layered trade tactics in dealing with CRM. The strategies appear to be multifold. On one side, they aim at decreasing reliance on the PRC in the production of rare earths. The Minerals Security Partnership was implemented for this purpose: an association between Australia, Canada, Finland, France, Germany, India, Italy, Japan, Norway, the Republic of Korea, Sweden, the United Kingdom, the United States, and the European Union that recently engaged in talks with a number of African states to discuss possibilities of investments in socially responsible mining projects. The EU started the re-negotiation of free trade agreements to open access to critical rare earths. On the other side, trade policies aim at incentivizing domestic industrial manufacturing and above all R&D of high-end semiconductors, notably through subsidies. The US CHIPS Act is raising a total of 52.7 billion USD to incentivize the domestic production and development. A 25 % investment tax credit for related capital expenditure (CAPEX) measures was implemented. These measures bar, however, the recipients from extending manufacturing in China. Similarly the EU Chips Act aims at mobilising more than € 43 billion of public and private investments in order to prepare, anticipate and swiftly respond to future supply chain disruptions. Simultaneously, export controls are implemented to protect intellectual property. As the U.S., the EU included strategic export controls in its work program for 2023.

State friendship: a forgotten international law concept

The concept of ‘friend-shoring’ is in stark contrast to the global mindset that has prevailed since the end of the Cold War, promoting trade liberalisation in a fully globalised world. It appears to imply economic relationships not only on the basis of a utilitarian negotiation of interests, but based on common values, such as trust or even benevolence. Historically, friendship had been for long a precondition of any relationship between political rulers. In antiquity, moral proclamations were not mere political statements, but had constructive effects on legal agreements.

Inter-state cooperation has a long tradition as an integral part of international economic treaties. State friendship played a prominent role in the 20^th century ‘Treaties of Friendship, Commerce and Navigation’. Although their ‘friendship clauses’ were primarily political in nature and did not constitute binding rights and obligations independent of the context of the concrete treaty provisions, as the International Court of Justice has noted (see here and here), the reference to friendship or amity in this type of treaty was not without normative content. It represented nothing less than the overarching objective of the respective treaty to achieve friendly relations across the entire range of activities covered. For the states involved, it had a selection function and served as an economic instrument to bind the trading partner to itself and its own political orientation. The ‘humanisation’ and moralisation of states, which is inextricably linked to any legal concept of friendship, seemed to have disappeared entirely from the international legal regime with the advance of modern trade and investment agreements after the end of the Cold War. Against this background, the revival of the friendship concept in trade matters is remarkable. How does the friendship of states materialise and what role does it play in the current security issue in WTO law? Are the new associations more than strategic partnerships based on self-interest? The definition of who is a friend always was and still is difficult. This is all the more true against the background that the choice of friends is limited when it comes to territorial owners of rare earths.   

‘Friend-shoring’ as a security matter in WTO law

From the perspective of WTO law, the change in trade policy needs to be critically examined. A major goal of the WTO is the dismantling of discriminatory trade barriers, i.e. the significant reduction of tariffs and other trade barriers. While it seems to be in the spirit of the WTO that free trade is extended to new supplies of rare earths, overall, friend-shoring tends to raise these barriers. Another objective of the WTO is the implementation of a viable and durable multilateral trading system, making the reliability of supply chains a legitimate interest. The Director-General of the WTO Ngozi Okonjo-Iweala criticised friend-shoring, however, as ineffective and even a detrimental instrument to attain resilience, pointing out related costs (i.e. reduction of global GDP by 5%) and instead advocating more diversified global supply chains. The concept of free trade underlying this statement is opposed to the new concept of ‘resilient trade’. Which one will prevail remains to be seen. What role the WTO and its dispute settlement system will play in this is also unclear, since – as in the case of China and the U.S. – the ‘national security’ exception is repeatedly invoked as justification, which goes hand in hand with the argument that the measures fall outside the scope of WTO dispute settlement. Security exceptions are only included in some WTO agreements, none is provided for in the SCM Agreement. The question if the security exception set forth in Article XXI of the GATT 1994 can also justify a breach of the SCM Agreement is disputed (see here and here). The general ‘proliferation’ of the use of the exception in state practice appears to be a sign of a more complex shift. Even though aspects of the application were reviewed in WTO proceedings in the past (see here), the repeated recourse begs the question to what extent the members of the WTO continue to affirm the institution as effective instrument and forum to address the current challenges and to find the right balance between interests of national security and economic efficiency.

Once ‘friend-shoring’ measures such as export controls (and, if considered, subsidies) are assessed against the yardstick of Article XXI(b)(iii) GATT 1994, a fundamental problem with regard to the temporal limitations of the exception arises: building and maintaining state friendships in trade matters is necessarily a long-term project that only makes sense if it outlasts concrete global political events. Article XXI(b)(iii) GATT 1994, however, only allows contracting parties to take any action which it considers necessary for the protection of its essential security interests ‘taken in time of war or other emergency in international relations’. The wording ‘in time of’ refers, as stated in the DS512 panel report, to a ‘chronological concurrence’ between the disputed state action and the events of war or other emergency in international relations, which constitutes an ‘objective fact, amenable to objective determination’. This limits the potential of friend-shoring to a ‘temporary (reversible) deviation’ from WTO obligations – making it clear that long-term friend-shoring necessarily takes place outside the WTO legal framework. Against this background, the question ‘Are we still friends?’ arises not only in the relationship between China and the U.S., but also in the relationship between states that foster ‘friend-shoring’ in light of national security concerns on the one hand and the WTO on the other.