How not to win a trade war

While there is significant confidence in many quarters that different countries or regions will capture gains from continuing disruption in trade, the reality is likely to be quite different.  Firms would, of course, prefer not to spend any additional money on pointless tariffs and would prefer not to pass these costs along to suppliers and consumers. 

Nevertheless, in the near term, higher business costs are inevitable for many firms. 

After looking at alternatives, many companies are likely to decide to just stay put, slash internal costs wherever possible, and figure out how to best ride out the turmoil.  Some will relocate, but the numbers are likely to be smaller than many anticipate and into locations that are not currently at the top of mind. 

Firms are more likely to move to Europe or Japan or even relocate some production back to the US than to move as much as expected into the rest of Asia.  Low labor costs are not the only important element in decisionmaking—an effective and supportive policy framework for business is also critical.

To recap the current state of events: as a result of the sanctions in place from Section 301, the Americans have imposed 25% tariffs on imported goods from China worth $50 billion and have 10% tariffs against an additional $200 billion in goods.  In retaliation, the Chinese have imposed tariffs on $110 billion in goods against the US.  Both sides have threatened more.

These are not, of course, the only tariffs in place.  As a result of the US Section 232’s on steel and aluminum nearly a year ago, the US has tariffs on these products and a wider range of countries, including Canada, Mexico and the Europeans have countermeasures in place against imported American products.  (For a nice visual recap on the meaning of “tariff” and who actually pays them, watch the recent video from the WTO here.)

Some of these tariffs have now been in place for some time.  The original actions against solar panels and washing machines happened more than a year ago. 

Even if the US and China somehow manage a miracle and resolve some of the issues between them before March 1 when US tariffs are set to lift from 10% to 25%, tariffs currently in place will not be removed at the end of the month.

The best case scenario for businesses caught in the tariff cross-fire is the halt on the further escalation under Section 301.  The existing tariffs on $250 billion could be rolled back, but not as quickly as March 1.

The tariffs under the steel and aluminum cases are not being addressed at all, so these are not going anywhere at the moment.  (The US may, in fact, impose more damage in two ongoing Section 232 investigations due to wrap up within weeks—on uranium and autos.)

Hence, the tariff and trade war is not going anywhere soon.  Companies are slowly starting to realize that trade conditions are not going to readjust back to “normal.” 

The logical conclusion from many is that companies will quickly start moving.  Firms in China, though, are stickier than commonly assumed. 

While some industries can switch locations, flex production patterns within their existing networks, or invest and change markets quickly, such changes are not typical of many firms. 

Even if it made sense for an individual factory owner, as an example, to shift production from inside China to a new location, the costs of doing so can be significant.  It is not just the direct costs that matter—finding or building a new facility and relocating equipment.  It is also the often total lack of the ecosystem in the new location that is extremely challenging for each factory owner to resolve. 

A single factory can shift.  But the factory still needs raw materials or parts and components.  These have to be brought in and final products shipped out.  These items need packaging, labels, and trucks to deliver everything.  These items are often missing or take time and money to develop in a new location. 

Modern firms—even tiny ones in China—often operate on a just in time philosophy.  Delays in transportation and high costs of logistics can ruin the slim profit margins for many companies.  Items that sit on the docks waiting for customs clearance or officials that refuse to stamp paperwork add time and money in delays. 

The skills and capacity to run the new facility can be completely impossible to find or so expensive and difficult to hire than no sensible factory owner or firm is going to tackle some locations at all.  There is no point in building a shiny new factory if no one can be found to run it or fix things when they break.

The legal costs and red tape needed to start new businesses can be extensive.  Even expanding existing facilities can be a long, painful and expensive process in many markets.

Basic costs for things like electricity, internet access or water can also be high and service is often unreliable.

Arbitrary or capricious rule changes are a significant danger for foreign firms looking to diversify out of China into other markets in Asia.  It certainly does no good to open a new warehouse or building, only to have a regulatory change that renders it unusable or be saddled with new requirements on staffing that drive costs into the red.  (See the parallel Talking Trade from today on India’s sudden decision on e-commerce.)

Most of the markets in the region that are currently expecting to capitalize on the trade war struggle with at least some—and usually all—of these problems. 

An honest assessment of market conditions in hopeful “winners” could bring about some necessary changes.  There is certainly an opportunity for many markets to capture new gains from trade in areas that have not been “in play” for years.  But absent some significant improvements in the ease of doing business in a remarkably short period of time, many of the locations that expect a windfall from relocations are likely to be bitterly disappointed.