Implications of Tariffs

Implications of Tariffs

1. Introduction

   • Total Cost of Ownership
     • The belief that when purchasing an asset, you should not just look at short term cost
     • House example
     • Applying the TCO view of costs to the cost imposed by tariffs
       • Focusing on hidden costs, not just the potential increase in prices
   • Previous US-China trade
     • Trade Deficit
     • % US Products made in China
     • Us imported $560bn worth of goods in 2018
     • Accounted for 21% of the value of all goods imported to the US
   • How tariffs came about
   • For the sake of time, I will be mainly looking at this question from the POV of Americans

2. Direct Costs

   • Price increases for consumers seen as direct cost. Is this always the case?
     • Tariffs' effect on prices is twofold; one raises prices, one lowers them. Depends which effect is stronger
       • As tariffs cause a large fall in demand for Chinese products, and since the US is such a large importer of Chinese goods, the demand for these goods will fall, thus lowering their price
       • Represented by the equation: American Price = Chinese Price (1-t)
         • Effect on prices depends on if the tariff is higher or lower than the fall in Chinese prices
       • Chinese tariffs imposed last year were not found to be inflationary by the federal reserve
     • Study estimated costs for a family of four to rise by $767 (The Trade Partnership)
     • That is to say that there is no cost imposed

3. Cost of Switching Suppliers

   • Survey found that 40% of American companies with suppliers in China plan actively look elsewhere (AmCham)
     • Imports from Vietnam jumped 21 per cent
   • Realigning the supply network might mitigate the effect of tariffs but other tradeoffs must be considered
     • Cost
     • Labour
     • Quality
     • Service levels
     • Cycle time
   • At first firms were reluctant to abandon long-standing relationships of possible short term trade dispute
     • Now many re-evaluating decisions
   • Switching Costs
     • Deadweight Losses
       • Accumulate when firms switch to cheaper but less efficient producers to reduce their exposure to tariffed goods
     • Time and effort sourcing, and evaluating the viability of new suppliers/regions
   • Lost benefits of close buyer-supplier relationship
     • Service and support
     • Quality

4. Hidden Finance Costs

   • Increase in cost of capital due to financial stress
   • Weak investment spending is further hurting trade because machinery, equipment and other capital goods are often imported
   • Uncertainty is the enemy of investment
     • Wait and see approach
   • Uncertainty to cause $585bn loss to global economy
   • Businesses unsure when trade war will end so reluctant to make large investments

5. Effect on Contracts/Design Costs

   • Example: ControlTek (NY Times)
     • ControlTek is rewriting contract language to make it easier to pass the cost of tariffs on to its customers
   • Changing the way in which US-China contracts are written
   • US farmers and the Chinese buyers previously had special relationship
     • When Chinese buyers draw up new contracts in the future, they may factor the possibility of another trade war into the transaction cost
   • Doesn't just affect Goods
     • High-tech engineering adding value and contributing to the price of end products
       • Engineering and design takes place across borders, giving new meaning to tariffs and increases design costs
       • ControlTek are shifting supply chains out of China where possible, and redesigning products to avoid Chinese components where it isn’t.

6. Conclusion: Was it Worth It?

   • Tariffs have not yet compelled businesses to return large-scale production to US
     • Labour and other costs tend to be too high to compete
     • Federal Reserve report found that US firms were actually worse off because of retaliatory tariffs and an increase in the cost of Chinese components
   • Administration did not get the structural changes to China’s economy
     • Example: Huge subsidies to Chinese companies
   • TBD whether or not China will stick to agreement, and only for two years
   • Marc Busch: “It’s more a cessation of hostilities, phase one, coupled with some barter.”
     • Unsurprisingly Trump selling the deal as a massive win
   • Termed "Phase One" to help Trump in 2020 election
   • Hard to say whether it was worth it given the difficulty in calculating the effect of the hidden costs
     • IMF economists calculated the direct costs imposed by the tariffs to reduce US GDP by .2%
     • But calculated the cost of indirect effects (weaker business confidence, productivity etc.) .4% of GDP
   • Trade deficit closed by $43bn

7. Phase one Deal

   • China agreed to buy $200bn of US products over 2 year period
   • Concessions on IP, currency and access to financial services
   • US will call off and reduce some tariffs
     • Though taxes on $350bn Chinese goods will remain
   • December 2019

8. Why Trump Imposed Tariffs

   • Unofficial Reasons
     • Stroke ego
     • Draw away attention from impeachment proceedings
     • Improve public image before election
   • Reduce trade deficit ($420bn in 2018)
   • Revive US manufacturing
   • Upset with special subsidies given to Chinese firms by Beijing
     • Nio, Tesla competitor
   • The stealing of US IP by China
   • Currency manipulation