There was a glorious time not long ago when corporate decision makers and small businesses had a clear understanding of how America’s two main political parties differed on economic and trade issues. Republicans were the champions of free market and open trade, small government and limited regulation. Conversely, Democrats were fighting to protect domestic industry from undue foreign competition and to protect consumers from malpractice through stronger regulatory checks and balances.
One could choose to agree or disagree with either position, but the positions were clear and, more importantly, they were firm. In less than a decade, a seismic shift has occurred that not only creates ambiguity over economic policy but also narrows the distinction in party platform on matters of trade. The choice is no longer between open trade and trade protectionism, but rather between trade protectionism and … more trade protectionism.
Indeed, since the initiation of Washington’s trade war with China, U.S. consumers have been forced to dole out about $215 billion in extra costs associated with the duties importers have to pay. What started out as a strategic move by the Trump administration to renegotiate the terms of NAFTA quickly morphed into a series of protectionist escapades, including a 25% tariff on almost all goods coming in from China and a comparable tariff on imports of steel and aluminum.
These practices were maintained by the Biden Administration. In addition, Congress allowed the Generalized System of Preferences (GSP) – a program that offered preferential duty to developing nations – to expire during the final days of the Trump administration. Since then, there has been tepid impetus by members of Congress on either side of the aisle to resurrect the program. In addition, a host of non-tariff barriers have been imposed by the current government in the form of various safety checks, domestic production quotas and barriers to entry in the U.S. market. Not only did the Biden administration choose not to reverse the Section 301 tariffs against China, but recently it doubled down on them by multiplying the rate as much as four times on some items and allowing pre-existing exceptions to the tariffs to expire.
Refusing to allow itself to be outdone, the Trump campaign has suggested imposing even more tariff barriers in the form of a universal 10% tariff on all imports irrespective of origin and using far broader strokes of tariff increases on goods coming in from China.
As noted above, these extra costs are summarily passed along to consumers who bear the brunt of these protectionist practices. But for each action, there is an equal and opposite reaction. America’s trading partners have expectedly reciprocated with tariffs of their own, making U.S. goods more expensive abroad. The outcome has been a meteoric rise in tariff barriers globally. In 2018, the first full year of the U.S.-China trade war, there were about 750 trade barriers on merchandise goods. In 2022, there were just shy of 3,000. That means it’s much more expensive to do business globally, which is precisely the effect the protectionists are looking to generate: Do more business domestically; less globally.
But there are still thousands of U.S. based businesses that source critical supply inputs from overseas providers. Many of these businesses are also looking to court consumers in international markets. What are these global businesses to do when policymakers in Washington continue to enact legislation and put forward policies that create barriers to trade?
Diversification
Much has been written to date about the virtues of trade diversification. Whether it’s the China+1 strategy, nearshoring, re-shoring, friend-shoring or something entirely different, U.S.-based businesses have awoken to the fact that the status quo is no longer a valid option. A 2024 report by the American Chamber of Commerce in China shows 50% of respondents intend not to expand investment or scale back investment with 12% looking to shift investment outside the country. That’s not surprising given that only 19% stated their EBITDA in China was higher than it was globally, down from 26% before the pandemic.
But divesting from China in favor of greener pastures isn’t clear cut. There are critical questions to be asked about the nature of the product and production process, the time sensitivity around getting product to end markets and the rules, regulations, taxes and tariffs that are going to impact landed costs for imported goods. Take for example Vietnam. Once a beacon of hope for product manufacturers looking to hedge their bets against China in the wake of the pandemic’s production shutdowns, Vietnam is beginning to look increasingly risky. The country’s political leadership has become unstable after a corruption purge saw an exit of the most likely successors to its aging leader. Moreover, Vietnam’s sudden spike in exports to the U.S. has put it on the radar of the United States Trade Representative, the Department of Commerce and U.S. Customs and Border Protection as a potential point of transhipment and circumvention of Section 301 duties and anti-forced labor legislation.
India too has been a darling of the diversification crowd. With its high-skilled labor it quickly became the choice alternative to China for hi-tech manufacturing, particularly consumer electronics goods. But its political stability is also beginning to show cracks in the aftermath of a recent election in which the ruling party saw its support slip significantly.
The Critical Questions
For corporate decision makers, knowing where to direct their investment dollars can often be a game of chance. The trick to success isn’t finding a single alternative, but multiple. Strategically setting up production in multiple locations that offer the ability to scale up or down to meet the needs of the business. To do this successfully, however, critical questions must be asked that go beyond production capacity. For example:
- Is the skill of the workforce commensurate with the requirements of production?
- Is the country’s road, energy and port infrastructure able to support a spike in volumes?
- Is there political, geopolitical, geographic or climatic risk?
- Does the country have free trade agreements with industrialized nations that allow you to integrate production through free trade zones or free trade agreements.
- Is there risk of a trade war or trade barriers between this country and the end market?
- Is there flexibility in modes of transport (e.g., can you ship via air instead of ocean, if necessary)?
This is by no means an exhaustive list, but it does offer a snapshot of often overlooked considerations. The reference to political risk is particularly critical in the lead up to the 2024 U.S. presidential election where both parties find themselves looking to score points with voters who are increasingly wary of globalism and celebrate reversion to domestication and self-sufficiency. As popular as that concept might be today, its long-term implications may be quite the opposite of what those voters might expect. The International Monetary Fund estimates the spike in trade barriers will ultimately result in a 7% decline or $7.4 trillion dollars in global economic output. In the U.S. specifically, the Tax Foundation estimates the China tariffs will shave 0.21% off GDP and eliminate about 160,000 jobs. Still, politics is a game of emotion, not numbers. And gauging how policy will be shaped by policymakers is never a precise science.
Some U.S. importers hoped Chinese companies setting up shop in Mexico could help them circumvent Section 301 tariffs and also take advantage of duty exemption through the United States-Mexico-Canada Agreement (USMCA). But the recent tariffs being imposed on Chinese EVs coming into the U.S. from Mexico may be a harbinger of more to come. And within days of those tariffs being put in place, the European Union followed suit with the same tariff policy on Chinese EVs. Canada is anticipated to be next in line.
Tariff Engineering
Often likened with “creative accounting” tariff engineering is frequently misinterpreted as a not-so-ethical practice. In reality, there’s nothing inherently wrong with it and many companies employ tariff engineering as a means of reducing their duty spend and optimizing their supply chains.
For the uninitiated, tariff engineering is a process by which a company that sources its product components from multiple points of origin and transports those components elsewhere for final manufacturing, shifts the form of each component to avoid paying more in duty than necessary. For example, a sandal manufacturer might source its leather, rubber and foam cushioning from three different countries and import all products into Vietnam for final production. Vietnam might have a 10% duty on each of these materials individually but might have only a 5% duty on a finished sandal sole and a 3% duty on a finished sandal strap (versus the unfinished leather). In this case, it might make more sense for the manufacturer to assemble the sole of the sandal at one point of origin before importing it into Vietnam, and similarly finishing the strap at another point of origin before import. The result is fewer dollars spent on transport, a reduction in customs paperwork and reduced spend on customs duties. Now multiply that sandal by a million units and the cost-savings potential becomes clear.
Yet, few companies have the capacity or expertise to calculate the various scenarios for duty costs when configuring their supply chains, resulting in overspend. In today’s world, time taken to make these calculations as part of a broader computation on landed costs can have meaningful impact to balance sheets. The trick is doing the calculations correctly and ensuring the products are classified correctly (a practice that is often treated with a degree of apathy until it’s too late).
Doing the math on tariffs and duty spend and running multiple scenarios allows companies to develop practical contingencies that can respond to likely or foreseeable shifts in trade and regulatory policies and coincides neatly with the diversification practices noted above.
No Panacea
For U.S. importers with overseas interests looking for a cure-all remedy to the disruption caused by America’s recent rejection of globalism, the bad news is there isn’t one. That isn’t alarmism or fatalism, it’s unvarnished truth. Every industry and every product will require its own solution because every country places varying degrees of protection against products depending on what serves the political and economic interests of that country. The ideal diversification model for an apparel company is likely never to mimic that of a smartphone maker, which will vary wildly from that of a pesticide producer. Each must evaluate its own production models with careful attention to existing and future costs, risks and, most importantly, agility.
With the outcome of the upcoming election still very much up in the air, and increasingly populist rhetoric from both candidates on the issue of trade, it’s anyone’s guess what the trade landscape might look like a year from now. As any business decision maker knows all too well, it’s what you don’t know that will hurt you. That’s why hedging bets and avoiding too much dependence on any one source or market may very well become the new normal for international businesses.
In the interim, the chess board of global trade is all set up to play. The next move is corporate America’s.
Jill Hurley is Senior Director of Global Trade Consulting at Livingston. As the practice leader, she spearheads U.S. import and export projects, offering comprehensive reviews of clients’ business models for risk assessment, crafting, and implementing import/export compliance programs, conducting audits, navigating export licensing requirements, and providing support in U.S. trade remedy matters.
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