U.S. Tariffs on Chinese Goods: Managing Tariffs In The Manufacturing Environment

Content was last updated for relevancy and accuracy on September 30, 2019. 

Will Tariffs Benefit or Hurt U.S. Manufacturers?

The primary intent of applying a tariff on raw materials is to help domestic producers of such materials be more competitive with their global counterparts, thus creating (or protecting) domestic jobs. And while this strategy can certainly help domestic producers compete with countries who can produce the same product at a lower cost, it will virtually always result in higher prices to the end user.  Historically speaking, domestic suppliers of goods protected under a tariff policy will often increase their prices higher than would otherwise be necessary to compete globally, prior to the imposed tariff.  Manufacturers who rely on these materials to produce various components and finished goods or products are therefore forced to pay higher prices, whether via a tariff or from a domestic supplier. In turn, manufacturers must either lower their margins (profits) or pass along the increase to their customers, which inevitably raises the cost to the consumers¹.

It is impossible for manufacturers to control (global) political environments or predict the long-term effect of tariffs on their businesses. However, having a global manufacturing footprint can often mitigate some of the risks associated with domestic tariff policies. By having factories in different countries, manufacturers can shift production from one factory to another, depending on the lowest total cost of production. The cost of raw materials, however, is just one factor manufacturers must consider.  Other costs, such as labor and logistics, could have an equal or greater impact.

The continued uncertainty surrounding the Trump administration’s position on global trade and its U.S. tariff strategy has made it difficult for manufacturers, especially in the United States, to understand and prepare for the impact it will have on their companies and on the global economy. President Trump’s political agenda has been focused on trade with the U.S. and its impact on the U.S. economy since 2016. Under the implications of Section 301, the recent trade talks and negotiations with China have created raised import duties on Chinese products and goods². As of May 2019, the increased tariffs apply to $200 billion of Chinese imports, where auto parts and circuit boards have taken the hardest hit³. With the trade war between the U.S. and China escalating, it is not unreasonable that companies who manufacture in China are uncertain about the future and whether it’s worth expanding their global manufacturing footprint. The tariff increase on Chinese imports has caused some retaliation which has created an impact on manufacturing costs, thus increasing prices for consumers. With 10-25% tariffs on most raw materials and components imported from China, as well as all foreign aluminum and steel, U.S. manufacturers are turning to Mexico as a way to mitigate their exposure to the current trade environment. As a result, the leading industries and manufacturing companies in Mexico include the aerospace and auto industries as well as the medical device industry. 

For example, a U.S. automotive supplier who requires steel may currently be sourcing it from outside of the United States and almost overnight saw their raw material cost on steel increase by 25% due to the increased tariffs on Chinese imports.  Their option is to pay the tariff on the steel auto parts or find a U.S. steel supplier to replace their current supplier, which is often difficult to do quickly due to quality control requirements, certifications and other factors. Also, there is no guarantee the U.S. supplier will offer a significantly lower cost. If, however, this manufacturer had a factory in Mexico that was capable of manufacturing the same product, it could import the steel directly to that facility, tariff-free, produce the finished good and then send that finished product to the U.S., avoiding the 25% tariff.

While manufacturing in Mexico is just one example, many manufacturers from virtually all industries have been expanding to Mexico due to lower labor costs, its proximity to the United States and the Mexican government’s continued effort to attract foreign investment. Also, Mexico enjoys free trade agreements and treaties with over 40 countries, making it possible to import most raw materials from around the world, tariff-free.

The unintended, but historically significant, consequences of imposing an aggressive tariff policy can lead to higher inflation, retaliatory tariffs from trading partners, lower GDP and ultimately the risk of recession.  The global trade disputes being negotiated by President Trump and his administration, among other factors, are creating talks around another recession. Many economic historians believe the Smoot-Hawley Tariff of 1930, one of the broadest tariff hikes in the history of the United States, increased the length and severity of the Great Depression⁴.

Being that approximately 70% of the U.S. economy (GDP) is comprised of consumer spending on goods and services, it is no surprise that higher prices on manufactured goods can result in less spending, which is often a catalyst for layoffs and ultimately a recession.  Most economists agree that economic growth is by far the most effective long-term solution to create new jobs and that the short-term effect of protecting jobs using tariffs is far less beneficial.

Sources

1. https://www.nber.org/papers/w25672.pdf
2. https://www.nber.org/papers/w25672.pdf
3. https://www.economist.com/finance-and-economics/2019/05/10/america-raises-tariffs-on-china-and-the-stakes-in-a-trade-war
4. https://fee.org/articles/the-smoot-hawley-tariff-and-the-great-depression/

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