Waiting game

Tariff war creates uncertainty for businesses

Posted on Sep 27, 2019 :: Insight Insider
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Posted by , Insight on Business Staff Writer

Beyond the headlines, tweets and 30-second sound bites about trade wars and tariffs, businesses ranging from manufacturers to farmers are trying to determine a way forward as they cope with higher costs, lower sales and a lot of uncertainty.

For more than a year, businesses have contended with higher tariffs on products imported from China and have seen China retaliate by placing higher levies on U.S. products entering its country. The back-and-forth between the countries has led to an increase in the number of products covered by the tariffs, which now includes consumer goods such as electronics and shoes. At the same time, the United States has trade disagreements with other countries, making the whole situation challenging to follow.

“All of this unease and uncertainty is bad for business,” says Soren Hauge, an economics professor at Ripon College. “Business owners are sitting on their hands and not investing in technology or machinery in case things get worse. That then affects other manufacturers because they’re not selling as much. It’s an unending cycle.”

During the past year, Wisconsin businesses have dealt with the negative impact of the trade war with China, whether it is farmers seeing the market for their soybeans dry up or manufacturers paying more for their inputs. As of Aug. 1, Wisconsin businesses paid an extra $533 million in import taxes on products subject to the tariffs, while at the same time, state businesses, including farmers, have faced $231 million in retaliatory tariffs, according to U.S. Census Bureau data.

If additional tariffs on consumer goods go into place in December as planned, the government predicts U.S. households will incur an extra $1,000 to $2,000 annually in higher costs.

“The current threats and trade restrictions between the U.S. and its trading partners are already damaging Wisconsin business interests, not only causing counter-retaliations but also in chilling trade flow” between businesses here and their Chinese markets, says Ngosong Fonkem, a senior adviser at Addison-Clifton, who works with companies on day-to-day compliance with U.S. trade laws and related audits, investigations and civil enforcement proceedings.

“The trade war not only impacts Wisconsin businesses on the importing side but also on the exporting side as Wisconsin products entering China, the EU and Mexico are subject to additional duties imposed by the trading partners,” he says.

Initially, some businesses thought the tariffs with China would be a short-term issue, so they resolved to absorb the costs, but as the trade war drags on and intensifies, some are now rethinking their original positions, says Brad Baumann, a principal with CLA in Oshkosh.

“Businesses realize this is a long-term play situation. This (trade war) is going to be around awhile,” he says. “Even if Democrats win in 2020, nothing will change overnight. Companies will need to decide whether they want to pass on the higher costs to their consumers or begin looking at other strategies.”

One of Baumann’s clients manufactures half of its product in Wisconsin and the other half in China. While tariffs are increasing its costs associated with manufacturing, he says the company doesnt have the space or people to produce those products in Wisconsin.

“This is leading them to look at adding a new building or looking to shift some sourcing to Mexico from China,” Baumann says. “In the ecosystems that today’s businesses are operating in, few companies can make a quick change in supply chain vendors.”

Bearing the cost

Importers originally bear the additional cost of the tariffs, says Marc von der Ruhr, an economics professor at St. Norbert College in De Pere. For example, if there’s a 15 percent tariff, that percentage of the item’s value is paid to the government. The importer then needs to decide if it wants to pass on the entire cost to its buyers, absorb it or split the increase between both parties.

“Of course, the degree to which this happens depends on many factors,” von der Ruhr says. “One is how price-sensitive the consumer is. If the consumer is insensitive to price changes in the purchase decision, the consumer will pay more of the tax than otherwise. Both consumers and producers stand to be hurt by tariffs.”

As for the industries taking the biggest hit in the trade war, Fonkem says it’s clearly manufacturing and agriculture. That’s not by accident, he says, since those two industry sectors “have been specifically targeted by China and other trading partners due to their belief that they form President Trump’s core voting base” and that he may be more willing to make a deal to aid those industries since he doesn’t want to lose their support.

While Trump suggested businesses move their supply chains out of China to get around the tariffs, Baumann says that’s not as easy as it sounds.

“The capacity in manufacturing is very tight in the United States. We don’t have enough workers, and if production is moved back (here), there would be higher labor costs,” he says.

Ripon College’s Hauge says overhauling a supply chain is also not an inexpensive task.

“For businesses that make products in China and ship them back to the United States, creating a whole new supply chain in another country in east Asia or even back in the United States — as the president suggested — takes time and can cost more money” than what the tariffs cost, he says.

Baumann says, however, that as the trade war drags on, some manufacturers may take a serious look at creating a supply chain in another country, such as Vietnam or India, but it won’t happen overnight.

“I work with a manufacturer who is looking at possibly moving production out of China to another country, but it takes time to get that all figured out,” he says. “There’s much to consider, including different lead times and that the quality may not be where it should be. Those are all intangibles that need to be considered.”

While it may be challenging for U.S. companies to find suppliers not affected by the tariffs, the Chinese, on the other hand, have easily found non-U.S. sources for what it needs, Fonkem says. For example, Wisconsin soybean farmers have been locked out of their primary market — China — as part of the trade war. China has turned to other markets, including South America, to get its soybeans.

When the trade war is resolved, Fonkem wonders if Wisconsin farmers will be able to win back their customers. That question and others are getting more consideration as the trade war continues, he says.

Baumann says the tariffs may be one of the factors that leads to an economic slowdown. He says farmers who are unable to sell their soybeans or must sell them at a lower-than anticipated cost then may be unable to purchase new equipment and become wary of making any new investments.

“Manufacturing output is slowing, but I think there’s a number of factors coming into play,” Baumann says. “There’s less demand because with the tariffs, some people are hesitant to spend. There’s also a lot of political uncertainty heading into the next election and businesses don’t like uncertainty.”

Past lessons

For businesses wondering how the current trade war will end, history may not be a good indicator, Hauge says. Prior to World War II, trade wars between nations were common, but “global trade, as we now have it, wasn’t in place,” he says.

The World Trade Organization was created after World War II to promote economic stability through trade. The thinking was if two countries had a good trading relationship, it would benefit each one economically, and political disagreements would be resolved through negotiation, not the battlefield.

“The United States took the lead in creating the WTO since it encouraged trade, which allows economies to grow and leads to overall global stability,” Hauge says. “Economies of scale — which grew in popularity after World War II — meant that only some manufacturers would build certain items, such as enormous airplanes. It’s cheaper to make a lot of jets in one place than make them in multiple spots.”

But in doing that, the United States lost out to other nations in the production of some low-cost items, Hauge says. “We lost those jobs and really missed an opportunity to retrain and re-educate those workers for other jobs,” he says.

Fonkem says there is no scientific methodology for calculating how long trade wars last.

“International trade is the bedrock of the U.S. economy, and the longer that is impeded, the more the economy will be disrupted,” he says. “Typically, trade wars end only after long periods of settlement negotiations by the feuding nations, but there doesn’t appear to be an end in sight.”

St. Norbert’s von der Ruhr says a trade war with Japan in the 1980s may be the best example of what may happen with the current trade dispute with China. “We had a persistent trade dispute with Japan that was attributed to ‘unfair trade’ practices. That dispute lasted decades,” he says.

In announcing the tariffs, the U.S. government cited both the trade deficit with China and intellectual property theft as reasons for the move. Regarding stealing intellectual property, Hauge says China “has definitely bent current WTO rules, but tariffs by one country won’t make them change their MO. It would have been better if the U.S. had worked with its allies to provide more leverage and pressure to change how companies doing business there share their technology.”

As for the current tariffs reducing the U.S. trade deficit with China, von der Ruhr says that’s unlikely. “Tariffs will not reduce the trade deficit because U.S. importers will likely substitute imports from nations other than China,” he says.

The entire global economy may suffer from a lengthy trade war between the United States and China, Fonkem says.

“The trade war may decouple our economy from the Chinese supply chain, which may lead to grave consequences not just to the two countries’ economies, but the global economy.”