US-China trade war – 7: The forgotten importers

So, Trump and Xi Jinping are meeting in Osaka on Saturday, for 90 minutes.  We are told they are good friends, there is hope.  Many are waiting – with bated breath.  Well I don’t believe it.  The bit about them being good friends.  How can you be good friends when you only have met a couple of times?   They are not meeting because of friendship; they are meeting because they have to.

Both sides have publicly hardened their position prior to the meeting, so much so that many experts say a deal will not be possible because it will be seen as capitulating by one side or the other.  But that too is nonsense.  Both leaders have enough power within their circles to dictate an outcome, both leaders are experts in presenting their message to their constituency, and both have enough ammunition to justify the big C.  And the big C is not “capitulation” it is “compromise.” Whether they will or not remains to be seen.  We will know more on Saturday.

The Forgotten Importers

In the meantime, importers are under a cloud instead of being appreciated and recognized for who they are: true champions of global free enterprise.

As a group, importers are seekers of efficiency.  They go find suppliers that can deliver quality products at the best possible cost. They are concerned about repeatability and scalability in order to deliver to their customers the best possible value over time.  They are preoccupied with corporate social responsibility (CSR) and so get involved in audits and certifications of factories.

They are most aware of the complexity of the supply chain, of the fact that it is not just the good factory they have found that delivers results but it is the network of sub-suppliers in the environment of that factory that enable it to produce the low cost, good quality product they need.

It was those importers, with their myriad of products and seemingly inexhaustible need for more and better goods, who enabled the rise of China.  They were the essential conduits that allowed China to export more and more products; they were the catalysts that caused the rise of the Chinese entrepreneur at the expense of state-owned enterprises (more than 90% of Chinese exporters are private enterprises today) in the China supply chain.

By the same token, importers can be credited for the stable, steady supply of low-cost goods that have allowed US consumers to enjoy such a high standard of living for a very long time.

Yet now they suffer, for two main reasons: Tariffs and uncertainty.

• Tariffs because it is the importer, not China, who has to pay the tariffs.
• Uncertainty because there is no stability, no predictability to the current situation.

Estimating the Impact

To estimate the trade war impact in general is difficult because each product has a different supply chain profile.  Some products are easily sourced in other countries, other products are nearly impossible to source outside of China.  Some imports are raw materials (think: rare earths); some are components of a bigger product (like car parts); some others are the product itself (like most consumer products).   Tariffs affect all of these differently.

Ultimately tariffs are designed to force importers to leave China.  25% tariffs on all imports (the Armageddon scenario) will eventually cause an ABC (Anywhere But China) syndrome.  But supply chains can be very difficult to shift.  So, the China exit may take a long time for many products and may even be impossible for others.

The general rule on tariff impact is simple: all tariffs will cause an increase in costs, and the longer they last the more pain they will inflict.  For example, tariffs of 5% or less can be absorbed (for most products) whereas tariffs of 25%, in the long run, cannot.  If the tariffs last one year, the supply chain will try and cushion the effect, and the end-user will endure less pain at the cash register. If it lasts more than one year, then most of the costs will progressively be passed on to the consumer.

Uncertainty also goes beyond China.  What if, for instance, Trump focuses on Vietnam or India next, and threatens them with tariffs like he did for Mexico?  How is an importer supposed to manage an international supply chain with this kind of uncertainty?

How Importers Can Protect Themselves

Keeping the above in mind, there are many strategies importers will consider to offset the threats, the damages, and the costs of this trade war, including:

• Sharing tariff costs: Example: If the tariffs are 10%, they might say to the supplier “let’s go 50/50” and demand a 5% discount.  The importer will absorb the rest.  If the tariffs are 25% the importers will look for a different country of origin but this may take time so, in the meantime, they will seek to share the pain, for instance: 7% from the supplier; 8% lower margin for the importer, and 10% higher price to the customer.
• Pretending to move out of China. Recently imports from Vietnam have soared, while China imports have dropped by nearly 14%. But US customs is questioning Vietnam imports because they suspect that most of the merchandise was actually made in China for final tweaking and labeling in Vietnam. This approach would not meet country of origin rules and is thus very risky for importers.
• Moving production out of China. For real, with Chinese suppliers.  This can be done for certain products quite easily. Often it is the Chinese manufacturers that make the move, taking their US customers with them.  Candidate countries for this are mostly adjacent to China, like Vietnam, Thailand, Laos, Myanmar, or close by in South East Asia, like Bangladesh, Cambodia, and Indonesia.  Some suppliers have established factories in Africa.
• Moving production to other countries, like Mexico, India, Pakistan, Turkey or Eastern Europe. This can work for certain products but setting up brand new supply chains is a risky and tedious process.  Murphy is alive and well, and much can go wrong.
• Re-shoring:Moving production back to the USA is the main objective of the Trump administration, and sometimes this is the solution.  But rarely. Mostly because (a) costs are still higher in the US; (b) the qualified labor infrastructure is no longer in place and, (c) most people are simply not willing to pay much more for a “made in the USA” label.

How will tariffs affect specific industries?  This articlefrom the Wall Street Journal, published on May 11, 2019, provides a good overview of the impact on various industries ranging from autos to bicycles, to consumer goods; semi-conductors; medical devices, etc.  But don’t look for good news: the gist is that the impact will be costly and most are hoping for a successful agreement while bracing themselves for the worst.

So, what is the impact of the trade war on importers?

• In the short to medium term, many will lose money and spend resources in trying to find solutions.
• In the long term, the weak will lose out and the strong will survive, some will even thrive.

Disruption can cause strange and unexpected behaviors, many of which do not conform to Trump’s objectives. Two examples:

• Apple has just decided to move to China the only product it was assembling in the USA, the Mac Pro.
• Harley Davidson has just announced it will manufacture motorcycles in China.  Its stock rose as a result.

In the meantime, we note this:

“We are right where we want to be with China. Remember, they broke the deal with us & tried to renegotiate. We will be taking in Tens of Billions of Dollars in Tariffs from China. Buyers of product can make it themselves in the USA (ideal), or buy it from non-Tariffed countries…”
(Trump Tweet 5:06 PM – May 12, 2019)

And we hear that China, prior to the meeting in Osaka, has issued the US a list of demands to settle the agreement, thus exhibiting great confidence in their position.

Be very afraid.

It is hard to imagine that with statements like these, Trump will have a friendly or a successful meeting with Xi Jinping on Saturday.  They both act so confident that compromise may not occur to them.  We can only wish that, deep down inside, they are both very afraid of the consequences of a continued trade war.

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