Supply Chains

July 16, 2018

As some of you may have discovered, Scott Miller and I have become The Trade Guys, doing a weekly podcast. We try to talk about trade in terms everyone can understand, or, failing that, at least terms we can understand. We are not (yet) as funny as NPR's Car Guys, but we aspire. After all, you can't say trade doesn't have its funny moments these days. Last week we did our first interview—with Blake Hurst, president of the Missouri Farm Bureau and a farmer himself, of soybeans.

Blake had a lot of thoughtful comments, but I particularly liked what he said about the difficulty of turning things on and off. There seems to be an assumption in the administration that tariffs are a simple tactic. You impose them to pressure the other guy, and then when that works you lift them and things go back to the way they were. Blake explained why it's not that simple. Trade with Asia in particular is relationship based. That is, buyers want to meet, know, and have a relationship with their suppliers. They want to know if they can trust them. That's why farmers travel—so they can develop relationships. Imposing tariffs breaks those relationships because they force buyers to find new sources at lower prices. In agriculture that can happen fairly quickly, since buyers, particularly in China, can see it coming and prepare. But what happens when the tariffs come off? Buyers are not simply going to abandon their new relationships and go back to the old ones, particularly when the United States is busy showing the world it is an unreliable supplier. In other words, putting tariffs on and off is not like flipping a switch. Markets lost are not easily or quickly regained. More likely they are gone for good. 

This is also true in manufacturing, although for different reasons. There the most significant development of the past thirty years is the creation of the global supply chain. In the good old days, which our president apparently wants to return to, products were made from start to finish in one country and either consumed there or exported. Thanks to huge improvements in transportation and communication, companies are now able to disaggregate the production process and obtain parts, components, and subassemblies from all over the world based on quality, price, and ability to deliver on time. For example, here is a snapshot of the Boeing 787 supply chain. 

This has been a transformational development from two perspectives. From the standpoint of the U.S. company, supply chains have enabled them to be globally competitive when they otherwise would not have been because of higher domestic labor and factor input costs. From the standpoint of other countries, particularly developing ones, supply chains create another path to industrialization, jobs, and growth. Now, if you're Thailand, for example, you don't need to do what the Malaysians did (with mixed success) and develop your own car. You need to figure out how to become part of Toyota's (or anybody else's) supply chain. That is not easy, but it is easier than going it alone, and in the process you develop the manufacturing know-how and job skills that are transferable to other sectors.

So what does that have to do with tariffs? For American companies it means supply chains that took years to develop and often required substantial investment in training and equipment will now have to be changed. That is neither quick nor cheap, and despite the president's desire, it will probably not involve bringing production back to the United States. It makes much more sense to establish new supply chains—also at significant cost and time—in other low-cost countries that are not victims of our tariff attacks. I would like to think our corporate executives are all patriots, but I also know they're not suicidal and are not going to take steps that they know will kill their company. Remember, again, the Harley-Davidson story.

For foreign countries, U.S. tariffs are a reminder of the importance of being in regional trade agreements. After all, TPP and now CPTPP are really about developing supply chains inside the free trade zone in order to take advantage of the reduced duties. For developing countries, being a member of the FTA zone is a big advantage for accessing supply chains. 

Companies, in turn, have an incentive to move to FTA zones to obtain the tariff advantages. That will be true of companies in third countries, but it is also true of U.S. companies. New FTAs like Japan-EU, Canada-EU, and Mexico-EU are all incentives for U.S. companies to invest there in order to obtain preferential access to those markets. The United States has begun the process of turning away from regional groupings and wants to force our companies back on shore by discouraging foreign investment and forcing them to alter their supply chains. It is clear that doing so would be time-consuming and expensive but also economically irrational. It would pull us out of the world at the very time it is more important than ever that we be in it and that we lead it. I think our companies will be smarter than that even if it means taking heat from the president. 

William Reinsch holds the Scholl Chair in International Business at the Center for Strategic and International Studies in Washington, D.C.

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