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Global supply chains adjust to escalating tariff war

2019-06-12 Source: Jctrans

Extension of US import duties to almost all Chinese products expected to accelerate trade diversion. But cargo owners have to consider multiple factors, including local labour costs and skills, infrastructure, proximity to demand as well as political and legal stability, Drewry notes

The threatened extension of US import duties to almost all Chinese products is expected to accelerate a process of ‘trade diversion’ that is already taking place, as cargo owners seek out alternative countries to manufacture and supply goods. But cargo owners have to consider multiple factors in making such decisions, container shipping and supply chain analyst Drewry observes, and it will take time for other locations to ramp up the production capacity needed to meet demand, while further trade attacks on other US partners could slow the process.

Drewry noted that in the first two years since US President Donald Trump entered office, from January 2017 to the end of last year, his actions saw the ratio of US imports from China covered by some form of trade protection rise from 2.3% to 14.9%, a figure that will rise to 100% if he follows through on his threat to slap tariffs on the remaining non-tariffed Chinese imports.

“His ‘weaponisation’ of tariffs is forcing cargo owners to re-shape global supply chains to avoid the fallout. There is very clear evidence from customs data that trade flows into the US have moved away from China to other locations of origin over the past year or so, with even the whiff of potential new tariffs hastening that movement,” Drewry noted.

“Switching the locations of production is not something done lightly and cargo owners have to weigh a myriad of factors, including local labour costs and skills, infrastructure, proximity to demand as well as political and legal stability, that all vary in importance depending on the sector. Adding to the complexity, having identified a new location, there can be no guarantees that the new production countries won’t find themselves being targeted by future tariffs. It is a costly endeavour with no safety assurances.”

Mexico, often cited as one of the US’ prime manufacturing alternatives to China, can certainly testify to the vagaries of President Trump actions, Drewry noted, highlighting the election promise of a border wall, followed by steel and aluminium tariffs that were used as bait to renegotiate NAFTA into the signed but yet-to-be ratified United States-Mexico-Canada Agreement (USMCA).

“Those tariffs (and the retaliatory measures) were lifted last month, but soon after President Trump threatened to impose escalating import duties (starting at 5% on 10 June and rising to 25% by October) on all Mexican goods in a bid to curb migration,” Drewry pointed out. “Following an agreement by the Mexican government to deploy thousands of National Guard troops the US President announced via Twitter that the tariff schedule has been ‘indefinitely suspended’.

“Trump can point to successes such as these, along with previous concessions by the likes of South Korea to limit steel exports, as vindication for his aggressive trade policy. However, ‘wins’ against smaller economies will not be so easy to repeat against a comparable economic super-power like China.

“They could even be counter-productive. By alienating its other trading partners, it could well be limiting its options just when it wants to reduce its inflows from China.”

Drewry noted that the three tranches of tariffs imposed on Chinese goods last year did chip away at China’s share of US imports in value terms, falling from 21.6% in 2017 to 21.2% in 2018, but eastbound trade between the two countries still increased by 6.7%.

“Trade growth with the rest of the world may have been faster last year, but there are limits to what can be expected in terms of substitution in the immediate future,” Drewry said. “Last year’s tariff schedule was designed to progressively attack Chinese imports in the sense that the earliest product lists had more readily available sourcing alternatives, making it easier for importers to simply ramp up production elsewhere to avoid the extra duties.”

Analysis of recent US customs data, split into the three different tariff products lists, shows how affected Chinese imports suffered as soon as the extra duties were applied, usually after a surge to beat the proposed deadline, Drewry observed.

“Unsurprisingly, the steepest fall off in Chinese imports occurred in the third $200 billion tranche, which has had the threat of increasing from 10% to 25% hanging over it even before it became effective in September, before it actually happened in May of this year,” it noted. “Shippers appear to have built the probability of a blanket 25% extra duty into their plans by switching as much of the cargo production to other locations as possible, even for goods that are currently untouched by tariffs.

“As we can see, there has already been some element of trade diversion, even for non-tariffed goods, but as the number of impacted products increases, inversely the capacity to switch decreases due to the dominance of China in particular product categories. For example, China commands over half of all US imports of furniture and footwear, goods typically shipped in containers. It has even greater penetration of high-tech electronic items such as cellular phones and laptops, items generally airfreighted. In such cases there is little scope for other locations to replace China on a like-for-like basis, and without a ready substitute these goods are due for some price inflation, potentially choking off demand.”

US consumers were largely shielded from the impact as the first two lists were primarily focused on intermediate and capital goods, Drewry noted, adding that even the bigger third list that contained more consumer items and was more heavily weighted towards China was offset by a lower tariff increase of 10% and devaluation to the Chinese currency. 

“It will be harder for Trump to protect American shoppers now that the third tariff list has been raised to 25% and the wheels have been set in motion to do the same for all remaining Chinese goods,” it added. “The US economy is in good health, with a long streak of high jobs and wage growth, but those indicators are slowing and any significant increase in common luxury goods such as smart phones might challenge Trump’s trade policies.”

So far, China has fought blow for blow with Trump, issuing its own retaliatory tariffs and responding to each social media missive from Donald Trump with its own equally combative statements, usually delivered via more traditional channels, Drewry noted. “But it will be hurting from this standoff with its biggest export market. Other markets might pick up some of the slack, but it will be afraid of losing its status as the world’s factory.”

Neighbouring economies in Asia are benefiting from the dispute, with US customs data revealing Asian exports, excluding China, the fastest growing exporters to America. “There is a risk that China will require fewer of their intermediate inputs if the export production line of finished goods to the US slows, but this is something they have grown used to as China’s manufacturing independence has developed,” Drewry noted.

It pointed to anecdotal reports that Chinese goods are being transhipped to places such as Vietnam and Malaysia, simply to have the ‘Made in China’ label replaced to avoid the duties. “If true, this gaming of the US tariffs means extra Intra-Asia traffic, a positive for shipping lines in the region, but equally that customs data is less reliable as a gauge for supply chain diversion,” Drewry said.

But assuming the data is trustworthy, there are various implications for shipping lines from the supply chain relocation, Drewry noted, with transpacific volumes likely to dip “as demand for the large swathe of Chinese goods that cannot readily be substituted wanes amid cost rises, although some element of substitution to other Asian territories will offer some support”.

It said transpacific shipping schedules will need to be broadened to reach more non-Chinese ports, noting that the relative scarcity of direct port links in other parts of Asia to the US is already being reflected in higher freight rates.

Meanwhile, greater US trade with Europe will favour US East Coast ports and demand more of the smaller ships that coast can currently accommodate, Drewry noted. But most worryingly for lines, more intra-regional NAFTA/USMCA trade will diminish the demand for ocean carrier services altogether.

But perhaps the most damaging aspect is the uncertainty, Drewry observed, adding: “Nobody can second-guess the US President and the changing panic level and deadline shifting has made it impossible to know what is coming next.

“Worse could follow if threatened auto tariffs come to fruition. Hope for the best, but prepare for the worst is probably the best advice to cargo owners.”

Drewry concluded: “It seems likely that all Chinese goods will be touched by tariffs in the near future. This will expedite trade diversion, but it will take time for other locations to ramp up the production capacity to meet demand and, in some cases, it is doubtful this is a possibility due to China’s dominance of certain products. Further trade attacks on other US partners could slow the process.”

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