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Rethinking the Supply Chain During COVID-19

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Archives, Global Logistics, Global Trade Daily

Rethinking the Supply Chain During COVID-19

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For decades, labor cost differences have been a primary influence in the continuous shift of manufacturing production from the U.S. to China. In 1980, the cost of labor in the U.S. was more than 30 times of that in China. As China became less agrarian and more of its population migrated to large cities to work in new factories, wages rose dramatically. By 2018, the U.S.-China wage gap had closed to only four times, rising approximately 200% in the U.S. but over 2,000% in China over nearly 40 years. Yet, despite the sharp rise in Chinese manufacturing wages over the last 20 years, offshoring continued. The U.S. manufacturing industry suffered, including millions of lost jobs, stagnant inflation-adjusted wages and a decline of the middle class.

Change in wages in U.S. and China from 1980-2018

Predictable wage increases in China do not tell the whole story of America’s declining status as a factory for the world. The establishment of special, quasi-free market Special Economic Zones, seemingly endless supply of relatively inexpensive labor, and fully globalized shipping networks allowed China to capitalize on the high cost of manufacturing in the U.S., but perhaps a more important development was the world’s relentless march toward automation and robotics.

The replacement of manual labor by machines and software may have had just as much influence on the decline of the American manufacturing industry as foreign labor costs, domestic labor unions, and international trade policy. Whether attributable to man or machine, parts of the American manufacturing industry have struggled for decades to be competitive and relevant, leading the industry to focus the remaining competitive advantages on the manufacture of niche, value-add, or raw material-dependent products.

Despite a steady increase in their workers’ productivity, most American manufacturers have not been able to automate or reduce logistics costs enough to remain competitive—and offshoring, primarily to Asia, became an unfortunate reality for corporations of all sizes. When any company established a manufacturing presence in China and built a global supply chain, pressure was applied to its remaining competitors in the U.S. to either innovate or follow suit. Among some of the first U.S. manufacturers to offshore en masse were labor-intensive sectors, such as furniture and textiles, followed by manufacturers with relatively low transportation costs, such as pharmaceuticals and semiconductors.

Approximately a decade ago, several institutions in the U.S. converged on a theory that significant changes in U.S. manufacturers’ cost-benefit analysis were occurring and could create a tipping point toward reshoring certain products. The average hourly wages for reliable, competent labor in China and the cost of transporting manufactured goods safely and efficiently to consumers had shifted to such an extent that American manufacturers could potentially reshore their operations to the U.S. or near-shore them to Latin America. Their tipping point theory, predicated on higher Chinese production wages and increasingly complex and expensive global transportation and logistics costs, asserted that over a dozen manufacturing sectors showed formulaic probability of reshoring.

Today, nearly 10 years after the tipping point theory was first publicized, the American manufacturing industry may be on the precipice of another large surge in activity. Through the Great Recession and recovery, American manufacturing was kept buoyant by high-margin, low-volume products. Factoring in the current public health emergency and the current Administration’s response, the U.S. manufacturing sector could regain some of its prior job losses in impacted industries.

The U.S. manufacturing industry is at a unique and unprecedented crossroads. Of the dozen or so manufacturing sectors that previously showed potential for being reshored by rising labor costs and comparatively steep transportation and logistics costs, the tipping point has further shifted, and justification for domestic manufacturing appears stronger. As the world struggles to contain the coronavirus and understand its long-term implications on our social, medical, educational and economic systems, Duff & Phelps has created a new analysis of the prior tipping point theory and integrated several key strategic factors that carry more (or at least equal) weight in a post-COVID-19 world.

To refresh the study, Duff & Phelps adjusted for new global economic conditions, plotted current data for all major production categories and determined a new tipping point for sectors across the manufacturing industry. We began our analysis by identifying, measuring, and weighting key metrics for companies with manufacturing operations in China, including cost (labor + logistics), automation (labor productivity), innovation (R&D, IP, patents, etc.), quality and safety, sustainability (environmental regulations and pollution), and national security (critical/essential designations). Specifically, our “reshoring analysis” used six objective criteria to analyze 28 sectors of the American manufacturing industry, identified by North American Industry Classification System (NAICS) codes, which were ultimately ranked according to which showed the greatest potential for re-shoring

The following six criteria and circumstantial factors show the highest probability of a given sector to reshore:

Cost: sectors with low labor costs and high logistics costs

Level of Automation: sectors that have seen a major increase in labor productivity

Innovation and Intellectual Property: sectors with relatively high R&D spending, particularly valuable intellectual property embedded within the manufacturing process or significant patent applications

Product Quality and Safety: sectors with stricter quality and safety regulations (e.g., food, drugs)

Essential Business Designation: businesses, sectors or products officially designated as critical or essential by the U.S. Department of Homeland Security or other governmental authority

Environmental Regulations: sectors whose cost of capital justifies capital investment in real or personal property improvements that allow production to meet or exceed U.S. emissions or pollution regulations

In our analysis of the six primary criteria and 28 sectors, a composite of the eight highest-scoring production categories emerged as the most probable candidates to reshore to the U.S. They share the characteristics of relatively low labor and high transportation costs and feature some of the most advanced robotics, automation and manufacturing techniques across all technology-enabled industries.  Their manufacturing processes are more compliant with and conducive to U.S. environmental regulations, labor laws, intellectual property protections and consumer safety standards. Their profit margins and global demand also tend to alleviate concerns associated with reshoring investment costs. Given the U.S. government’s renewed focus on homeland security and essential goods and services in the wake of COVID-19, the following industry sectors will have to reevaluate their manufacturing costs, supply chain reliability and risk of significant business interruption even while the pandemic is still ongoing:

-Automobiles, bodies, trailers and parts

-Other transportation equipment (e.g., boats, rail)

-Navigational, measuring, electromedical and control instruments

-Basic chemicals

-Semiconductor and electronic components

-Medical equipment and supplies

-Communications equipment

-Aerospace products and parts.

U.S.-China trade flows and top candidates for reshoring

Today, cost isn’t the only significant factor influencing U.S. corporations’ manufacturing footprint. Based on the following factors, manufacturing in the U.S. may become economically feasible for more sectors and the U.S. may experience active and passive reshoring effects as companies consider these variables:

Economic

-Rising cost of labor in China

-Increasing transparency into foreign working conditions and safety measures

-Rising logistics costs

-Corporate supply chain risk mitigation and the identification of critical supplies

-Internet/information-driven consumer awareness and sentiment

-Cost and threat of intellectual property theft

Environmental

-Enforcement of environmental laws and regulations in China’s manufacturing sector

-Sustainability and a global shift away from fossil-fuels power

-Reduced consumerism among millennials and younger generations with increased spending power for durable and non-durable goods

Geopolitical

-U.S.-China trade war and tariff impacts

-Anti-globalization and nationalist political, social and cultural trends across the world

-Consumers’ increasing demands for transparency of product content and origin

-The Trump administration’s calls for U.S. companies to reduce China-centric supply chains, even before COVID-19

-U.S.-China tensions over democracy protests in Hong Kong, origins of COVID-19, military escalation along the Indian border and in the South China Sea

-Human rights abuses of millions of ethnic Uyghurs in Chinese detention camps

Domestic Policy

-U.S.-Mexico-Canada Agreement ratification

-COVID-19 related essential business, industry and product designations by various U.S. agencies

-Potential for new legislation, regulation or designation of previously outsourced or offshored products and services that are now deemed critical to the U.S. economy or economic infrastructure

Regardless of COVID-19’s impact to the global economic structure, many large American manufacturing operations will likely remain anchored in China since production in the U.S. continues to be labor-intensive and/or global distribution is still so cost=efficient. However, our analysis suggests that additional factors beyond economic ones are being weighted more heavily and that many products historically made in China and destined for U.S. consumers or other markets around the world show high potential for being reshored.

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Gregory Burkart is managing director and global leader of Duff & Phelps’ Site Selection and Incentives Advisory practice. Kurt Steltenpohl is a managing director in Duff & Phelps’ Transaction Advisory Services practice and leader of Operations Consulting.

Duff & Phelps’ Danielle Dipietra, Meegan Spicer, Anthony Schum and Wesley Michael also contributed to this article.

A version of this article was previously published in IndustryWeek.

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Archives, Global Trade Daily, International Trade

U.S.-CHINA TRADE WAR TIMELINE

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Unconventional Trade Warfare

Since taking office, the Trump administration has been building its case against Chinese practices they view as unfair to American businesses, including subsidization of industrial production and requirements to transfer proprietary U.S. technologies. The Trump administration has also taken aim at the opaque connections between state-directed and strategic private enterprises, seeking to tighten oversight of Chinese investments in the United States and make examples of Chinese companies like ZTE Corporation that might be working around U.S. sanctions against Iran and North Korea.

It has been an unconventional and rapid-fire series of steps as the Trump administration deploys a variety of executive powers, U.S. trade laws, WTO proceedings, and threats. American companies and the average consumer can hardly keep track of proposed tariffs, real actions, and market reactions. Some of these measures our manufacturers and innovators have been seeking for years, but other measures they aren’t sure they want at all, or worry about the consequences of Chinese retaliation. America’s farmers are especially worried about getting caught in the crosshairs.

On January 15, the United States and China signed an unprecedented type of trade deal. If you’ve lost track of how we got here, below is a handy quick guide to recent events in this unfolding U.S.-China trade war. Download and share the graphic, updated as of October 14, 2020.

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Andrea Durkin is the Editor-in-Chief of TradeVistas and Founder of Sparkplug, LLC. Ms. Durkin previously served as a U.S. Government trade negotiator and has proudly taught international trade policy and negotiations for the last fifteen years as an Adjunct Professor at Georgetown University’s Master of Science in Foreign Service program.

This article originally appeared on TradeVistas.org. Republished with permission.

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Archives, Global Logistics, Global Trade Daily, Stories

THE PANDEMIC DISRUPTED GLOBAL SUPPLY CHAINS BUT WERE THEY ALREADY MORPHING?

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COVID-19 is disrupting the operation of global supply chains, causing many businesses (and countries) to rethink where they source their products. Is the pandemic accelerating trends already underway? Were trade policies – both liberalizing and protectionist – inducing some degree of “nearshoring” to avoid tariffs or to focus on regional trade made easier and less costly through free trade agreements?

In the case of the United States at least, the answer may be yes.

How Global Supply Chains Stretched

Supply chains encompass all the people, technology and resources that go into producing a final product or service. Supply “chain” is an oversimplified term as they are not linear; they are more like interconnected networks.

Historically, supply chains were extremely short – you, or maybe your village, were the entire chain. As economies grew more complex, so did supply chains, enabling more firms to specialize. Companies are now able to source from a wide variety of suppliers to reduce costs and improve efficiency.

Advances in communication technologies and transportation made it both inexpensive for products to cross national borders multiple times and easier to coordinate complex activities at a distance. Resources, labor and technological expertise in multiple countries are leveraged as value is added throughout global supply chains. International production strengthened many companies’ competitiveness. Many multinational companies also invested in production overseas as part of their supply chain strategies.

Stretched and Strained

As supply chains stretched, imports became increasingly important in the U.S. American manufacturers rely heavily on imports for the inputs into their American-made goods whether those goods are consumed domestically or ultimately exported.

For many years China has been the go-to for much of this intermediary production, with companies attracted to its large supply of low-wage workers and China’s specialization in certain manufacturing. The concentration of manufacturing in China has led to mounting concern over whether China is competing unfairly through subsidization, market access restrictions, technology transfer and localization requirements. These and other policies have attracted more manufacturing to China and away from both advanced economies like the United States and other low-cost producers in Asia, a trend that may be now reversing.

The COVID-19 pandemic brought this concern into sharp relief, sparking policy discussions over whether U.S. innovators and producers have become over-reliant on China for resources, inputs and final production. But even before the pandemic, the subtext of the U.S.-China trade war was U.S. pressure on companies to reexamine and “rebalance” the structure of their supply and production networks as incentivized by mounting tariffs.

And even before the tariff war heated up, businesses were seeking ways to shorten their global supply chains to reduce their vulnerability to external disruptions such as changes to trade rules, natural disasters, or other crises, according to a 2017 report by The Economist Intelligence Unit and Standard Chartered.

Has Global Value Chain Participation Peaked?

So now that COVID-19 has caused severe disruption to supply chains, the question on everyone’s minds is: will it cause a retreat in participation in global value chains? Or, was participation in global value chains already peaking before the pandemic and if so, will the pandemic hasten the decline?

We can calculate trends in global value chain (GVC) participation using the UNCTAD-Eora Global Value Chain (GVC) Database. Though supply chains and value chains are not exactly analogous, both show the spread of supply networks across countries. A country’s global value chain participation index can be calculated by summing the foreign value added (FVA) and the indirect value added (DVX) content of its exports, and dividing this by its gross exports.

The chart below shows participation in GVCs generally flattened out from around 2010-2012 after dipping in 2008. It does not show a retreat from global supply chain involvement (though India shows a slight decline). COVID-19 renders the future trajectory unpredictable.

Another measure of trends in global value chains is global foreign direct investment (FDI). In this respect, the trends are far clearer. The data show a significant and sharp decrease in FDI since 2008. This may be a reflection of the decreasing rate of return on FDI, as the initial returns to scale for large multinational corporations start to diminish and new local competitors come online.

The expansion of the digital economy is also likely a big factor in shifts away from FDI commitments, as improvements and diffusion of technology allows businesses to provide services without foreign direct investment in a location. A reduction in FDI may therefore show a complete removal of international involvement, or may just represent a shift in the distance and nature of involvement and investments in foreign markets.

Diversification and Regionalization, Not De-globalization

The expansion of global value chains does appear to have slowed from the heady pre-recession era, and direct on-the-ground investment has plummeted. But, just as with globalization in general, it is too early to say whether supply chains as a whole are shrinking, shifting or something else. Companies could be mitigating risk by diversifying supplier relationships and regionalizing supply chains in response to a proliferation of regional trade agreements that removed barriers.

Looking at the United States specifically, there is evidence of both shifts.

As seen in the chart below, the share of total U.S. imports from China have sharply declined. As we might expect, 2017 marks the beginning of a downturn in the share of imports coming from China. The particularly sharp drop after 2018 shows the effects of the U.S.-China trade war, reflecting the increased costs imposed by tariffs. The sustained political risk combined with trade policies prompted businesses to reduce reliance on exports from China in favor of sourcing elsewhere in the world.

Over the same time period, low-cost Asian producers such as Thailand and Vietnam saw an uptick in share of U.S. imports. U.S. companies may be diversifying production relationships away from China and toward other countries in the region, or at least taking advantage of excess production capacity in facilities elsewhere. The increases are significant but not massive in real monetary terms for a single country, suggesting a “don’t put all your eggs in one basket” mentality.

Even the United States’ largest tech companies like Apple, Microsoft and Google have been reportedly exploring similar moves. In their recent re-shoring report, Kearney found evidence that low-cost producers in Asia have been the beneficiaries over the last five years of efforts from U.S. companies to diversify their supplier networks.

There is also evidence that companies are doubling down on natural geographic trading partners through regionalization of supply networks. Mexico’s share of U.S. imports has increased steadily over the last few years, with a particularly sharp increase in 2019 in tandem with the U.S.-China tariff war.

Regional economic integration is not a new policy strategy. Many of the earliest free trade agreements were regional in nature. Under NAFTA, U.S. firms leveraged the complementary assets of our neighbors to the north and south to strengthen the global competitiveness of regionally-made products. As the Bush Institute Global Competitiveness Scorecard shows, the United States, Canada and Mexico are more competitive as a North American region than any other region in the world. The implementation of the U.S.-Mexico-Canada Agreement will provide incentive to reinforce these relationships as U.S. companies think about “rebalancing” their supply networks.

What to Look For

It is still too early to see the real effects of the COVID-19 pandemic or even the US-China trade war in the data on imports and global value chains, predictions notwithstanding.

Global value chains may be expected to remain complex, but could shift to cross borders that are closer geographically as trade increases among regional partners within Europe, North America and Pacific Rim countries. A key indicator for this will be changes in shipping trends. Expert Martin Stopford predicts a decrease in demand for large container ships and an uptick in demand for smaller shipping vessels that are more economical for shorter routes.

Before the pandemic, global supply chain expansion was not increasing at the speed it once was, but reports of its demise are premature. Instead, companies are thinking about diversification for improved resilience without sacrificing the benefits of a global and interconnected system of international trade.

Meanwhile, hopes for American reshoring may be equally overblown. The United States has obstacles to overcome, including a shortage of skilled labor and high production costs. Nonetheless, companies will have to assess whether a cost-above-all-else approach to manufacturing and sourcing is sustainable in a post-pandemic global economy.

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Alice Calder received her MA in Applied Economics at GMU. Originally from the UK, where she received her BA in Philosophy and Political Economy from the University of Exeter, living and working internationally sparked her interest in trade issues as well as the intersection of economics and culture.

This article originally appeared on TradeVistas.org. Republished with permission.
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Archives, Global Trade Daily, Imports/Exports, International Trade

Global Stock Markets Impacted by Trade War

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Understanding the finer points of the stock market and the how and why of its ups and downs is a complex task for anyone. When major shifts in a whole diaspora of fields occur, people often look to the stock market as a gauge for how significant those shifts really are and what the potential results are going to come out as. World news is often reported as to how it has an impact on the world of finance, and this is certainly one such instance, as President Trump trades tariff blows with China in a rapidly escalating trade war. The impact of this trade war certainly didn’t avoid the stock market, which took notice of the shifting costs of exports and imports and created a noticeable response. Let’s take a look at what’s really going on in this recent episode in the global economy.

Trump VS China

The US President’s attitude towards foreign nations is an eternally shifting spectrum, though it does tend to rest somewhere towards antagonistic for the sake of sending a message. Trump’s ‘show of force’ tactics recently got him into a situation with China on a trade front, causing a situation that has impacted all of the global markets, and heavily impacted the American and Chinese markets. “Trump has a latent tension towards China that simply won’t abate, no matter how few tangible issues there are in reality. This drove him most recently to impose some pretty severe tariffs on Chinese goods,” reports Samuel Chang, data analyst at WriteMyx and BritStudent.

US Tariff

The United States began a 15 percent tariff on hundreds of billions of dollars of Chinese goods for import, from tech to clothing. Trump’s explanation for his move relates again to his suspicion of all of the largest global powers, from Russia to China. He spoke out, via his favorite medium Twitter, about the US over-reliance on Chinese exports, and that his tariff was a motivator for US companies to look for alternative solutions for suppliers outside of China, rather than simply turning to some nation over and over again to supply the products they needed.

Trump’s Reasoning

Trump’s steps to disincentivize US trade with China could be viewed as impulsive, since the immediate effects of so drastic a tariff will likely fall on the US consumer, with US household costs potentially rising by up to $1000 a year, with such a large selection of consumer goods now made noticeably more expensive. Similarly, Trump’s plan, though it must have considered the possibility of consequences, didn’t allow for a reaction in the opposite direction as the Chinese trade officials lashed back at the tariff.

The Chinese Response

Not ones to be out-maneuvered, least of all by Trump, the Chinese responded to the tariffs with sanctions of their own that were as much a political response as a practical one, as they delivered a counter punch to Trump’s initial move. China immediately imposed additional tariffs on exported goods on a $75-billion target list, and further tariffs were placed on thousands of items originating from the US. Similarly, China was quick to begin imposing new duties on US crude oil, a predictable but damaging move that has made the potential fallout and impact on global stock markets more noticeable.

The Trade War Fallout

“Such actions from nations as influential as the US and China don’t come without an impact that affects people from all around the world. In this instance, a variety of shifts have left most markets a little worse for wear, but most drastic damage has been avoided”, explains Mark Cherry, a business writer at Australia2Write and NextCoursework. The fallout included the US stock futures dipping 0.7% and the Asian markets are down. A noticeable drop in oil prices was also recorded, as would have been expected after the duties imposed on US crude by the Chinese.

Conclusion

This is the latest in a series of jabs between the US and China, though there is no sense in which these sorts of interactions have all that much of a practical purpose. Though this particular episode abated pretty swiftly, the threat of further escalations has made the market quite jittery.

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Mildred Delgado is a young and responsible marketing strategist at PhdKingdom and AcademicBrits. She works with a company’s marketing team in order to create a fully-functional site that accurately portrays the company. Mildred is also responsible for presenting these details to stakeholders in a series of marketing proposals. You can find her work at OriginWritings.

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Archives, Global Trade Daily, Imports/Exports

Most Affected Industries By US-China Trade War

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Since Donald Trump became president, the US and Chinese governments have been at loggerheads after the Trump administration started imposing hiked tariffs on goods coming from China. This came hot on the heels of a trade deal that the two governments had been negotiating on, a deal that was supposed to strengthen trade between the two global economic powerhouses. Hundreds of billions of dollars’ worth of Chinese goods are now being tariffed at 25%, up from 10%. China is threatening to come up with stringent countermeasures, which threatens to precipitate a full-blown trade war.

Trade experts are predicting that American companies that import goods from China will be paying unreasonably hefty taxes to their government by 2020. That could cripple their operations.

This trade tension has precipitated many harsh and far-reaching consequences. Manufacturers and importers in the US are now cutting costs, postponing key business deals, and putting off investments in a bid to cushion the business-crippling impact of the trade wars. Moody’s Analytics- an American economic research firm- estimates that this has already cost 300,000 Americans their jobs and if things don’t change for the better, more than 450,000 job opportunities will have been quashed by the end of 2019. This impact is being felt across industries, although some industries have been affected more than others. Here are some of these industries:

The Energy Sector

Steel and aluminum are very important to America’s energy sector. They are used to construct oil pipelines, to build solar panels, to distribute electric power- you name it! President Trump has proposed an additional tax on aluminum and steel imports from China, which has already caused the country’s energy PD to hike significantly. Projects in the energy sector will keep getting pricier, which in turn will force consumers to pay higher prices for clean energy. If the price gets out of hand, there is a serious danger of many Americans ditching the expensive clean energy for the cheaper dirty energy.

Automobiles

American automakers sell most of their products in the Chinese market. In 2018, as a countermeasure, the Chinese government raised tariffs from 15% to 40% for all automobiles entering its market from the US. This hasn’t affected the Chinese so much, bearing in mind that the Asian nation has a thriving automobile sector that can satisfy the local market.

On the other hand, American electric automakers including Tesla Inc. (TSLA) will be feeling the pinch in the long run if the China-US trade tension deteriorates. Auto parts sellers will also stand to lose if the situation won’t improve. That being said, things are looking up for this industry as the Chinese government promised to suspend the tariffs as an act of goodwill. If the US could return the gesture, fortunes are likely to turn in favor of American automakers.

Translation Industry

Digital technology has allowed many American firms to expand their products and services in China. The Asian market helps companies from the west to generate a consistent growth rate of 4-5% per annum, sometimes more. That is why localization services have become very marketable in the recent past: If you want to expand in China, you should consider hiring professional translation services to handle all your localization projects, failure to which you could greatly hurt your chances of understanding or impressing your Chinese customers. But then with the growing trade tension, lesser companies will be keen to move to China in the future, which will mean lesser need for translation services. The translation industry in China could really suffer going forward.


Food and Agribusiness

The Chinese government cut off imports of corn, soybeans, nuts, lobster, and other farm products from the US. The American farmers are now struggling to find a market for their produce, which has, in turn, affected their productivity. Tractor manufacturers and farm input sellers are also feeling the pinch. Processed food companies in the US might be forced to lay off workers and close some of their processing plants if things remain as they are.

Tech Sector

Most tech companies in the US have opened shops in China, some of them including NVIDIA Corp. (NVDA) and Intel Corp. (INTC). Chinese tech manufacturers, on the other hand, depend on American semiconductor suppliers to run their businesses. An escalation in the U.S.-China trade war could really hurt tech traders in both countries.

Conclusion

The tension between the U.S. and Chinese officials could end up hurting key industries in both economies. It could be a battle over who will control international trade, but it can easily boil over and become counterproductive. The sad thing is that no one really knows for sure if the tension will rage on or we still are going to witness more draconian tariffs. Only time will tell.

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Archives, Global Trade Daily, In The News

Coronavirus and Global Trade

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Global trade is affected by myriad factors. The latest event to affect the international supply chain is the recent coronavirus that causes COVID-19. This novel virus has infected more than 80,000 people and killed more than 2,700.1 More cases are expected as the virus moves beyond its point of origin in China’s Hubei province to the rest of the world.

Resulting labor deficits and quarantine procedures could have major effects on production and shipping worldwide. Events like this one reinforce the need for companies to have detailed logistical plans in place to compensate for the shortages and delays that are likely to result.

Serious impacts expected

Worldwide health crises and other disasters have had significant effects on the global supply chain in the past. The comparatively minor outbreak of sudden acute respiratory syndrome (SARS) identified in 2003, also originating in China, cost the global economy about $40 billion dollars.2

In the wake of such catastrophes as SARS; the attacks of Sept. 11, 2001; Hurricane Katrina in 2005; and the meltdown at the Fukushima Dai-ichi nuclear power plant in 2011, it is reasonable to expect that the coronavirus could have similarly long-reaching effects. Several factors are likely to exacerbate its impacts on global supply chain economics.

First, the outbreak occurred during the Chinese Lunar New Year holiday, which took place between Jan. 25 and Feb. 4. Annually, this holiday precipitates what is considered the largest human migration on Earth over a period of about 40 days.3 Between early January and mid-February each year, hundreds of millions of Chinese people travel to visit relatives, much as Americans do during the Christmas holiday.

In an effort to slow the spread of the virus, many Lunar New Year celebrations were canceled, and the government issued travel bans4 and instituted a quarantine of millions of people, which prevents laborers from returning to work.5 The quarantine has had major effects on the labor force responsible for producing goods as well as loading and piloting the ships and planes used to transport goods all over the world.

The effects of the coronavirus outbreak might also affect the detente in the trade war between the United States and China signified by the signing of the “phase one” trade deal on Jan. 15. The new deal orchestrated by the administration of President Donald Trump promises $200 billion in sales to China.6 The coronavirus outbreak has the potential to impede these sales by creating a drag on the supply chain.

Identifying alternatives

Companies increasingly have attempted to anticipate the consequences of unexpected events on their suppliers and shippers. Disaster recovery plans have become an essential defense against the ramifications of these events.

While the production of these plans has become an industry in and of itself, all plans are not created equal. Some do not factor in delays in production and transport. A comprehensive disaster recovery plan needs to account for both. Merely hoping that problems will not rear their heads is no longer an adequate strategy.

In the case of the coronavirus outbreak, if a vendor relies on goods produced in China, it needs to have an alternative source of production. With a labor supply held up by quarantine procedures, it might be a while before production capabilities reach normal levels. The trade war has opened competitive production markets in Mexico, India, Malaysia, and Indonesia, among other places. Thus, there is little if any excuse not to have identified other production centers that can make up the shortfall in the event of a disaster.

Furthermore, it is imperative to assess whether transport services will have the capacity to ship existing inventory in the case of a crisis. If there is a backlog and a resulting lack of transport space, shipping costs might increase substantially. Delays in the wake of the Chinese Lunar New Year take place every year regardless, and in a time of crisis, delays will be even more marked. Establishing a plan with shipping partners for such events might not totally offset the cost increase. However, it can create space in the budget for it. Additionally, locating alternative routes and carriers ahead of time can allow companies to circumvent delays entirely.

While certainly expensive and complicated at the outset, disaster planning can pay dividends in the inevitable case of a major global crisis. Even if anticipated delays never manifest, planning for them might open new routes of production and shipping that ultimately can be used to increase efficiency during times of normal business operation.

Thinking ahead

Ample precedent exists for the alternative of no plan, which leads to an inability to meet demand and the financial consequences that result. Investors take note of such deficiencies and allocate funds accordingly. Developing an agile approach to anticipated problems will increase in importance as the global economy becomes more complex.

While the coronavirus outbreak continues, another disaster is already looming. The implementation of Brexit over the next year will have massive consequences in terms of customs and duty, taxation, and supply chain strategy. Getting ahead of this incipient crisis by anticipating its effects on the production and movement of goods can increase your company’s resilience.

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 Learn more

Pete Mento, Managing Director at Crowe LLP

+1 202 779 9907 or pete.mento@crowe.com

Endnotes

1. Helen Regan, Adam Renton, Meg Wagner, Mike Hayes, and Veronica Rocha, “February 25 Coronavirus News,” CNN, Feb. 25, 2020, https://www.cnn.com/asia/live-news/coronavirus-outbreak-02-25-20-hnk-intl/index.html

2. World Health Organization, “SARS (Severe Acute Respiratory Syndrome),” https://www.who.int/ith/diseases/sars/en/; William Feuer, “Coronavirus: The Hit to the Global Economy Will Be Worse Than SARS,” cnbc.com, Feb. 6, 2020, https://www.cnbc.com/2020/02/06/coronavirus-the-hit-to-the-global-economy-will-be-worse-than-sars.html

3. Karla Cripps and Serenitie Wang, “World’s Largest Annual Human Migration Now Underway in China,” CNN, Jan. 23, 2019 https://www.cnn.com/travel/article/lunar-new-year-travel-rush-2019/index.html

4. “China Coronavirus Spread Is Accelerating, Xi Jinping Warns,” Jan. 26, 2020, BBC https://www.bbc.com/news/world-asia-china-51249208

5. Emily Feng, “45 Million Chinese Now Under Quarantine as Officials Try to Halt Coronavirus Spread,” NPR, Jan. 27, 2020, https://www.npr.org/2020/01/27/800158025/45-million-chinese-now-under-quarantine-as-officials-try-to-halt-coronavirus-spr

6. James Palmer, “The ‘Phase One’ Trade Deal Is Still Hypothetical,” Foreign Policy, Jan. 15, 2020, https://foreignpolicy.com/2020/01/15/phase-one-us-china-trade-deal-hypothetical-trump-liu-he/

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Are You Prepared for the Outcome of the U.S.-China Trade War?

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For exporters, importers, manufacturers and investors who are heavily involved in U.S.- China trade, the recent agreement provides potentially immense benefits – but still doesn’t end their uncertainty or anxieties about what the future may bring.

Every participant in U.S.-China trade should now be reassessing his or her own expectations and strategic plans for not only surviving the trade war but, as importantly, for maximizing business success.

Clearly, preparation is essential for businesses to thrive and avoid suffering substantial harm at a time when critical political, economic and legal factors beyond a company’s control are constantly changing.

To help business owners and senior executives shape business and legal strategies tailored to their company operations, I’ll first clarify what the U.S. and China have decided and what is still in play. I’ll then lay out possible scenarios and the strategic approaches that executives should consider taking to protect themselves and position their businesses for future success.

The New Phase 1 Agreement

Under the signed agreement China will:

-Buy at least $200 billion of additional US exports in goods and services over the next two years, on top of amounts it imported in 2017, in the following areas:

-$78 billion of manufactured goods including vehicles and industrial machinery

-$52 billion of energy products, including crude oil and LNG

-$32 billion of agricultural and food products

-$38 billion of financial and business services

-Open its financial sector by abolishing limitations on foreign ownership of Chinese securities by April 1, 2020 and ensure market access on a non-discriminatory basis for US securities, insurance and fund management companies.

-End its longstanding practice of requiring US companies to transfer technology to Chinese companies as a condition for obtaining market access.

In exchange, the U.S.:

-Suspended a planned tariff scheduled to go into force on December 15th covering $156 billion of apparel products (Tranche 4B) and lowered the tariff rate from 15 percent to 7.5 percent on another group of apparel products (Tranche 4a)

The signed Phase 1 deal also requires China to:

-Adopt an action plan to make major structural changes for protecting US intellectual property

-Implement a dispute resolution mechanism that puts in place “strong procedures” for the US and Chinese parties to resolve disputes fairly and expeditiously

Under the Phase 1 agreement, the U.S. will maintain its current tariffs of 25 percent on $250 billion in Chinese products and 10 percent on an additional $300 billion of Chinese consumer goods.

FUTURE SCENARIO #1:

The U.S. and China Reach a  Phase 2 Deal & Comprehensive Settlement

Without question, the Phase 1 agreement signed on January 15th is a game-changer for U.S.-China trade relations – the likely beginning of the end of the trade war.

Phase 1 represents the first time since the opening shots of the trade conflict, approximately 20 months ago, that the parties have found common ground and enshrined it in a binding legal agreement. With public expectations for a complete settlement raised by both President Trump and President Xi, negotiators are now incentivized to reach agreement on the remaining U.S. and Chinese demands.

Even though most previously existing tariffs still remain in place, it is now realistic to anticipate a broad negotiated settlement in a Phase 2 deal that includes a sharp reduction in tariffs, Chinese implementation of necessary reforms, and a far more balanced U.S.-China trade relationship. A settlement of this kind would significantly expand business opportunities for American companies to export more products to China and to import more Chinese products to the United States.

Consequently, both exporters and importers can and should now formulate and implement plans as part of their business strategies for improved trade relations with China that seemed highly unlikely and unrealistic only a few weeks ago.

U.S. Importers

To prepare for the possible elimination of high tariffs imposed by the U.S. and China during the trade war as well as other beneficial reforms, key  executives of U.S. importers should  ask the following questions:

-How can we expand the quality and quantity of Chinese products we import?

-To what extent will a sharp reduction of tariffs improve the competitiveness of the products we import in various S. market sectors?

-If Chinese companies curtail their practice of forcing transfer of U.S. intellectual property, how will this help us expand our China-based supply chain?

-If the Chinese government significantly reduces its subsidies for competitive Chinese companies, what kind of openings for increased imports will this create?

-In what ways can and should we encourage our Chinese business partners to invest in the U.S. by building factories here for which our company could handle marketing and distribution?

U.S. Exporters

To  take advantage of China’s Phase 1 agreement to buy $200 billion in U.S. export products during the next two years on top of amounts it imported in 2017 as well as to prepare for the elimination of high tariffs in Phase 2, key  executives of U.S. exporters should ask  the following questions:

-How can we expand the quality and quantity of products we export to China?

-In what sectors of the Chinese market will the products we export become more competitive?

-How will the potential reduction of government subsidies to our Chinese competitors allow us to penetrate the China market more effectively?

-In what areas should we explore new relationships with Chinese companies for producing finished products that include the American intermediary goods we export?

-To what extent will a full Phase 2 settlement of the trade war and the reforms accompanying it enable the U.S. government to modify the controls it currently imposes on specific exports?

FUTURE SCENARIO #2:

The U.S. and China continue their negotiations for a Phase 2 deal but find it difficult to reach agreement

Despite agreement on a Phase 1 deal, the tensions and uncertainty of U.S.-China negotiations mean the U.S. and China may face complications and delays reaching a meaningful Phase 2 deal requiring new Chinese commitments and an end to high U.S. tariffs.

Factors that could slow down the process of reaching a Phase 2 agreement include various threats by the Trump administration:

-Delisting Chinese companies from S. stock exchanges

-Blocking a range of public and private pension funds and university  endowments  from making certain investments in China

-Putting other capital controls on U.S. private sector investment in China to protect against opaque Chinese company accounting and business practices

-Broadening scrutiny of potential Chinese investments in the United States on national security grounds

-Expanding checks by the Securities and Exchange Commission (SEC) of Chinese companies that do business in the S.

-Disrupting the flow of capital between Hong Kong and mainland China if China does not adequately respect the autonomy of Hong Kong

Each of the U.S. measures described above would likely cause China to take reciprocal retaliatory actions – just as China has responded to U.S. tariffs with reciprocal tariffs of its own on American products.

At stake in the Phase 2 negotiation are issues that will determine whether the Trump administration achieves its core objectives in the trade war, including:

-Stricter rules to strengthen information security for cross-border data flows of American companies that do business in China

-Limiting the subsidies by China’s government to state-owned companies which facilitate unfair competition

The issue for Phase 2 that is likely of greatest importance to American importers is whether an agreement removes U.S. tariffs on more than $500 billion in Chinese products that threaten the well-being of their businesses.

Given the uncertainty of reaching a follow-on Phase 2 agreement, key executives of U.S. importers and exporters should ask the following questions:

U.S. Importers

-If a Phase 2 agreement with China does not materialize, how should we plan to modify the sourcing of products we currently import from China to avoid high tariffs?

-What kind of exploratory discussions with suppliers outside China should we initiate as a hedge against uncertainty and continuing tension in S.-China trade relations?

-To prepare for a possible shift in import strategy, should we participate in the Customs Trade Partnership Against Terrorism (CTPAT) program that reduces the number of Customs examinations, accelerates Customs processing times and expedites border crossing privileges?

-What measures can we take to lower cost and raise efficiency to improve the competitiveness of Chinese-origin products in the S. market?

-Does our supply chain include middlemen who resell products to us at a marked-up price? If so, can we utilize the established “first sale rule” under U.S. law that allows us to avoid paying any duty on the amount of the mark-up?

U.S. Exporters

In light of continuing uncertainty about the Phase 2 negotiations, exporters should ask themselves:

-How can we modify the quantity and type of our exports to China in light of unfair competition from state-owned companies receiving government subsidies?

-If existing Chinese tariffs remain in place for the foreseeable future, how will that affect sales of our products in the Chinese market?

-How will increased U.S. controls on exports of American products to China affect our business strategy?

-If the U.S. imposes new tariffs on China and China retaliates, how can we manage and mitigate the likely negative impact on our sales in China?

-In light of the trade obstacles we now face and may continue to face, how should we modify our export strategy for China?

FUTURE SCENARIO #3:

The U.S. and China break off discussions on a final Phase 2 settlement of the trade war after negotiations fail and they pursue hostile trade policies toward each other

If the U.S. and China cannot reach a meaningful trade agreement in 2020, it is likely they will break off negotiations and pursue hostile trade policies toward each other. In this case, some or all of the following economic and political developments are likely to occur:

-The trade war will evolve into a major, multifaceted dispute – the equivalent of a cold war – that involves geopolitical and security disputes as well as trade issues

-Both the U.S. and China will find it difficult to stop a vicious cycle of retaliation and counter-retaliation on trade and other issues

-China and the S. will strive to consolidate their own trade blocs that exclude the other country – potentially decoupling the U.S. and Chinese economies/financial sectors

-China will enhance the role of its state-owned businesses using increased subsidies

-The U.S. will significantly expand its restrictions on trade with China by delisting Chinese companies from U.S. exchanges, blocking public and private U.S. investments in China, enacting much more restrictive export controls, ending most Chinese investment in the United States, exercising greater scrutiny by the SEC of Chinese companies and taking other restrictive measures

Outlook for Importers and Exporters

While future events could potentially reignite the trade war and eventually lead to a breakdown in U.S.-China relations, this dire prospect should not be the immediate focus of planning and preparation by importers, exporters, manufacturers and investors. The collapse of normal economic and trade relations represented by Scenario #3 is only likely to occur after China and the U.S. go through an extended period of uncertainty, tension,  and deterioration in trade relations described in Scenario #2.

Companies involved in U.S.-China trade should therefore base their business and legal planning on the high probability that the trade war will likely evolve either toward a settlement of most outstanding issues or toward continuing uncertainty characterized by the inability of negotiators to resolve remaining differences.

It would be a major mistake at this time to take a “wait and see” approach or bet exclusively on either Scenario #2 or Scenario #3 coming to pass.

For this reason, importers, exporters, manufacturers and investors should focus on modifying their business/legal strategies to take advantage of the potentially immense benefits of the Phase 1 agreement and preparing contingency plans for either a Phase 2 agreement or the occurrence of Scenario #2 in trade negotiations with China – the two scenarios that are most likely to materialize between now and the end of 2020.

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Donald Gross  is  founding  partner  of  Donald  Gross  Law,  an international trade law and strategy advisory firm in Washington, D.C. (https://www.donaldgrosslaw.com). He participated in U.S. negotiations with China as a Senior Adviser for International Security Affairs at the State Department from 1997 to 2000, and as Counselor of the U.S. Arms Control and Disarmament Agency from 1994 to 1997. He is the author of “The China Fallacy: How the U.S. Can Benefit from China’s Rise and Avoid Another Cold War” (Bloomsbury, 2013). He can be reached at don@donaldgrosslaw.com.

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How U.S. Trade Policies are Speeding the Development of a Multi-Polar Global Economy

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Several years in to the multi-front trade conflict led by the current U.S. administration, the world economy teeters on the edge of a possible recession.  The International Monetary Fund (IMF) estimates that up to $700 billion in global trade could be wiped off the books by the end of next year due to the trade war.  Much of the direct loss, of course, is tied to reduced trade between the U.S. and China, but other trading regions, such as the rest of Asia and Europe, are impacted by this global slowdown.  How is this shaping future trade flows?

Of course, there are some immediate winners in this tussle between the two economic giants.  Countries such as Mexico and Vietnam have seen sharp increase in trade as businesses scramble to find new production sites that would allow them to duck tariffs. Hidden behind these headlines, however, is perhaps a more important story; the rapid development of a multi-polar global economy.

Observers wringing their hands over the U.S.-China trade dispute may have missed what else is going on in the world.  Europe has been negotiating trade agreements at a rapid clip, finalizing deals with Canada, Japan, Singapore, Vietnam, several African regions and South America (MERCOSUR) over the last three years.  Africa is launching the Africa Continental Free Trade Area (AfCFTA), a 54-nation trade block that is hoped will dramatically increase inter-African trade. After a snub from the U.S., the Trans-Pacific Partnership (TPP) was retitled the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) and is now an active free trade area among 11 partner nations.  Asian countries are considering a 16-nation trade pact called the Regional Comprehensive Economic Partnership (RCEP).  In brief, world leaders are not sitting on their hands waiting for the U.S.-China dispute to get resolved.  They are seizing opportunities to trade elsewhere.

World demographics make this multi-polar trading system inevitable.  Despite the United States’ tremendous economic power, it represents less than five percent of the world population. Although it is a wealthy sliver of the overall market, that means that 95% of the world’s consumers still reside elsewhere.  Over the next few decades, rapid population growth in Asia and Africa will continue to change these market numbers, with 79% of the world’s consumers residing in Africa or Asia by 2050. The global middle class will continue to grow outside of ‘traditional markets’ and by 2030, over half of the world population will be considered middle class.  Some estimates suggesting that over 90% of future middle class growth will come in Asia and Africa. 

This dramatic surge in wealth and consumer spending power outside of Europe, the U.S. and Japan demands more infrastructure to support logistics.  China’s initiatives to help itself carve out a primary role in developing these new markets through the Belt and Road program are well known, but Europe has also jumped into the seize a piece of the action, especially in Africa, and programs to upgrade infrastructure at the state level are fueling building from South America to the Philippines. 

“It’s my expectation global trade will become even more fragmented over the next decades,” notes European logistics expert Louis Coenders, owner of the Dutch advising firm De Transportheker, which has been consulting on transportation, warehousing, and global distribution since 2010 and has stressed to clients the growing importance of diversity in logistics as the world becomes multipolar.  “You cannot rely on one single source. From a risk management perspective, it’s never smart to put all your eggs into one basket. That also applies to international trade.”  Coenders further noted that the growing middle class in places like Eastern Europe, Asia and Africa will encourage infrastructure changes to bring products into these markets as consumer spending rises.  For the moment China has an edge into many of these areas, as illustrated by the first train shipments from Alibaba arriving into Liege, Belgium just last week as twice-a-week rail shipments are now sent directly from China to the EU courtesy of the improved rail system.

When the U.S. resolves its trade disputes with China (and potentially the EU, Turkey, Russia and other targets of the current administration), it will find that the unintended consequence of this long-term conflict is that the world has by necessity sped up economic exchanges, and adjusted trading systems and flows to accommodate this new multi-polar world.  While some of the trade may ‘come back’ to the United States, the changes in world population and fast-paced creation of new free trade blocks outside of North America means that other markets will seize this opportunity to deepen their trade relations and the U.S. will find itself in a more competitive and varied trading environment. This change was inevitable, but the recent trade war has sped up its development.  Agile, strategic companies will react to this market change by diversifying and partnering with colleagues in the growing markets of Africa and Asia. Those that are slow to change will find it hard to remain competitive in this brave new trade world.

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Kirk Samson is the owner of Samson Atlantic LLC, a Chicago-based international business consulting company which offers market research, political risk assessment, and international expansion assistance.  Mr. Samson is a former U.S. diplomat and international law advisor who lived and worked in ten different countries.