Uncertainty from levies on imports

The media is providing a lot of commentary concerning the political and economic implications from the American imposition of additional tariffs on imported goods, but what could be the effect on supply chains?

Imposts charged by governments on imports are a consumption tax paid by the importer and passed on through Nodes in the supply chain (wholesalers, agents etc.), so that higher prices are paid by the end user. If the impost is applied equally to all countries (to meet WTO rules), then the competitive position does not change between importers, although it does with domestic businesses.

In addition to tariffs, there can be other types of impost on imported goods into a country or an alliance of countries. For example, the European Union CBAM (Carbon Border Adjustment Mechanism) rules. This mechanism places a cost on greenhouse gas emissions generated from the production of carbon-intensive products, initially addressing steel, aluminium, cement, fertilisers, hydrogen and electricity. However, a value added tax (VAT) is paid by all parties in a supply chain, irrespective of whether they are an importer or domestic producer; but VAT can be reclaimed for exports, whereas tariffs and sales taxes cannot be reclaimed.

The introduction of the new US import duties and the EU’s CBAM bought a negative reaction from the trading countries. As expected, China retaliated on the same day with its own tariffs on a range of products imported from the US. In the case of CBAM, India argued that the new mechanism was “trade protectionism in the name of environmental protection”. Retaliatory action by affected countries should therefore be expected. 

What is currently happening may provide short-term disruptions in your organisation’s supply chains. But more importantly, actions by governments in pursuit of political objectives generates uncertainty in businesses and may have a longer term influence on trade relations. Uncertainty increases risks for a business, including that investment decisions are postponed. But waiting is not free, as there is an opportunity cost imposed from delays.

Cross-border imposts and supply chains

An adaptation of an old saying is that a country (and a business) does not have ‘partners’ or friends on a permanent basis, it only has permanent interests. So, it follows that on matters of national (or business) interest, high levels of uncertainty are of concern. When there is uncertainty in international trade, every country (and business) will look after its own interests. Game theory shows that when a player in a network affects the ‘Nash equilibrium’, the other players will respond and responses are traded until a new equilibrium is reached. But in international trade, what process is undertaken to arrive at the new equilibrium? The many answers of ‘don’t know’ provide even more uncertainty.

An accumulation of uncertainties can lead to companies and governments trying to mitigate the risks associated with tariffs and other imposts on imports. They may explore new markets and alternative supply chains, and realign their trade relationships, with countries forming new economic blocs and enhancing existing blocs. This could lead to a more dispersed and potentially more stable global trade system with economic cooperation that is more regionally focused. For companies this might provide enhanced resilience.

But there is no evidence that this is occurring, because changing supply locations takes time. Despite much commentary concerning nearshoring and other types of ‘shoring’, the consulting firm McKinsey states that nearshoring is not happening as a global strategy. Also, there is no trend towards diversification of suppliers, nor is the ‘global concentration’ of suppliers changing – this is where three or fewer economies provide more than 90 percent of the globally traded supply of a particular product.

But changes in supply chains continue to happen, either for geopolitical or commercial reasons. Prior to the current tariff actions by the US, China was moving the majority of exports and imports away from developed countries to developing countries. The US has been moving away from direct imports from China to imports via intermediary countries, where final assembly, test and pack occur. And Europe has reduced its emphasis on trade with Russia.

Considerations when changing supply chains

When changing suppliers, it is easier to build business relationships if there are commonalities between the parties, such as language, legal systems, currencies, colonial legacies and political structures. Also, trade is more likely between businesses of countries with similar high levels of income. An added attractiveness is that trade efficiency can be enhanced, due to the more effective logistics processes and transport networks in each country.

A factor when building trade relationships is the Gravity model. This states that trade is proportional to the size of each country (measured by GDP) and inversely proportional to the geographic distance between them (which is a proxy for transport cost). A study by the World Bank identified that doubling the economic distance between countries reduces the trade potential by approximately 40 percent. Therefore, businesses have a built-in incentive to trade with buyers and sellers in countries that are closer.

And another factor in trade is the Natural Trading Partner hypothesis. This states that trading with a larger country has a lower risk. For imports, a large country is more likely to satisfy the trading country’s import demand at the world price and for exports from the trading country, the large country will continue importing from the world market, even when there are changes to its macro trading arrangements.

An event that provides lots of ‘noise’ can have its significance overstated, and then businesses reacting with ‘action’. The US tariff impost will take time to flow through supply chains, but the effect will generate decisions by businesses that have high imports into the US. These outcomes could take twelve months to evolve, so there is time to evaluate the situation for your organisation.

Decisions about changing the flows in supply chains are often made by senior management. However, the decision will be improved if input is obtained from Procurement and Logistics professionals, but this requires that they have knowledge. As supply chains are inherently geopolitical, Logisticians should enhance their reputation through understanding the potential effects on supply chains from geopolitical actions. This will mean that your analysis of events is recognised and appreciated.