Companies have forgotten how much the global trade regime matters to daily firm operations. If it did, in fact, collapse, the result would be a disaster. The global trade rules are like air. They have existed for so long that companies and consumers take them for granted. They don’t even notice them any longer. But, like air, if it suddenly went away, firms and consumers would discover to their great dismay that they actually like and need air (or the global trade system) very, very much. Why do firms need the WTO? Start with the obvious issues. Right now, 164 countries are constrained in what they can do with tariffs rates. Up until this past year, WTO members did not just randomly hike tariffs overnight. Keeping tariffs consistent has allowed firms and customers to have stability and reduce risk.
Arbitrary or capricious rule changes are a significant danger for foreign firms looking to diversify out of China into other markets in Asia. It certainly does no good to open a new warehouse or building, only to have a regulatory change that renders it unusable or be saddled with new requirements on staffing that drive costs into the red. Most of the markets in the region that are currently expecting to capitalize on the trade war struggle with at least some—and usually all—of these problems. An honest assessment of market conditions in hopeful “winners” could bring about some necessary changes. There is certainly an opportunity for many markets to capture new gains from trade in areas that have not been “in play” for years. But absent some significant improvements in the ease of doing business in a remarkably short period of time, many of the locations that expect a windfall from relocations are likely to be bitterly disappointed.
The third lesson is that the details matter. Some of the provisions that are currently being ignored by commenters on NAFTA are buried deep in the texts and schedules. These may turn out to be deeply consequential for NAFTA parties. Some may also affect outside parties. As an example, the auto rules of origin require a significant and growing share of autos, trucks, parts, components, steel and aluminum to be made within NAFTA (with more expensive labor inputs as well). For suppliers based outside of NAFTA, this is going to be extremely problematic or even catastrophic. These orders could be cancelled outright and never replaced. Alternatively, NAFTA 2.0 could force a renewed look at offshoring or sourcing entirely for export. Either way, existing supply chains are likely to be under severe stress.
The fourth lesson is that NAFTA contains some problematic provisions that might spread elsewhere.
This has been an interesting, mixed, two weeks in trade. On the one hand, the system continues to receive new shocks, particularly from US President Donald Trump. On the other hand, trade integration is also moving forward. The net result continues to highlight the increasingly unsettled global environment. Firms need to focus on how to mitigate the risks facing their business operations.
Let’s start with the bad news. Two separate hearings have wrapped up in Washington. The first focused on product categories for an additional $16 billion in 25% tariff rate hikes against goods coming from China. Regular readers may recall that the Americans first produced a list of items totaling $50 billion for new tariff increases. The list was revised on the basis of hearings. The first $34 billion in tariffs have already gone into force (and were met with retaliation by China on a similar amount). But $16 billion in products were contested, resulting in a new list from the USTR. Now that hearings on the revised list of products has been completed, tariffs can be imposed at any time. Expect them to be announced on Friday (since this seems to be the preferred approach of the Trump administration). These new Section 301 tariffs will likely be met with $16 billion in matched retaliatory tariffs by China.
While our primary focus has been on the evolution of the trade battle between the US and China, the conflict has widened. Late last week, the Trump administration announced the end of a temporary stay on the imposition of steel and aluminum tariffs for the European Union, Canada and Mexico. Starting at midnight on June 1, steel exports to the United States were slapped with 25% tariffs, and aluminum with 10% tariffs. US National Economic Advisor Larry Kudlow argues that the tariffs are simply a matter of a “family quarrel,” the imposition of new barriers on trade into the US shows the spread of conflict. There are at least four reasons why this is absolutely not just a minor issue. Kudlow has said that tariffs with Canada “may go on for a while or they may not.” For the firms that are suddenly paying significantly higher prices for imported steel and aluminum, it probably doesn’t much feel like a small argument. A 25% price hike overnight is sufficient to drive firms out of business entirely. Finding new sources of supply takes time, effort and probably escalated costs.