When the Trump administration claims that the tariffs they have imposed on China have brought money into federal treasury coffers, they are correct. However, they are incorrect when they say that money is coming from China.
Because tariffs operate as a tax on imports, when the United States levies a tariff, it is the U.S. importer who pays when the goods arrive at U.S. customs, not the foreign exporter. A tariff is a border tax on the buyer, not the seller — tariffs make it more expensive for a buyer to import goods into the country. (For a quick primer on tariffs, check out Bowen Reports’ June 2018 piece “Tariffs Stir Trade War Winds. But What Are Tariffs?” https://bowenasset.com/tariffs-stir-trade-war-winds-but-what-are-tariffs/)
Trade war with China, rumbling with Mexico
The United States is now engaged in a major trade war with China and has put a 25% tariff on $250 billion worth of Chinese goods. This tariff fight has resulted in the U.S. and China importing fewer goods from each other, especially products subject to higher levies. The administration also threatened to impose 5% tariffs on all goods from Mexico, with the possibility the levy could ultimately rise to as high as 25% over a period of months, but these tariffs were suspended for 90 days as part of an immigration compromise.
The United States is the largest market for both China and Mexico. In 2018, China sold $539.5 billion of goods to the United States, while Mexico exported $346.5 billion of goods to its neighbor to the north. Whereas Chinese exports to the United States account for less than 5% of China’s gross domestic product (GDP), Mexico’s U.S. exports account for significantly more — over 28% of the Mexican economy.
Economists from the Japanese investment bank Nomura found evidence that Vietnam and Taiwan benefited the most from increased exports to the U.S., while Chile, Malaysia, and Argentina have gained by selling more to China. Looking at the products subject to higher tariffs, Nomura economists found that levies imposed by Washington on China pushed U.S.-based firms to opt for alternative sources other than China for many products. That includes electronic equipment for phones, parts of office machines, automatic data-processing machines, furniture, and travel goods. On the other hand, China’s tariffs on the U.S. resulted in Chinese importers buying soybeans, aircraft, grains, and cotton products from other countries.
Here is a breakdown of the products Nomura noted as being increasingly exported to the U.S. or China by the top five beneficiaries as a result of the trade war:
• From Vietnam: phone parts, furniture, automatic data process machines.
• From Taiwan: typewriter parts, office machines, phone parts.
• From Chile: copper ores, soybeans.
• From Malaysia: electronic integrated circuits, semiconductor devices.
• From Argentina: soybeans.
U.S. goods exported to Mexico in 2018 were $265.0 billion, up 8.9% ($21.7 billion) from 2017 and up 75.2% from 2008. U.S. exports to Mexico are up 537% from 1993 (pre-NAFTA). Given Mexico’s population of 126 million people, its total $450.9 billion in 2018 exports translates to roughly $3,600 per resident.
From a continental perspective, four-fifths (79.6%) of Mexican exports by value were delivered to the United States and Canada — Mexico’s fellow members under the North American Free Trade Agreement (NAFTA), which is still in effect until Congress acts on the Trump administration’s replacement, the United States-Mexico-Canada Agreement (USMCA).
Mexico ranked first among the United States’ top trade partners through April 2019. In the same period in 2018, it ranked third. The United States’ top five trade partners so far this year, by value, are Mexico, Canada, China, Japan, and Germany. The top five U.S. exports to Mexico by value through April were the categories of gasoline and other fuels, motor-vehicle parts, computer parts, low-value shipments, and computer chips. These categories accounted for 27.3% of total exports to Mexico. The value of the top five categories of U.S. imports from Mexico –– motor vehicles for transporting people, computers, motor-vehicle parts, commercial vehicles, and oil –– accounted for 35.29% of all inbound shipments.
Looking more closely at U.S. exports to Mexico:
• Gasoline and other fuels rose 2.13% compared to last year, to $9.09 billion.
• Motor-vehicle parts rose 2.5% compared to last year, to $5.6 billion.
• Computer parts rose 25.79% compared to last year, to $4.43 billion.
• Low-value shipments fell 0.58% compared to last year, to $2.4 billion.
• Computer chips fell 16.68% compared to last year, to $2.01 billion.
Looking more closely at U.S. imports from Mexico:
• Motor vehicles for transporting people rose 17.24% compared to last year, to $12.75 billion.
• Computers rose 4.43% compared to last year, to $8.42 billion.
• Motor-vehicle parts rose 2.28% compared to last year, to $8.35 billion.
• Commercial vehicles rose 19.25% compared to last year, to $7.58 billion.
• Oil fell 1.62% compared to last year, to $4.18 billion.
Who’s paying? Sometimes them, mostly us.
When Chinese goods arrive in America, importers — who are generally American but can also be U.S.-registered entities of foreign firms — pay tariffs to U.S. customs to receive their products. In that sense, American businesses are correct in asserting they are the ones paying the tariffs.
American companies aren’t only importing finished products from China. They’re also importing parts and raw materials for products that are then manufactured in the U.S. So even for Made-in-the-USA products, the supply chain might include parts imported from China and subject to tariffs, which raises the cost of production and likely the retail price.
For example, more than 1,000 Chinese companies export auto parts to U.S. automakers and retailers of replacement parts for cars. The U.S. imports about $10 billion in parts from China annually, according to a recent Boston Consulting Group study. Incentives for U.S.-based importers include accepting lower profit margins and cutting costs, including wages — which could mean deferring any potential wage hikes or eliminating jobs altogether for American workers.
That’s not to say there no circumstances in which China may pay for tariffs, if indirectly. For example, a U.S. importer could seek a discount or a payment from a Chinese exporter to offset the cost of the tariff. If the Chinese exporter needs or wants to keep the business — perhaps hoping to ride out the tariffs in the hope that they are only temporary — the exporter might agree to this, while in turn passing the cost along at their end of the chain. Generally speaking,
if China is the only supplier for a product, more of the tariff payment is passed on to U.S. consumers. But if China is merely one of the many countries that sell a product, prices may not change all that much and Chinese suppliers will lose market share. Then the pain is felt mostly by Chinese producers.
The opposite can also be true, as in the example of American farmers, especially those growing soybeans. The trade war with China is compounding the strain of five years of falling commodity prices and losses from spring flooding across the Midwest. Overall, U.S. farm income dropped 16% last year to $63 billion, about half the level it was as recently as 2013. Government data indicates China bought about 13 million metric tons of American soybeans after the countries agreed to a truce in December, in a goodwill move aimed at resolving the trade dispute. While U.S. Secretary of Agriculture Sonny Perdue said in February that China had pledged to buy an additional 10 million tons of American soy, those purchases have now stopped. USDA data also showed that China is yet to take delivery of about seven million tons of U.S. soybeans that it has committed to buy in the current marketing year.
To make up for farmers’ losses, the Trump administration will pay farmers $16 billion in subsidies. But these payments will cut into any increased revenue coming into federal coffers, meaning any economic advantage from the tariffs is being blunted, no matter who pays.
Even if the dispute is resolved, the U.S. would not see a return to record export levels of soybeans, says Paul Burke, a senior director at the U.S. Soybean Export Council. In 2016, China imported an all-time high 36 million metric tons, which sank to 8.3 million tons last year. “The longer we are out of the China market,” Burke says, “the likelihood is that we will not regain all of the share or all of the volume.”
In another example, higher duties on imports of metals and Chinese products increased Caterpillar’s production costs by more than $100 million last year. In response, the heavy-duty equipment maker increased prices for its products. Tractor manufacturer Deere & Company estimates a $100 million increase in its raw materials costs this year because of tariffs on Chinese imports. Deere has cut costs and increased prices to protect its profits.
Also undercutting administration claims of economic success is the Indiana engine-maker Cummins, which lost the gains from the Trump administration’s 2017 corporate tax cut this year due to the extra tariffs the company now must pay, according to the firm’s CEO Tom Linebarger.
The evidence continues to pile up. A Congressional Research Service report in February found that the tariffs boosted washing machine prices by as much as 12% compared to January 2018, before tariffs took effect. Steel and aluminum tariffs increased the price of steel products by nearly 9% last year, pushing up costs for steel users by $5.6 billion, according to a study by the Peterson Institute for International Economics. U.S. companies and consumers paid $3 billion a month in additional taxes because of tariffs on Chinese goods and on aluminum and steel from around the globe, according to a study by the Federal Reserve Bank of New York, Princeton University, and Columbia University. Companies shouldered an additional $1.4 billion in costs related to lost efficiency in 2018, the study found.
Higher tariffs also meant more woes for the bicycle industry. The number of bicycles sold in the U.S. dropped by about 15% in the first quarter compared with the same period a year earlier, according to the market research firm NPD Group. Revenue dropped by about 2% as bicycle companies passed along higher costs. One company has put on hold plans to expand production. Another bike company accelerated moving its manufacturing out of China to make 70% of its bikes in Vietnam and the other 30% in Taiwan.
Meanwhile, in mid-June, India announced that they would impose retaliatory tariffs, some as high as 70%, on 28 U.S. exports, including apples, almonds, and walnuts. Department of Agriculture data show that India is the largest buyer of the U.S. almonds, paying $543 million for more than half of the imports. It’s also the second-largest buyer of the nation’s apples, buying $156 million worth in 2018.
Data indicate uncertainty
China stated that its overall trade surplus was $41.65 billion in May, significantly more than expected as the trade impasse between Washington and Beijing drags on. Economists polled by Reuters had expected China to post an overall trade surplus of $20.5 billion in May. The larger trade surplus came as the country’s dollar-denominated exports surprisingly increased last month, while imports came in worse than expected. China’s General Administration of Customs said that exports in May inched up 1.1% year-on-year, while imports fell 8.5% during the same period.
But using bilateral trade data to interpret complex movements of goods through multinational supply chains has limitations. A primary reason for the complexity behind seemingly straightforward trade data is that the entire value of a product is counted towards the export value of the country where final assembly takes place — even if much of the actual value of the finished product was added in an intermediary country. Besides seeing a decline in trade between China and the U.S., one of the things you can see in the data is a huge amount of uncertainty over the economy. Uncertainty is not good for anyone.
So, what does all this mean?
We do not live in a static environment, and when the government tries to help one industry, other peripheral damage is often caused. Tariffs contribute to economic uncertainty by increasing expenses. Tariffs on steel increase costs for consumers of steel. Despite the implementation of tariffs with China, the tariffs do not appear to have meaningfully changed the level of trade deficits.
Higher wages pushed by full employment is offset by higher tariff expenses. The profit gains offered by the tax cuts are being offset by price increases. In short, the consumer pays more for the finished product and the benefits of the tax cuts are being overtaken by higher pricing. Even if the Fed reduced interest rates, are companies going to invest back in their businesses near term? Likely not, considering the tariff uncertainty near term.
What happens in this environment? Why build out a new plant or make investments in your business unless you can see a clear path to sales growth? As a result, we expect to see continued volatility in the market until the uncertainty is removed.