Traditional economic wisdom warns that President Donald Trump’s trade war with China will backfire and harm American consumers and companies. More and more studies have shown that traditional wisdom is correct.

A working paper written by Di Fan, Chris Lo and Andy Yeung of the Hong Kong Polytechnic University focused on how much Trump’s tariffs did harm to American companies; Yi Zhou of Monash University; and Christopher of UCLA Anderson S. Tang.

Researchers measure damage in two ways. First, tariffs increase the number of days the goods are in inventory, which increases holding costs and reduces operational efficiency. Second, they looked at the company's return on assets, which is an indicator of profitability. Many companies that participate in world trade have seen their return rates have declined.

Tariffs reduce the competitiveness of U.S. producers

The increase in inventory found in the analysis can also be seen from the increase in the US trade deficit, which climbed 12% in 2018 to a 10-year high of US$621 billion. The increase in deficits and inventories indicates that importers may be buying frantically due to expected tariffs. The deficit with China fell the following year, but the overall trade imbalance rose; the company shifted production from China to Vietnam, Mexico and other low-wage countries.

The survey results show that tariffs did not increase the strength of American producers, but reduced their competitiveness.

"Managers should understand that protectionism does not necessarily protect domestic industries," the author wrote.

Trump launched a trade war with China in early 2018 and eventually imposed tariffs on approximately US$370 billion of imported goods. He said that tariffs are necessary to stop unfair trade practices, help domestic manufacturers and reduce the US trade deficit, and they will mainly hurt Chinese exporters, who will be forced to lower prices to stay competitive.

Mainstream economists generally oppose the levy of tariffs. It is expected that the trade war will reduce US GDP, increase financial market volatility, and harm US consumers and businesses.

For example, Whirlpool has been lobbying for years to protect low-cost imported washing machines from China and South Korea, and imported washing machines are one of the first products hit by tariffs in the trade war.

But Whirlpool did not benefit as expected. After the tariffs took effect, the prices of washing machines and dryers rose almost immediately, but Whirlpool's raw material costs were also rising, thanks to similar tariffs on steel and aluminum imports. Net income in the first quarter of 2018 fell by US$64 million, or 41%, from the previous year to US$94 million.

"In the era of global supply chains, the cost of lobbying for tariff protection may not produce the benefits that people hope," the author wrote.

Declining inventory holdings and sales hurt the company in the trade war

In their study, the researchers used a "quasi-natural" experiment—a method often used to measure the impact of legal changes—to assess how tariffs affect U.S. importers. To this end, they compared 215 companies that purchase directly from Chinese suppliers with 215 similar companies that do not have direct Chinese suppliers. Then, they measured the performance of these companies between 2015 and 2020.

One indicator of a company’s performance is the number of days its inventory is available; holding inventory for a long time will bring higher costs. Threats of supply disruptions, such as increased tariffs, give companies incentives to stock up before the fees take effect. Declining sales will also extend the inventory holding period.

The study found that after tariff increases, companies with direct Chinese suppliers have about eight days longer inventory holding periods than companies that do not purchase directly from Chinese companies.

Due to rising inventory costs and declining sales, the trade war has also hurt the profitability of affected companies. The study found that after the tariff hike took effect, the return on assets of companies with Chinese suppliers fell by 3.89%.

The structure of a company's supply chain has a major impact on the extent to which its profitability is affected by tariffs. Highly vertically integrated companies—those that directly control the production of more product components—have not reduced their return on assets due to tariffs.

But tariffs have a greater impact on the return on assets of companies with more diverse and complex supplier arrangements. For example, companies that have Chinese suppliers and whose supply chain exhibits a high degree of "spatial complexity" (meaning their suppliers are distributed in more regions) have a return on assets that is 6.37% lower than that of companies that are not directly affected by tariffs.

For those suppliers with a high degree of "cooperative complexity" in the supply chain, for example, when a supplier's output is used as an input for other suppliers in the same chain, the return on assets after tariffs is reduced by 8.25%.

Supplier diversification brings market disruption challenges

Supplier diversification should help hedge the risk of supply disruption, such as new tariffs. But diversification is accompanied by increased transaction costs, because more complex supply structures require more communication and collaboration to make them work. The study shows that when international markets are disrupted, this may place additional burdens on global companies.

The author writes: “Due to the US-China trade war, companies with distributed supply bases are more affected by tariff increases.” “Our empirical evidence shows that diversification of procurement may become a burden for companies to respond to political risk events.”

Increasing economic inequality, job loss in low-wage countries, and increased nationalism have led to a revival of mercantilist economic thinking, prompting people to believe that if the country has a large trade surplus with the rest of the world, the situation will be better. But in the global economy, trade wars and other nationalist policies are no longer fulfilling their promises.

"Because the supply chains of influential [multinational companies] rely heavily on global trade, any interruption will have a serious impact on the operations of these companies, which in turn will have a serious impact on the domestic economy," the author wrote.

Distinguished Professor of University of California, Los Angeles; Edward W. Carter, Chairman of Business Administration; Senior Associate Dean of Global Initiatives; Director of Faculty and Staff, Global Management Center

Fan, D., Zhou, Y., Lo, C., Yeung, A, Tang, CS (2021). The impact of tariff trade barriers on the operating performance of US companies: the role of supply structure and complexity.

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