The U.S.-China Trade War Will Continue Hurting the U.S. Economy

U.S. businesses should consider the following strategies to mitigate the impact of U.S. and China tariffs.

Since 2015, China has been the United States' largest trading partner, representing approximately 15 percent of U.S. trade. Meanwhile, the U.S. became China's top and most important trading partner in 1998. According to a recent analysis by the U.S.-China Business Council, the trade relationship supports approximately 2.6 million jobs in the U.S., representing a wide range of industries and businesses. China has become an important market for U.S. goods and services as a result of the rapid growth of the Chinese middle-class and its significant increase in purchasing power. American companies are selling high-value products to Chinese customers, including cars, semiconductors, aircraft, medical devices and agricultural products, like soybeans, fruit and pork, all of which are critical to the Chinese economy.

In Spring 2018, however, under Section 301 of the Trade Act of 1974, the current administration determined that China's trade practices with respect to U.S. businesses were discriminatory and unfair, including forced technology transfers, theft of intellectual property, limited market access for companies and state sponsored acquisition of critical technology. In response, President Trump imposed tariffs on approximately $250 billion of Chinese imports to the U.S. China retaliated, imposing tariffs on approximately $110 billion of U.S. imports to China. The U.S. has threatened to impose tariffs on the remaining $267 billion of Chinese imports if talks between President Trump and President Xi at the G-20 Leaders Summit in Buenos Aires are unsuccessful in resolving the U.S.’s concerns. Trade experts believe it is unlikely the two leaders will reach an agreement or make significant progress. In fact, President Trump rejected China's written proposal to end the trade war and he recently announced that he is likely to increase tariffs on $200 billion of Chinese imports from 10 percent to 25 percent on January 1 and impose duties on all remaining imports from China upon his return from Argentina this weekend. Therefore, U.S. businesses and consumers should expect additional tariffs as early as December, which will result in rising prices for inputs and finished goods, an increase in business closures and weakened export markets.

Although the current U.S. administration argues that the imposition of tariffs on Chinese imports and the continued pursuit of a trade war will lead to a stronger U.S. economy, the initial impact of President Trump's trade policy created an adverse effect. While third quarter gross domestic product (GDP) rose by 3.5 percent, trade served as a fairly significant drag to GDP, subtracting 1.78 percent from third quarter results. In other words, if trade was neutral (meaning it did not add to or subtract from GDP), third quarter GDP would have grown at an impressive 5.3 percent. It is not unreasonable to expect trade to serve as a drag on fourth quarter GDP as the Trump administration's tariffs, and China's retaliatory tariffs, continue to impact U.S. manufacturers and retailers, as well as agricultural and energy producers. While many large manufacturers absorbed the initial impact of tariffs, in part due to the windfall received through the Tax Cuts and Jobs Act, the rising cost of raw materials and other inputs will eat into margins and force manufacturers to continue to absorb the increase or to raise prices. Manufacturers who cannot afford to absorb price increases or who cannot pass on increased costs to their customers may be forced to lower production/layoff staff, forgo expansion, or shift production out of the U.S.

As the cost of inputs has increased, many U.S. small and medium enterprises (SMEs) have reduced costs through other means, including reducing hours or layoffs. Staff reductions have led to delayed or even failed delivery downstream. For some SMEs, the margins are so thin that staff reductions and other cost reductions have not been enough to keep the lights on. Bankruptcies and closures are rising and are expected to continue into 2019 as more companies can no longer afford to bear the burden of increased costs or the loss of customers caused by the tariffs and cannot afford to shift production to other markets.

U.S. retailers also will begin to feel the impact of U.S. tariffs on Chinese imports. Because the initial round of tariffs focused primarily on intermediate inputs and capital goods, most retailers avoided the impact. However, with President Trump’s expanding the scope of tariffs to include many consumer goods, chief executives from Walmart, Target and Gap, Inc. warned that price increases are inevitable. Many predict these increases will impact consumers in early spring 2019 after the 25 percent tariff takes effect on January 1.

While U.S. agricultural producers have been spared from U.S. tariffs, they have been unable to escape China's retaliatory tariffs on certain imports. Soybeans have been especially hard hit by Chinese tariffs. China was the largest export market for U.S. soybeans, accounting for 57 percent of U.S. exports in 2017. Now that U.S. soybeans are subject to Chinese tariffs, many Chinese buyers have moved to other sources of supply, most notably Brazil. In August 2018, soybean exports to China accounted for less than 2 percent of total U.S. soybean exports. After the latest round of tariffs was announced, one U.S. soybean producer reported that tariffs reduced soybean crop prices by $150 per acre. Banks that finance U.S. farmers have indicated that the number of non-performing loans are increasing, evidence that U.S. agricultural producers continue to be adversely impacted by U.S.-China trade policy.

Oil and gas producers also have experienced a loss in sales as a result of the trade war. In 2017, China accounted for 20 percent of all U.S. oil exports. Through July 2018, U.S. exports to China remained on track to equal last year's total. However, in August, China turned off the spigot. The U.S. has not exported oil to China since. Exports of liquefied natural gas also are declining since China imposed retaliatory tariffs.

U.S. businesses should consider the following strategies to mitigate the impact of U.S. and China tariffs:

1. Understand Your Supply Chain

  • Where do you source parts/components/raw materials?
  • Make sure parts/components/raw material imports are properly categorized under the Harmonized Tariff System (all tariffs are keyed to the HTS code).
  • Are you the importer of record? Ensure you understand shipping terms.

2. Understand All Tariffs on All Your Imports

  • Ordinary tariffs that may apply.
  • Additional recent tariffs that may be added on top:
    • Section 301 on Chinese imports.
    • Section 232 on steel and aluminum.
    • Antidumping/Countervailing duties that may apply.
  • Consider tariffs that have been announced but are not in effect:
    • Opportunities for public comment.
    • Opportunities to testify or participate in a public hearing.
    • Planning risk mitigation strategies and contingencies.

3. Consider Filing an Exemption or Exclusion Where Appropriate

4. Consider Alternatives

  • Review all existing contracts (negotiate the following into new or modified contracts where possible):
    • Price and adjustment provisions (raw material, pricing formulas).
    • Provisions addressing requests for cost increases.
    • Termination rights based on increases in costs due to tariffs.
    • Include tariffs in force majeure provisions.
  • Consider alternative sources of supply in non-tariffed countries. Be aware of:
    • All pricing details.
    • County of origin under relevant origin rules.
    • Reliability of supply.
    • Potentially unlawful circumvention of applicable duties.
  • Some Chinese companies are convincing U.S. customers to allow them to transship through non-tariffed countries or even lying regarding the true country of origin in an effort to avoid duties. This is illegal and may result in jail time.

5. Other Risk Mitigation Strategies

  • Is it possible to change the HTS subheading of your product by breaking it apart or combining components that provide an opportunity to assign a different, non-tariffed HTS subheading?
  • Is it possible to shift production to other facilities located in non-tariffed countries?
  • Consider shipping products directly to other countries, e.g., where you sell to customers or where components can be substantially transformed through further assembled/modification.
  • Consider expanding sales to countries beyond the U.S.

John M. Scannapieco is a shareholder in the Nashville office of Baker Donelson and is chair of the Firm's Global Business Team. Frank Xue is an associate in Baker Donelson's Nashville office where he is a member of the Commercial Transactions and Business Counseling Group and the Global Business Team.

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