On Trade Wars and Supply Chain Risks

2018 doesn't look like a good year for international supply chains, with trade wars and Brexit on the horizon...
Trade wars are good, and easy to win — Donald J. Trump on Twitter
History teaches that wars begin when governments believe the price of aggression is cheap. — Ronald Reagan, speech, Jan 16 1984.

In recent times supply chain risks have mainly been concerned with three things:

As well as the above major examples, there have been thousands of others which did not make the international news.

There are some common ways of mitigating these risks:

  1. Stockpiling. Ensuring that there are sufficient supplies on hand to cope with minor supply chain interruptions.
  2. Supplier business continuity plan audits. Ensuring that the supplier takes the security of supplying you seriously enough that they have put realistic plans in place to cope with any disaster.
  3. Supplier financial audits. Ensuring that the supplier's business is viable and is unlikely to fail.
  4. Second sourcing. Using more than one supplier for a particular component or using components available form multiple suppliers so that the supplier can be easily switched in the event of disruption.

As the world seemed to moving towards free trade areas and the reduction of trade barriers a third supply chain disruptor was increasingly forgotten: political risk. However, with the advent of Brexit and the trade policies of Donald Trump, it's become evident that trade agreements are not forever. A political mood swing can create an environment where trade barriers increase and retaliatory tariffs loom on the horizon.

This is not a new problem: it's just an old problem that has been easy to forget.

The international automotive industry developed in an environment with major political risks, and used some simple techniques to mitigate it:

  • Locate manufacturing plants employing significant numbers of people in the same political jurisdiction as the market they are serving.
  • Use "local" suppliers whose supplies are unlikely to be disrupted for political reasons.

These make the well-being of the manufacturer of significant interest to local politicians, and make it less likely that the local supply chain will be disrupted to meet political goals.

Unfortunately we're not all large or diverse enough to be able to employ these options.

So what are tafiffs going to mean?

Economically, the effects on the market of tariffs are well understood:

  • Supplier prices will go up, both due to tariffs and decreased competition.
  • Increased selling prices (either due to direct tariffs or increased supplier costs) resulting in lower sales.
  • Companies will exit marginal markets where the new cost structure renders their business unprofitable.
  • Local companies supplying goods which are protected from foreign competition by tariffs will be more profitable in the short term.

And for our supply chain…

When considering risks to our supply chain and evaluating key suppliers I think anolther type of risk now needs to be (re-)introduced. Political Risk. The risk that politicians will do something that causes increased costs or limited supplies. We can try and quantify this risk by examining:

  • The political distance between us and the supplier. Are politicians likely or able to place a trade barrier between ourselves and our supplier?
  • The political risk of the supplier's business being adversely affected by trade disputes. We are not their only customer. If they lose a major part of their business due to a tariff or quota, or if they lose a key supplier, will they still be in business to supply us? And will they still be able to supply us at a mutually agreeable price?

To minimize the possibility of disruption, a local supplier for our goods is slightly more preferable. And locating new production closer to the market it serves makes increasing sense. As always, it's a balance between price and risk. We're already seeing the effect of this rebalancing, with US companies moving production overseas to avoid international tariffs, and investments in Britain being curtailed since it is unlikely to provide tariff-free movement of goods and services to European markets in the future.

And the future…

When trade rules change, there will always winners and losers. Economic theory suggests that buyers will generally be worse off with reduced competition and choice, and that some lucky suppliers protected from competition will initially do well. But the supply chain is a complex system which is always reorganizing to try and optimize itself. Even if you think you are a winner, as manufacturing and services move and restructure to avoid tariffs, it's really too early to tell whether your market or margins will actually increase or decrease in the longer term.

But what about services…?

Shhhh… with the exception of EU-Brexit negotiations, politicians haven't noticed the large trade in international services yet. But when they do…

Resources

  • The 1930s depression led to a major trade war with adverse effects for many countries. The Economist has an excellent article looking at the origins and effects of the Smoot-Hawley Act. Written in 2008, it puts the current trade wars in a good historical context.
5 July 2018

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