Is a Global Trade War Avoidable?

By Mitch Gurney

September 2009

A few days ago while reading through a series of articles posted on Mish’s financial blog, US Fires Opening Salvo In Trade Wars With China, I began thinking about an article I wrote and posted here in March of this year. In “American Protectionism – 30 years too late” I wrote about the complexities of the globalized economy through the activities of U.S. multinational companies (U.S. MNC) and their foreign affiliates and the global supply chains these relations create. In the articles featured in “US First Opening Salvo” the topic centers on possible trade restrictions the Obama administration is considering against tires made in China and I wondered which of these Chinese companies are operating as affiliates of either U.S. or foreign MNC’s as discussed in “American Protectionism.”

Over the past weekend while I was working on this latest article the Obama administration announced its decision to impose a 35 percent tariff on tires made in China, China: Trade penalties will hurt US relations. This new tariff takes effect Sept 26 and is in addition to an existing 4 percent tariff.

Concerns over retaliation by China as well as others seem not only valid but potentially very dangerous. I share in these concerns and agree with some of the perspectives in Mish’s latest postings, “Obama Risks Global Trade War with misguided Tariffs”.

In “American Protectionism” I noted any measures the U.S imposes could prove rather difficult to say the least as well as dangerous and potentially ineffective. To explain my reasons for these views and before discussing the tire industry in more detail I’d like first to establish a foundation that will serve two objectives; one is to explain how global supply chains function for those that might have limited knowledge on the subject and second, to provide support for my concerns.

To achieve this I will focus on two reports I found recently, the first is a research paper written in May 2007 “Mapping the Value of an Innovation: an Analytical Framework.” The primary purpose of the research paper is explained as follows:

Innovation is held to be a key to U.S. competitiveness, but there is little understanding of who captures the value from a successful innovation. This paper is a preliminary report on a study that will answer the question for specific examples of innovation. Here, we begin by looking at Apple’s iPod, a successful innovation whose thriving ecosystem has upended business models across the consumer electronics, computer, and entertainment industries.

It notes the challenge of assigning such values as follows:

Up through the 1980s, innovative electronics companies retained much of the benefits of their innovations which were manufactured within their vertically integrated operations. Since then, supply chains in the global electronics industry have steadily disaggregated across separate companies and across oceans. Although some companies, particularly in Japan and Korea, still pursue a vertically integrated business model, most companies that formerly manufactured most products in-house, such as IBM and HP – as well as recent start-ups who never had manufacturing capabilities – have outsourced production to global networks of contract manufacturers.

In fact, as a side note to the discussion of this report, to assist firms with accessing supply networks within their nation, in 2002 China established The China Supply Chain Council (CSCC) with “the mission of being the vital link for supply chain and logistics professionals who must stay on top in our fast-growing, ever-changing industry”:

The CSCC is…the largest professional organization dedicated to furthering the knowledge, understanding, and career development of executives, managers, and professionals in the field of supply chain, logistics and procurement management in China.

The Council is today:

• A leading professional organization aiming to educate, develop, and advance the supply chain profession
• A key communication link with thousands of supply chain, manufacturing and logistics professionals working in Asia
• The industry’s premier resource and knowledge center for supply chain expertise, services, equipment, systems and technologies.

In returning to the topic of the “Mapping the Value” research paper I utilize it for the illustration it provides of the global supply chain as it relates to Apple’s iPod and recommend reading it for further details. Please bear in mind that the construction of these supply chains can vary depending on the products and companies in question.

The iPod used for this study was the 30GB 3^rd Generation iPod that came to market in 2003 and consist of some 424 components. Although this report does not identify which of these foreign sources may be owned in part or wholly by Apple, all of the components are sourced through different entities, mostly foreign affiliates. In order to begin their supply chain analysis the authors obtained several “teardown” reports based on the actual dismantling of the product and identification of each of the suppliers of the various components. The result of this “teardown” can be seen on Table 1, page 9 where the top 17 most expensive components are listed noting the manufacturing sources, the supplier, the manufacturing location, and company headquarters that could be identified. Most of these 17 components are foreign made. As we can observe there are many players from around the globe that contribute to the making of this one product.

The second research paper was prepared for members of Congress and Congressional Committees in January 2009 by the Congressional Research Service (CRS), “Globalized Supply Chains and U.S. Policy”. This report goes further in explaining globalized supply chains then the report just discussed as it has a completely different objective which appears to be one of calling attention to the sensitivities in determining governmental policy when it comes to national and international trade, stating:

In the globalized world of business, production is becoming fragmented into discrete activities and can be spread geographically within and across national borders while remaining integrated organizationally within a multinational company or network of companies. Such globalized production networks are called supply chains or value-added networks. This world of supply chains raises both challenges and opportunities for U.S. policymakers, firms, and workers.

As I had written in the “American Protectionism” article U.S. MNC trade activities and globalization has created a new paradigm and the CRS report reinforces this view plus makes it very clear that determining national and international trade policy is extremely difficult and complex not only for U.S. policy makers but for other policymakers around the globe:

A New Paradigm:

The globalized American economy poses challenges for U.S. trade and regulatory policy. The traditional paradigm for policy was that the American economy consisted of U.S. businesses that operated primarily in the domestic market, hired U.S. workers, and sold to U.S. consumers but with some production either imported or exported. International trade took place between countries according to each nation’s competitive and comparative advantage. A trade policy aimed at a particular country had impact on businesses and consumers in that country. Only indirectly would adverse effects rebound to harm U.S. business interests such as when foreign governments retaliated in kind.

The world now has changed. Like a child’s neural network, the global economy is constantly organizing and reorganizing itself with new linkages, supply networks, manufacturing chains, and marketing channels that rise in response to market forces and government policies.

International trade now is less between countries than within a global supply network that may include headquarters, design, branding, and engineering in the United States but manufacturing in China with parts from Singapore, Japan, and the European Union and call center services in India.

The globalization of production networks has raised policy issues and has called into question certain long-held perceptions about the efficacy and effects of policy initiatives. Traditional trade and investment policy is based on national governments, national economies, and country-to-country relations, but much of trade today is between related companies spread across the globe.

How does protecting or promoting one domestic industry affect other parts of its or other supply chains? How does the United States ensure the security and integrity of products assembled offshore from components that are procured from a variety of markets around the world? How does policy affect the competitiveness of U.S.-based businesses in the global marketplace?

The report is well worth reading in full but for now draw your attention to the charts it provides illustrating the dynamics of international trade between US MNC companies and their affiliates. Please see; “Figure I. International Trade by US Parent MNC, 2006” pg 9 of the PDF document; “Figure 2. Manufacturing Supply Chain and Input Costs for the Apple Computer iPod© in 2005” pg 7; “Figure 3.Typical Manufacturing Supply Chain for Wood Furniture from China in 2007” pg 13; “Figure 4. Major Global Sourcing for the Boeing 787 Dreamliner” pg 16; and “Figure 5. A Typical Global Supply Chain with Pertinent Policy Levers” pg 22. As we can see international trade and the worlds MNCs relationships are perhaps far more complex and interwoven than what may be widely understood.

In returning to the topic of tires made in China what I find is equally as complex. I visited two tire stores in my area, a Cooper Tire retail outlet and Cost Co. Cost Co had primarily Michelin and some BF Good Rich Tires both U.S made products. The country of origin is embossed on the tires and can be easily seen. The Cooper store primarily features its own brands which are U.S. made but also trades with China. They also offered numerous competitor brands, such as Goodyear (U.S. made), Hankook Tire (A Korean company with products made in China), Westlake (One tire brand of numerous by a parent company called Rakla Tire Inc, a Canadian company who’s products are made in China), Trazano, (a “Brand of Tires and Wheels …designed developed for Independent Tire Dealers”…a network of “some of the most successful and respected Tire Dealers in the nation and around the world.”). Essentially I found an extensive list of tires from around the globe, StarFire from Mexico, Continental from France, and Dunlop from the US, Federal Tires from Taiwan plus many others.

A list of who owns what reveals numerous companies have vested interested in their competitors and these relationships cross national borders. Federal Corporation, a Taiwan company founded in 1945, for example, received “technical cooperation from  Bridgestone Tire Co. Ltd. (Japan) that began in 1960 and lasted for almost 20 years, when in 1981 the company switched to technical cooperation with Sumitomo Rubber Industries, Ltd. (a.k.a. Dunlop Tire Japan).” They have two major brands, Federal (sold globally) and Hero (sold mostly in China) and both are made in China.

The worlds leading auto manufacturer’s source tires from any number of companies regardless of national origins. Hankook Tire for example was established in 1941 as the “Chosun Tire Company” changed names to Hankook Tire Manufacturing in 1968 and established manufacturing in China in 1998. Today “the company supplies tires as original equipment to the Toyota Motor Corporation, Ford Motor Company trucks, General Motors trucks, International Truck and Engine Corporation, and others.”

Please bear in mind that at this point we have only discussed where tires themselves are made and have not conducted a “teardown” as to where all the components are sourced to manufacture them as was done with the iPod. But I think it is safe to conclude tire production is primarily fragmented with supply chains being global and equally as complex as those we have already discussed. How tires are made can be viewed here.

This reality renders a statement made by New Zealand’s Prime Minister Kohn Key in a recent Wall Street Journal interview more poignant when he replied when ask by the reporter about the “Buy American” provisions:

“Mr. Key chuckles when I ask him about the “Buy American” provision tucked into the Obama administration’s stimulus package. The previous government’s “Buy New Zealand” campaign got a “lukewarm” reception, he recalls. “There are so many component parts manufactured in different parts of the world, you’re chasing your tail the whole time about where something’s actually made.”

And as noted in the CRS research paper:

Raising import barriers in the United States on products from China, for example, may increase costs for Chinese exporters, but they also have a parallel effect on U.S. multinational companies with manufacturing operations in China that ship to the United States.

Obviously the risk of retaliation is not only possible from China but others. The tariffs announced by the administration over the weekend will not only impact China but Canadian firms such as Rakla Tire’s Inc., or Trazano a firm formed by and for a network of independent tire dealers from around the U.S. and the world whose products are made in China, or the Korean tire company Hankook whose products are made in China. How will China or any of these other players respond? If China does retaliate what impact will this have on the market activities of U.S MNC such as Goodyear and Cooper Tires or other foreign MNC, such as Pirelli who have made vast inroads into their market?

Upon assuming office, President Obama and his new administration received a report of recommendations, “China and the US Economy: Advancing a Winning Trade Agenda” from the “US-China Business Council” organized and founded in 1973 by leading U.S companies engaged in business with China. It outlines a series of action plans and given the councils purpose to serve its members with deeply developed partnerships established in China naturally presents a positive spin on the benefits of outsourcing and encourages the Administration to provide favorable policies toward China as “our” trading partner. Again I encourage reading the full report. In conclusion it provides a glimpse into the national mission as perceived by the members of this council:

American companies do not go to China to be role models or missionaries of change, but by their very presence they do offer a model for Chinese enterprises that are new to the world of modern global commerce.

This is particularly true on issues related to food and product safety, where US companies have the experience of operating under effective safety regimes. In fact, some in the consumer protection field have estimated that new safety requirements by major US companies over the past year have contributed more to the 46 percent decline in toy recalls than government action.

By simply being there, American companies and employees bring new ideas, new ways of doing things, new experiences, the best of company human resource practices, and proper environmental practices. They bring a day-to-day, working-level, unplanned, uncontrolled, but pervasive example of better ways to do things. It is not always perfect, and no doubt there are examples to the contrary, but the American company presence in China has been overwhelmingly positive.

A recent Manpower, Inc. poll showed that 75 percent of Chinese workers preferred to work for a wholly foreign-owned employer, rather than a Chinese company or joint venture. In general, the experiences of USCBC member companies have shown that the more China becomes integrated into the international economy, the more likely China will continue to move along a path of reform and development. That is good for the Chinese people and good for us.

We should support a greater presence by US companies in China, if we want to help bring improvements to workplace labor and environmental practices and improve consumer safety.

Whether the tariffs announced over the weekend by the administration are viewed as favorable by members of this council is unknown at this time but that U.S MNCs conduct massive volumes of business as described above is beyond debate.

As discussed in “American Protectionism” The Bureau of Economic Analysis (BEA) issues an annual report which tracks the trade conducted between U.S. MNC and their affiliates. This report lags behind two years and the latest report was issued in August of this year reporting for 2007. Please see “Table 3. U.S. Trade in Goods Associated with Nonbank U.S. Multinational Companies 2006 and 2007” on page 6 of the PDF document, U.S. Multinational Companies – Operations in the United States and Abroad in 2007. Within the table refer to the bolded heading “MNC-associated U.S. Imports, total.” For 2007 this figure was $728 billion and in 2006 was $694 billion (a revised figure from the prior year’s report). This figure is based on survey reports provided to the BEA from reporting US MNC on trade conducted with their foreign affiliates whom they have ownership.

I spoke with an individual of the BEA within the department responsible for this report and was told the BEA does not distinguish American brands made abroad from competitive foreign brands that are imported into the U.S. Essentially an import is an import. The nearest the BEA comes to placing a figure on the amount of American brands made abroad is tabulating the $728 billion found in Table 3. But this figure can include foreign made components purchased by a parent U.S MNC in the assembly of a product that may not necessarily be an American branded product. The BEA representative was not certain what percentage of American branded products contribute to our overall import business but explained that some officials and economist are growing concerned as there is a growing belief this is distorting the competitive issue. A conference on this concern was held in 1998 and I was sent a link to a book “Geography and Ownership as Bases for Economic Accounting” generated from the conference. The prevailing argument for years has been that the justification for outsourcing by American companies’ are their claims they would not be able to compete otherwise. But how valid is this argument today given how global supply chains and U.S. MNC trade operate?

The BEA publishes a historical recap of the U.S. Trade in Goods and Services –Balances of Payments but I was unable to find a historical recap of the U.S. MNC trade reported in Table 3 of their U.S. MNC Operations report. While speaking with the BEA representative I inquired if such historical data existed and was told the BEA does not publish such a record but was sent an excel spread sheet tracking these figures beginning in 1977 – at about the same time frame when outsourcing began. BEA did not track this activity between 1978 through 1981 but resumed tracking in 1982 and has continued doing so since. I have recapped theses figures below plus included the total imports and the trade imbalance after deducting our exports and in addition prepared a graph, also below. This data shows a direct correlation in the growth in U.S. imports and the trade conducted between U.S. MNC and their affiliates:

Click on link to view spread sheet: 

HistoricalUSImportTrade

In my conversations with BEA I inquired as to whether government officials or economist have concerns that U.S. MNC are in part contributing to the growing U.S. trade imbalance and was told yes but the prevailing theory is that at some point this will balance out over time. That is, this imbalance will be offset as the U.S. exports more. But again given how U.S. MNC firms conduct trade among their foreign affiliates is this theory reflective of 21^st century trading practices? It seems there will always exist to some degree an imbalance due the volume of American branded products imported for consumption in our own market. When I raised the question, the BEA representative expressed concern that I was perhaps attempting to make US MNC out as the villains, but that is not my objective.

My objective is to become acquainted with the world as it now functions in terms of international trade. It seems that in many respects for many this has not occurred yet. This can be seen for example on a governmental level by the outdated accounting practices for tracking import-export trade not only in the U.S. but other nations as well. A trade imbalance would perhaps be a minor issue if there were some standardized means of exchange. The BEA representative agreed with this perspective. As I’ve noted in “American Protectionism” and other articles I’ve authored relating to international trade, globalization essentially renders national borders and sovereignty meaningless.

Could something be in the works to achieve such standardization of exchange thus furthering the globalization agenda? And could the current global economic crisis serve as the catalyst? A couple of articles authored by Ellen Brown raises the specter of this noting:

The month after Lehman collapsed, Gordon Brown and the EU leaders called for using the financial crisis as an opportunity to radically enhance the regulatory power of global institutions. Brown spoke of “a new global financial order,” echoing the “new world order” referred to by globalist banker David Rockefeller when he said in 1994:

“We are on the verge of a global transformation. All we need is the right major crisis and the nations will accept the new world order.”

Richard Haas, President of the U.S. Council on Foreign Relations, wrote in 2006:

“Globalisation . . . implies that sovereignty is not only becoming weaker in reality, but that it needs to become weaker.”

Sovereignty is one of these cherished rights that nations will give up only with “the right major crisis.” Gordon Brown put it like this:

“Sometimes it takes a crisis for people to agree that what is obvious and should have been done years ago, can no longer be postponed. . . . We must create a new international financial architecture for the global age.”

“In April 2009, Gordon Brown and Alistair Darling hosted the G20 summit in London, which focused on the financial crisis. A global currency issue was approved, and an international Financial Stability Board was agreed to as global regulator, to be based in the controversial Bank for International Settlements in Basel, Switzerland.

Returning once again to the CRS report please refer to “Figure 7. Exports and Imports by U.S. Multinational Companies in Selected Industries, 2005” page 44 which shows:

“…exports and imports by U.S. multinational companies in selected sectors in 2005. The sectors are ranked according to those with the largest net exports at the top and those with the largest net imports at the bottom. There were many other sectors with data collected by the U.S. Bureau of Economic Analysis in which multinational companies operated, but those sectors had fewer than three companies reporting, and their data was suppressed to avoid disclosure of amounts for individual companies. The rank order in the figure roughly parallels the rank order for size of the fiscal multipliers for the sectors indicated. Food, computers and electronics, machinery, chemicals, metals, and mining tend to have the higher first round effects (less import leakage and more exports), while motor vehicles, retail and wholesale trade, and petroleum products tend to have lower first-round effects (more leakage abroad).

In conclusion the CRS report notes:

International business supply chains provide the structure for the new world of globalized business. Much of U.S.  international trade is conducted by globalized supply chains. For public policy, supply chains affect the magnitude of impact for fiscal stimulus packages and also the incidence of trade policy. Supply chains also are affected by the range of policies that have an impact on the competitiveness of U.S. business. Whether taxes, environmental regulations, labor policy, or shipping security, business supply chains are directly affected by changes in the business environment, whether in the domestic or foreign markets. In the world of globalized supply chains, a policy aimed at imports, may actually hit U.S. parented supply chains as well as foreign companies and countries.

The fracturing of business into core and non-core competencies and into domestic and foreign segments of supply chains implies that what had been purely domestic economic and regulatory policy now may affect the operations of U.S. parented supply chains abroad, and what had been primarily international economic, trade, and investment policy now also has a clear domestic effect. The globalization of supply has added complexity to both the managers of the supply chains and to policymaking.

In many respects it is primarily through policies and goals pursued over the last 30 years by America’s business and political leaders as well as other foreign participants that have lead the global economy to this point in our history. National financial interest transcends the borders of most industrialized nations. Borrowing once again a few statements I made in the “American Protectionism” article that seem equally appropriate here:

We do indeed live in a more complex era. Few things in our human endeavors and enterprises are simple. Usually they are far more complex and multi-faceted. These circumstances present an intriguing conflict of interest for all parties plus a boatload of other complexities for America in general and American policy makers in particular.

From a traditional perspective how does a country protect its domestic producer’s (DP’s) or their labor force in their home market from foreign competition when the DP’s themselves have essentially become the competition, are no longer domestically based, are transferring national wealth, proprietary knowledge, technology, and products to foreign nations through their foreign associations, whose dependency encompass the globe, and whose profit decisions are often self-serving and potentially detrimental to their country of origin? From a 21^st century perspective, if protectionist measures are necessary, what form should they take, who would we impose them on, and what are the potential consequences? Whatever the answers to these questions might be it seems clear we need to think before we react.

I don’t know whether a trade war is avoidable or not but have my doubts. Can policymakers and business leaders maintain? Historically when people and the institutions we create have felt threatened some defensive actions eventually follows. Can we transcend our past? The potential of a trade war through the actions undertaken thus far by the administration is in a real sense the first major test to globalization. It is in essence a clash between old world and new world business and governmental models coming to a head. It is also about striking a balance between the needs that best serve those of corporations versus those that best serve working people around the globe and that today transcend national sovereignty issues with governments finding themselves somewhere in between. It is a test as to whether capitalism can survive in this new world order and whether the world can find a way to share fully in its potential abundance.

Mitch Gurney