Supply Chains, Not Trade Agreements, Keep Tariffs Low

Based on the research of Kishore Gawande

Look at the iPhone in your hand. From the outside, you might see a gadget for taking pictures or playing Candy Crush Saga. On the inside, though, you’re holding a miniature Trans-Pacific Partnership.

That’s because Apple’s iconic phone picks up parts from at least 10 countries, most of them Asian, along its path to final assembly in China. And according to faculty members at the McCombs School of Business, it’s this growth in global supply chains (which now account for two-thirds of international commerce) that’s actually keeping tariffs low — not multinational trade legislation like NAFTA or the TPP.

High on Supply Chains, Low on Tariffs

In research for the World Bank, Kishore Gawande, professor of Business, Government and Society, tried to quantify the roles of trade agreements and supply chains in keeping tariffs low. He started with a question: Why didn’t tariffs go up during the Great Recession the way they had decades earlier in the aftermath of the Great Depression?

His interest, he says, stemmed partly from memories of growing up in India, where he never saw a Ford or Toyota. To protect its own automakers, the country had levied tariffs of 400 percent on imported cars.

To analyze present-day tariffs, Gawande looked at seven emerging nations that make parts for multinational firms. He compared their import fees before and after the 2008 crash, averaging out their various rates for different kinds of goods.

All the countries had histories of high import duties. But Gawande found that four of them — China, India, Mexico, and South Africa — had lowered overall tariffs from 2008 to 2009, rather than boosting them to shield their manufacturers. The other three countries — Argentina, Brazil, and Turkey — had raised their rates only slightly.

Under existing agreements, each nation actually had room to set tariffs much higher. For Argentina, the ceiling was 31.94 percent. But in 2009, it set average rates of only 5.96 percent — a mere 0.5 percentage points up from the previous year.

“The fact is,” says Gawande, “that even when each country has the right to increase tariffs within the bounds of trade agreements, they don’t do it.”

Some factor besides trade agreements was holding import charges down. To pinpoint the role of global supply chains, Gawande looked at data from the United Nations Conference on Trade and Development. The UN scans the documentation (known as a “bill of lading”) that accompanies all cross-border shipments. It tracks more than 5,000 commodities and assigns a six-digit code to each.

He found several significant links between supply chains and tariffs:

• The more parts a country exports, the lower its tariff rate tends to be on imports.
• Trading goods within the same industry (like countries that both import and export auto parts) also corresponds with lower tariffs.
• Conversely, in countries where most parts were used domestically, tariffs were higher.

Gawande finds that exporting companies have incentives to keep duties low — even when domestic manufacturers want them high. A steel maker might want high tariffs against imported steel, Gawande says, but that’s counter to what benefits local auto producers, so they lobby politicians against them.

“Protecting domestic producers is passé,” Gawande adds. “If I’m buying parts from you, I don’t want protectionism. It just raises the price at which you sell them to me.”

Offshore to Onshore

Besides keeping tariffs down, supply chains are having a second effect, says Michael Hasler, a fellow at McCombs’ Supply Chain Center of Excellence. They’re making tariffs less important when companies decide which countries to do business with or where to put a factory.

That’s thanks to the same advances in information technology that make global supply chains possible. They help planners factor in many costs besides customs fees, from political stability to transportation time. “The tariffs or the lack of tariffs involved in a purchase are just one line item in the total cost calculation for that purchase,” Hasler says.

The TPP tries to address these broader risk factors by adding protections for intellectual property and investments, he notes. “One country may be a terrific environment for low cost of manufacturing, but you run the risk of having the facility nationalized once you’ve got it up and running.”

Meanwhile, a few U.S. firms are hedging supply chain risks by bringing some production back home — a phenomenon known as onshoring. “If I source this product in the U.S., I might be able to get it here in 10 days,” he says. “I can get it produced in Vietnam for one-quarter of the price, but it takes 90 days to get here. I put a greater value on shortened lead time than on lower tariffs and cheaper labor.”

Apple itself is making some of those cost calculations, notes Gawande. It still assembles a $600 iPhone in China. But in 2013, it moved production of its Mac Pro, which commands a $3,000 price tag, to Austin.

“When offshoring is not reliable, companies will bring it back onshore,” Gawande says. “Now, in some circumstances, we are poised to take advantage of global supply chains.”

Story by Steve Brooks