Sunday, 29 January 2017

Impact of Protectionism and Trade Wars on Small Businesses

President Trump has recently signed executive orders that clearly indicate his administration’s intention to de facto heighten protectionism and global realpolitiks tensions. As they take effect, small businesses dependent on international trade are likely to undergo a cost increase, the magnitude of which will depend on how far they are in the supply chain. At this time, it appears that those businesses with trade relations with Mexico will be the first to experience it, but if the renegotiation of NAFTA becomes a reality, there could be a contagion effect to those dealing with Canada.

On the other hand we have the consumers.  Typically, cost increases lead to hikes in consumer prices and this pass-through effect tends to be quite close to the amount of the cost increase. Ceteris paribus (all else held constant), higher consumer prices will increase inflation rates and put upward pressure on nominal interest rates, and therefore on borrowing costs as well. In relation to profits, the likely outcome is a decrease in profits for businesses that sell goods and services with elastic demand, whereas those operating in markets with inelastic demand will be the least affected. Markets with an elastic demand are far more common that those with inelastic demand.

However, reality is in fact more complex.  For example, Mexican imports contain 40% of American made inputs on average.  Hence, domestic producers of those inputs will also be negatively impacted by tariff increases on Mexican products. Even more so if Mexico retaliates with tariff increases on American imports (i.e. beggar-thy-neighbor policies).

As most small businesses tend to be at the end of the supply chain (retailers, food and beverage establishments, etc.), business owners should considerer changing the country of origin of their supplies. This exercise should take into account not only the price listed by domestic suppliers but also foreign, and the tariff schedule that regulates imports per country – click here to access the US Harmonized Tariff Schedule (HTS).

For example, recent media reports suggest a potential additional tariff of 20% on Mexican imports. Such increase may justify changing suppliers.  More details about the specificities of the law will have to be disclosed in order to determine which products and services will be affected. Notwithstanding, regulatory changes often lead to additional costs for small businesses due to the time required to assess their impact and adaption to the new rules (e.g. logistics).

Another action that US importers and exporters should evaluate is the need to hedge exchange rates.  Protectionist policies tend to appreciate the domestic currency. This expected appreciation may be further augmented by plans to increase US investment in infrastructure.  As businesses dislike uncertainty, one may find it cost effective to buy or sell future contracts according to their needs – click here to access CME quotes and contract specifications.

Globalization is too big of a phenomenon to go away. It will not stop even if the US decides to shell itself from it. Globalization is just recently becoming truly global. Globalization keeps on growing as South American countries make new deals with the China, or African countries with the European Union. Lastly, one should not ignore history lessons. In the great recession of the 1930s there were similar populist outcries for protectionism in the US which led politicians to implement the Smoot-Hawley Tariff Act, raising tariffs on over 20,000 imported goods. The end result was a decline by more than 50% of US imports and exports, further exacerbating the depression and augmenting unemployment to 25% by 1933.

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