Uncertainty Creates Risk for Companies

uncertainty-risk impact
19 Jun, 2019

IMPACT

Uncertainty Creates Risk for Companies

uncertainty-risk impact
June 2019

When the White House in mid-May accepted the Commerce Department’s conclusion that auto imports constitute a threat to U.S. national security, Toyota was quick to respond.

“Today’s proclamation sends a message to Toyota that our investments aren’t welcomed, and the contributions from each of our employees across America are not valued,” the automaker announced.

Those are hefty investments and lots of employees. Although headquartered in Japan, the global automaker owns and operates 10 manufacturing plants in this country as well as 1,500 Toyota and Lexus dealerships, and employs 137,000 Americans.

Only weeks before the administration’s announcement, under a so-called Section 232 trade report, Toyota said it would be investing $13 billion in the United States over the next half-decade — a commitment the company intends to keep, despite the uncertainty that characterizes American trade and tariff policies.

“We’re a Fortune 10 company that does business in over 170 markets around the world,” says Stephen Ciccone, group vice president, Toyota Motor North America. “We make investment decisions 20 to 30 years out and cannot afford to sacrifice long-term success to manage a short-term crisis. Toyota must do business as usual in uncertain times, but the current threat of tariffs on all auto imports is a total game changer. It’s as if the sword of Damocles has been hanging over our heads for the past year and it will continue to overshadow the entire industry for the next six months at least.”

This sword of Damocles is the possibility that the Trump administration will impose 25% tariffs on all imports of automobiles and automobile parts. The Section 232 ruling grants the president the authority to impose the tariffs, though the White House says it will give the U.S. trade representative six months to negotiate remedies before doing so.

“A 25% tariff on all autos and auto-part imports would be one of Trump’s largest trade actions to date, second only to the tariffs he has imposed on $250 billion worth of Chinese goods,” Politico reported in May. The U.S. imported $157 billion in car parts in 2018 alone.

“It’s my job to protect Toyota from these tariffs,” Ciccone says. “We need everyone to understand that tariffs are just a tax on consumers. They will raise the cost of every single vehicle sold in the United States. These higher prices will in turn put pressure on the auto market, leading to decreased sales, lower production and fewer jobs.”

Unfortunately, this uncertainty will drag on with no immediate end in sight. “This is going to be the norm for the next five to 10 years,” says Michael Gravier, a professor of marketing and a supply-chain expert at Bryant University’s business school. “This is all part of a deeper struggle, as countries reorder their political and economic alliances, and this is taking place in a time of great technological change.”

Strategic planning in such uncertain times is even more challenging than in more settled ones. “Uncertainty creates risk for companies, which affects economic growth,” says Council President Doug Pinkham. “The fact that companies don’t know how the tariff issues will be resolved makes it difficult to plan, which means they postpone or even cancel new manufacturing plants, consider relocating operations from countries involved in trade wars and hold off hiring. Sometimes adjusting to bad policies can be less difficult than trying to plan when you don’t know what the policies will be.”

China as a Global Player

Christopher Mitchell, a professor of international relations and politics at Mount Holyoke College, says the struggle “goes back much further than Trump, though Trump’s theory of trade policy is what the media has focused on. This is about where China fits into the world as a global player. After World War II, the pattern was for the U.S. and European countries to set the rules, and everyone else followed. That is no longer the case. All the rules are being rewritten.”

As this reordering takes place, companies are trying to figure out how to make strategic decisions. “Domestic uncertainty has a chilling effect on investment,” says Joe Quinn, vice president for public affairs with The Aluminum Association. “We’ve had the same global supply chain for 30 years, and all that is being disrupted and the international market for aluminum is being distorted because of Chinese overcapacity.”

China can subsidize its production without regard for market forces or demand, in part just to create jobs. “So it becomes difficult for our member companies to compete with China’s companies,” Quinn says.

“Our domestic demand for aluminum is terrific, but there’s no way we can meet demand domestically,” he adds. “Since Section 232 tariffs were imposed in 2018, Chinese production increased a lot, while ours increased only marginally.

“Getting the Section 232 tariffs removed from Canada and Mexico was a major win for the industry. But they remain in place for other market economies. It becomes extremely difficult to commit resources to build a new smelter in the U.S., for example, if you don’t know whether the tariffs are going away or not.”

‘Tech Cold War’

All this uncertainty in manufacturing may be only part of a larger struggle with more serious long-term implications. “Yes, the geopolitical environment makes it more difficult than it was before the trade war started,” says Leon Levy, an analyst with Ian Bremmer’s Eurasia Group. “But the bigger contest, which gets less attention, is what at the Eurasia Group we call the ‘tech Cold War.’”

That’s the contest over who is going to control the development of world-changing technologies, “whether it is the American — or Silicon Valley — model of private companies doing so for profit, or the Chinese model, which is state-backed companies that are part of a larger national-security agenda,” Levy says. “For the past 20 years or so, politics hasn’t been that important to [the development of these technologies], but today it is. Now there will be battles over the regulation of this development, and they will be intense.”

Immediate Challenges

In the meantime, companies must deal with more immediate challenges. “Those with the greatest exposure are those whose manufacturing is done in China,” Levy says. “Then there are all those companies that want to reach those billion-plus consumers in China.”

John Scannapieco, chair of the law firm of Baker Donelson’s global business team, was in China advising Chinese clients doing business in the U.S. for several weeks in the spring and returned with fresh insights. “We’re seeing a lot of retaliation from China that goes beyond tariffs,” Scannapieco says.

Among these, he says, is “more aggressive enforcement of China’s own anti-dumping and anti-corruption laws aimed at U.S. companies doing business in China and other laws that make it more difficult for U.S. companies to repatriate profits. I believe these are designed to pressure U.S. companies to go back to the U.S. and complain to their elected representatives about what this trade war is doing to their business.”

Scannapieco also worries that as a result of the trade war, the U.S. is being seen by the rest of the world as an untrustworthy trading partner. “They’re wondering if the U.S. will slap tariffs on them. This is a slippery slope in so many areas, and the efforts of the administration to protect U.S. interests will actually hurt them. Other countries will decide that they cannot rely on the U.S. to license new technologies, for example, and they will seek their own systems of doing this.”

China Needs the West

However, other experts say China’s appetite for retaliation, as well as its ability to continue the trade war, is not limitless. “China is in dire need of Western technologies and, contrary to what you hear in the media, they don’t steal everything,” says Stanley Chao, president of All In Consulting and author of Selling to China: A Guide for Small and Medium-Sized Businesses.

“The Chinese want more open markets, and they want to reduce the level of intellectual property theft,” Chao contends. “They’ve actually been getting better and more market-oriented over the past five years or so, and I believe they will continue to improve, but only on their own terms.”

Nevertheless, Chao says that China cannot meet the demands the Trump administration is placing on it “in one fell swoop or with a single document. It is unrealistic to think Beijing can simply stop subsidizing state-owned enterprises, because so many people are employed by them, although it has already done some of that. That system has been in place for 30 years and cannot be dismantled that easily. Trump was correct to shine a bright light on these issues, and China is responding in small ways that show it is sensitive to how foreign companies view it.” 

That’s why Chao thinks Western companies should approach trade with China on an industry-by-industry, case-by-case basis. “Where they once insisted, for example, that U.S. companies enter into joint partnerships with Chinese companies, they are no longer requiring that,” he says. “They are willing to accept Western goods and services because they need them so desperately.”

Chao is hopeful, “just as I was after Tiananmen Square, when a lot of Western companies bailed out. If anything, this is the time to double down, just as with stocks you buy low and sell high. I think the trade war will last two to three years. This, too, shall pass.”

Companies that want to trade with the countries that are part of the “one belt, one road” market “need to be working with China,” Chao says. “I think there is an 80% chance Trump and Xi [Jinping, China’s president] reach a deal, because China over the long haul wants to move in the direction Trump is demanding.”

Rejecting Retrenchment

Another reason for Western companies to stay the course and reject retrenchment is that the world’s fastest-growing economies are in Asia — China in particular — and India, says John Manzella, founder of ManzellaReport.com and author of Global America: Understanding Global and Economic Trends and How to Ensure Competitiveness.

“These are also the biggest markets, and where the greatest employment by U.S.-based firms has occurred,” Manzella says. “What President Trump doesn’t understand is that when U.S. firms invest overseas, it creates jobs. The ‘giant sucking sound’ Ross Perot talked about never happened. There is no question that uncertainty is the enemy of prosperity. I believe the president’s policy of creating uncertainty is deliberately designed to discourage U.S. firms from investing overseas, which is a huge mistake. It is a 1960s mentality, and the world is a very different place than it was back then.”

Manzella agrees with Chao that the president is making unrealistic demands on Beijing. “China’s culture requires that Xi save face, and he cannot meet these demands without losing face,” Manzella says. “Xi would have to reform entire industries, and China was already moving in that direction, toward a more market-driven system, when it joined the World Trade Organization. There’s no question that China engages in predatory behavior, and Trump was right to take them on on this issue, unlike his predecessors. But the way he is going about it is not good.”

Surveys by the American Chamber of Commerce in the People’s Republic of China show that U.S. companies with facilities there believe the trade war is hurting their business, but 65% of those companies want to maintain their operations in China. “The ones who are considering relocating aren’t planning to bring their operations back to the U.S.,” Manzella says. “They’d move to India, Vietnam and the Philippines — near where their Asian markets are. Only 6% were thinking about relocating back to the U.S., which means Trump’s policies aren’t discouraging investment overseas.”

That doesn’t mean that any of these companies can make strategic decisions about investment as effectively as they could if policies were more settled and predictable. “Whether you are for or against the tariffs, and we are against them, if you don’t know if or when they are going away, you cannot plan,” says The Aluminum Association’s Quinn. “Sometimes the uncertainty can be worse than the policies themselves, whatever those policies will be.”

When Will the Trade War End?

How soon will the trade war end? How soon will U.S.-based companies have a better sense of the landscape in which strategic investments can be made?

Mitchell at Mount Holyoke believes that it all depends on American domestic politics. “Being authoritarian, China can endure more economic pain than we can, so the question is how long the Trump administration can maintain a hard line,” he says. “That’s why China’s tariffs are aimed at Trump-supporting areas. Massachusetts is lost to Trump, but Michigan and Iowa are Trump states, which is why there have been bailouts for farmers. The question is whether the Trump coalition will hold together or break apart — if and when the economic pain of the trade war starts to affect our own politics.”

Until then, companies whose operations are hurt by the current uncertainty need to make their voices heard. “I think it is time for U.S. companies to engage more with their elected representatives,” says Bryant University’s Gravier. “It is important in this environment for government to hear from business about what this uncertainty is doing to them. Companies need to be involved in this process. They need to be telling their elected representatives how this is causing them pain. The faster they get the word out, the bigger influence they can have.”

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