Think Tank: War-gaming Seen as an Antidote to Trump Trade Policy Uncertainty
Business abhors uncertainty. But uncertainty has been the organizing principle of the Trump administration’s approach to global trade policy, leaving every American business with an offshore supply chain scrambling for clarity and options. The financial survival of thousands of retailers is dependent on two factors: which set of conditions emerges, and how effectively they react.
In a trade environment that threatens to penalize large U.S. importers, especially retailers in certain categories such as electronics and apparel, the question is not how to avoid risk, but rather how to be better prepared than your competitors to respond to whatever policy scenario emerges once the rhetoric and “tweet storm” settles.
Here, we focus on three plausible trade scenarios: the imposition of a Border Adjustment Tax (BAT); what happens if NAFTA is dismantled, and the possibility of trade conflict with China.
BAT
A Border Adjustment Tax is included in the Paul Ryan-Kevin Brady plan, a Congressional blueprint for corporate tax reform advocating a reduction of the corporate tax rate from today’s 35 percent to 20 percent. Under a BAT, companies would be taxed on revenues generated in the United States less cost of goods sold, provided, of course, those goods were not imported, in which case their costs couldn’t be deducted. Exporters could keep all profits from goods sold outside the United States. This nets out as an effective 20 percent, across-the-board, tax on all imports.
While they provide localized services, retailers buy goods from diverse locations — often overseas. Because they rarely export, a BAT would hit retailers especially hard, raising the costs of many goods by 20 percent. Even more troubling, that impact doesn’t show up at the border, but rather in the company profit-and-loss statement, potentially destabilizing retailers with thin margins or high imports.
BAT proponents argue that resulting exchange-rate moves will compensate for the increased costs of imports. If that doesn’t happen immediately, retailers with significant imports would face considerable financial risk.
NAFTA
During his campaign, candidate Trump described NAFTA as “the single worst trade deal ever signed anywhere.” We don’t know how that translates in terms of policy but, at a minimum, the administration will likely seek to renegotiate the treaty — assuming they don’t tear it up altogether. Since NAFTA took effect, Mexico has enjoyed tariff-free access to the United States, and in 2016 exported $24 billion worth of food and beverages such as vegetables, fruits and juices; $28 billion of household durable goods like TVs, refrigerators, and cell phones, and $8 billion of household nondurables like apparel to American retail shelves.
Under a benign NAFTA scenario, the U.S. and Mexico might agree to modifications, like those previously agreed to during Trans-Pacific Partnership negotiations — primarily in areas like environmental standards on overfishing, needed updates to e-commerce and digital trade, and rules of origin regulations that are important to the auto industry. While certain labor standards updates may raise costs, specifically in areas like apparel, these reforms wouldn’t cripple U.S. retailers.
In a disruptive NAFTA scenario, American and Mexican negotiators would be unable to agree to a deal. The U.S. Congress must ratify any changes to NAFTA, but President Trump can terminate it with a stroke of his pen — an Amerexit, to borrow a phrase — and tariffs would return to pre-1994 levels.
China
China is the other target of the Trump administration’s ire. The most extreme Chinese trade policy proposal involves imposing a 45 percent tariff across the board. This would profoundly impact retailers, specifically in the apparel and electronics categories. Chinese exports account for 20 percent of U.S. household spending on furniture and household goods categories; for clothing and shoes, the rate reaches 36 percent.
The math is simple. Retailers would have to either absorb massive increases, killing their margins in the process, or pass those increases on to consumers. China would retaliate, likely by imposing counter-tariffs on American exports. The recent closure of South Korean department store operator Lotte’s Chinese outlets by Chinese authorities — a way of showing China’s displeasure over American missile deployments in South Korea — suggests yet another plausible response. American retailers might suffer Lotte’s fate in the event of U.S.-China confrontation, either economic or political. Wal-Mart Stores Inc. is a prominent example of an American retailer in China, alongside outlets for iconic American brands like Apple and Nike.
As these scenarios suggest, retailers face risks and certain categories of retailers are unevenly impacted. What unites them all is the need to understand their risk exposure to trade disruption and an imperative to develop plans to address those risks. In the words of GE chief executive officer Jeff Immelt, there are two ways to succeed: “One is when everything’s perfect. And the other one is when everything’s in chaos, but you’re better than everybody else.”
A number of optional responses exist for retailers and other importers, each requiring detailed thought and analysis. Absorbing costs will be difficult for most retailers given thin margins in many categories, so costs may have to be passed on to consumers. Importers face a number of issues, including: determining cost impacts under different scenarios; assessing real price elasticity in their category; thinking through competitive response; calculating currency implications; considering how retaliation by other nations may affect export markets.
On the supply side, assessing alternative location options – including serious consideration of re-shoring to the U.S. – requires understanding the necessary investments, cost differences between countries, technological and demand capacity, and what happens to prices if large demand volume moves to a new set of suppliers in a short time frame. These responses must be framed against wider considerations such as whether these policies are being used as short-term negotiation tactics or reflect a longer shift toward a more protectionist age.
While future success can’t be ensured, war-gaming potential responses helps companies develop strategic blueprints and the flexibility of thinking needed to address whatever the future of trade may bring. Furthermore, it gives them first mover advantage over their competition.
Jim Singer is a partner and board of directors member at management consulting firm A.T. Kearney. Jim is based in New York City and can be reached at jim.singer@atkearney.com.
Johan Gott is a principal in A.T. Kearney’s private equity/mergers & acquisitions practice and heads up its Trade Wargaming initiative. Johan is based in Washington D.C. and can be reached at johan.gott@atkearney.com.
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