Content was last updated for relevancy and accuracy on December 20, 2023. 

Will Tariffs Benefit or Hurt U.S. Manufacturers?

The primary intent of applying a tariff on raw materials is to help domestic producers of such materials be more competitive with their global counterparts, thus creating (or protecting) domestic jobs. And while this strategy can certainly help domestic producers compete with countries who can produce the same product at a lower cost, it will virtually always result in higher prices to the end-user.

Historically speaking, domestic suppliers of goods protected under a tariff policy will often increase their prices higher than would otherwise be necessary to compete globally, prior to the imposed tariff. Manufacturers who rely on these materials to produce various components and finished goods or products are therefore forced to pay higher prices, whether via a manufacturing tariff or from a domestic supplier. In turn, manufacturers must either lower their margins (profits) or pass along the increase to their customers, which inevitably raises the cost to the consumers1.

It is impossible for manufacturers to control global political environments or predict the long-term effect of tariffs on their businesses. However, having a global manufacturing footprint can often mitigate some of the risks associated with domestic tariff policies. By having factories in different countries, manufacturers can shift production from one factory to another, depending on the lowest total cost of production. The cost of raw materials, however, is just one factor manufacturers must consider. Other costs, such as labor and logistics, could have an equal or greater impact.

The uncertainty that surrounded the Trump administration’s position on global trade and its U.S. tariff strategy made it difficult for manufacturers, especially in the United States, to understand and prepare for the impact it has ultimately had (and is continuing to have) on their companies and on the global economy. From his election in 2016 through the end of his term in January of 2021, President Trump’s political agenda was focused on trade deals with the U.S., and the impact of trade on the domestic economy. Under the implications of Section 301 (of the Trade Act of 1974), the ongoing trade talks and negotiations with China during his term served to raise import tariffs on Chinese products and goods2.

As of May 2019, the increased duties had been applied to $200 billion of Chinese imported goods, where auto parts and circuit boards took the hardest hit3. With the trade war between the U.S. and China continuing to percolate under the Biden administration, it is not unreasonable that companies who manufacture in China are uncertain about the future and whether it’s worth expanding their global manufacturing footprint.

The tariff increase on Chinese import products has caused some retaliation, which has had an impact on manufacturing costs, thus increasing prices for consumers. With 10-25% tariffs on most raw materials and components imported from China, as well as all foreign aluminum and steel, U.S. manufacturers are turning to Mexico as a way to mitigate their exposure to the current trade environment. As a result, the leading industries and manufacturing companies in Mexico today include the aerospace and auto industries, as well as the medical device industry.

As an example, a U.S. automotive supplier who requires steel may be sourcing it from outside of the United States, and almost overnight would have seen their raw material cost on steel increase by 25% due to the increased tariffs on Chinese imports in recent years. Their options are to pay the tariff on the steel auto parts, or find a U.S. steel supplier to replace their current supplier, which is often difficult to do quickly due to quality control requirements, certifications and other factors involved. Also, there is no guarantee the U.S. supplier will offer a significantly lower cost. If, however, this manufacturer had a factory in Mexico that was capable of manufacturing the same product, it could import the steel directly to that facility, tariff-free, produce the finished goods, then send the finished products to the U.S., avoiding the 25% tariff.

While manufacturing in Mexico is just one example, many manufacturers from virtually all industries have been expanding in Mexico due to lower labor costs, its proximity to the United States, and the Mexican government’s continued effort to attract foreign investment. Additionally, Mexico enjoys free trade agreements and treaties with over 40 countries, making it possible to import most raw materials from around the world, tariff-free.

The unintended—but historically significant—consequences of imposing an aggressive tariff policy can lead to higher inflation, retaliatory tariffs from trading partners, lower GDP and ultimately the risk of recession. The global trade disputes that were negotiated by President Trump and his administration, among other factors, ultimately spurred talks of another recession, and this speculation continues today under Biden. With that in mind, it’s important to note that many economic historians believe the Smoot-Hawley Tariff of 1930, one of the broadest tariff hikes in the history of the United States, increased the length and severity of the Great Depression4.

Being that approximately 70% of the U.S. economy (GDP) is composed of consumer spending on goods and services, it is no surprise that higher prices on manufactured goods can result in less spending, which is often a catalyst for layoffs and ultimately a recession.  Most economists agree that economic growth is by far the most effective long-term solution to create new jobs and that the short-term effect of protecting jobs using tariffs is far less beneficial.

Sources

1. https://www.nber.org/papers/w25672.pdf
2. https://www.nber.org/papers/w25672.pdf
3. https://www.economist.com/finance-and-economics/2019/05/10/america-raises-tariffs-on-china-and-the-stakes-in-a-trade-war
4. https://fee.org/articles/the-smoot-hawley-tariff-and-the-great-depression/

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