There is still a lot of uncertainty swirling around what effect the U.S.-China trade war will have on the global economy.
One way to gain a sense of how tariffs are affecting global trade is to look at IHS Markit's Global Purchasing Managers' Indices (PMIs). The Global PMI has proven to be a reliable indication of world trade dynamics. (Figure 1, for example, shows how the Global Manufacturing PMI for new export orders is a leading indicator of world trade volumes.) The PMI is a series of diffusion indices, where a reading of more than 50 on an index indicates growth, while a reading below 50 indicates contraction.
![[Figure 1] New export orders index leads world trade dynamics](/media-library/20191023monetary-ex1.jpg?id=53611678)
![[Figure 2] Change in market share for the goods subject to tariffs](/media-library/20191023monetary-ex2.jpg?id=53611679)
![[Figure 3] Overall impact of tranche 4 on GDP](/media-library/20191023monetary-ex3.jpg?id=53611680)
Since 2019, the IHS Markit Global PMI has been below 50, indicating that global trade has been contracting. IHS Markit believes that this weakness in global trade has been largely brought about by substantial changes in U.S. tariffs on goods imported from China.
In the past year and a half, the United States has imposed tariffs on three different lists or tranches of goods and has identified a fourth. The first three rounds of tariffs have already resulted in a significant shift away from China and to other countries of origin for goods imported into the United States. Mexico, Taiwan, and South Korea have all gained noteworthy market share. Tranche four, the last to go into effect, stands to see further erosion of Chinese market share as trade shifts substantially toward Vietnam. (See Figure 2.)
As country of origin shifts away from China and toward other markets, there will be reverberating effects elsewhere in all major markets—those in which goods will now be sourced, as well as across all markets that are buyers and consumers of those goods. Those effects will include changes in consumption, changes in production, and changes in investment. These market disruptions will cause the global economy to migrate to a new and suboptimal equilibrium. Under that scenario, the United States and China are both losers as measured by real gross domestic product (GDP), with the United States set to experience a 0.9 percent deviation from baseline and China set to experience a slightly larger deviation of 1.4 percent. Perhaps the most underappreciated fact in the narrative of this bilateral trade war is that the rest of the world will be negatively impacted by it as well, if not to the same degree as the primary participants. IHS Markit estimates that the global economy, at peak impact in 2021, will experience a 0.6 percent deviation from baseline real GDP. (See Figure 3.)
This analysis highlights the broad effects of the ongoing trade war between the United States and China. It is negatively impacting markets beyond those two countries and is resulting in multiplicative impacts in the economy beyond a reduction in trade, including changes in consumption patterns, production, and investment. In other words, the U.S. tariffs have implications for all companies with a global footprint, whether they are exposed to the Chinese market or not. It is incumbent upon each and every company to understand the risks in their current global footprint and the opportunities in new markets to ensure the best response.
Understanding your risks
It's not just tariff increases and the threat of an outright trade war between the United States and China that have led global manufacturers, retailers, and consumer brands to reassess their global supply chains and their sourcing and procurement costs. Other recent political events—such as the uncertainty around an open European marketplace after Brexit and the pending ratification of the United States-Mexico-Canada Agreement (USMCA)—will also have an impact on global supply chains.
These events emphasize how necessary it is for companies to pay attention to broader geopolitical events and trends and understand their possible economic ramifications. Furthermore, new risks are present today that firms didn't have to deal with a decade ago and even more will emerge tomorrow—driven by policy uncertainty, shifting bilateral and multilateral alliances, the expansion of consumers in new regions, and new patterns of unrest. Failing to identify the pertinent risks is incredibly expensive—realized through delayed investment and unforeseen losses.
Companies need to take a more rigorous and quantitatively justified approach to their strategic sourcing decisions than they have in the past. When deciding where to source from, it is critical to deploy a holistic decision-making framework informed by the broad spectrum of economic, risk, and industry factors that vary across countries.
There are a series of broad questions that companies should be asking themselves:
- How stable and reliable are my current strategic sourcing partner countries? What are the odds of disruption? What are the greatest areas of risk? How are risks evolving over time?
- What new strategic sourcing partner countries should I consider? Where do economic, demographic, and risk conditions align? What origin markets already support a product or segment? What origin markets produce adjacent products or segments?
- Is my sourcing strategy appropriately diversified? Is my current strategy resilient to local, regional, and global events? Are there hidden or underlying risks that exist across my current strategy?
In a similar fashion, as specific events and developments arise, companies need to analyze how these events could affect their commercial operations. For example:
- Will the recent presidential elections in Brazil have substantial effects on the real exchange rate to the U.S. dollar? Could this disrupt our company's input prices?
- What effect could labor changes in Southeast Asia (such as changes in wages, labor force availability, and possible industrial actions and disruptions) have on our supply chain network? How would our total costs be impacted?
- Could a disruptive event or violence in Latin America, such as large-scale demonstrations against government policy, pose a risk to our in-country team members, facilities, or partners?
- How sensitive is our network to changes in the U.S. dollar?
- How would a "hard landing," or sudden rapid decline, in the Chinese economy affect our network?
While each company is digesting, measuring, and responding to these critical questions and implications, the global marketplace is constantly changing and growing increasingly complex and interconnected. For example, evolving macroeconomics are dramatically impacting the costs for labor, raw materials, packaging, and shipping, and are doing so differently in countries around the world. Commercially relevant risks, including contract enforcement, labor strikes, and corruption, are increasingly impacting business operations and, sometimes, even strategically impacting companies through reputational risks. Meanwhile policy environments and social conditions, including regulatory, international trade, and tariff regimes, are changing rapidly. Finally, the sourcing behavior of competitors is constantly changing, presenting companies with both new strategic challenges and opportunities.
Companies need to recognize the cost of making the wrong decision, as well as the limitations of their current world view. A proactive and informed strategic sourcing framework is critical to secure existing revenue today and to grow a business tomorrow.
