[SCMP Column] Preparing for a long war

September 24, 2018

Recalling Donald Trump’s infamous claim that a trade war is good, and easy to win, I for some reason keep thinking back to that other war - a real war - that the US believed would be good and easy to win – the Vietnam war, launched blithely late in 1955, and dogging the term of four US Presidents.

Recall the newly inaugurated Lyndon Johnson at a White House meeting in November 1963: “I am not going to lose Vietnam. I am not going to be the president who saw Southeast Asia go the way China went.”

And 18 months later: “We will not be defeated. We will not grow tired. We will not withdraw either openly or under the cloak of a meaningless agreement.”

But then recall a recently-unveiled late night phone log from Johnson to a top aide in May 1964: “It’s damn easy to get in a war, but it’s going to be awfully hard to ever extricate yourself if you get in.”

Leap forward to Richard Nixon in November 1969, after countless loss of American and Vietnamese life: “Let us understand: North Vietnam cannot defeat or humiliate the United States. Only Americans can do that... I'm not going to be the first American president to lose a war.”

 Hindsight casts a terribly unforgiving light on the hubris of the day.

One can always hope that the war-drum team around Donald Trump recall the harm that hubris can do, and can untangle the mess more speedily and effectively than did the four US Presidents entangled by 20 years of armed entanglement in Vietnam. But at this point, prospects do not seem good. Note Chad Bown at Peterson Institute in Washington, among those economists most carefully tracking the course of our trade war: “Trump has not articulated exactly what he wants from China, or how he wants to achieve it. Until the president himself engages on this very critical question, his administration’s only likely outcome seems the costly and destructive path of tariffs.”

And so what to do? I was fascinated last week by a valuable Deloitte briefing that walked methodically through how companies are responding, and what strategies they should pursue as trade war is fully engaged.

What are they doing so far? Studying the data to assess potential impacts, examining their supply chains to see what can be tweaked, laying the foundations for customs value planning, examining the tariff classifications they export under and consulting on whether or where they might win exclusion.

Step one is to assess impacts. As the new round of tariffs takes effect today, embracing up to 6,000 products, the first need is to discover how customers will respond. If buyers stop buying, then many China-based exporters (most of them US, Hong Kong, or Taiwan-owned) face one kind of challenge.

But if (as seems more likely for most exporters) US customers continue to buy, the main challenge is to arm-wrestle over who will carry the tariff burden. Best estimates so far seem to be that Chinese authorities will relieve up to 45 per cent of the burden by providing export tax reliefs of one kind or another, or reducing fees and charges for affected companies, while US consumers will swallow 45 per cent of the burden in higher retail prices, leaving exporters and US importers to absorb the rest by squeezing profit margins.

According to Deloitte, some of the most interesting activity will focus on country of origin rules, on wriggling around export classification codes, and on paring down the export value that is exposed to a tariff charge.

To fall victim to the new US tariffs, two things must be clear: is the export made in China, and is the export on the 5,000+ list of tariff codes that will carry the tariff. Deciding on country of origin is less clear than it seems. Under WTO rules, it should be the country in which the last “substantial transformation” occurs. But with long and complex supply chains in place, the location of this final substantial transformation may not be clear, and in some instances might easily be “tweaked” – away from China.

I had always thought the six-digit “Harmonised System” codes that have since 1988 determined what category an export falls under were immutable, with the six digits broken down into three parts: the first two digits identify how the goods are classified, e.g. 09 = Coffee, Tea, Maté and Spices. The next two identify groupings within that chapter, e.g. 09.02 = Tea, whether or not flavoured. The final two are even more specific, e.g. 09.02.10 Green tea (not fermented). But it seems many goods are not so clear-cut, and are often agreed in haste and inaccurately. Many are now being scrutinized in case they can be reclassified away from the Trump tariff list.

Most fascinatingly, many companies are looking at “price unbundling” to reduce the amount subject to tariff. At present, if our export good costs US$70, and your trading agent in Shanghai marks the price up to US$100 to include his fee, the dutiable price is $100. Paring out the middleman fee – or royalty costs, commissions, R&D costs or licence fees – can reduce the value exposed to duty.

As the US administration wades deeper into this quagmire, we must hope that the Trump trade team recognize sooner rather than later that trade wars are neither good, nor easy to win.

I recall the revered CBS anchor, Walter Cronkite, returning from Vietnam in February 1968 to say: “It seems now more certain than ever, that the bloody experience of Vietnam is to end in a stalemate. To say that we are closer to victory today is to believe in the face of the evidence, the optimists who have been wrong in the past.” It took another seven years for the US government to recognize reality and end the war. I hope it does not take today’s US administration so long.
David Dodwell researches and writes about global, regional and Hong Kong challenges from a Hong Kong point of view. Opinions expressed are entirely his own.

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