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5/4/2020  The Lockdown Loosens and More Trade Issues Emerge


by Lewis Liebowitz

As the Coronavirus lockdown enters its third month, some states are starting to reopen their economies. As of this writing, 23 states were partially reopening as May 1. Every state is different, of course, and no state has reopened all businesses.

Manufacturing continues to take tremendous hits. Auto producers are shut down and May not resume production until mid-May, if then.

While demand for raw materials and components is on hold, producers are cutting back, waiting for demand to rebound. Industrial production is off by double digits—and workers are being laid off not just here, but all over the world.

As reopening begins, we can see glimpses of what the post-pandemic world may look like. There is still a great deal we do not know, but it is becoming clear that things—many things—will change.

Companies and governments are beginning to examine domestic and global supply chains. The pandemic upended a lot of assumptions for workers, employers and government about the costs and benefits of globalization. Today, while it is still important to keep costs low, the prospect of further supply disruptions has companies exploring ways to keep their supply options open. A single supplier business model does not look as attractive as it did only a few months ago.

A couple of examples from the past couple of weeks: in Mexico, which is just now seeing a peak of new cases, several weeks behind the United States, Mexican governors are shutting down operations, including many that supply critical materials to U.S. companies. Baja California is particularly affected by this, but factory closures are happening all over Mexico.

Some companies in Mexico supply components for ventilators—without the components, the ventilators can’t be made in the U.S. This could lead to shortages at U.S. hospitals. Governors in Mexico have declared these suppliers “non-essential” businesses and forced them to shut down, rejecting pleas from U.S. companies to stay open because the components are essential to United States customers. The Mexican governors are not so quick to see American production as worth the risk to Mexican workers.  These issues remain largely unresolved.

Buy America

News reports surfaced this week concerning efforts to keep prices up and factories operating in the United States by steering government purchases to domestic sources. Buy America laws incentivize companies to produce for government customers by promising higher prices. How government will manage to pay more while spending so much during the lockdown is a major problem vexing the states and the federal government.

Companies that manufacture personal protective equipment (PPE) for hospital workers and first responders want to beef up “Buy America” requirements, incentivizing customers to buy domestic by giving domestic firms a price premium over foreign firms. However, critics argue that increasing prices during a supply emergency is counterproductive.

Buy America is an important subject, because it aims to increase American production and jobs, but does so imperfectly (as much of government, and indeed much of the private sector does). The point of Buy American legislation is to make government purchasers of materials for maintenance, construction, clothing and other products look to domestic suppliers. But the rules are necessarily complex and give companies numerous avenues to keep costs down by using some foreign components and materials. It’s hard to draw the right lines and be fair to everyone without getting complicated.

Buy America rules are designed to make products more expensive than they would otherwise be. Governments must operate on budgets, so more Buy America means fewer and smaller government projects. On the other hand, when there is a major global pandemic, the usual foreign sources may not be reliable or even available. When demand spikes for products like PPE and ventilators, the presence of a domestic industry able to fill the need can be very important.

Governments both state and federal need to be able to plan for emergencies, but they also need to be sure they are paying a fair price. If they pay too much for one product, they have less money to buy other products.

Another initiative we are seeing recently is a push to have private companies “reshore” their supply chains. This first took shape in the trade war with China. When the China tariffs first were applied, product exclusions encouraged companies to reshape their supply chains away from China. Now, advisors like Peter Navarro are urging companies to reshape their supply chains toward the United States. The future may see “urging” replaced by compulsion.

One wonders how it will take to remake supply chains created over decades. Economists, logistics firms and efficiency experts know that reshaping supply chains is a formidable task, requiring years. Incentives like Buy America, which until now has been directed at government procurement, have never been very successful at forcing businesses to pay more for raw materials and components—they will find a way around tariffs and other trade restrictions; the complexity of the rules provides opportunities to take advantage of quirks in the rules.

A successful strategy will require consistent pressure on companies and the government to be fair. Americans have never liked being imprisoned by high taxes—and tariffs, of course, are taxes. Quotas for necessary raw materials are also difficult to maintain over the long run—companies figure out the rules and adapt to them so that quotas won’t really change conduct for long.

Antidumping duties, safeguards, and national security measures also begin to show leaks after a relatively short time. Companies have ways of adapting to them too.

In an emergency like we are in right now, government can move the needle through incentives and commands (like the Defense Production Act), but not too far. Successful long-term measures have a sound mixture of carrots and sticks, not all one or the other. Right now, all we’re hearing about are the sticks.