Trump’s Tariff Threats and Supply Chain Bifurcation: A Lose-Lose Proposition

Donald Trump has threatened to raise tariffs when his second term in office starts in January 2025. These include an across-the-board tariff of 10 per cent, a 25 per cent tariff on Canada and Mexico, a 100 per cent tariff on the BRICS countries, and a 60 per cent tariff on China. It is unclear if he will carry out all these threats, which are either Trump’s characteristic bluster or a negotiating tactic. Perhaps the most likely threat to materialise would be the one on China, as it is the most repeated and would have bipartisan support. It will also have the largest impact, indirectly, on Southeast Asia.

How are the new tariffs on China likely to play out? First, size matters. The proposed new tariffs of 60 per cent are significantly higher — double or triple — than the original tariffs imposed by Trump. The effective rate of these new tariffs would be a further multiple of the proposed nominal rates. This multiplier effect operates as a manifestation of producing through supply chains (where value is added in multiple destinations).

While the tariff is imposed on the import’s total value, it is triggered by the share of value-added in China. The average share of value-added in manufacturing for so-called “Made in China” exports is about one-third. Therefore, the tax on adding-value in China, represented by the effective tariff, is about 3 times the nominal rate, or 180 per cent. For example, a shirt that sells for US$100 in the US can be hit with a 60 per cent tariff (US$60) because a third of its value (US$33.33) is added in China. The effective tariff is 60 divided by 33.33 (180 per cent). This means that production is likely to shift out of China to alternative sites like Vietnam or Thailand if the same activities can be undertaken at no more than 180 per cent of the cost in China. This represents a significant incentive for producers to move China out of the supply chain.

Second, the starting point matters. President Biden not only retained the original Trump tariffs but also expanded their scope and introduced a host of potent non-tariff measures, including export controls and subsidies. There have been three rounds of mostly cumulative punitive measures, with the most recent and comprehensive package denying 140 Chinese entities access to US technology to further arrest the development of China’s chip-making industry. China was quick to retaliate, blocking exports to the US of critical raw materials, including gallium and germanium.

These are worrying signs for Southeast Asia. The China-centred regional electronics supply chain has Malaysia, Singapore, and Thailand as key players, with the Philippines and Vietnam playing important roles at the assembly end. The escalation in US-China tensions has seen Chinese and foreign firms shift out of China and into Southeast Asia. Trump 2.0 will further accelerate this restructuring.

The Trump tariffs could lead to an all-out trade war, as happened in 1930 when the US unilaterally raised around 900 tariffs by about 40 per cent to 60 per cent. This prolonged the Great Depression and world trade contracted by a startling two-thirds. There is no reason to expect a different outcome this time around.

As the trade war escalates, the likelihood of bifurcation of supply chains also increases. Trump is likely to continue targeting firms based on their nationality rather than their location. If these measures are implemented effectively, then any geographical reconfiguration of supply chains to circumvent these punitive measures will no longer work. As the incentive to engage in costly relocation diminishes, the prospect of bifurcation increases.

This could soon result in a world where semiconductors and products that include them and other targeted products are produced by duplicate supply chains: one for the US and other markets like the EU that penalise value addition in China, and yet another for others. That is, another supply chain is engineered purely to bypass tariffs, when one supply chain is the most efficient. In this scenario, Chinese firms would no longer invest in Southeast Asia purely to bypass tariffs but foreign firms in China could still shift to Southeast Asia.

If China retaliates with matching measures, which is likely, this could lead to further fragmentation of supply chains. China is an important enough market for yet another supply chain to be configured, without US and/or European value-added, to avoid retaliatory measures. Many products are produced with multiple supply chains, but when the duplication is driven by policy distortions, it is costly and inefficient.

Overall, these multiple supply chains would be highly inefficient because scale economies will be compromised and resources misallocated, resulting in higher prices for all. The question facing Southeast Asia and other regions is whether these supply chains can operate without China or the US/EU.

The answer is no. As the world’s largest trading nation, China is deeply immersed in the global web of manufacturing supply chains. It could be quite difficult and costly to try and remove China from all aspects of the production process. Some goods cannot be produced or produced in the desired quantities without Chinese value-added in cases where the country is the only or main supplier of a critical input, such as rare earths. The same could be true for the US, with how it is restricting access to its superfast chips, for instance. Therefore, many products will still be produced by one supply chain but their prices will increase because of tariffs rather than inefficiencies.

The Trump tariffs could lead to an all-out trade war, as happened in 1930 when the US unilaterally raised around 900 tariffs by about 40 to 60 per cent. This prolonged the Great Depression and world trade contracted by a startling two-thirds. There is no reason to expect a different outcome this time around. Lose-lose propositions may be as elusive as win-win ones, but Trump’s tariff threats, if carried out, will be one such outcome. There is still time to avoid it by abandoning this potentially disastrous tariff policy.

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