We often hear about new rounds of tariffs affecting trade, and strengthening or deteriorating trade relations between nations. As a small business owner, it is important to know what all of this can mean for you: how do tariffs affect your processes, your inventory, and your bottom line?
What is a Tariff?
Let's start at square one: what is a tariff? The simple answer is that a tariff functions as a protective tax on a country's imports and exports with the desired result being less foreign product entering a domestic market, and more domestic product staying in the country's market. The point of all of this is to protect domestic business interests in order to boost business productivity, and therefore domestic GDP.
Within this definition, there are two sub-types of tariff: bilateral and unilateral. Bilateral tariffs, which will be the focus of this blog post, are put in place to protect successful domestic companies from industry rivals based in a specific foreign country. For example, bilateral tariffs between China and the United States would discourage trade of a certain group of products between the two, so that, say, a major Chinese soda manufacturer would be less likely to enter Coca Cola's domestic market.
Do Bilateral Tariffs Really Protect Domestic Interests?
In theory, yes, but in practice the answer is more complicated. Bilateral tariffs are often created between countries that have similarly powerful industries (such as China and the U.S) as a protective measure. However, it is not uncommon for wealthy countries to subsidize the tariff and continue to compete in the foreign market.
Since tariffs act simply as a tax on trade, they do not eliminate the possibility of competition from foreign producers. There are even ways to get around tariffs without paying the tax: countries that export goods to a country that does not have a bilateral tariff against them, but trades with the country that does. For example, if China wanted to evade a bilateral soybean tariff instituted by the U.S, they could instead export soybeans to Mexico, who could then export them to the U.S without a tariff.
Can Bilateral Tariffs Hurt Domestic Producers?
The answer is complicated. Though they intend to protect domestic economic interests, bilateral tariffs can create difficulties for domestic small businesses. The tax on imported goods can result in added costs for domestic producers who rely on foreign manufacturers to fulfill orders.
In some cases, the increased cost of production can be absorbed, as is often the case with large corporations that outsource manufacturing. However, most small businesses do not have the ability to absorb a price increase in their value chain as easily, and often do not have the same flexibility in getting around it as a large corporation would.
What Does This Mean for Your Small Business?
Bilateral tariffs often impact small businesses by adding costs of production. That is, many domestic producers who rely on foreign producers from countries under the influence of bilateral tariffs are forced to diversify their supply chain and seek producers from other countries. Unfortunately, as more businesses try to circumnavigate a bilateral tariff by seeking production facilities in other foreign countries, they are faced with transfer costs. These transfer costs can take away focus from business operations, therefore limiting cash flow, leaving business owners with even greater problems to tackle.
In light of recent tariff legislation, our borrowers have seen first-hand how difficult it is to avoid costs associated with bilateral tariffs. Their frustration over the attention taken away from daily business operations is matched with wariness over the quality of the goods being produced by new manufacturers. They have also struggled with having to start from ground zero in their relationships with these new manufactures: business owners are forced to rebuild decades-long relationships with new suppliers, who may not yet understand the quirks of the business.
Bilateral tariffs are often enacted as a symbolic means of protecting domestic business interests because large foreign competitors, or their governments, can easily absorb the added production costs associated and continue competing in the market. Unfortunately, bilateral tariffs affect small businesses proportionately more than they do large corporations. Effects of the tariff, which often include the increased cost of production for businesses that utilize foreign manufacturing, can cause more harm than good and can put a small business at risk for shutting down as opposed to protecting it.