Sep 26, 2018

The Effects of Tariffs on Tech

The Trump administration has delivered wallop after wallop on Sino-American exchange. China has ratcheted up its own penalties at each turn—an initial volley of penalties on $34 billion in Chinese goods this July and $16 billion more in August were quickly matched by the PRC. Now the administration has responded with another 10 percent tax on $200 billion in exports, which will rise to a 25 percent tax by the end of the year. China has retaliated with its own levies on $60 billion in US products.

The tech industry, in particular, has braced itself for the ultimate effects of the Trump administration’s trade war with China. Many of the tariffs are aimed at undercutting China’s foray into next-generation technologies like artificial intelligence and autonomous cars—what’s called the “Made in China 2025” industrial policy. Some of the taxed goods include tech-critical parts and final goods like sensors, circuits, cables, and screens.

Not only do many tech firms rely on Chinese-based manufacturing and supply chains, but the Chinese consumer market is also of critical importance. Any impediments towards accessing these resources and markets could spell big trouble for tech firms’ bottom lines and future investments.

Tech leaders’ reactions have been broadly negative. Dell CEO and founder Michael Dell characterized the trade war as an act of “mutually assured destruction,” and his company claims that the tariffs will increase component costs for US-based services and manufacturing. Cisco’s CEO Chuck Robbins echoed this contention, suggesting that the breadth of tariffs touching their supply chains meant they would have no choice but to raise prices on consumers.

Apple CEO Tim Cook has been particularly vocal, perhaps because his company is so reliant on good relations with China. Apple was shielded somewhat from this round of tariff blowback since consumer products like smartwatches and earbuds were spared. But this may not hold for future rounds of tariffs, and a policy environment where only charismatic or well-connected leaders are safe from the consequences of aggressive trade posturing is problematic. Plus, Apple will still be affected by increased costs of materials, parts, and labor on which it relies.

While firms like Apple, Cisco, and Dell get much of the media attention, the brunt of these tariffs will fall on smaller technology companies. Think about the US firms that assemble parts and components that the bigger guys use, or smaller consumer product manufacturers and service providers. These companies can have thinner profit margins, and a 25 percent tax on Chinese imports could spell disaster for their firms. Some of them may need to consider closing their US-based manufacturing.

There are indirect negative effects as well. The Chinese government can exert pressure through a variety of means, including delaying or rejecting various bureaucratic applications. Many suspect that the Chinese government’s refusal to approve a proposed merger of Qualcomm and NXP Semiconductors, who had hoped the deal would enable the firms to expand into new markets, was an act of revenge against the US tariffs.

Then there’s 5G: companies like Intel warn that the tariffs will raise the cost of building this super-fast wireless network, which will rob consumers of options and set us behind the global pace of technology adoption. Other technologies like driverless cars and virtual reality are developing under the assumption that 5G Internet speeds will soon be a reality. If this is not the case, then the technologies that rely on super-fast speeds may be temporarily scuttled.

Tariffs on technology components and raw materials could have another unintended consequence that would undermine the entire enterprise: making China more competitive. If selling low cost goods to America becomes prohibitively expensive, savvy Chinese businessmen will shift production to higher cost items that would directly compete with our firms. Some Chinese companies appear to be doing this.

And it’s not just about “China,” but all of our global competitors. One study from the Information Technology and Innovation Foundation uses cloud computing as a case study of the effects on international competition. The US is a leader in this industry, and American businesses invested some $70 billion in cloud infrastructure and services last year. Many of the necessary components for cloud infrastructure—simple things like circuit boards and assemblies, routers, and power and coaxial cables—are subject to the new tariffs.

The report estimates that a 10 percent levy on such imports would slow overall US growth by $163 billion over the next decade. A 25 percent levy would lead to a loss of $334 billion. That’s a lot of forgone wealth, and only in one industry. Meanwhile, other nations without such tariffs can potentially speed ahead of us, putting us at another long-term competitive disadvantage. Extend that thinking out to every company—tech or otherwise—affected by the tariffs, and the potential costs become all too alarming.

Supporters of this trade brinkmanship argue that the tariffs are a temporary tool to compel a fairer playing field from trade partners who have imposed their own unfair policies on us for too long. Once the administration’s long-term goals—an end to Chinese intellectual property violations and forced technology transfer—are accomplished, the tariffs should be rolled back.

It remains to be seen whether this strategy will work, but many seasoned trade economists are not optimistic. Supporters argue that we may reach a point where China is economically unable to respond to the administration’s escalations.  In the meantime, however, the tariffs generate significant negatives for American businesses and consumers that could resonate for years.

It is heartening that most supporters of this strategy do not defend tariffs on their own merits because the economic case against customs duties is so strong. Tariffs act as a tax on domestic consumers and generally fail to accomplish their policy goals in the meantime. The result is higher prices, wasted time, and a misdirection of capital.

The tariffs are still fresh, but they are already having a significant effect on the way that American businesses conduct their affairs and plan for the future. Still, Americans can be forgiven if they don’t exactly understand the import of these trade barriers. US markets have reacted fairly neutrally to the tariffs. US Commerce Secretary Wilbur Ross argues that “nobody is actually going to notice [the tariffs] at the end of the day” because they are “spread across thousands and thousands of products.” Of course, the businesses and employees directly affected by these tariffs will certainly notice, as my colleague Veronique de Rugy points out.

But as my colleague Tyler Cowen writes, Ross has a point, albeit probably not in the way the Secretary intended. When Americans go to the store to purchase a tariff-induced, artificially-expensive computing device, all they see is a slightly higher price at the register. A tariff is a kind of tax, but it’s not separated on a receipt as such. A typical consumer does not connect higher prices with the underlying policies that created them. And because of a trick of behavioral psychology, consumers restrict consumption more in response to hidden taxes than itemized ones. So the tariffs should have a slightly depressing effect on demand.

Tariff supporters hope that import taxes will be a cudgel to compel a fairer playing field. But they create much economic distortion in the short-term. The negative impact on individual consumers will be relatively small in the short-term, which may make the fallout from these policies all the harder to detect.  In the meantime, the effects on technology and innovation may be significant and would have a compounding negative effect on American competitiveness. Let’s hope this trade war wraps up quickly.

Photo credit: ROMAN PILIPEY/EPA-EFE/Shutterstock

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