Navigating uncertain waters: manufacturing in the midst of a trade war

With the trade conflict between the United States and China heating up, David Loneragan explores what this could mean for Australia’s export manufacturing sector.

The latest escalation in the trade spat between the United States and China has sent tremors through the media. Expert observers of economic trends, financial analysts, investors, business- owners and politicians have, in recent months, become accustomed to hypothesising what the emergent US trade policy will mean for the global trade system. And now, with US president Donald Trump’s announcement in September that 10 per cent tariffs would be imposed on US$200 billion ($280 billion) worth of Chinese imports, lines are being drawn that could have significant repercussions for the Australian manufacturing industry.

The 10 per cent tariff is planned to rise to 25 per cent on 1 January 2019. The White House had already placed a 25 per cent tariff on $50 billion worth of Chinese goods earlier in the year. The Trump administration has claimed that it is responding to what it described as China’s “unfair policies and practices relating to US technology and intellectual property”. The broader aims, according to most observers, are to re-balance the US trade deficit with China and bring back more manufacturing to American shores. But its adversary isn’t buckling just yet. The September tariff imposition by the US was met with a Chinese retaliatory effort: tariff levies on approximately $85 billion-worth of American goods.

China is Australia’s largest trading partner, accounting for 29 per cent of its exports. The tit-for-tat tariffs are being warily observed by Australia’s leading economists and chief financial institutions. A Reserve Bank of Australia (RBA) report prepared in March found that the worst-case scenario, a global trade war, would see Australia’s exchange rate rise by six per cent, with the overall national economy contracting by 2.5 per cent. A best-case scenario modelled by KPMG, where tariffs do not escalate beyond the current threats from the White House, projects Australia’s GDP to be 0.3 per cent lower by 2022. This represents a $36 billion drop in economic growth over five years.

More recently, minutes from the RBA’s September monetary policy meeting said that current “significant tensions” around global trade policy represented a “material risk” to the global economic outlook. And, in October, the International Monetary Fund (IMF), in its World Economic Outlook report, downgraded its global growth forecasts for 2019, citing the uncertainty and instability produced by the US-China tariffs. The report indicates Australia will slip to 2.8 per cent growth next year, 0.4 per cent down from an expected peak of 3.2 per cent this year.

Uncertain times

Much of the focus so far has been on the potential hit the tariffs could have on Australia’s major exports to China, such as minerals, agricultural products, education and services. For the time being, at least, what ramifications the ongoing trade war will have for the Australian manufacturing sector remains uncertain. But this uncertainty itself could disturb the delicate balance that has enabled Australian export manufacturing to gain in strength over recent years, according to Mark Goodsell, NSW head of the Australian Industry Group (Ai Group).

“The sheer uncertainty of the current moment is of particular concern. We’ve just come to terms with globalisation as a country and as a manufacturing industry; and it’s not been comfortable, requiring a lot of learning and a lot of new business models,” Goodsell told Manufacturers’ Monthly. “It will be really disconcerting if the two major global players, the US and China, have a really sustained and deep spat, because we could all get affected.”

Goodsell said that with Australia’s manufacturing sector at nearly 80 per cent capacity, the future outlook had been, for the most part, extremely positive. “Manufacturing is going quite well at the moment: it’s employing people, it’s feeling good about itself – it’s a broad-based growth,” Goodsell said.

However, the tariff increases were already moderately dampening investment. “If it weren’t for the recent trade situation, we would  expect investment plans to be looking pretty robust,” he said. “But you just get a feeling that there is some nervousness about investment decisions – in the short-term at least. And the trade situation is certainly not helping that.”

According to Goodsell, while the downstream effects of the US-China trade war were hard to determine, secondary and tertiary impacts on other nations, including Australia, could be expected. For instance, American buyers have been pulling forward orders out of China to get ahead of the tariffs. As a result, Australia has suffered from what Goodsell called “small customer syndrome”: the Chinese have been looking after their larger customers in the US rather than their smaller customers in Australia.

“As a result, some Ai Group members have had trouble getting components out of China, because Chinese companies have been paying attention to this demand from the US ahead of a perceived tariff war coming down,” Goodsell said. “So that’s an immediate effect that may be transitory and short-term.”

In May, the US Department of Commerce initiated an investigation into the economic impact of car and auto part imports for its domestic industry. It is unclear what consequences this may have for the Australian auto component manufacturing sector, which currently exports approximately $200 million to $300 million in parts to the US annually. In recent months, the Morrison government has been lobbying the Trump administration to exclude Australian products from possible tariff increases. A similar strategy saw Australian steel exempted from US tariff impositions earlier in the year.

In other manufacturing markets, too, uncertainty reigns. Bruce Turner, managing director of the leading Australian shutters and blinds manufacturer Wynstan, said that the recent announcement of expanded US tariffs on Chinese goods was concerning for his business.

“We’re exporting products to the US, and one of our products, which is shutters, actually comes out of China. So we’re going to be hit with a tariff. It’s got the potential to damage our growth in the US.”

With the financial support of St. George Bank, Wynstan has been expanding in recent times, investing $20 million so far in Los Angeles and setting up stores similar to those it has in Sydney. Turner was doubtful much good would come from the changing trade climate. “We’re caught right in the middle. In recent years, manufacturing exports have been healthy. But one of the things about the trade war is that it creates uncertainty for manufacturers like us: we are wondering what the next move will be in the Trump administration’s trade policy.”

Problems and possibilities

One thing that economists do agree upon is that a continuing trade war will lead to the depreciation of the Australian dollar against the American greenback. Goodsell explained that, while a fall in the Australian dollar has historically been considered a good thing for local manufacturers, there is a point of diminishing returns when it drops too low.

“With company supply chains so integrated, it’s not unambiguously and broadly good that the dollar keeps dropping. A significant drop can price you out of the technology you need to remain competitive and innovative, which is typically sourced from overseas,” he said.

“A mild drop would do little harm; but a sustained, substantial drop would not be good, particularly if it is a sign that the global economy is slowing down because of trade restrictions.”

IBISWorld analysis presents a more positive perspective, projecting a larger export market share for some Australian products in both the US and China. In 2017-18, China is expected to account for 25.1 per cent of export demand for the Australian wine production industry, and this is forecast to grow in response to a 15 per cent tariff recently imposed on US wines. Additionally, US tariffs on Chinese chemicals, medicinal products, and electronic components might also create opportunities for Australian firms, the analysis found.

However, according to Professor Roy Green, former Dean of UTS Business School and the special advisor and chair of the UTS Innovation Council, while some cases of trade conflict between two nations can be beneficial to a third-party country such as Australia, it was difficult to predict such an outcome in this case.

Green said that while a depreciation in the value of the Australian dollar could possibly help some export manufactures, other products manufactured in Australia could end up losing out where the US has imposed product-specific tariffs that apply without regard for the country of origin.

“The net effect is likely to be a depreciation of the Australian dollar,  which, theoretically, makes us more competitive,” Green said. “But this is offset by the impact of the increase in tariffs between the US and China where tariffs are related to specific products.”

Speaking to Manufacturers’ Monthly, Peter Thorpe, general manager of ESS Engineering, said his own company was already experiencing the impacts of currency depreciation. “The recent surge in the US dollar has effectively led to a 10 per cent jump in our costings and what we buy out of China,” Thorpe said. In the short-term, the depreciation of the Australian dollar against the US dollar will make ESS Engineering products more competitive in the US, but it could hurt their exports in other countries.

“We also sell overseas in other areas that are typically sold and price in US dollars, so that makes our products go up in price elsewhere, such as in African markets,” said Thorpe.

There are, however, potential openings. Green said that when tariffs were exclusively targeted against China on the one hand and the US on the other, it could possibly provide Australian manufacturers with opportunities that they would not otherwise have had. That is, in specific circumstances, Australian firms might fill the gaps in these markets. “And that’s where I think we can make some gains: where the tariffs are not product-centred, but specially directed at the products of the two antagonists in the trade war.”

According to Giovanni Di Lieto, lecturer in international trade law at Monash University, the US tariffs and the retaliation from China are creating opportunities for third countries to manoeuvre in terms of trade diversion. Indeed, trade diversion has been, historically speaking, an ordinary  effect of trade wars and the erection of barriers to markets. With Chinese goods being hit by American tariffs and vice versa, some Australian products could possibly become more cost-competitive in these and other markets.

“There are some countries that can reap the gains more effectively than others. Australia is well placed because it has strong relations with both the US and China and is geographically placed at a crossroads between the two, with easy access to maritime routes right across the Asia Pacific region,” Di Lieto said.

Michael Grogan, Victorian director of the Advanced Manufacturing Growth Centre (AMGC), said that opportunities presented by downward currency movement would mostly be short-term and limited. “Manufacturing requires long-term investment strategies,” he told Manufacturers’ Monthly. “The dollar movement can be either an advantage or a disadvantage, but firms would not make long-term strategic decisions based on this. Stability is what everyone wants.”

Steering Australia towards stability

Following the Trump administration’s announcement of the new China tariffs, Australia’s trade and investment minister, Simon Birmingham, declared that it was imperative a culture of open and free trade was preserved globally. Also, with one in five Australian jobs dependent on exports, he said the federal government would continue to push for other countries to follow the international trade rules on tariffs and subsidies.

“Tariffs ultimately result in consumers paying more and disruptive trade practices ultimately hurt economies rather than help them,” he told ABC radio in late September.

The Business Council of Australia responded to the US tariffs by calling for the federal government to direct greater attention towards negotiations for an Australia- European Union trade agreement. “The negotiations demonstrate Australia’s and the EU’s commitment to rules-based global trade at time when the voices against freer and more liberal trade are increasingly louder in Australia and abroad,” said Business Council chief executive Jennifer Westacott. “This deal can help put momentum back into the agenda for liberalisation and help to reduce the effects of the increased tariffs on US-China trade.”

Goodsell said that, with uncertainty on the rise for exporters, it was especially important for federal and state governments to be both aware of the impact their own policies have on the industry and to be more open and transparent with the industry when developing trade policy.

“Leadership would mean really understanding how each component of the Australian economy works,” he said. It would also mean remaining connected to manufacturing sectors that are affected by the decisions that they make and the positions they take in trade. “There’s a view within the Australian manufacturing industry that we’re not always as well appraised of what the game-plan is as the industry in some other countries, especially with regard to trade negotiations,” Goodsell said.

According to Goodsell, preserving the conditions that make Australian manufacturing competitive would also mean bringing along communities that increasingly feel they are getting left behind, thus preventing the development of powerful pro-protectionist political forces locally.

“There is clearly legitimate political and community concern about how globalisation plays out in local and regional communities and economies, but it’s not necessarily an argument against globalisation,” said Goodsell. “It’s more about figuring out how local communities and local economies can make and handle the adjustments that they need to make to keep Australia ahead.

“And we really do have to understand how much our standard of living is driven by globally- integrated supply chains. We’d miss them if they went away and we wouldn’t want to put ourselves in the position of testing that proposition.”

At this critical juncture, government leadership in the manufacturing sector is lacking, according to Green. “Australia does not have a coherent manufacturing industry policy. We have some haphazard policies around manufacturing at federal and state levels, but no coherent overall assessments of our existing or potential competitive advantages or how to capitalise on them,” said Green. “And that’s where we have a big weakness in our current range of policies: firms need better support to project themselves into global markets.”

Green said more government schemes that promote Australian SMEs in global markets and value chains were needed, particularly those that enable a greater clustering of opportunities in specific sectors and technology areas.

Seizing opportunities

According to Green, keeping Australian manufacturing viable would require the continued development of the nation’s high-end technological capability, particularly when the ongoing trade conflict is seeing the United States reassert its technological and industrial pre- eminence at the very moment that China is rapidly moving up the value chain. He suggested that Australia would be missing its chance if it didn’t try and grasp the opportunities available, despite the re-appearance of protectionist trends in trade relations.

“The markets for advanced manufacturing products are very competitive. And for Australia to be involved in them successfully doesn’t depend entirely on price anyway; it’s about effective research and development and how we translate that into successful commercial outcomes.”

Australia, Green said, needed to be increasingly involved in “smart specialisation”: accessing targeted areas of competitive advantage and participating in those value chains. “In auto-components firms, we have been successful – like Bosch with power diodes, for example,” Green said. “But, if the world goes protectionist, and, in particular, if these trade disputes shut us out of the markets where we do have opportunities, then our attempt to move up the value chain and into these high-knowledge-intensive sectors is bound to be slowed.”

Green said that pushing Australian manufacturing up the value chain was the best way
to respond to uncertain trade conditions, as its competitive advantage would increasingly depend less on cost and more on knowledge and ingenuity. “And, with such a strategy, it is more likely that we can withstand the effects of protectionism.”

The manner in which value chains will adapt in the future were in large part a question of political decision- making, according to Di Lieto. “There is a danger of over-dramatising the trade element of the current disputes between the US and China,” he said. “The real crux is geo-political rather than commercial. In commercial terms the impact is smaller than usually understood by many pundits and the general public.”

Di Lieto pointed out that data indicated that manufacturing had historically proved well-suited to adapting to changes in supply chains, and was generally more resilient than the services sector in this regard. And, while there would be a long-term shift in the organisation of supply chains, how Australia ultimate fits within the future setup would be determined at the geo-political level. “I would say, in terms of the impact of the trade conflict on Australian manufacturing trade, we shouldn’t panic yet,” Di Lieto concluded.

It may indeed be too soon to determine the consequences of the US-China trade struggle. According to the results of the latest Australian International Business Survey (AIBS), Australian exporters are expecting to employ more workers, are predicting better financial positions and are anticipating access to more markets. Conducted over April and May this year, the survey indicates that 45 per cent of businesses expected to move into at least four new international markets over the next two years, while 66 per cent indicated they expected their operations to have a better financial outlook than the previous two years and 75 per cent planned to increase employee numbers in Australia over the same time period.

Whether the recent escalation in the trade war will substantially affect these numbers remains to be seen. For his part, Peter Thorpe from ESS Engineering is keen to plough ahead. While there could be opportunities for greater competitiveness as the Australian dollar lowers, with high- costs the norm for manufacturing in Australia, he said the most important path forward for his company was to work smarter: investing in skills and technologies and knowing where outsourcing can be most effective.

“We’re trying to do it smarter and we’ve got programs to re-design and re-engineer a whole range of our products to make them more cost-competitive, both in lowering manufacturing costs and enhancing quality,” Thorpe said. “So, I think we can compete and we do compete on quality and capabilities. We have our battles ahead of us, but we will always protect our designs and our quality of workmanship here in Australia.”

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