The vulnerability of global supply chains have been exposed less by global shocks than by country or region-specific shocks. The 2011 Thai floods and the 2011 Fukushima earthquake in Japan highlight how a disruption to just one segment of production reverberates throughout the supply chain, leading to a sharp contraction in final output.
The China-US trade war is another country-specific shock because discriminatory tariffs are only applied to each other’s trade.
Although the bilateral tariffs of the China-US stand-off are relatively small, ranging from 10 per cent to 25 per cent, their impact on competitiveness can be much greater. While the tariff is levied on the total value of the product, it can be completely negated by simply removing the share of value added in the tariff-targeted country.
To illustrate, the domestic value added of Chinese total manufacturing exports to the United States in 2018 was estimated to be 30 per cent. Imported inputs account for US$70 of a US$100 made-in-China shirt, while the final production processes in China add US$30.
It follows that a 25 per cent tariff on the US$100 shirt is really a US$25 tax on the US$30 value added in China.
Other countries, such as Vietnam, effectively receive a “buffer” of US$25. If Vietnam can add the same value while keeping total costs less than US$55 – within the buffer provided by the tax – it would be more profitable to produce there.
This multiplier effect of the discriminatory tariff is termed the effective rate of spillover protection because it creates a magnified and unintended advantage to all competitors, not just the United States. It also explains why the relocation of global supply chains could happen in response to a relatively small tariff if the value-added share is small.