The value of world trade has grown consistently faster than the growth rate in the world economy since 1960, and it has been much higher since the turn of the century. Since 2000, trade across country borders has been at least double the total production of all countries combined.
These numbers may appear strange. Surely, we can’t trade more than we make, and of course we don’t. Instead what accounts for this trade growth is the combined trade of raw materials, work-in-process (e.g., component parts) and finished products. Unfortunately, when we talk about trade, oftentimes we think about finished products only.
Finished products account for less of the total trade value across countries than ever before. Take these numbers: By 2020, we expect the value of world trade to be about 167 times larger than it was in 1960, whereas the world economy will be 65 times larger.
It means that the world economy has become much more efficient, to no one’s surprise. But, these numbers and global efficiencies are now threatened with the escalation of tariffs. The agricultural industry is just the latest, newsworthy victim.
The reason for the increased global efficiencies has a lot to do with the lowering or removal all-together of barriers to trade, such as tariffs. Let’s be clear here: Tariffs are custom duties on imported products (as well as on raw materials and component parts) that are intended to give a price advantage to products manufactured locally. Tariffs can raise revenues for governments but most of the time they also hurt production efficiencies.
Using the simplest explanation, countries that are superior at manufacturing certain products or parts have increasingly done so since barriers to cross-border trade have been lowered. With lower barriers, countries become more specialized and the world is more efficient.
Increasingly, we see more countries and companies specialize in manufacturing parts. These parts are then shipped around the world in a complex web of supply chains for final assembly.
Tom Linebarger, CEO of Cummins, wrote a nice opinion column in The New York Times on tariffs and supply chain efficiencies recently. Cummins rely on some 2,500 American companies to make their decades-in-the-making supply chains function well.
Others, such as General Motors, rely on more than 50,000 suppliers worldwide to make cars and trucks. In short, the world has become considerably more efficient at orchestrating value-added supply chains since 1960.
The trade wars that we are now engaging in leave many global strategists puzzled. Are policymakers accounting for and really understanding the efficiency dynamics in the global marketplace? What seems difficult to grasp, it appears, is the bullwhip effect that tariffs in one area of the economy have on the massive network of supply chains that U.S. companies are involved in worldwide in other areas.
The negative trade-related bullwhip effects got compounded by policymakers also perhaps not expecting that global players like China and the European Union would escalate the trade wars in areas that the U.S. administration did not focus on.
Consequently, the U.S. government is now saying that we need to help the U.S. agricultural sector with a $12 billion subsidy.
This targeted subsidy is needed so U.S. farmers can compete better with foreign producers. To many, the agricultural subsidy came as somewhat of a random solution to a problem that really should not exist, nor does it provide a solution most U.S. farmers or a capitalistic system want. Instead, like most companies, U.S. farmers want to compete fairly and freely against rivals from around the world.
Thus, the bullwhip effect that we have analyzed for decades in supply chains became a reality in the larger global economy. U.S. farmers stand to lose sales and be hurt by tariffs against them from various world markets as a measured response to tariffs the U.S. initiated in unrelated industries.
In this case, we then see a complex network of bullwhip effects across economic sectors and industries — not just the normal upstream and downstream supply chain effects.
Unfortunately, the combination of escalated trade wars using tariffs as the strategy and the dramatic growth in cross-border trade since 2000 relative to total world production spells serious problems.
A small increase in tariffs in seemingly a small part of the economy — like the initial $34 billion in tariffs between China and the U.S. — ultimately has the potential for massive disruption of the global economy due to its unintended bullwhip effects in international trade.
What we should keep in mind when instituting tariffs is that the larger the difference between the growth rates of world trade and world production, the greater the extent of global efficiencies that may be disrupted.
And, as probably the most efficient country in the world in most economic sectors, the United States stands to lose a lot, perhaps the most, by disrupting global supply chains and manufacturing efficiencies.
Tomas Hult is professor in the Broad College of Business at Michigan State University, and executive director of the Academy of International Business. In 2016, Hult was selected as the Academy of Marketing Science Distinguished Marketing Educator, as the top marketing professor worldwide for career scholarly career achievements.