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IMA Tax Policy Blog

Applying Operational PDCA to Trade and Tariff Risk

by Daron Gifford

Plante & Moran, PLLC is an IMA Member

The Trump administration is pursuing its balanced and fair trade agenda on several significant, parallel fronts: 1) negotiations on the North American Free Trade Agreement (NAFTA) with Mexico and Canada, 2) tariff response to the Section 301 investigation related to unfair Chinese intellectual property and other technology transfer infringements, and 3) the Section 232 investigation on the national security implications of all automobile and automotive part importation.

Because of these many moving pieces, taking an operations approach with the tried-and-true method of plan-do-check-act/adjust (PDCA), made popular by W. Edwards Deming and Toyota, might be the best way to coordinate the numerous business function areas involved and marshal-required resources to mitigate final market uncertainty, production and capital investment cost risk, and supply chain disruption danger.

The North American Free Trade Agreement negotiations

Recap: The United States, Canada, and Mexico continue to negotiate new terms for the 24-year-old NAFTA agreement. With the May 17 deadline set by U.S. Speaker of the House Paul Ryan come and gone, the negotiation strategy took a bilateral direction with the United States and Mexico negotiating major automotive terms, including domestic rules of origin, content labor rates, sunset clauses, and dispute resolution. The Office of the U.S. Trade Representative (USTR) announced on August 27 that, “a preliminary agreement in principle, subject to finalization and implementation” had been reached with Mexico. This preliminary agreement will be the basis for negotiation with Canada.

This strategy implies an August 31 deadline with at least the Mexican negotiators as the U.S. Congressional review requires a 90-day window, and this allows resolution before president-elect Andres Manuel Lopez Obrador takes office on December 1. The administration left open if this will result in a separate U.S.-Canada agreement or Canada being added to the U.S-Mexico agreement.

The USTR reported that the Mexican deal requires a domestic content level of 75 percent, an increase from 62.5 percent, from U.S. and Mexican sources to qualify for free trade. New to the automotive provisions is a labor value content rule stipulating that 40 to 45 percent of that automotive content be made by workers earning at least $16 per hour to be counted. Given that the wage provisions are new, and given the 20 percent increase in domestic content, there may be grow-in provisions over a number of years.

Section 301 investigation on Chinese practices and response

Recap: On March 22, 2018, the USTR issued the following: “The investigation of China’s Acts, Policies, and Practices Related to Technology Transfer, Intellectual Property, and Innovation addresses four categories of acts, policies, and practices of the Government of China that unfairly result in the transfer of technologies and intellectual property from U.S. companies to China. These policies harm U.S. businesses and workers and threaten the long-term competitiveness of the United States.”

In response, the United States placed a 25 percent tariff on $34 billion of imported goods. On August 23, an additional list of $16 billion of imported Chinese goods received incremental tariffs of 25 percent. The USTR was directed on June 18 to create a target list of $200 billion of products that could be targeted with a 10 percent tariff. The product codes and descriptions for the three lists may be found in the U.S. Federal Register.

On August 1, the President asked the USTR to consider increasing the proposed level of additional duty from 10 percent to up to 25 percent on its third list of $200 billion worth of imported products. Companies need to carefully review the third list, as it includes a wide range of intermediary goods such as electronic chips and items used in production such as milling, tapping, drilling, and turning tools. It was reported that the U.S. and Chinese trade discussions the week of August 20 centered on three key topics: the purchase of U.S. goods by China, rules restricting U.S. operations in China, and Chinese industrial policy. In parallel, the United States held public hearings that week to determine the final list of goods.

The automotive Section 232 investigation

Recap: U.S. Secretary of Commerce Wilbur Ross announced on May 23 that the United States will initiate a Section 232 investigation under the Trade Expansion Act of 1962 to determine whether automobile and automotive part imports threaten to impair national security, as defined in the legislation. While Commerce Secretary Ross first stated the investigation will likely be completed by the end of August, in recent interviews, Secretary Ross has implied that the negotiations on NAFTA and other trade issues may be taking higher priorities than completion of the automotive Section 232 investigation. Delaying the report, and the subsequent deadlines for the president’s response, gives the administration more time for trade talks with Canada related to NAFTA, and the European Union related to the broad range of reciprocal tariffs on the original steel and aluminum tariffs earlier in the year.

Plan-Do-Check-Act/Adjust: A framework for response to trade-related factors

Given how interrelated and fluid these negotiations are, companies are best to set up processes to monitor the U.S. government actions and the reciprocal actions of countries on the other side of the table. Official statements, lobbying offices, trade associations, press reports, and the like are all good resources. Companies also need to monitor how competitors and suppliers are responding, and consider other elements of the value chain like changes to transportation logistics availability. One way to constantly monitor, develop contingency plans, and respond as needed to these political, competitor, and supplier actions and reactions is to set up a PDCA process within your organization.

  1. Plan: Every functional area should create an action plan related to the enacted and proposed tariffs and quotas by the United States, reciprocal action by trading partners, and outcomes of the NAFTA negotiations. Companies might think of stress testing their operations. What happens if NAFTA rules of origin rise to 75 percent? Will my customer drop me if my component misses regional content levels or is hit with a 25 percent tariff? What happens when South Korea hits its steel quota level? This gaming involves purchasing, finance, marketing, operations, labor relations, legal, and government and community relations.
    b. Do: Plans should consider proactive actions such as speaking to customers about potential mitigation paths even before tariff costs take effect, prepping manufacturing sites for product moves and, perhaps, even taking on costs of preparing production part approval process (PPAP) validations to be prepared. While companies may not need to use these plans, the preparation can be considered an insurance policy against future supply chain or manufacturing disruption. Definitive actions should take place immediately, like applying for tariff exemptions, ensuring all imported material is classified accurately, and triggering any physical or financial hedges.
     c. Check: With timing and actual tariffs of the United States and its trading partners uncertain, and customer, supplier, and competitor reactions varied, companies need to check their plans against intended and unintended consequences. Companies should look at these activities not as one-time costs in reaction to tariffs, but actions to harden their supply chains and customer relationships.
    d. Act/Adjust: The market environment will remain fluid as products that are approved for exemption and potentially new products are added to tariff lists. Companies will need to react to competitor and supplier actions to safeguard their market position, cost competitiveness, and supply allocations. The political environment will be equally fluid through the November, mid-term elections, lame duck period, and initiation of the new Congress. And, while we’ve discussed U.S.-centric trade activities in this piece, don’t forget there’s likely to be equal uncertainty with actions and reactions with trading partners, beginning with the roll-out of BREXIT as well as free trade agreements that are being negotiated between regions and countries well outside the U.S. borders.

Timeline: The knowns and unknowns

Below is a brief timeline of what we know today:

  • September 5: Section 301 Chinese List 3 written comment submissions and post-hearing written comments due
  • October 9: Deadline for exemption requests to the original list 1 and 2 Section 301 Chinese tariffs
  • TBD: Section 301 Chinese List 2 tariff implementation
  • TBD: Section 301 Chinese List 3 tariff implementation
  • TBD: Automobiles and automotive parts Section 232 investigation release
  • TBD: A complete set of the U.S.-Mexico trade agreement revised terms release

 

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