Overview
A centerpiece of the new administration’s platform is the introduction of tariffs in an effort to make American manufacturing more competitive. The underlying assumptions are that exporting countries need America more than the reverse and that America can be more competitive in various industries. The purpose of this installment is to question those assumptions, which, of course, have massive implications for sophisticated institutional investors and risk managers over the next several years.
Some Perspective Please
The Republican party’s election season refrain has been that the country must reset some of the lopsided trade agreements and use tariffs to punish cheaters. In particular, the thought is that China has gained a massive advantage since joining the World Trade Organization (WTO) and is subsidizing its goods while disadvantaging American manufacturers.
Moderate Dependency
Perhaps a starting point for the discussion is to determine the level of dependency China has on America. Multiplying the share of GDP resulting from exports (37% in 2023¹) by America’s share of exports (16% in 2023²). The product is 6%. From a statistical basis, a trade war between America and China would impact both short-term and long-term Chinese growth, which has been about 5%.
Of course, the math above does not account for the knock-on effects to other parts of the value-add supply chain given a trade war. It also doesn’t consider substitute buyers of goods should American demand dry up.
Porous Trade Sanctions
Another item to bear in mind is the relative effectiveness of trade sanctions. The prior administration prohibited the export of various computer chips to China several years ago. The thought was that Huawei and other telecom manufacturers would have difficulty introducing 5G-capable phones. To the surprise of many, Huawei introduced new phones in short order³. While investigators are still searching for explanations, as we have seen with sanctions on Russian energy exports, trade barriers are often surmountable. (Our view is that partners of Huawei were able to get chip designs and quickly replicate the modern chips.)
Impact
Before throwing up your hands at the futility of trade sanctions or tariffs, perhaps it is worthwhile to examine their effectiveness to date. Over the past several years, there has been encouragement for major American firms to move production away from China and cease sales in Russia.
Two good barometers for measuring impact are the level of factory activity and the level of political unrest (i.e., protests). For both measures, recent moves have had a significant impact.
A Brave New World
Regardless of actions taken or not taken over the next several quarters, we expect a few outcomes to be certain:
Solar Cell Dominance
China manufactures 80% of the global solar cells⁴, and even with hefty tariffs, it will take time for others to catch up. A possible outcome is that manufacturers shift production to countries that are not on the disfavored list (sanctions typically apply to the location, not ownership).
Auto Manufacturing
With advances in battery technology (a Xiaomi SU7 purportedly has a range of 434 to 515 miles⁵), it is rapidly becoming apparent that Chinese manufacturers have a significant competitive advantage. Supporting this notion is the rise in Chinese-manufactured autos in Mexico:
“According to official figures, 20 percent of light vehicles sold last year in Mexico were imported from China, representing 273,592 units and a 50 percent increase compared to 2022.” ⁶
Manufacturing “Effectiveness”
Underpinning this entire discussion are manufacturing costs, technology, and efficiency (collectively “manufacturing effectiveness”). As mentioned in a prior Risk Commentary (“Productivity Revolution”), our premise is that, over a relatively short period of time, general-purpose robots will advance to the point that they are widely used in business. As shown in the appendix, the hourly cost could be around $1.60 per hour, which beats labor in nearly any realistic manufacturing base country. (Caveat: Typically, the benefits of technology take longer to realize than expected, but the benefits are greater than expected). Note that these general-purpose robots will be suited to perform tasks performed by people today but may also replace tasks performed by specialized manufacturing machines.
Now for the expertise side, our plebeian view is that cutting-edge manufacturing expertise is being built via the employees of SpaceX and Tesla.
Conclusion
We expect discussions regarding this topic will be front and center for many over the next couple of years, with the upshot being massive changes in the way the world conducts business.
Appendix — General — Purpose Robot Costs
Assuming the typical auto worker is paid $28 per hour⁷, translating into a fully loaded cost of approximately $40 per hour, the annual cost for 3 shifts is around $192K per annum. (i.e., $40 per hour × 24 hours × 200 working days). Assuming that a robot costs $100K, is useful for 5 years, and needs $10K in annual maintenance and electricity costs, the annual cost is approximately $30K. Hence, for one workstation, the robot-based business has a $160K advantage or an hourly cost of $3.42 (i.e., $40K ÷ (24 ×360 days)). However, assuming the robot has typical controls, the quality of output is likely to be higher, and over time, the quantity greater. Extending this analysis over the range of stations in a typical factory, it becomes apparent that a new age is dawning. Furthermore, Mr. Musk is predicting the price of the Optimus will be around $20K, thereby reducing our estimate to merely $1.60 per hour (i.e., $20K ÷ 5 years = $4K per year; ($4K + $10K) ÷ (24 × 360 days)).
Sources
[1] https://www.theglobaleconomy.com/china/exports/
[2] https://wits.worldbank.org/CountryProfile/en/Country/CHN/Year/LTST
[4] https://www.iea.org/reports/solar-pv-global-supply-chains/executive-summary#:~:text=China
[5] Google AI search: “Xiaomi SU7, battery range”
[6] https://www.wired.com/story/china-conquers-mexican-automotive-market-and-the-us-is-worried/