Corporations Will Never Allow A Trade War To Happen, Because Their Business Models Will Be Broken

Chinese Factory

We tend to see the current China yuan-peg brouhaha as nothing more than a political gambit by the Democratic administration. We have an inkling that the pressure on China’s trade practices will ease remarkably once the elections are over.

However, beyond our gut, there’s a simple reason why a true trade war with China can’t happen — it would be blocked by U.S. companies.

Note that by trade war we mean extensive tariffs aimed at forcing industries to produce manufactured products in the U.S. rather than abroad, not a few token tariff give-aways to a steel or auto union.

The problem is that any large scale erection of trade barriers would inflict substantial damage to U.S. companies, in addition to Chinese ones. This is because most U.S. business models which use low-cost labour simply aren’t feasible with U.S. wages.

Firstly, this means that if the U.S. imposes China-specific trade barriers, then companies will just manufacture from places such as Vietnam or Bangladesh, which already have lower labour costs than China’s coastal regions.

If the U.S. were to impose trade barriers on all low-cost countries, then many American companies’ margins would collapse.

For example, imagine a U.S. company that manufactures products in China where labour is one tenth the cost of America. Now imagine that for a $100 product they sell they earn a 20% margin and labour costs represent just 2% of their final price. Thus for a $100 product they pay $3 in labour costs, have a total product cost of $80, and earn $20.

Now, if this company were forced to endure 10x higher labour cost, they would suddenly have $30 of labour cost, and their margin would be wiped out. The $100 product would cost $118 to manufacture and this example just assumes $3 of labour cost for every $100 of product, and a rather healthy 20% original margin on the product. The company’s business model would be completely ruined and they’d either have to hike prices massively or find a different business.

They’d likely just go and find a different business and this is why a true trade war just isn’t feasible. Developed-nation labour costs just can’t work for many American companies given the nature of global competition and the low product prices we’ve all gotten used to.

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