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The Trade War and Its Impact on the Location Decision Process

How can site selectors survive and also find fresh opportunities in a world where not only tariffs, but also national boundaries and trade barriers, will become more meaningful than they have been in the recent past?

Q4 2019
If you’ve picked up a newspaper, gone online or even walked past a television during the past two and a half years, you know that the U.S. government has been in an outright trade war with the People’s Republic of China and has levied, or threatened to levy, tariffs on friend and foe alike. The Trump administration views tariffs as its primary weapon in addressing what it sees as global trade imbalances that are harmful to the economic and even national security interests of the United States.

The Trump administration’s trade ire has not been reserved for countries considered strategic adversaries but has also been directed at some of America’s oldest and staunchest geopolitical allies, such as Germany, France, South Korea, Canada, and others. The administration’s primary focus, however, has been on China, which it views as both a trade manipulator and the first significant geopolitical adversary the U.S. has faced since the end of the Cold War. Although recently (October 2019) the Trump administration announced a partial trade deal with China, that “deal” left in place Section 301 tariffs of 15–25 percent on $360 billion worth of Chinese goods and sidestepped many critical issues in the U.S.-China trade relationship, including intellectual property protection.

The purpose of this article is not to give an opinion regarding the administration’s goals or tactics, but to give tips on how to survive, or even thrive, in the midst of the many changes under way in America’s trading relationships around the world.

Uncertainty and Opportunity
So, how does the trade war impact the site selection process? First, the bad news: Uncertainty is the enemy of long-term capital investment, and tariffs create uncertainty by the container shipload. Tariffs can be put on or taken off by simple Executive Order of the president, sometimes with no more than a few weeks’ notice. Enacting laws via Congress, by contrast, frequently takes years, which can be frustrating but at least gives companies time to prepare.

Tariffs further ratchet up uncertainty by causing unpredictable knock-on effects, such as counter-tariffs by trading partners (e.g., the Boeing/Airbus squabble). Another common knock-on effect is that tariffs may suddenly make the importation of a U.S. manufacturer’s critical component prohibitively expensive, thus disrupting the manufacturer’s ability to churn out “Made in America” end products.

The Trump administration believes that the uncertainly created by tariffs is worth the pain in order to fundamentally re-route global trade on terms more advantageous to the United States. And although the trade war has created difficulties for many, there are signs that the administration’s strategy is having its desired effect. One of these signs is the recent scramble by many multinationals to move production out of mainland China. This scramble creates opportunities.

Uncertainty is the enemy of long-term capital investment, and tariffs create uncertainty by the container shipload. Many of the multinationals scrambling to get out of China are U.S. companies that years ago offshored production to China with the intention of selling their products back into the American market. The Section 301 tariffs have taken dead aim at these companies, in hopes that they’ll move production back to the U.S. But will production move back to the U.S. or to other production platform countries such as Mexico, Vietnam, or Indonesia? The United States is experiencing its lowest unemployment levels in half a century, which will make many U.S. companies think twice before moving production back home, although many other factors (shorter supply lines, being closer to customers, etc.) will exert a homeward pull.

Substantial Transformation and Country of Origin Analysis
But what exactly does “leaving China” mean? For example, a complete pullout may not be necessary. It may be possible to continue to manufacture in China and yet avoid producing “Made in China” goods so long as the goods are “substantially transformed” into their final, imported condition in another country. This perhaps surprising result arises because, as a general rule (under U.S. Customs law dating back for decades), the country in which goods are “substantially transformed” into their final condition prior to importation into the U.S. is the “country of origin” for most purposes.

How is a good “substantially transformed” into its final state prior to importation? According to U.S. Customs Headquarter Ruling 734124 issued on July 16, 1991, there are several factors to consider in making this determination, including:
  1. Whether a physical change in the material or article has occurred as a result of the manufacturing or processing operation;
  2. The time involved in the manufacturing/processing operation;
  3. The complexity of the manufacturing/processing operation;
  4. The level or degree or skill and/or technology required in the manufacturing or processing operation; and
  5. The value added to the article or material in the purported country of origin when compared to its value when imported to the U.S.
Importantly, simple assembly in a foreign country is not sufficient to constitute substantial transformation. In the oft-cited case of National Hand Tool Corp. v. United States, 16 C.I.T. 308 (1992), the Court of International Trade held that whether substantial transformation has occurred boils down to whether the name, character or use of the good has changed due to the manufacturing process in question. By way of an example, the same court held in an earlier case — Ferrostaal Metals Corporation v. United States, 11 C.I.T. 471,666 F. Supp. 535 (1987) — that the process of galvanizing and annealing steel in New Zealand was sufficient to “substantially transform” full hard cold rolled steel sheets from Japan into a product originating in New Zealand.

Trade agreements may, in some instances, alter the substantial transformation analysis. For example, under portions of the United States-Mexico-Canada Agreement (USMCA), substantial transformation may be deemed to have occurred under the USMCA’s “tariff shifting” rules without engaging in the name, character or use change analysis described in National Hand Tool. Under the “tariff shifting” paradigm, the fact that a good enters (for example) Mexico under a certain tariff code and is then worked upon in such a way that it leaves Mexico in a different tariff classification creates a presumption that it has been substantially transformed while in Mexico. Thus, the good’s country of origin becomes Mexico.

Practical Tips for Addressing Country of Origin Issues
In an era of high tariffs, whether substantial transformation has occurred in a given foreign country is one of the critical questions which must be answered before deciding whether a site is appropriate for a given facility. For better or worse, it becomes one more column to add to the decision factors matrix (groan!). Substantial transformation determines country of origin; country of origin in many cases determines whether a tariff applies, and tariffs help determine a site’s suitability.

The country in which goods are “substantially transformed” into their final condition prior to importation into the U.S. is the “country of origin” for most purposes. Whether substantial transformation has occurred need not be a guessing game. The U.S. Customs and Border Protection Agency (CBP) provides a binding “advanced rulings” program that addresses many tariff and importation issues, including country of origin determinations. Although CBP will not rule on mere hypotheticals, to the extent that an importer has actual plans to import a product and is uncertain of its country of origin, CBP advanced rulings can help clarify the gray areas. Further, CBP publishes a large library of prior rulings, known as CROSS (Customs Rulings Online Search System), which provide historical precedents that can guide importers in making country of origin determinations.

In Sum
Since WWII, Americans have lived in an increasingly “flat” low tariff world from which we, as consumers, have benefited greatly. That world was always, however, to some extent an historical anomaly. It arose out of specific geopolitical considerations arising from the Cold War, which ended three decades ago. The world of the future will be much hillier, chunkier, and clunkier than the flat world we’ve become used to.

Accordingly, while the Trump administration may or may not cut some kind of trade deal with China, the world is irreversibly entering into an era where not only tariffs but also national boundaries and trade barriers, in general, will become more meaningful than they have been in the recent past.

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