Strategic Exchange: The third round of Chinese tariffs include flooring - Oct 2018

By Kemp Harr

Right before press time, the news hit that the third round of Chinese tariffs were going into effect starting September 24, and the list of products includes most types of flooring. Initially, the tariff will be 10%, but on January 1 of next year, it rises to 25%.

What’s interesting about this list of $200-billion worth of Chinese imports is that this round included consumer goods, which means it will have an immediate impact on the prices households pay for products they buy on a routine basis.

I hesitated to devote this column to this story since our president has been known to capitulate on issues like this as part of the negotiation process, so all this could change tomorrow. The core mission of any politician is to stay in office, and with midterms around the corner, this is a bold and potentially unpopular decision because of the impact it will have on inflation as well as retaliatory implications for American farmers, who will suffer the most when the Chinese hit back with counter tariffs.

Back in March, the United States Trade Representative (USTR) released the findings of its “exhaustive Section 301 investigation that found China’s acts, policies and practices related to technology transfer, intellectual property and innovation are discriminatory and restrict on U.S. Commerce.” On July 10, a 6,031 product classifications were proposed, and, in spite of a lengthy hearing process in August, only 297 products were removed from the list. No flooring items were removed, despite a differing set of circumstances depending on the product category, which I’ll get to in a moment.

It’s also important to understand the significance of China in the flooring business. According to analyst Santo Torcivia, imports represent half of the flooring that’s consumed in the U.S., and half of those imports come from China-so 25% of the flooring consumed today is made in China.

CRITERIA TARIFF EXCLUSION
In July, the USTR published the criteria for keeping a product off the tariff list. First and foremost, is the product available from an alternative source outside of China? Secondly, would additional duties cause severe economic harm to the requestor or other U.S. interests? And lastly, is the product strategically important to the “Made in China 2025” industrial growth strategy?

As we consider each flooring category, the one flooring category that, given that criteria, might deserve exclusion is LVT and especially rigid core LVT. Of the $2.7 billion (at wholesale value) of LVT that will be consumed in America this year, only 25% is made domestically. And when you consider rigid core LVT-which represents more than half of the total LVT consumed-most of it is made in China. So, today there is not enough capacity outside of China to satisfy U.S. demand.

10% VERSUS 25%
At the onset, the initial tariff of 10% will not be as significant as the 25% rate that has been promised for the first of next year. In fact, some say the 10% rate will hardly make a difference because the Chinese Yuan has already been devalued by nearly 10% since the March/April time frame when the currency was impacted by the threat of a tariff. But a 25% tariff, especially over an extended time frame, will be more significant.

To survive, companies that produce in China will be forced to move to alternative Asian countries, and domestic brands will have a greater incentive to invest in U.S. production.

One might have thought that the percentage levied would vary depending on the availability of alternative sources, coupled with the role Chinese suppliers have played in the global market. Porcelain tile, for example, has ample manufacturing capacity around the world, and China’s role in the tile industry, according to USTR hearing testimony by Eric Astrachan, executive director of the Tile Council of North America, fits within the predatory criteria of the Section 301 initiative. More of a copycat than an innovator. So a 25% tariff might be warranted.

With LVT, on the other hand, the tariff should arguably be lower and may not even be justified because of the lack of global capacity and, more importantly, because of the role the Chinese have played as an innovator. Both types of rigid LVT were initially developed in Chinese factories.

THE THREAT OF INFLATION
Most historians can attest to the fact that tariffs cause prices to rise-not only because the product is being taxed by the importing country, but also because domestic suppliers see it as an opportunity to increase their prices as well. Just a week before the tariffs were announced, one of the flooring industry’s largest suppliers sent out a customer letter announcing a price increase equal to the amount of the tariff, effective on the same day as the tariffs are enacted. This is going to be interesting to watch.

If you have any comments about this month’s column, you can email me at kemp@floorfocus.com.

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