Following the US' decision to continue the Section 301 tariffs against China, associate professor of apparel and textile studies at the University of Delaware, Dr Sheng Lu reveals what it means for the apparel sector four years on.

On 2 September 2022, the Office of the US Trade Representative (USTR) announced it would continue the billions of dollars of Section 301 punitive tariffs against Chinese products. USTR said it made the decision based on a request from “domestic businesses benefiting from the tariff action.” As a legal requirement, USTR will launch a full review of Section 301 tariff action in the coming months. In other words, the US-China tariff war, which broke out four years ago, is not ending anytime soon.

A brief history of the US Section 301 tariff action against China

The US-China tariff war broke out as both unexpected and not too surprising. For decades, the US government had been criticising China for its “unfair” trade practices, such as providing controversial subsidies to state-owned enterprises (SMEs), insufficient protection of intellectual property rights, and “forcing” foreign companies to transfer critical technologies to their Chinese competitors. The US side had also tried various ways to address the problems, from holding bilateral trade negotiations with China, and imposing import restrictions on specific Chinese goods to suing China at the World Trade Organization (WTO). However, despite these efforts, most US concerns about China’s “unfair” trade practices remain unsolved.

When former US President Donald Trump took office, he was particularly upset about the massive and growing US trade deficits with China, which hit a record high of US$383bn in 2017. In alignment with the mercantilism view on trade, President Trump believed the vast trade deficit with China hurt the US economy and undermined his political base, particularly with the working class.

President Trump lost his patience with China in the summer of 2018. In the following months, citing the USTR Section 301 investigation findings, the Trump administration announced imposing a series of punitive tariffs on nearly half of US imports from China, or approximately $250bn in total. As a result, for more than 1,000 types of products, US companies importing them from China would have to pay the regular import duties plus a 10%-25% additional import tax. However, the Trump administration’s trade team purposefully excluded consumer products such as clothing and shoes from the tariff actions. The last thing President Trump wanted was US consumers, especially his political base, complaining about the rising price tag when shopping for necessities. The timing was also a sensitive factor — the 2018 congressional mid-term election was only a few months away.

President Trump hoped his unprecedented large-scale punitive tariffs would change China’s behaviours on trade. It partially worked. As the trade frictions threatened economic growth, the Chinese government returned to the negotiation table. Specifically, the US side wanted China to purchase more US goods, reduce the bilateral trade imbalances and alter its “unfair” trade practices. In contrast, the Chinese asked the US to hold the Section 301 tariff action immediately.

However, the trade talks didn’t progress as fast as Trump had hoped. Even worse, having to please domestic forces that demanded a more assertive stance toward the US, the Chinese government decided to impose retaliatory tariffs against approximately $250bn US products. President Trump felt he had to do something in response to China’s new action. In August 2019, he suddenly announced imposing Section 301 tariffs on a new batch of Chinese products, totalling nearly $300bn.

As almost everything from China was targeted, apparel products were no longer immune to the tariff war. With the new tariff announcement coming at short notice, US fashion brands and retailers were unprepared for the abrupt escalation since they typically placed their sourcing orders three to six months before the selling season.

Nevertheless, Trump’s new Section 301 actions somehow accelerated the trade negotiation. The two sides finally reached a so-called “phase one” trade agreement in about two months. As part of the deal, China agreed to increase its purchase of US goods and services by at least $200bn over two years, or almost double the 2017 baseline levels. Also, China promised to address US concerns about intellectual property rights protection, illegal subsidies, and forced technology transfers. Meanwhile, the US side somewhat agreed to trim the Section 301 tariff action but rejected removing them. For example, the punitive Section 301 tariffs on apparel products were cut from 15% to 7.5% since implementing the “phase one” trade deal.

Trump lost the 2020 presidential election, and Joe Biden was sworn in as the new US president on 20 January 2021. However, the Section 301 tariff actions and the US-China “phase one” trade deal stayed in force.

Debate on the impact of the US-China tariff war

Like many other trade policies, the US Section 301 tariff actions against China raised heated debate among stakeholders with competing interests. This was the case even among different US textile and apparel industry segments.

On the one hand, US fashion brands and retailers strongly oppose the punitive tariffs against Chinese products for several reasons:

• First, despite the Section 301 tariff action, China remained an indispensable apparel sourcing base for many US fashion companies with no practical alternative. The trade statistics show that three years into the tariff war, China still accounted for nearly 40% of US apparel imports in quantity and about a third in value as of 2021. Studies also consistently find US fashion companies rely on China to fulfil orders requiring a small minimum order quantity, flexibility, and a great variety of product assortment.

• Second, having to import from China, fashion companies argued that the Section 301 punitive tariffs increased their sourcing costs and cut profit margins. For example, for a clothing item with an original wholesale price of around $7, imposing a 7.5% Section 301 punitive tariff would increase the sourcing cost by about 5.8%. Should fashion companies not pass the cost increase to consumers, their retail gross margin would be cut by 1.5 percentage points. Notably, according to the US Fashion Industry Association’s 2021 benchmarking survey, nearly 90% of respondents say the tariff war directly increased their company’s sourcing cost. Another 74% say the tariff war hurt their company’s financials.

• Third, as companies began to move their sourcing orders from China to other Asian countries like Vietnam, Bangladesh, and Cambodia to avoid paying punitive tariffs, these countries’ production costs all went up because of the limited production capacity. In other words, sourcing from everywhere became more expensive because of the Section 301 action against China.

• Further, it is important to recognise that fashion companies supported the US government’s efforts to address China’s “unfair” trade practices, such as subsidies, intellectual property rights violations, and forced technology transfers. Many US fashion companies were the victims of such practices. However, fashion companies did not think the punitive tariff was the right tool to address these problems effectively. Instead, fashion brands and retailers were concerned that the tariff war unnecessarily created an uncertain and volatile market environment harmful to their business operations.

On the other hand, the National Council of Textile Organizations (NCTO), representing manufacturers of fibres, yarns, and fabrics in the United States, strongly supported the Section 301 tariff actions against Chinese products. As most US apparel production had moved overseas, exporting to the Western Hemisphere became critical to the survival of the US textile industry. Thus, for years, NCTO pushed US policymakers to support the so-called Western Hemisphere textile and apparel supply chain, i.e., Mexico and Central American countries import textiles from the US and then export the finished garments for consumption. Similarly, NCTO argued that Section 301 tariff action would make apparel “Made in China” less price competitive, resulting in more near sourcing from the Western Hemisphere.

However, interestingly enough, while supporting the Section 301 action against finished garments “Made in China,” NCTO asked the US government NOT to impose punitive tariffs on Chinese intermediaries.

NCTO’s president Kim Glas testified at a public hearing about the Section 301 tariff action in 2019 and said: “While NCTO members support the inclusion of finished products in Section 301, we are seriously concerned that…adding tariffs on imports of manufacturing inputs that are not made in the US such as certain chemicals, dyes, machinery, and rayon staple fibre in effect raises the cost for American companies and makes them less competitive with China.”

Mitigate the impact of the tariff war: fashion companies’ strategies

Almost four years into the trade war, US fashion companies attempted to mitigate the negative impacts of the Section 301 tariff action. Notably, US apparel retailers were cautious about raising the retail price because of the intense market competition. Instead, most US fashion companies chose to absorb or control the rising sourcing cost; however, no strategy alone has proven remarkably successful and sufficient.

The first approach was to switch to China’s alternatives. According to US Fashion Industry Association’s 2021 survey, 93% of respondents say they “moved some apparel sourcing orders from China to other Asian countries.” However, in the same survey, respondents admit that few other sourcing countries could match China’s flexibility and agility, production capacity, speed to market, and overall competitive price. As one respondent acknowledged: “There’s a need for retailers/commodity buyers to become less dependent on China, which would mean the need for other countries to increase infrastructure for less expensive and quality fabrics and raw materials. Or, a need for faster logistics and cheaper transportation costs for raw material export from China.” Another respondent adds: “China will continue to be a significant player in raw material sourcing, but less so for finished goods.”

Also, unlike what US textile manufacturers had expected, there was no clear sign the tariff war had resulted in more apparel sourcing from the Western Hemisphere. Instead, trade statistics suggest that Asian countries such as Vietnam and Bangladesh picked up most of China’s lost market shares in the US apparel import market from 2018 to 2021.

The second approach was to adjust what to source from China by leveraging the country’s production capacity and flexibility. For example, market data from industry sources showed that since the Section 301 tariff action, US fashion companies had imported more “Made in China” apparel in the luxury and premium segments and less so for the value and mass markets. Such a practice made sense as consumers shopping for premium-priced apparel items typically were less price-sensitive, allowing fashion companies to raise the selling price more easily to mitigate the increasing sourcing costs. Studies also found that US companies sourced fewer lower value-added basic fashion items (such as tops and underwear), but more sophisticated and higher value-added apparel categories (such as dresses and outerwear) from China since the tariff war.

The rise of tariff engineering

Related, US fashion companies such as Columbia Sportswear leveraged the so-called “tariff engineering” in response to the tariff war. Tariff engineering refers to designing the clothing to be classified at a lower tariff rate. For example, “women’s or girls’ blouses, shirts, and shirt-blouses of man-made fibres” imported from China can tax as high as 26.9%. However, the same blouse added a pocket or two below the waist would instead be classified as a different product and subject to only a 16.0% tariff rate. Nevertheless, using tariff engineering requires substantial financial and human resources, which often were beyond the affordability of small and medium-sized fashion companies.

The third common approach was to work with Chinese vendors to absorb the increasing sourcing costs. According to industry sources, it is not rare that vendors in China would “lower the price to keep the sourcing orders.” Trade statistics also show that while the unit price of US apparel imports from the rest of the world went up since 2018, the price of apparel “Made in China” experienced a significant drop. However, as Chinese factories face rising costs from raw materials and shipping to labour amid the pandemic, such a practice was regarded as not sustainable.

Additionally, recognising the negative impacts of Section 301 on US businesses and consumers, the Office of the USTR created a so-called “Section 301 exclusion process.” Under this mechanism, companies could request that a particular product be excluded from the Section 301 tariffs, subject to specific criteria determined at the discretion of USTR. The petition for the product exclusion required substantial paperwork, however. Even companies with an in-house legal team typically hire a DC-based law firm experienced with international trade litigation to assist the petition, given the professional knowledge and a strong government relation needed. Also of concern to fashion companies was the low success rate of the petition. The record showed that nearly 90% of petitions were denied for failure to demonstrate “severe economic harm.” Eventually, since the launch of the exclusion process, fewer than 1% of apparel items subject to the Section 301 punitive tariff were exempted. Understandably, the extra financial burden and the long shot discouraged fashion companies, especially small and medium-sized, from taking advantage of the exclusion process.

In conclusion, with USTR’s latest announcement, the debate on Section 301 and the outlook of China as a textile and apparel sourcing base will continue. Notably, while economic factors matter, we shall not ignore the impact of non-economic factors on the fate of the Section 301 tariff action against China. For example, the overall US-China bilateral trade relationship significantly deteriorated in recent years. Besides the tariff war, the friction between the two countries had expanded into highly politically sensitive areas such as forced labour and human rights. This explained why the US Biden administration “wilfully” chose to keep the Section 301 tariffs for apparel as negotiation leverage with China. Domestically, President Biden also didn’t want to look “weak” on his China policy, given the bipartisan support for taking on China’s rise.

By Just Style