How is Political Economy Intertwined with the Global Supply Chain?

As geopolitical tensions have risen over recent years, the reconstruction of the global supply chain has become increasingly intertwined with the economic and trade policies of individual states. Geopolitical tensions not only impact government policymaking, and the adjustments that companies and industries make to such policies but also affect the behaviour of companies that have supplier relationships with governments. In this context, do U.S. government suppliers reduce their imports from countries that are affected by trade tensions, such as China? If this is the case, what is the value of a firm’s relationship with the U.S. government? Would government decisions about whether to approve a contract bid from a supplier be affected by its products being imported from China?

In the study The Golden Revolving Door: Hedging through Hiring Government Officials, we examined the sourcing behaviours of U.S. government suppliers during the U.S.-China Trade War and found some surprising results. Analysis of import data of nearly 1,000 U.S. public companies from January 2016 to December 2019 showed that government suppliers had lower imports from China than other companies prior to the trade war. But after tariffs were imposed by the U.S. in the third quarter of 2018, imports from China dramatically increased for government suppliers, while those of non-suppliers gradually declined. (However, the effect is weaker for suppliers that mainly work with the U.S. Department of Defence, which bans imports from China by contractors.)

“Our research suggests that tie to the government serves as a means of navigating and hedging the increasingly murky political landscape of global markets. The closeness to the authority making rules allows you to skirt rules more easily in bad times.”

Prof. Jing Wu

To explain the counter-intuitive result, we explored various indicators of the strength of suppliers’ connections with government. These were: geographical distance from the political capital; how long the company has been a government supplier; and whether its executives and board members or employees had previously worked in government. Analysis showed that suppliers who were closer to Washington D.C. had served as government suppliers for longer; and had employees with experience in government; all increased their imports from China faster, while for those with board members and executives who had previous careers in government, the increase was much faster. This suggests that tie to the government serves as a means of navigating and hedging the increasingly murky political landscape of global markets. The closeness to the authority making rules allows you to skirt rules more easily in bad times.

In a further key finding, we demonstrated that having a connection with the government provided these companies with an advantage in getting applications for tariff exclusions approved. Government suppliers secured 14 percent more approvals on average than other companies for imports from China. Over time, these advantages resulted in higher corporate operating performance for government suppliers during the trade war, with market share and profitability both increasing. The number of companies bidding for government contracts also increased after the trade war started, with small-value and short-term contracts, which are subject to less regulation, showing a sharper increase.

Multinational industrial conglomerate Honeywell, which has a strong manufacturing base in China, exemplifies the effect. Honeywell’s imports from China rose by more than 10 percentage points after the trade war started, while its total transactions soared by 157 percent in the 2018 financial year. The corporation, which has at least four senior executives who previously served in government departments or agencies, applied for 25 tariff exemptions on imports from China in the study period, of which 24 percent were approved, nearly double the average approval rate of 12.9 percent.

To check the broader validity of the findings, we conducted a similar analysis on imports from Russia by U.S. government suppliers during the Russo-Ukrainian War, which began in February 2022. The conflict led to a wide range of economic sanctions on Russian banks, companies, oligarchs and politicians being imposed by Western countries, including the U.S. Bans on exports of fossil fuels and blocks on Russia’s central bank accessing foreign exchange reserves held abroad were also imposed. The results showed that U.S. suppliers increase their imports from Russia by more than 60% compared to the average imports from Russia prior to the trade war. This indicates that our findings are not exclusive to the U.S.-China Trade War and should be generally applicable to other instances of geopolitical trade tension.