Trend Tracker Aug/Sept 2018July 12th, 2021 by Nathan Hobbs
Will Tariffs Affect Industry Demand?
Economic Effects on the Industry Might Not Be Dramatic
By Michael Collins
In the short term, tariffs have the effect of increasing the price of foreign goods brought into the United States. Tariffs are paid on goods passing through the border. Some industry discussions incorrectly imply that the overseas producers of these goods pay the tariff. Rather, it is the buyer of the products and materials that does this. Thus, an Economics 101 class would tell us that the price of these various goods has increased and there will be an accompanying decrease in demand for the products. If tariff costs are passed on to consumers, demand for the affected goods would be expected to suffer a corresponding decline.
Wouldn’t that mean that the demand for doors and windows would decrease in any and all cases where the prices of those products increased due to tariffs? You can’t make a case that tariffs increase demand or even leave it unchanged. However, we believe there are unique aspects of doors, windows and other building products that will mitigate many of the effects of tariffs. Support for this comes from an economics concept called the elasticity of demand, which is the amount by which demand for a good changes in response to price changes, regardless of what caused them. Typically, the more vital the product, the less demand will change in response to price changes. For example, a 10-percent price increase for ice cream and milk will affect sales of the former more than the latter.
Answering a Need
Most door, window and building products purchases are made out of necessity, rather than out of fashion or whim. Even when remodeling is undertaken in order to approve the aesthetic appearance of doors and windows, an energy-efficiency improvement is generally an important part of the equation. Failing to remodel doors and windows leaves a homeowner violating the admonition of parents everywhere not to “heat the whole neighborhood.” The economic benefit of increased energy efficiency makes consumer demand for doors and windows less elastic in the face of tariff-driven price increases.
Another factor making building product demand less elastic—and less likely to decrease because of tariffs— is the low-interest-rate environment. Whether building a home or a commercial structure, the cost of financing is still near all-time lows in the cur-rent market. Delaying construction to avoid tariffs on a portion of the components of a project could leave a home-owner or commercial developer forced to build at a time when interest rates are meaningfully higher. Since such interest expenses would outweigh the increase in tariffs, demand elasticity is less, and consumers and developers will likely push ahead with purchases.
The construction of homes has failed to keep pace with household growth over the past 10 years, and this serves as another key factor reducing the elasticity of building product demand in response to tariff-driven cost increases. Individuals building their first home or upgrading in advance of having children are not doing so on a whim. The centrality of our homes to the conduct of the rest of our lives means that home decisions will not be delayed over a price increase of a few percent.
Trade War Worries
What about the retaliatory tariffs from China and other nations whose product sales could be affected by the current U.S. tariffs? Typically, these counter-tariffs are chosen to apply to products manufactured by stakeholders with sufficient political clout to lobby Washington to resolve the situation. Examples include Levi’s, Caterpillar tractors and others. These counter-tariffs make news and help draw political pressure on the administration.
However, they are also the harbinger of a resolution to the problem. When two nations have bled some tax revenue and economic performance from each other, they are more likely to approach the negotiating table with an open mind about arriving at an agreement. There are no winners in a trade war, as producers of goods on both sides sell less of their products than would be predicted in a free market.
Clearly, price increases driven by tariffs will not increase door and window demand. However, we must view building products purchases in their proper context and in comparison to other purchases. We believe it is likely that their vital, primarily non-discretionary and price-inelastic nature will cause less impact on demand in the short term while the overall trade issue is addressed.
Michael Collins is an investment banker and a partner in Building Industry Advisors. He specializes in mergers and acquisitions in the door and window industry.
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