Our research documents a subtle but surprisingly powerful way that some firms have been able to hedge these disruptions relative to competitors. It focuses on the US-China trade war that began in 2018 and explores how all firms importing from China responded to the imposition of import tariffs. Unsurprisingly, our results show that the average firm reduced its quantity and value of Chinese imports following the tariffs. However, firms that supply to the US government increased their Chinese imports by about 33 percent following the start of the trade war.
Our research performs several analyses to confirm that the trade war drove this effect. First, we examined trade patterns to Japan, South Korea, and Taiwan along the same trade route that reaches the United States. Our results show no evidence that US government suppliers increased imports from these countries relative to nongovernment suppliers following the onset of the trade war. Thus, US government suppliers generally increasing imports from East Asia does not explain the increase in Chinese imports. Second, we studied trade disruptions triggered by a natural disaster rather than political tensions. Following the 2011 Tohoku earthquake and tsunami in Japan, US government suppliers and nongovernment suppliers reduced Japanese imports by similar amounts. This suggests that ties with the government play a hedging role only when trade disruptions are associated with political tensions.
Our research also examines the responses of firms importing from Russia after the onset of the Russia-Ukraine War and the resulting trade sanctions imposed by the United States. Similarly, our findings suggest that government suppliers significantly increased Russian imports relative to otherwise equivalent nongovernment suppliers. These findings suggest that foreign political tensions may benefit government suppliers in political conflicts beyond the two that we studied.
Additionally, our research explores the reasons behind this phenomenon. Firms can request exemptions from these additional tariffs, and our findings reveal that government suppliers were over twice as likely to receive tariff exemptions as otherwise equivalent nongovernment suppliers.
Our findings also show that following the onset of the trade war, government suppliers significantly increased Chinese imports of both products subjected to additional tariffs and those that were not. This might occur because the products not subjected to additional tariffs may be production complements (i.e., involved in the same production process as products that are subjected to additional tariffs), so imports increased in lockstep. Additionally, firms that import products that are similar to products subjected to additional tariffs may reduce their imports due to uncertainty about whether these products will be added to the tariff lists soon. However, firms with strong connections to the government may be able to more efficiently receive clarity about future policy, allowing them to avoid preemptive import reductions. Indeed, our findings show that among firms that import products similar to those subjected to additional tariffs, firms with government connections were least likely to reduce imports of these products in addition to the products on the tariff list.
Our research also quantifies the strength of government connections. First, we considered the distance of each firm to the government agency it supplies. Our results provide strong evidence that the closer a firm was to its government agency, the more the trade war increased its Chinese imports. Furthermore, we analyzed detailed data on the backgrounds of executives and employees at the firms we studied. The evidence suggests that increases of Chinese imports were greater for firms with more direct ties to the government. For instance, firms with several former government employees had especially large increases. These increases were even larger for firms with former government employees who specialized in government contract allocation during their time in government.
Finally, our research considers the implications of this phenomenon on the market performance of government suppliers. Following the increase in Chinese imports after the onset of the trade war, government suppliers’ profitability and market share rose relative to nongovernment suppliers. Moreover, government suppliers experienced outsized stock returns.
