Should Multinational Suppliers Relocate Their Production Capacity to Preferential Tariff Regions with Unreliable Supply under the Impact of Tariffs?

Abstract

This paper investigates the impact of tariff escalation on multinational suppliers relocating their production capacity to tariff-preferential regions with unreliable supply caused by low-production technology. We build a game theory model to analyze this issue based on three decisions for supplier-capacity relocation: no relocation, partial relocation, and full relocation. Our analysis finds that when tariffs are low or the production technology of the base in a preferential tariff region is not advanced, the supplier tends to adopt a partial-relocation strategy, but this strategy may be hindered by a manufacturer’s order-allocation decision, leading to a no-relocation strategy as the supply chain’s equilibrium. This may result in greater losses for the supplier. When tariffs are high or the production technology of the base in the preferential tariff region is advanced, the equilibrium strategy for the supply chain shifts to a full-relocation strategy. Interestingly, in the partial-relocation strategy, the higher production technology in the preferential tariff region negatively impacts the manufacturer’s expected profits but benefits the supplier’s expected profits due to the increased double marginalization. Finally, we find that the supplier can reduce the impact of tariffs by relocating their production capacity, especially with the partial-relocation strategy, as the supplier is always motivated to improve the production technology of the base in the preferential tariff region, with a potential purpose of transferring tariff costs to the manufacturer and consumers.