Podcast: What Do Trump Tariffs Mean For Aerospace And Air Travel?

AeroDynamic Advisory’s Kevin Michaels joins Aviation Week editors to discuss the worrisome implications for the industry.

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Transcript.

Joe Anselmo:

Welcome to the Check 6 Podcast, I'm Joe Anselmo, Aviation Week's editorial director, and Editor-in-Chief of Aviation Week & Space Technology magazine.

US President Donald Trump has unveiled sweeping tariffs on imports, and if you're trying to piece together what it all means for aerospace and aviation, don't feel bad, we are too. In that spirit, we decided to invite our Check 6 listeners into the room as we talk about the implications of the tariffs, what we know and what we don't know.

Joining me is Michael Bruno, Aviation Week's Executive Editor for Business, based in Washington D.C. From Europe, we have Jens Flottau, Aviation Week's Executive Editor for Commercial Aviation. And rounding out the discussion is supply chain expert Kevin Michaels, Managing Director at Aerodynamic Advisory and a regular Aviation Week contributing columnist. Michael, why don't you start us off with a quick rundown on the tariffs announced by the president on April 2nd.

Michael Bruno:

Right, so here's what we know, and a lot is still getting figured out. But on Wednesday, April 2nd, after stock markets closed their regular trading in the United States, President Trump emerged in a White House ceremony to unveil new taxes on the American consumers based in these tariffs on foreign goods imported to the US from other countries. So, there's this baseline 10% tax that's going to be applied seemingly around the world to practically every country, but several countries are going to get hit by tariff levels that are multiples of this 10% baseline.

For instance, Chinese imports will see a 34% tax from these new tariffs announced April 2nd. European Union goods will see 20%, Vietnam, 46%, Taiwan, 32%, India, 26%, and Japan, 24%. However, the thing we're starting to piece together is that when compounded with other protectionist policies already announced by the Trump Administration, some countries are going to see even higher total tariff rates.

For example, Chinese goods actually will see a 54% tariff generally, and that's according to the U.S. Commerce Secretary, Howard Lutnick. So, it's not immediately clear what the cumulative effects are on cross-border aerospace, and defense supply, and I'm sure we're going to talk about that a lot in a little bit. But there's quite a bit of this, billions of dollars of cross border, aerospace, and defense supply.

Commerce Secretary Lutnick said April 3rd that Trump was not interested in a product by product negotiation, he was more interested in country by country. But according to a White House statement and several other news reports, goods from Mexico and Canada that comply with the U.S.-Mexico-Canada, that's the revised NAFTA trade agreement, will largely remain exempt from these new tariffs, except for auto parts and steel and aluminum that fall under separate tariff policies. These tariffs are going to roll out starting April 3rd and over the next few weeks, and the Trump Administration said they're open to negotiations with other countries and they're awaiting their phone calls. So, that's where we're at, Joe.

Joe Anselmo:

Wow, that is a lot to digest.

Kevin, you had a post on LinkedIn that is getting a lot of attention. You argued that free trade has made Americans incredibly prosperous, with a per capita income that's more than double the per capita income in Japan, and 30% higher than Europe. And you wrote, "This will not end well. Inflation and a trade war are on the way at a time when the U.S. is killing it in the global economy."

Kevin Michaels:

Yes, Joe, it's hard to watch these policies roll out and the proclamations come out that are so opposed objectively to the empirical facts. And what I try to remind people is that if you go back in time to 1990, when I was doing my MBA, one of the most popular classes was the Japanese business system. Well, why was it? It was because Japan was going to take over the US and we had to get ready for it, because they were ripping us off with unfair trade practices. And we discovered a few years later that actually the reason they were killing us in the auto industry is because they had adopted a US system from W. Edwards Deming, of total quality management, and what we now know as the Toyota Production System. And we actually learned from the Toyota Production System, and that's made us more efficient producers today.

You fast-forward to today and the nominal GDP in Japan is under $40,000, and in the U.S. today it's over $80,000. And that's what I pointed out is, around 1990 before NAFTA and even before aerospace globalized in the way it did, the per capita incomes of Japan and most major European economies and the U.S. and Canada were all pretty close, between $18,000 and $23,000 per capita. Today, the U.S. is at $81,000, and that's as of 2023, which is 20-30% higher than Europe. It's 30% higher than Canada, and it's double what it is in Japan. So naturally, we're going to buy more stuff because we have more money to spend, and that means you run up a trade deficit.

Joe Anselmo:

Kevin, let's talk about aerospace specifically. You wrote a column in the last issue of Aviation Week magazine before these Trump tariffs were announced, warning that tariffs would cause a lot of harm to aerospace. How so, and where?

Kevin Michaels:

Yes, Joe. My column unpacked five different tariffs that were on the table up until yesterday. One was steel, one was aluminum, and then three were country specific, and they were imposed on Canada, Mexico, and China.

So Joe, the steel and aluminum tariffs are in the hundreds of millions [of dollars] in the case of aluminum, and probably in the tens of millions when it comes to steel. And while they're not welcome news, they're probably largely manageable, given the amount of cost imposed. Although, it is worth noting that the steel supply chain right now is really out of whack and there are very long lead times, and this will only add to some of that uncertainty. But the vast majority of aluminum alloy and steel comes out of U.S. mills, although pure aluminum does come out of Canada.

But the country-specific tariffs were the ones where you had the big costs. And I looked at Canada, which exports $10 billion a year, and that would equate to a $2.5 billion cost, a lot of that in business aviation. And then in the case of Mexico, $8 billion a year to the U.S., which is a $2 billion tariff, and that's many hundreds of factors.

So kind of fresh off the press right now as we're trying to unpack this, is the news that just came out of few hours ago from RBC, which indicated that USMCA-compliant aerospace products out of Canada can avoid the tariff. And RBC went further to state that specifically this is good news for Bombardier and CAE, which makes simulators, and companies like Pratt & Whitney and Pratt & Whitney Canada that make engines and others. One of my sources at a big OEM in Canada has confirmed this, so it does look as if in the case of Canada, being USMCA-compliant could allow Canada to dodge this bullet that is affecting just about every other country on the list.

Of course, we don't know yet how much of the Mexican exports to the U.S. are USMCA-compliant, I'm assuming it'll be a fair number, a fair percentage of that. But this of course does nothing in the case of Europe and those 20% tariffs that have come out yesterday in the Rose Garden ceremony. So, if this all stands up, it looks like the roles have been somewhat reversed, where the USMCA partners are going to get away with lower tariffs and now we have higher tariffs on Europe and other parts of the ecosystem.

Joe Anselmo:

Jens Flottau, what are they saying about all this in Europe? And are we in danger of a trade war, which I think would be pretty harmful to aviation and aerospace?

Jens Flottau:

Yeah, I'd say generally everyone was surprised and shocked by the extent of what was announced. And absolutely, there is a danger of trade war because retaliation measures are already being discussed. And if the administration doesn't stop this, as it doesn't seem like it will, I think some kind of trade war will be inevitable. Although, the overwhelming conclusion that people have drawn is that the US hurts itself the most by far.

If I talk about Airbus for a moment, I just pulled some numbers here before we did this podcast. Airbus has, and this is just narrowbodies, a backlog of around 7,700 narrowbodies. That's A220s and A320neo family aircraft globally, and the US is a little over 10% of that. So yes, there is exposure, but it's not like the end of the world for Airbus, particularly when you see how demand is elsewhere in the world.

Airbus’ problem has been for the past few years that it can't produce enough aircraft, and they've already indicated that they might in the short term, as long as this drags on, just redirect deliveries away from the US and into other regions of the world that are happy to take more aircraft. So, that's one.

The other effect that I see potentially is that as part of retaliation, and we've seen this before, countries, airlines, particularly state-owned airlines, might opt to say, "Okay, we're not taking as many Boeings as we had wanted before. We're not ordering them anymore." China is the prime example. Look at the MAX crisis, when for a number of years they haven't really taken many 737s at all, or 787s.

There's that, but I'm not dismissing the risk for Airbus as well, it's real, it's there. It impacts its US customers of course, but I think the main issue for Airbus is also that this is introducing more uncertainty, more risk into the overall supply chain, which it largely shares with Boeing. And I think we probably all agree that financially, in terms of financial stability of companies, the biggest risk here is not for the Boeings or the Airbuses of the world, but for the smaller supply chains, the tier two, tier three people that are having to deal with this right now.

Joe Anselmo:

I think Kevin talked about the complexity of supply chains. This is a global industry. Aviation is a global supply chain. Airbus airplanes are full of content made in the United States and elsewhere. Boeing sources from all over the world. Kevin, you can't just pull this apart and move it all to the United States, can you?

Kevin Michaels:

No, you can't. And we've been a relatively terror free industry. We go back in time the GATT, the global agreement on tariffs and trade, then what was the annex of civil trade and civil aircraft parts, which goes back to the late 1970s. So proceeding NAFTA, proceeding the enlargement of EU and so forth, we've been a relatively tariff-free industry and our ecosystems have developed around that over time, and now we're introducing this new thing. And we can talk about the economic damages or the potential economic damages, but you know what, Joe? It is the wasted time to comply with all of this and the freeze this is putting on strategic planning.

I was with a client two weeks ago that has a factory in Mexico and they put all their inventory on a truck and all the trucks were taken to take it north of the border before April 2nd, and basically shut down operations to do that. And that inventory is now in Arizona in a bonded warehouse. And what do you do? What happens next? And so, it's putting a freeze on capital allocation decisions, and Lord knows how many bureaucrats we're going to have to hire to comply with these excruciatingly complex calculations that are going to have to take place, let alone the lawyers. And yeah, government affairs, that's a prediction. Government affairs people are going to go up quite a bit. That's going to be a growth area in our industry now, but it's all wasted overhead at a time when we don't need it. And to Jens' point, these tier twos and tier threes that are already struggling and struggling to make money are now going to have to deal with this as well on top of it, and it's just not good news at all.

Michael Bruno:

I just want to slide in and echo what Kevin is saying, because I've been hearing very similar things from other people. Gary Weissel from Tronos Aviation, which I know Kevin knows well, is probably good friends with Kevin because everyone's good friends with Kevin. Gary was telling a Bloomberg intelligence webinar recently, he's like his phone's ringing off the hook. He says, "I'm talking to clients, they're setting up war rooms. They're starting to warn their sub tier suppliers that there's going to be price negotiations." Even though right now, most everybody's under some kind of long-term agreement, you're either already looking to renegotiate that long-term agreement or maybe upend it if you can claim force majeure type circumstances, whatever.

But everybody is setting up and reacting in not quite a panic, but this is absolutely a new regime that's coming into the business of aerospace and defense supply, and people are responding. We may not be hearing it from the top trade associations in Washington, and we can talk about whether that's disappointing or whether they're just secretly trying to lobby hard behind the curtain and nobody really sees it. Either way, what people in industry are seeing is the major suppliers already responding. There's already movement happening, and this was before the tariffs were even announced on April 2nd.

So, we won't be begin to see many of the ramifications probably for weeks, maybe months. It's certainly going to be the number one issue in the first quarter teleconference calls that begin at the end of April, and it's probably going to dominate for the rest of this quarter. It won't be, how are you impacted, but how are you, major tier one OEM or even big tier two, how are you going to deal with your supply chain and how aware are you of the costs that they're going to incur because of this? Because that's what's happening here. No matter how you look at it, it's just going to raise the baseline costs of doing business in aerospace and defense for the midterm, if not the long term.

Kevin Michaels:

If I could add to that too, I mean, one of the questions of course is, who will eat the tariffs, right? It's in this complex B2B industry. And as far as I can tell in talking to the aircraft OEMs, the existing contracts, so the backlog that Jens just talked about for Airbus, right? And as far as I understand, most of those contracts don't have a tariff provision in them where you can pass that onto the airline. But going forward, it will probably be part of future negotiations.

So, if we look at the existing contracts and the existing backlog, it just doesn't look like there's much capacity for Boeing and Airbus at the end of the day, or the engine OEMs, to pass that on to the airline, which means it has to be absorbed in the chain. And there are clauses in there about price escalators and that sort of thing, which we've dealt with, but most of those are rearward looking. And so I think that's going to be something. So, I think tariffs will become part of future contracts between OEMs and airlines, but that backlog we have in place with existing contracts, it just doesn't look like there's much capacity to pass that on.

Michael Bruno:

It's like COVID all over again, Kevin. I mean, it kind of reminds me, it's like a sudden spike in the cost of doing business that isn't reflected in the current agreements. And it takes time for those agreements to be renegotiated with the new reality, either the new labor costs or the new raw material costs, in here it's going to be the new tariff costs. Right? So if you're looking for an example of what happened, you have to look no further than just three, four years ago with how the industry tried to and struggled to adjust to COVID-19 costs.

Jens Flottau:

And it's also, if you look at the airline side for a moment, it's also kind of COVID all over again, not the extreme case of zero travel. But what's air traffic being built on? It's built largely on global trade, right? And this is, we should probably all agree, not good for global trade.

So, what's going to happen for air travel demand? It's going to go down, at least it's not nearly going to grow as fast as everyone had hoped. What that means for OEMs is also clear, they're going to sell less aircraft, suppliers are going to sell less components. You are already seeing that in the US-Canada market, where the Canadians have decided, and this is less trade than tourism, but the Canadians basically have decided they're not going to spend their holidays anymore in the US. So, capacity and demand into the U.S. has tanked, for some airlines double-digit declines. So, airlines are struggling too, and this doesn't even take into account yet what are the effects of this new round of tariffs. So, all the basic growth outlooks that we've seen over the last few years and months have to be revised based on this.

Joe Anselmo:

Michael, you mentioned at the beginning, there's so much we don't know yet. Is this just the starting point for negotiations? I mean, Donald Trump has incredible leverage with these.

Michael Bruno:

It is absolutely a beginning point for negotiations. Everybody from Trump to Howard Lutnick, he's saying it right now on TV as we record this podcast. They're sitting there waiting by their phones ready for countries to call them and say, "We want to negotiate and figure out how we can get you to lower the tariff on our country. How can we make you happy?" That's what they want.

Now the crazy thing is, it's more of a hope and not a strategy, right? The what ifs if these countries don't call, don't call quickly. What if they start taking other actions like striking bilateral deals with other countries on their own around the United States? And whatever it is, there's absolutely no roadmap that's been laid out at least by the administration about how to respond to this. So, negotiations absolutely are welcomed by the Trump Administration, I'm not speaking for them. They've made it very clear that that's exactly the tactic they're taking here.

The question is, how does this end? It's again kind of like COVID-19, if you all remember, there were a couple of years where nobody could really see how these were going to end. We saw repeated waves of infections, here we could see repeated waves of tariffs. It was finally a scientific breakthrough with vaccines that really started to change the course of the pandemic. What could be that vaccine breakthrough here with tariffs? I have not heard anybody say anything.

So, negotiations can take a very long time between countries, especially when it comes to trade negotiations. Look what happened with GATT, NAFTA and the USMCA. So, will this take all of the Trump Administration plus to try to even unwind, even if Trump says he agrees to unwind these tariffs fully, could he even do it in his administration? These are big unknowns.

Joe Anselmo:

Kevin, I heard the president talk about U.S. automakers, I think building new factories in this country because of this. And it reminded me of a visit last year. You took Ron Epstein, Richard Aboulafia, and me on a tour of River Rouge, the giant Ford plant that Henry Ford created outside of Detroit. And at its peak, it was employing 100,000 people. I think it employs like 5,000 or 6,000 people now. So, even if you build new factories, because of automation, they're not going to employ huge numbers of people anymore, are they?

Kevin Michaels:

That's right, and I think that's something that is lost on much of the public, certainly in America, is that people like to bring up H. Ross Perot's famous phrase, the giant sucking sound, that he raised in a debate in 1992 about what would happen when NAFTA. The reality is, most manufacturing jobs that have been lost have been lost to automation, not to free trade. Now, is it true that some labor intensive jobs have gone to Mexico and other places? Absolutely, that is absolutely true, but it's within the confines of NAFTA and now the USMCA that we operate.

And by the way, the reason that many companies are in Mexico today, it isn't because of cost savings, it's because they can find labor there. It's very hard to find labor in this country right now with a 4% unemployment rate. And let's talk the dirty little secret. Not a lot of young people want to get in aerospace and be in hard manufacturing jobs. Mexico provides the labor, the training. Young folks are motivated there to be in aerospace and take on these labor-intensive tasks, which by the way, make U.S. and European and Canadian OEMs more competitive on the global market.

Jens Flottau:

I can't stress enough the point that Kevin just made about labor. You have very, very low unemployment rates. You could argue in some parts of the country you don't have unemployment, right? So, where are you going to get all the people that you need for manufacturing? You won't get them. So, what happens? Labor rates are going to go up, inflation is going to go up even further.

I was just at the ISTAT Americas conference, which is like a couple of weeks ago, well before this was announced. But back then, I mean, people who were really worried about that angle too. Where are we supposed to get the people? They are not there.

Kevin Michaels:

One of the byproducts of tariffs, too, is that it makes domestic manufacturers less competitive. So even if, let's say I'm a US OEM and I'm not terribly affected by the tariffs, let's just do a thought experiment for a second. But my competitor is. I've got a license now to raise my prices because my competitor is raising his prices. So, this whole period of price inflation from the OEMs to airlines, we've seen it in the aftermarket in spades, where aftermarket maintenance spending has skyrocketed in recent years because OEMs are pushing through 8%, 10%, 12% annual price increases for parts and maintenance services. Well now, with tariffs, that is going to continue. That's guaranteed to continue, whether you're affected or not, because the ceiling goes up. And of course, labor costs are set to go up as well, as has been pointed out here.

Joe Anselmo:

Michael, you want to take us to the finish line?

Michael Bruno:

Whether someone agrees with President Trump's approach and reasoning, and there are several other reasons we haven't even touched on that he's mentioned are behind doing tariffs such as fentanyl supply from China and things like that. So, where anybody sits in this political debate is a separate question from the economic effects that these actions are going to have on industry in the near to midterm. And it's pretty undeniable that the economic effects are going to be somewhat, if not significantly harmful to the current state of business. That isn't to say things can't adapt, people can't make changes. The business of aerospace and defense can adjust over time, just like it's adjusted over the more than century that it's been around. But in the near to midterm basis, this is absolutely a shock. It's just a question of how big of a shock it's going to be.

Joe Anselmo:

Well, to your earlier point, I'm certain this will not be our last podcast on the issue of tariffs, but I wanted to thank you and Jens for sharing your insights. Kevin, special thanks to you for taking the time to join us. Can't wait to read your next column in Aviation Week, and in the meantime, I'll keep following you on LinkedIn because it's always good stuff that you post.

Kevin Michaels:

Hey, Joe, to any policymakers or politicians that might be listening to this podcast, it is worth reminding them that the U.S. enjoys the largest trade surplus in aerospace and defense of any industry except for crude oil -- $114 billion a year trade surplus in this industry that has worked so well and created so many high paying jobs in our economy. So, we're going after the biggest example, our industry, with this wonderful trade surplus. So, it is a sad day, it's a sad day, and hopefully this will not last.

Joe Anselmo:

And on that point, we will wrap up this week's Check 6. A special thanks to our podcast producer in Ohio, Andrea Copley-Smith. If you haven't already, be sure to subscribe to Check 6 so you never miss an episode. If you found today's discussion helpful, consider leaving a rating or review. Better yet, share this episode with a friend or colleague. That's all the time we have for now. Thank you for your time, and join us again next week for another Check 6.