New Tariffs Impact on Global Services Market

Introduction to the Impact of Tariffs on the Global Services Market

A lot of our clients, especially CIOs and Global Business Services (GBS) executives, are asking about the effects of the new tariffs on the global services market. The most important impact of tariffs is their effect on the broader macroeconomy. Currently, we are seeing many firms postpone projects and move to a more defensive posture. As the uncertainty continues, we anticipate that enterprises will further curtail their discretionary spending. It is likely that a slowing economy will shift focus away from spending to support growth to cost-cutting initiatives.

Regarding the Potential for Tariffs Levied on Services

As of today, it does not look like there will be tariffs on services. And it’s highly unlikely that even if the tariff wars intensify that there will be tariffs on services. There are numerous reasons for this conviction. However, the primary reasoning is the level of difficulty in executing a tariff strategy on services. Simply put, there is no clean way for any country to put tariffs on invisible exports, such as services, without creating tremendous unintended consequences.

However, there has been some talk that the EU and India will put tariffs/taxes on US firms. These new taxes could be levied on the US firms’ IP and cloud services. That said, it seems that this talk is primarily aimed at creating bargaining leverage for the upcoming trade negotiations and likely will not materialize in actual fact. If the move to tax US IP and cloud services does move forward, we think they will have a modest to negligible effect. Taxes on US cloud services will be easy to evade. There is already substantial processing power in the EU and other untariffed countries. Firms such as AWS, Microsoft, and Google, as well as their clients, will quickly transfer workloads to these centers.

The Modi Administration Positions to Increase Taxes on Services Delivered in India

Modi has signaled that he and his administration are considering increasing the tax levied on services exported to the US and other countries. At this time, this appears to be talk aimed at creating bargaining leverage for future trade talks. However, if they do move forward with these taxes, they will modestly increase the cost of firms’ buying services originating in India. As these taxes have yet to materialize, it is hard to know if they will affect third-party services and GCCs/captives in the same way.

Other Real Dangers to Worry About

Other potential moves by the Trump administration may impact the global business services market. Clearly, this administration has a restrictive view of immigration. At the outset, their early moves have largely focused on the undocumented at our southern and northern borders. These immigrants have very little impact on the services industry. But, if the administration moves to tighten eligibility for H1B and L1 visas, this could adversely affect the services industry modestly. This is a play we have seen before. This time, the industry is well prepared to cope with these potential changes and will lean on the learnings from their experience with the last Trump administration. For that reason, we think this will have a de minimis impact on the global services industry if it happens.

Even the Most Aggressive Tariffs Will Have a Modest Impact Compared with the Growing Impact of AI

Here is the biggest worry for global services executives: the emerging impact of AI on services. This development seems to be much more profound than the threatened tariffs. Companies are becoming more efficient in using AI to do their own development. We believe the impact of AI is likely to be far more significant both in the short run and long-term than the potential impact of tariffs to restructure global trade that the Trump administration is attempting.

We are already seeing firms deploying AI in their IT development and at the same time shifting work in house from third-party vendors. This phenomenon has been at the heart of the slow recovery of IT services spend. Additionally, we are starting to see new system-of-action software eat into both IT and BPO workloads. As this AI revolution unfolds, it is likely to threaten the core assumption around labor arbitrage on which the modern services industry is built on. Hyper-productive AI first delivery may well need to be delivered in more proximate time zones, with the hyper-productive AI delivery making the offshore model far less compelling.

Conclusion

The impact of tariffs on the global services market is a complex issue, but it seems that the tariffs will have a modest effect on the industry. The bigger challenge is the emerging impact of AI on services, which is likely to be far more significant in the short and long term. The industry needs to prepare for this change and transform its operating models to remain competitive.

FAQs

• Q: Will there be tariffs on services?
  A: It is unlikely that there will be tariffs on services due to the difficulty in executing a tariff strategy on invisible exports.
• Q: How will the Modi administration’s potential tax increase on services delivered in India affect the global services market?
  A: The tax increase will modestly increase the cost of firms buying services originating in India, but its impact is unclear as it has yet to materialize.
• Q: What is the biggest worry for global services executives?
  A: The emerging impact of AI on services, which is likely to be far more significant than the threatened tariffs.
• Q: How will the AI revolution affect the global services industry?
  A: The AI revolution will threaten the core assumption around labor arbitrage, making the offshore model less compelling, and will require the industry to transform its operating models to remain competitive.