United States

What does a trade war really look like?

The differences between a trade spat and a trade war


There has been quite a bit of talk about “trade wars” lately, and while such loose talk is often bandied about, the idea of what constitutes a serious trade war is not well understood. It has been nearly 90 years since the trade wars of the 1930’s upended the 1875-1914 period of globalization, so there is little memory of what a trade war looks like or even how to identify one has started.  One thing, however, is clear: If the Trump administration follows through on its threats to impose taxes on steel and aluminum imports we will move from the first stage of a trade spat to a full-blown trade war.

The goal of this policy, ostensibly, is to save jobs in the steel and aluminum industries. So let’s do the math. Let’s say the tariffs result in saving 10,000 jobs. The 25 percent tax on $29 billion of imported steel, and 10 percent tax on $17 billion of imported aluminum, will result in increased costs passed along to firms and consumers to the tune of $9.15 billion. Therefore, the implied cost of saving those jobs amounts to about $915,000 per worker. (Incidentally, this is line with the costs of the failed tariff policy pursed by the Obama administration between 2009-2012).

Since the middle of the 20th century the U.S. has largely refrained from engaging in trade spats and trading tariffs due to the inherent economic damage that is associated with them. Trade conflicts are often followed by higher prices, job losses, and economic distortions that cause more harm than good, and where the costs outweigh whatever benefits follow the imposition of targeted taxes on imports.

It is essential that policymakers, investors and business managers understand the differences between a trade spat and a full-blown trade war. The following framework is intended to bring a bit of reason to the discussion around what is quickly emerging as the major risk to the U.S. and global economic outlook in 2018.

Trade Spats

Friction between trading economies is the natural state of affairs for states in the global economy. Despite efforts to reduce frictions between states over the past 30 years through the World Trade Organization, such frictions from time to time result in trade spats. An example of a trade spat would be the 1980s era dispute between American and Japanese agricultural producers. That featured non-tariff barriers and was most famously illustrated by disputes around apple (the fruit, not the company) imports into Japan.

In an effort to protect its upscale apple market, where a single apple could cost more than $5 dollars, the Japanese government erected a series of non-tariff barriers in an attempt to prevent entry of cheaper American apples into the national market using the justification that it was attempting to prevent entry of fire blight bacterium into the domestic ecosystem via the import of apples. In 2002 the U.S., via the WTO, convened a panel where that trade spat could be mediated. Japan and the U.S. reached a mutual agreement ending the trade spat in September 2005.

Trading Tariffs

Trading Tariffs is best defined as the tit-for-tat or asymmetrical retaliation across industrial or tradable service products between two or more trade partners. Tariff wars are often short in duration and typically involve the party that instigated the trade conflict to withdraw tariffs after losing in the World Trade Organization courts, or due to domestic economic losses associated with the tradeoffs that typically involve job losses and higher prices.

Recent examples of tariff wars would be the actions taken by the George W. Bush and Barrack Obama administrations. The former imposed 20 percent tariffs on steel imports in 2001 that resulted in a retaliation via the WTO, which ruled such actions were illegal under existing treaty obligations. That was quickly followed by the imposition of $2.5 billion in retaliatory tariffs by the European Union. The Bush administration quietly withdrew the import taxes in 2002.

The Obama administration imposed taxes of 35 percent on the import of tires in an effort to “save jobs.” That resulted in a net increase of about 1,200 jobs at a cost of roughly $1.1 billion, or $900,000 per job, according to trade economists Gary Huffbauer and Sean Lowery. After a rigorous economic analysis by the Obama administration, it quietly backed away from the tariffs and they were withdrawn in late 2012.

The prospective tariff war that the Trump administration intends to start will likely look like the Obama experience. Policymakers, investors and businesses should anticipate asymmetrical and substantial targeting of industries outside of steel and aluminum, such as agricultural, advanced technologies and mobile system ecosystems. Google, Amazon, Facebook and large U.S. banks will also likely become potential targets.

For now we would not characterize the actions of the Trump administration as a trade war. For that we would need to see something more far reaching.

Trade War: Disruption and Devolution

A move into what we would refer to as “a trade war” would be when countries move beyond the WTO and engage in punitive trade and financial taxes. The first indictor that a trade war has begun would be the announced intention to withdraw from, or abrogate, current trade treaty arrangements. The best example of that would be the ongoing threats by the Trump administration to withdraw from the North American Free Trade Agreement. Under this framework we would not categorize a move into a trade war until the formal notification to withdraw from the trade pact is put forward.

Should the trade war spin out of control then one will likely see a period of disruption and devolution in global trade featuring the following: Dissolution of the global trade regime featuring the abrogation of multilateral trade treaties such as NAFTA and the WTO, the aggressive erection of non-tariff barriers, limits to capital flows and, in some cases, the risk of nationalizing and expropriating foreign-owned firms and property. At that point one could not rule out the return of the beggar-thy-neighbor currency devaluations that characterized the 1930s and intensified the Great Depression.

While the U.S. rests on the edge of a trade friction spilling over into a period of trading tariffs, it is not yet on the brink of a trade war. There will be plenty of opportunities for the U.S. Congress and business community to prevent such one from happening. Over the last 75 years the U.S. has helped provide the foundation and framework of the global trading system. The decision by the Trump administration to impose tariffs of 25 percent on all steel imports, and 10 percent on all aluminum imports, and sustained threats to pull out of the North American Free Trade Agreement, have stimulated fears that the U.S. is on the cusp of starting a trade war and bringing that era to an end.

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