Many who have watched the growing trade dispute between the United States and China, the world’s largest trading partners, have been fast and loose with terminology since tensions began to heat up in early 2018. While we have remained cautious, now there is no mistake: A trade spat initiated by the United States last year with the imposition of tariffs on steel and aluminum imports has clearly escalated into a full-blown trade war.
Last week the Trump administration boosted tariffs to 25 percent from 10 percent on $200 billion in Chinese goods. The United States is also facing a May 18 deadline over how to move ahead on an earlier threat to slap levies of as much as 25 percent on imports of vehicles and automotive parts. Meanwhile, the administration is readying a new list of $300 billion of Chinese goods to tax at 25 percent, including a host of agricultural products such as livestock, dairy and produce.
The markets are now showing signs of the protracted tension. In addition to recent volatility in equities, the offshore yuan is down 2.6 percent this month, according to Bloomberg, its weakest point since December. Worries that China may retaliate against U.S. tariffs by dumping $1.1 trillion of U.S. government debt are intensifying.
What constitutes a serious trade war is not well understood. It has been nearly 90 years since the trade wars of the 1930s upended the 1875-1914 period of globalization, so there is little memory of what a trade war looks like.
Since the middle of the 20th century, the United States has largely refrained from engaging in trade spats and trading tariffs due to the inherent economic damage associated with them. Trade conflicts are often followed by higher prices, job losses and economic distortions that cause more harm than good; the long-term costs outweigh whatever near-term 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 clarity to a trade war that has now emerged as the major risk to the U.S. and global economic outlook for 2019 and beyond.
Friction between trading economies is the natural state of affairs for states in a global economy. Despite efforts to reduce frictions between states over the past 30 years through the World Trade Organization, such tensions from time to time result in trade spats. Consider the 1980s-era dispute between American and Japanese agricultural producers. That dispute featured non-tariff barriers and was famously illustrated by apple imports (the fruit, not the company) 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; it justified the moves as attempts to prevent entry of fire blight bacterium into its domestic ecosystem. In 2002, the United States, via the WTO, convened a panel so the trade spat could be mediated. Japan and the United States reached a mutual agreement in September of 2005.
Trading tariffs are best defined as tit-for-tat or asymmetrical retaliation across industrial or tradeable service products between two or more trading partners. Tariff wars are often short in duration and typically involve the party that instigated the trade conflict withdrawing tariffs after losing in the WTO courts, or suffering domestic economic losses associated with the trade-offs that typically involve job losses and higher prices for consumers.
Recent examples of tariff wars include the actions taken by the George W. Bush and Barack Obama administrations. Bush imposed 20 percent tariffs on steel imports in 2001 that resulted in retaliation via the WTO; it ruled such actions 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 in 2009 on the import of tires in an effort to “save jobs.” That move 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, the Obama administration quietly backed away from the tariffs and they were withdrawn in late 2012.
Trade war: disruption and devolution
A move into what we refer to as a trade war occurs when countries go beyond the WTO and engage in punitive trade and financial taxes. The first indicator that a trade war has begun would be the announced intention to withdraw from, or abrogate, current trade treaty arrangements. The best example by the Trump administration are its ongoing threats to withdraw from the North American Free Trade Agreement.
f the trade war spins out of control, then we will likely see a period of disruption and devolution in global trade featuring the following: dissolution of the global trade regime characterized by 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, we could not rule out the return of the beggar-thy-neighbor currency devaluations that characterized the 1930s and intensified the Great Depression.
Over the last 75 years, the United States has helped provide the foundation and framework for the global trading system. The decision by the Trump administration to impose tariffs on steel imports, aluminum imports, agricultural commodities and many consumer goods will have devastating consequences for the global economy. Policymakers, investors and businesses should anticipate asymmetrical and substantial targeting of additional industries, with Google, Amazon, Facebook and large U.S. banks likely becoming the next targets.
Originally published March 2018, updated May 2019.