Make America (and its business partners) Lose Again!

The face of the global trading system changed profoundly at the end of 2016 and the beginning of 2017. Following the British referendum which supported the United Kingdom’s exit from the European Union, the American presidential election resulted in the victory of Donald Trump, who made numerous protectionist statements during the campaign, including threatening imports from Germany, China and Mexico with tariffs. In particular, he announced the imposition of tariffs of 35% on Mexican imports and 45% on Chinese imports in order to “protect American jobs from unfair competition”.

The economic study of trade wars has been the subject of many articles, books and reports. The “Smoot-Hawley Tariff Act” has received considerable attention in particular. In June 1930, 8 months after the October 1929 Wall Street Crash, the US Congress increased customs duties on 20,000 imports. The average customs duty on protected imports increases from 39% to 53%. Many trading partners retaliated against the United States in the months that followed. If world trade collapsed in 1930, the share of the United States in it fell from 16 to 11% between 1930 and 1935. In 1998 Douglas Irwin concluded that the “Smoot-Hawley Tariff Act” implied a loss of US Gross National Product from 0.3 to 1.9%[1].

Would a new trade war, initiated by the US government, cause the United States to lose again? And what could be the consequences for their business partners?

In a recent study[2], we provide an assessment of potential trade wars initiated today by the United States, using a model of the world economy that studies 18 trade war scenarios. These scenarios differ by the trading partners involved by the United States (China, Mexico or both), the level of protection adopted by the United States on all imports from the partner (s), except the energy, (different levels of increase in customs protection ranging from around 10 percentage points to 35 percentage points), and the severity of the trade reprisals of the partner(s) on products from the States States (various levels ranging from around 10 percentage points to 35 percentage points).

Our first political conclusion is that in neither scenario does the United States benefit from a trade war. More precisely in all the scenarios considered, the impact on the well-being[3] or the Gross Domestic Product (GDP) of the United States is zero or negative. Some sectors may benefit, for example in terms of added value (Textiles, Clothing and Leather, Electronic Equipment, etc.), but others lose at least as much (Chemicals, Rubber and Plastic Products, Cereals, Meat and Dairy Products, Motor Vehicles and Transport Equipment…). All of these scenarios are also to the detriment of American workers, whether skilled or unskilled, working in agricultural sectors or not. Owners of capital and agricultural land also lose in any case.

The second political conclusion is that increases of 35 percentage points in US protection against China and/or Mexico and similar retaliation by these countries clearly constitute political overreaction. The losses in well-being and GDP are, in this scenario, much greater than those in a scenario of an increase of 10 percentage points on either side.

A third political conclusion concerns the trading partners of the United States. While China is significantly affected by trade wars (0.2% to 1% welfare and GDP losses in the case of a US-China war), welfare and GDP losses for Mexico are potentially enormous (between 0.5 and 3.2% of well-being and GDP in the case of a US-Mexico war). In certain Mexican sectors, the effect is devastating: 22% reduction in value added in the Motor Vehicles and Transport Equipment sector, for a sector which today represents 3.3% of the country’s economic activity.

A fourth policy conclusion concerns the emergence of free riders, ie regions or countries that benefit from a trade war in which they are not directly involved. This is the case, for example, of countries in the Central America Free Trade Agreement (CAFTA), which obtain gains in well-being or GDP from 0.1 to 0, 9% in the scenarios studied. Obviously this increase in activity comes from an increase in exports to the United States, replacing Chinese or Mexican products.

Does this study exaggerate the potential effects of a trade war? It is true that President Trump appears less protectionist than candidate Trump and that American threats against China and Mexico have decreased in intensity since his election. It is also true that if these threats were carried out, we have no information on the extent of the reprisals of the commercial partners, and even we do not know if they would react. Nevertheless, in the event of the adoption by the US government of protectionist laws, the exercise of reprisals is highly probable, firstly because moderate reprisals make it possible to lose less in GDP and well-being, then to avoid appearing like a weak country that “receives blows without reciprocating”.

Finally, President Trump appears particularly unpredictable. It should also be kept in mind that beyond import taxes, China has considerable means of reprisals against the United States, particularly in financial and monetary terms (the amount of assets in USD and US T -Bonds from the Chinese central bank), or in terms of export restrictions on strategic minerals such as rare earths, of which China controls a major part of the world’s production. On the Mexican side, the deterioration of the conditions of Mexican workers implied by such a trade war could increase migratory pressures, which would constitute new challenges for the American government.

By way of conclusion, it is important to reaffirm that trade wars are potentially harmful to the global economy. Protectionism is certainly not the right way to combat current account deficits, which are rather the consequence of insufficient internal savings. It should also be noted that the multilateral trading system is there to offer intermediation to governments who believe that some of their partners are using unfair practices. If the American government considers that certain partners are “unfair”, it is in the arena of the World Trade Organization that it is necessary to complain in order to obtain the withdrawal of practices deemed unfair.