Who Can Win Trade Wars?

Trade wars are economic conflicts resulting from extreme protectionism in which nations raise or create tariffs or other trade barriers against each other. Their intellectual ancestor is the theory of mercantilism, the very first theory of international trade that predates all modern free trade theories. Trade wars have been the arsenal of statecraft for ages. During the Napoleonic Wars, Britain imposed economic blockade on continental Europe, and France retaliated by blocking continental Europe from trading with Britain. During the Cold War, communist countries such as the Soviet Union, China, North Korea, and Vietnam were subject to much higher discriminatory tariffs by the Western world. However, since the end of the Cold War, which coincided with the founding of the WTO in 1995, trade wars had largely disappeared. Only in the current edition of Global Business has "trade war" become a key term that students must study.

In February 2018, President Donald Trump launched the first salvos of a series of new trade wars: imports of aluminum, solar panels, steel, and washing machines would be subject to high tariffs. While a major exporter of solar panels, China is not a major exporter of the other three products. As major exporters of aluminum, steel, and washing machines, Canada, the European Union, Mexico, and South Korea naturally protested and quickly implemented retaliatory tariffs on US exports to them. In July 2018, $200 billion worth of Chinese imports of numerous categories were subject to 25% US tariffs. The Chinese quickly retaliated with their tariffs on US exports. By August 2019, another $250 billion worth of Chinese imports were hit with US tariffs, to which the Chinese reciprocated. Overall, trade wars escalated.

While the Chinese government argued that the real motive of trade wars launched by the United States was to stifle China's growth as a geopolitical rival, US trade wars against allies and partners are unlikely to be fueled by such motivation. From an institution-based view, trade wars can be viewed as manipulations of the rules of the game governing trade in order to discourage imports, encourage domestic production and exports, and reduce trade deficits. Although lengthy and tension-filled, negotiations between the United States and Canada, the EU, Mexico, and South Korea eventually resolved major differences. Trade wars between them gradually disappeared from media headlines. The rest of our case focuses on the most important and most challenging trade war between the United States and China, which is still ongoing.

In 2018, Trump famously tweeted that "trade wars are good, and easy to win." Really? According to Bloomberg Businessweek, Trump was "wrong on both counts." In 2018, despite the opening salvos, Chinese exports to the United States increased by $34 billion, growing 7% year-over-year. But US exports to China decreased by $10 billion, an 8% decline year-over-year. The COVID-19 pandemic highlighted the US dependence on imports from China. As China is the only country capable of rapidly increasing its personal protection equipment (PPE) output to meet surging demand, the United States had to embarrassingly bite its own trade-war bullet and "temporarily" waived the tariffs on PPE during the height of the COVID-19 outbreak in 2020.

The US-China trade deficit did fall from $419 billion in 2018 to $311 billion in 2020, but the overall US trade deficit with the rest of the world increased from $872 billion in 2018 to $905 billion (a new record) in 2020 (see Figure 5.9). An inconvenient truth, according to a Foreign Affairs article, is that US trade deficits "don't spring from the practices of US trading partners; they come from the United States' own spending habits."

Who gains from the US-China trade war? Vietnamese manufacturing workers, Brazilian soybean farmers, and Canadian lobster catchers. Some US import orders were switched from China to Vietnam, which was eager to expand output to meet US demand. Vietnam ended up boosting its GDP by 0.2%. Brazilian soybean farmers were delighted to receive import orders from Chinaat the expense of soybean farmers in Iowa. Maine lobsters were "cooked." China's 25% retaliatory tariffs resulted in a 70% drop in US lobster exports. But their Canadian rivals could ship their catch duty-free, doubling Canadian lobster exports to China. At the same time, Chinese foodies continued to enjoy the lobsters caught from essentially the same waters.

While the Vietnamese, Brazilians, and Canadians must be secretly thankful to the US-China trade war, the trade war is lose-lose to both the United States and China. Consumer prices rise, supply chains are disrupted, and economic growth slows down. Prior to the trade war, some export-oriented, labor-intensive manufacturing operations had been leaving China, but not for the United States. They typically went to Bangladesh, Indonesia, Malaysia, and Vietnam. The goal of moving jobs back to the United States has remained an aspirational one. In 2019, Trump tweeted that he "ordered" US manufacturers to "immediately start looking for an alternative to China." But there is little evidence of any such shift taking place. China is General Motors' largest market (ahead of the United States) and Apple's largest foreign market (and second-largest market, only behind the United States). They are unlikely to be interested in pulling out from China. Instead, US foreign direct investment (FDI) into China increased slightly from $12.9 billion in 2016 to $13.3 billion in 2019. Surveyed US firms generally cite the rapid growth of China's consumer market combined with its strong manufacturing capabilities as reasons for expanding there.

Although Trump repeatedly claimed that "the Chinese are paying billions in tariffs," it is American consumers who are footing the bill. One study found that every American household coughed up $620 per year (about $80 billion in the aggregate)known as dead-weight loss. This would be about 0.4% of US GDP. In addition to the COVID-induced supply chain disruption, the trade war contributed to the general retail price increase of a lot of goods in the United States, such as birthday candles, coffee makers, power tools, printers and cartridges, shoes, textiles, and toys. Given that China exports a lot of low-end goods to stores such as Walmart and Dollar Tree, tariffs hit especially hard on low-income families, which spend a larger portion of their income on such goods. Given that COVID-19 has increased economic inequality, such families are already struggling to make their ends meet. Adding the new tariffs is like adding a regressive tax that weighs most heavily on such economically vulnerable families.

As the other side of the lose-lose trade war, China probably suffered from 0.3% of its GDP being shaved off. While China's exports to the United States declined, its exports to the rest of the world kept growing. In COVID-plagued 2020, they rose 3.6%China was the only major economy with positive trade growth.

In January 2020, both sides came to their senses. Reaching a truce, they signed a phase-one trade deal, in which Beijing made an ambitious commitment to import $172 billion worth of US goods. Washington agreed to remove the tariffs of half of Chinese exports to the United States, but still maintained a 25% tariff on the other half, including nearly all high-tech exports. The biggest victory claimed by the Trump administration as part of the deal were promises from Beijing to enhance intellectual property rights (IPR) protections. But that was probably in China's interest anyway. Whether the US-China trade war will escalate or deescalate depends on how effective the terms of the phase-one deal, in effect for two years (2020-2021), are met.

Case Discussion Questions

Why do nations fight trade wars? What are their goals?

Using both the institution-based and resource-based views, explain why Chinese exports to the United States were able to increase during 2018, the first year of the trade war?

ON ETHICS: As a soybean farmer from Iowa or a lobster catcher from Maine, you have a chance to meet your senator who is famous for advocating a policy of "decoupling from China," what are you going to say to her?