Trade Wars and How They Affect You

A Global Trade War Will Raise Prices

••• National Economic Council Director Gary Cohn (left) quit over tariffs.  Getty Images

A trade war is when a nation imposes tariffs on imports and foreign countries retaliate with similar forms of trade protectionism. As it escalates, a trade war reduces international trade.

A trade war starts when a nation attempts to protect a domestic industry and create jobs. In the short run, it may work. But in the long run, a trade war will cost jobs and economic growth for all countries involved.

U.S. Trade War with China

On March 8, 2018, President Trump asked China to develop a plan to reduce its trade deficit with the United States by $100 billion. China is amenable to the idea. Part of its economic reform plan is to reduce its reliance on exports. But it cautions there isn't much it can do, since the deficit is fueled by high U.S. demand for low-cost Chinese goods.

U.S. politicians have long threatened a trade war with China. In 2017, the U.S. trade deficit with its biggest trading partner was $375 billion. The trade deficit exists because America only exports $130 billion to China. The three largest export categories are aircraft ($16 billion), soybeans, ($12 billion), and automobiles ($11 billion).

The United States is left with a trade deficit because imports from China were $506 billion. Most of it is electronics, clothing, and machinery. But a lot of the imports are from U.S. manufacturers that send raw materials to China for low-cost assembly.

Once shipped back to the United States, they are considered imports. As a result, tariffs hurt U.S. corporations as well as foreign ones. 

China is the world's No.1 exporter. Its comparative advantage is that it can produce consumer goods for lower costs than other countries can. China has a lower standard of living, which allows its companies to pay lower wages.

American companies can't compete with China's low costs, so it loses U.S. manufacturing jobs. Americans, of course, want these goods for the lowest prices. Most are not willing to pay more for "Made in America."

Trump's Trade War

On March 8, 2018 President Trump announced a 25 percent tariff on steel imports and a 10 percent tariff on aluminum. America is the world's largest steel importer. The tariff would help the 147,000 workers in the steel industry. But they could hurt the 6.5 million workers in industries that need steel, including imports.

Trump said, "Trade wars are good, and easy to win." But the markets disagreed. Stock markets around the world tumbled in fear of a trade war between the world's three largest economies. They recovered briefly when Trump hinted there would be flexibility in the execution of the tariffs.

For example, Trump said Canada and Mexico would be exempt until the NAFTA renegotiations were finalized. Canada is the largest source of U.S. steel imports. Mexico is the fourth largest. Australia may also be exempt, since the United States has a trade surplus with it.

As expected, U.S. trading partners were aghast. The European Union said it "will react swiftly, firmly and proportionally." The EU said it is considering tariffs on $3.5 billion worth of U.S. exports.

European Commission President Jean-Claude Juncker warned, “We will put tariffs on Harley-Davidson, on bourbon and on blue jeans — Levi’s.”

Canada "will take responsive measures." Japan's trade minister said, "I believe there is absolutely no impact on America's national security from imports of steel and aluminum from Japan, which is an allied nation." 

Trump believes the tariffs would protect U.S. steel and aluminum manufacturers. It might improve those industries, but it will raise costs for steel users, like automakers. They'll pass those costs onto consumers.

In 1962, Congress gave the president power to curb imports that threaten national security. The Commerce Department reported that dependence on imported metals threatens the U.S. ability to make weapons. But the Aerospace Industry Council said Trump's tariffs would raise costs for the military and exporters.

 The tariffs could also threaten national security by dampening economic growth. A strong economy is necessary to increase U.S. military spending.

The tariff is designed to reduce the U.S. trade deficit with China. Its economy depends heavily on steel exports. Trump's move comes a month after he imposed tariffs and quotas on imported solar panels and washing machines. China is also a world leader in solar equipment manufacturing.

China could respond by slapping tariffs or quotas on $12 billion in U.S. soybean imports. China needs soybeans to feed pigs, its primary meat staple. But China can replace U.S. beans with those from Brazil. U.S. farmers sell one-half of their crop to China. If that market disappears, it will hurt the United States more than China. 

How It Affects You

A trade war would raise prices for imported products right away. Costs would rise by the same amount as the imposed tariff. It would give a competitive advantage to domestic producers of that product. Their prices would be lower by comparison. As a result, they would receive more orders from local customers. As business grew, they would add jobs.

On the flip side, domestic manufacturers that rely on imported raw materials or parts would see higher costs. It would cut into their profitability. They would either have to raise prices, slash jobs, or both. 

In the long term, trade wars slow economic growth. They create more layoffs, not fewer, as foreign countries retaliate. The 12 million U.S. workers who owe their jobs to exports would get laid off.

Over time, trade wars weaken the protected domestic industry. Without foreign competition, companies within the industry don't need to innovate. Eventually, the local product would decline in quality compared to foreign-made goods.