“The contours of US President Donald Trump’s trade strategy are becoming clearer by the day. America’s trading partners face dramatic threats. But, as the revamp of the United States-Korea Free Trade Agreement and the “reform” and renaming of the North American Free Trade Agreement (NAFTA) demonstrate, most countries need to offer only minor concessions to appease Trump. The only country Trump really cares about – his “public enemy number one” – is China.” (Daniel Gros, Who Wins in Trump’s Trade War? Project Syndicate, Oct 9, 2018)

Donald Trump’s version of populist economics has rarely had it so good. The American economy is roaring, the stock market has, up till recently, been very strong, and thus far protectionism has had only a negligible impact on growth.

Trump’s dictum that “trade wars are good” seems to be catching on politically since his supporters seem to accept that tariffs are an appropriate weapon to contain China’s economic ambitions. Is Trump’s belief in the value of tariff wars winning the day? As Daniel Gros points out, Trump is preoccupied with the US trade deficit with China, which amounted to about $375bn last year.

Trump believes that he has the upper hand in the trade conflict with China because the US economy is so strong, but is he wrong? Is China in fact in a better position to win, since in theory all it needs do to avoid any damage from the US tariffs is respond with a full-scale Keynesian stimulus?

Gros indicates that the consequences from a prolonged tariff war may be positive for some European economies and other Asian countries. With the US imposing higher tariffs on Chinese goods, European producers would enjoy a competitive advantage over Chinese producers in the US market. Likewise, in the Chinese market, both European and Asian producers will have a new competitive advantage over US producers.

“A substantial share of US-China trade is thus likely to be diverted to Europe, Japan, and other Asian economies close to the Chinese market. The European Union is likely to reap particularly large benefits, because it remains one of the largest trading partners of both the US and China, and because European producers are often US companies’ closest competitors.”

Daniel Gros’ analysis indicates that the trade tariff war will hurt both the American and Chinese economies, but the losses could turn out to be larger for the US.

The reason for this is that China’s imports from the US are heavily weighted to agricultural commodities, and alternative suppliers are relatively easy to find. For example, China could import soybeans from Brazil rather than the US, at little additional cost.

Gross argues that a “substantial” share of US-China trade is “likely to be diverted to Europe, Japan, and other Asian economies close to the Chinese market.” The EU is “likely to reap particularly large benefits, because it remains one of the largest trading partners of both the US and China, and because European producers are often US companies’ closest competitors.”

While both the US and China will lose in an all-out trade war, the losses will differ in kind and in amount. Gross estimates that China’s exports to the US will be reduced by about a third, some $200 billion annually, while US exports to China would decline by about $50 billion a year. The question is whether Europe, Japan, and other Asian economies will be able to export goods worth $200 billion to the US and $50 billion to China respectively? 

In sum, the short-term trade disruptions could be huge for both countries. Gros believes that if US firms see no end of the trade war, they will move their production to countries with lower labor costs, like Vietnam, Malaysia, Indonesia, Mexico, and Peru.

Chinese firms that buy high-tech intermediate goods from the US could move some of their production to South Korea, Canada and Australia.

Finally, Beijing will strongly encourage Chinese firms to produce many of their imported goods at home, despite much higher costs.

All in all, a not very pleasant series of conclusions.

Trade wars are bad, not good.