The trade war between the U.S. and its trading partners began in early 2018. Initial tariffs on steel and aluminum were followed by several waves of tariffs on a wide range of products. As time passed, the Trump administration’s protectionist trade policy zeroed in on the trade practices of China. These policies were motivated by questionable national security concerns and what the administration thought were unfair policies (i.e., government subsidies to producers) in other countries, especially China.
The administration decided to use import tariffs as the primary policy tool to get China, as well as our other trading partners, to change polices that impact international trade. The president seemed to think this approach had few costs to the U.S. He argued that “trade wars are good, and easy to win.” However, international trade policy is not carried out in a vacuum. Countries first tried to negotiate exemptions from the tariffs on their exports. When that failed, they retaliated with their own tariffs on U.S. exports to their own countries.
The result of the trade war was a net economic loss to the U.S. It was hardest on businesses and consumers that purchased imported goods. The policy was also a political loser. Republicans lost votes in the 2018 elections in those areas hard hit by the trade war. The Biden administration should take heed of these losses and end the trade war. This policy shift would be good for the economy and a political winner for Democrats in those parts of the country that were negatively impacted by the previous administration’s policies.
Why Do We Trade?
President Trump viewed international trade as a zero-sum game where one side wins and the other loses. This is contrary to basic economic theory, which explains that international trade is mutually beneficial. Countries export products (or services) they produce at a lower cost than their trading partners and import products (or services) that other countries produce relatively cheaply. International trade enables businesses to import raw materials and machinery at lower costs or of better quality than what they could buy in their home markets.
Moreover, consumers can purchase products and services at lower costs, raising their real income. The increased variety of differentiated products that results from international trade makes both businesses and consumers better off. Finally, opening up an economy to global markets expands the sales of U.S. businesses, which increases employment and profits. Higher profits benefit stockholders. Larger product markets also increase the payoff to investment in innovation, resulting in new and better products.
Direct Economic Costs of the Trade War
Early on, the Trump administration imposed import tariffs as a way of changing our trading partners’—especially China’s—behavior. It argued that allowing more steel and aluminum imports into the U.S. was a national security risk. The administration thought favorable treatment of export industries in China and the EU gave these businesses an unfair advantage over U.S. firms at home and in world markets.
An import tariff raises the price of a product in the home market, so on the surface, imposing such tariffs is a bad policy move. But it is generally argued that for a large country like the U.S., the tariff-caused decrease in purchases of the product in global markets is large enough to cause the global price to decline: Foreign sellers would effectively end up paying part of the tariff and would receive a lower after-tariff price. As a result, the home price would end up rising by an amount less than the tariff, making it less costly to U.S. consumers. Using this logic, President Trump said the Chinese would be paying for the steel and aluminum import tariffs, not American businesses and consumers.
However, recent research has found that domestic prices on products subject to the tariffs actually rose by the full amount of the tariff. The reason for this result is still an open question. In the case of Chinese exporters, it appears that they were able to sell more of their product in markets outside the U.S., stabilizing the international price. Businesses may have increased demand in anticipation of higher future tariffs. Finally, long-term contracts may have kept the price from changing. Regardless of the cause, however, the bottom line is that American businesses and consumers ended up bearing the cost of the tariffs.
One study recently updated its calculations on the costs and net gain or loss from imposing the import tariff, factoring in the retaliation tariffs on U.S. products sold abroad during the trade war period (2018-19). It finds the average U.S. tariff increased from 3.7% to 25.8% for 17,495 products worth $420.6 billion (17.6% of total imports in 2017). The retaliatory tariffs on U.S. exports rose from 8.7% to 20.8% for 8,400 products worth $133.9 billion (8.7% of 2017 total exports). Given these significant increases in tariffs, it is not surprising that U.S. exports and imports declined.
The study not only calculates the increased cost to businesses and consumers from the tariff, but also computes the value of any net production effects that might have occurred because of the U.S. import tariff and foreign retaliatory tariffs. Finally, it calculates the tariff revenue raised by the government. For the 2018-19 period, consumers and businesses that purchased imported products paid $114.2 billion more for their purchases. In terms of production effects, output can increase in the protected industry, contract for downstream users of the protected products and decrease in the industries experiencing retaliatory tariffs. Accounting for these possibilities, net production gains equaled $24.3 billion, and tariff revenue equaled $65 billion. The net loss to the country—the $114.2 billion consumers paid, minus the net production gains and tariff revenue—was $24.9 billion. In other words, the country was made worse off because of the trade war. Consumers and businesses that purchase imported goods were hit the hardest by these policies.
Another recent study uses an economic-growth model to estimate the long-term effects of the trade war if the Trump trade policies were to continue in the Biden administration. In this scenario, U.S. GDP would be almost $60 billion lower, and employment (measured by full-time-equivalent jobs) would decline by 176,800. If our trading partners were to implement additional tariffs (that they have already announced), U.S. GDP would decrease by an additional roughly $10 billion, and another 30,000 full-time-equivalent jobs would be lost. The trade policies of the Trump administration negatively impacted many individual businesses and consumers. On net, these policies resulted in fewer jobs and lower incomes for Americans as a whole.
Political Costs of the Trade War
Several academic papers (Fetzer and Schwarz, Blanchard, Bown and Choc, Kim and Margalit and Chyzh and Urbatsch) examine whether the trade war had political consequences for Republican candidates during the 2018 midterm congressional elections. The higher costs of imported products from the original tariffs, plus declining sales overseas because of the retaliatory tariffs imposed by our trading partners, harmed certain groups and areas of the country more than others. If voters in these areas blamed Republicans for their economic distress, it is possible that Republicans would have lost votes.
Complicating matters, countries imposing retaliatory tariffs may have chosen products that are disproportionally produced in Republican areas. For example, they might target industries that are concentrated in states that voted for Trump in the 2016 presidential election. They might also target congressional districts that had close elections that a Republican won in 2016. The idea behind such strategies would be to impose tariffs on U.S. products that would inflict the greatest political damage for Republican candidates. Countries could adopt such a policy to apply pressure to change U.S. trade policy.
All the papers listed above find that the trade war reduced the Republican share of votes in the 2018 congressional elections. By one estimate, the trade war cost Republicans between five and eight House seats. These papers also provide evidence that the retaliatory tariffs were in fact directed at districts where the previous election was close.
The Trump administration responded in two ways. First, since agricultural states—particularly heavy soybean-producing states—were hard hit (in terms of lower prices and sales) by China’s retaliatory tariffs on U.S. soybeans, those states received direct federal aid worth up to $12 billion. The aid went to producers of soybeans and other major export crops, such as corn. Second, the administration included a relief program as part of the tariff policy. Businesses that imported intermediate goods (raw materials and capital goods such as machinery) could file a request for exemption from the import tariff if it inflicted serious economic harm on their operations. In addition, to receive an exclusion, the business had to show it could not purchase the product of sufficient quality and quantity domestically. Only about 13% of the exclusion requests were granted.
However, the exclusion program was used politically by the administration. According to one study of steel exclusion requests for the 2018-19 period, the probability of getting an exemption increased by 30-40% if the firm was in a state that Trump won in 2016, compared with a similar company located in a state that Trump lost. Politics clearly played a central role in the trade policy decisions of all the players in the trade war (U.S., China and the EU).
The Need for an Alternative Approach
The Trump administration began using tariffs in 2018 as a policy tool to correct what it perceived as economic imbalances in the post-World War II international trading system. The result of these actions was a trade war. Contrary to the claims of the administration, research has shown the trade war resulted in a net economic loss to the U.S.
The economic loss was exacerbated by the actions of our trading partners, who retaliated with tariffs on U.S. goods sold in their markets. In addition, these retaliatory tariffs caused political losses: They targeted Republican-leaning congressional districts, and districts where the election was close, in 2018. As a result, Republicans lost votes in the 2018 elections. Thus, the trade war made little economic or political sense for Republicans. If the current administration chooses to continue this path, it too may experience related political losses in the upcoming 2022 elections.
The Trump administration gained very little in exchange for these losses from the trade-war approach. All it got was the Phase One agreement with China, which postponed additional tariff increases from both nations and modestly reduced some of the most recent tariffs imposed by the Trump administration. Most of the tariffs remained in place.
Moreover, a major component of the Phase One agreement was that China would purchase more U.S. goods. So far, Chinese purchases of U.S. goods have fallen short of the agreement’s goals, though the pandemic has played a role in this shortfall. Bottom line, the trade war generated little change in China. Rather than promoting free trade, the Trump administration’s actions were an economically dangerous movement toward a managed trade system that is subject to political manipulation.
The current policy issue is how the Biden administration will handle trade relations with China and other U.S. trading partners. Will the administration continue with Trump’s approach to trade or move closer to the pre-Trump, more liberal international trading system? At this point, the jury is still out. Given the cost and lack of success of President Trump’s approach, a reset is clearly needed. It makes the most sense to return to a freer trading system that benefited the U.S., its trading partners and the emerging economies of the world.