For decades, the Unites States has been the main promoter of global free trade. A recent IMF report shows that free trade has driven output growth, lower price levels and higher standards of living. But a different wind is blowing at the moment. The US administration is convinced that a trade war is "easy to win". Its significant tariffs on imports from China and other countries mark an abrupt end, and even a partial reversal of, the gradual decades-long trend towards more free trade. Who stands to benefit from the escalating trade war between China and the United States, and who will lose out?
From free trade to protectionism
To identify the macroeconomic impact of a trade war between the United States and China, we use DNB's own variant of the ECB's multiregional general equilibrium model EAGLE. This model covers the entire global economy and explicitly models, for each region, bilateral trade flows and their relative prices, including exchange rates. It distinguishes between the following regions: the United States, the euro area, the Netherlands, and China together with the rest of the world. Firstly, the model outcomes show that higher import tariffs in fact have the same effect as higher export taxes, in accordance with the Lerner symmetry concept. This implies that higher tariffs depress not only imports, but also exports. Secondly, trade tariffs make domestic demand shift from imported goods to locally manufactured products, with prices going up as a result. This drives up exchange rates and makes these products less competitive on export markets.
The figure below illustrates the macroeconomic impact of a trade war between the United States and China. We first assume that only the United States imposes a 10% tariff on all US imports from China (solid lines). In a second scenario, we assume that China retaliates by imposing an equal tariff on all Chinese imports from the United States, i.e. on all US exports to China with a three-month delay (dotted lines). Figure 1 shows the impact on gross domestic product (GDP) in each of the regions.
Figure 1: Effects on GDP