The election of Donald Trump as President of the United States saw protectionism return to the political agenda. President Trump argues that free trade agreements and globalisation have worsened US exporters' competitive position, resulting in job losses in the United States, citing the bilateral trade deficits the United States has with countries like Germany and China.
Complex trade structures
Bilateral trade relations cannot be analysed easily, as they not only involve final consumer and investment products traded between nations, but also intermediate ones used to manufacture end products (for instance component parts used to manufacture cars). Intermediate products represent 40% of all US imports from the EU. For example, US producers use products imported from Germany in their manufacturing processes, which means that not all products imported from Germany are immediately consumed by US citizens. Matters are even more complex if products cross borders several times. US cars, for instance, cross the US-Mexican border more than once during the manufacturing process. As it is not easy to make adjustments for the trade figures of such value chains, bilateral trade balances between two nations cannot function as a clean measure of their trade relations.
The effects of protectionism
To chart the effects of protectionist policies, we analysed two scenarios in which the United States imposes trade restrictions, using the NiGEM macroeconomic model, which accurately models mutual trade relations. An important caveat when considering the outcomes of a model is that no macroeconomic model can quantify all possible effects of protectionism. This is because models assume households and businesses to be homogeneous and representative agents, whereas in reality globalisation, free trade and, hence, protectionism, produce both gains and losses in society. Some agents are worse off at sector and micro levels. For this reason alone, the model's outcomes merely suggest potential economic ramifications.
In the first (short-term) scenario, the United States unilaterally raise import tariffs on products from key exporting countries like China, Japan, Germany and Mexico by twenty percentage points. The simulation results suggest that all countries are worse off, not in the least the United States itself. As import prices rise, the United States will import fewer products. Consumers will notice price increases in the supermarkets, and consumption will slow down. US exporters will be faced with more expensive intermediate goods, which will depress US exports. The Fed will raise interest rates in response to higher inflation, causing investments to slow down even further. World trade will slow down, which will adversely impact all other countries (see the blue bars in the chart).
The second (long-term) scenario looks at the effects after five years if the directly affected countries take retaliation measures, raising their import tariffs by 20 percentage points. This scenario also assumes a 2% slowdown in productivity growth, based on the notion that less international competition and fewer possibilities for specialisation cause a negative productivity shock globally. The outcome is negative for all countries, again also for the United States (see the orange bars in the chart).
Chart: Effects of US protectionist measures on the US and various other economies
Deviation from baseline projection (%)