During the campaign, Donald Trump promised to raise tariffs on imports from countries like China or Mexico. A lot warned against the risk of retaliation and a trade war. But what’s a trade war?
What is international trade?
Exchanging goods and services with other countries isn’t an obvious thing. A country can have strong borders, tending toward what’s economists call autarky. An good exemple of a virtually autarkic country is North Korea. On the contrary, a country can be open to the world: it’s free trade. Of course, between pure free trade and pure autarky there’s a continuum of intermediate positions.
When two countries decide to settle on a trade agreement, trade goes both ways: China exports goods and services to the US, but the US also exports goods and services to China. In other words: some companies in China benefit from the trade agreement, by selling their production in the US. But some US companies also benefit from the trade agreement, by selling their production in China.
When a vast majority of countries have a free trade policy, it means a lot of trading occurs between almost every country on Earth. It’s called globalization. Since the 1980s’, more and more countries have opened their borders1. International organisations like the World Trade Organization (WTO) helps coordinate and regulate those worldwide efforts.
How to prevent trade to occur?
As long as there’s specialization (and there’s always specialization, even at the biological level), trade will emerge. Preventing trade is possible though, and barriers to international trade can take numerous forms.
The most effective barrier is pure and simple forbidding of trade with foreign countries. It’s quite extreme though, and only totalitarian regimes like North Korea or the former Communist regime in the Soviet Union can implement this kind of policy. A softer version of this barrier consists to forbid import of specific goods and services.
The usual barrier used to prevent international trade is tariffs. A tariff is a tax paid by customers on imported good and services. For instance, importing 100 kilos of “plucked and drawn, without heads and feet but with necks, hearts, livers and gizzards turkeys” in the European Union costs 34 EUR. With a tariff, trade isn’t forbidden per see but it raises imported goods and services prices, making them less attractive for national consumers.
Another form of trade barrier are legal norms. For instance, the US Food and Drug Administration (FDA) forbids raw milk cheeses, unless aged of more than 60 days for alleged health safety reasons. A lot of unpasteurized2 European cheeses like munster or roquefort can’t be exported to the US. But Frenchs (and Europeans) eat unpasteurized cheeses in large quantities each year without any health trouble. Some thinks the raw milk cheeses ban is in fact protectionism.
Usually, a trade agreement consists of getting rid of all those barriers (or to significantly lower them). Due to their complexity, such agreements take years to be negotiated.
A trade war is what happen when two countries that settled on a trade agreement start to recreate trade barriers. One of those countries pulls the trigger first, and the second retaliates. In a worst-case scenario, the first country also retaliate, and so on. There’s a fair chance of escalation, something that could lead to destroy jobs and wealth in both countries. Trade wars are sometimes called “tariff wars” or “customs wars”.
Several examples of trade wars can be found on the past. The most famous one is probably the Smoot-Hawley Tariff Act, passed in 1930 in the US. The law increased tariffs on over 20,000 imported goods, and (notably) Canada retaliated. In the mid 1920s, a customs war between Poland and Germany took place, and the Fordney–McCumber Tariff led to some severe reactions in Europe. More recently, in June 2013 the EU raised tariffs on Chinese solar panels from 11.8% to 47.6% because Chinese manufacturers allegedly sold government subsidised solar panels in Europe at an unreasonable low price. China retaliated by threatening the European wine industry. Almost one year later, the trade war stopped.
Retaliation is likely, escalation isn’t (anymore)
The 9 year long customs war between Germany and Poland is the closest occurence of a trade war where both sides escalated. Nevertheless, this trade war wasn’t motivated by economic reasons but by geopolitical reasons.
Since then, the world has changed. Wars are less common. And international institutions like the WTO prevent escalated trade wars to occur. But the fact trade wars aren’t likely anymore doesn’t mean retaliation can’t happen, as shown by the recent trade war between China and the EU featured retaliation.
While the common view that the Smoot-Hawley tariff caused the Great Depression is supported by no evidence, it’s still clear that high tariffs decrease the potential output (namely, the maximum amount of wealth a country can produce during one year). A country that retaliate to a tariff increase can actually harm his ex-partner’s economy. But as the ex-partner can retaliate to the retaliation, it’ll reduce the probability of a long-sustained, escalated trade war.
In other words, “pure” trade wars where both countries retaliate until the end of time is pretty unlikely these days. But after a raise in tariffs, the targeted country can retaliate and then harm the economy of the country that raised the tariff first.