The Real Cost of Trump’s Trade Wars

By Daniel Gros

BRUSSELS – FOR A WHILE at least, trade tensions between the United States and China seemed to have settled into a “new normal.” After both countries imposed high tariffs on a substantial proportion of each other’s goods, US President Donald Trump refrained from further escalation. But, following another inconclusive round of bilateral trade talks in Shanghai last week, Trump announced that the US will impose 10% tariffs on a further $300 billion worth of Chinese goods, effective September 1.
Should this new measure take effect, almost all US imports from China will be subject to tariffs. (The US already levies 25% tariffs on $250 billion worth of Chinese imports.) Although the US has also imposed non-tariff barriers in its trade war with China, reciprocal tariffs are the most visible component of the dispute – and are likely to hurt America more than China.
One way to compare the restrictiveness of countries’ trade policies is to look at their average tariff rates. For the US, this seems to paint a fairly reassuring picture. Before Trump took office, the average US tariff rate on industrial imports was about 2%, somewhat lower than that of China.
Even under Trump, this figure has (so far) not increased that much. Imports from China account for about one-quarter of all US imports, and the 25% tariff affects about one-half of imported Chinese goods. This implies that the average US import tariff has increased by about three percentage points, to 5% or so, which does not appear excessive.
But the average tariff is a misleading indicator. Economic theory suggests that tariffs have disproportionately negative effects on the welfare of consumers and producers. A doubling of a tariff, for example, will lead to more than double the welfare loss. A 25% tariff on a limited share of trade is thus much more serious than an average tariff of 3%.
Many countries have high import tariffs on a certain number of specific products, with a rate above 15% usually considered to be a “tariff peak.” But whereas these peaks apply to less than 1% of total imports for most industrialized countries, they cover a far larger share of US imports.
Moreover, Trump’s tariffs discriminate against China: the 25% tariff is paid only by Chinese producers, not by their European, Latin American, or Asian competitors. Such a country-specific tariff is equivalent to levying a general tariff on all imports while providing a production subsidy for competing producers outside China – with this subsidy paid by US consumers in the form of higher prices.
Because non-Chinese producers can raise their prices by up to 25% and still remain competitive in the US, prices for American consumers are likely to increase on a wide range of goods. The indirect effect of Trump’s China tariffs on consumer prices is therefore likely to be much greater than the recent estimate of a direct impact of only 0.1%. These indirect harmful consequences of country-specific tariffs are the main reason why the “most favored nation” principle has long been a cornerstone of the global trading system.
Moreover, preliminary studies suggest that Chinese producers have not significantly lowered their prices as a result of Trump’s tariffs. And even if they did, the small gain to US consumers from lower Chinese prices would likely be far outweighed by higher prices on competing imports diverted to the US market by Trump’s country-specific tariffs.
Although China previously imposed a reciprocal 25% tariff on many of its imports from the US, the negative impact on the Chinese economy is likely to be limited because US goods account for less than one-tenth of China’s overall imports. Chinese retaliatory tariffs thus have a small impact on the Chinese economy. And China has actually lowered tariffs on its imports from the rest of the world.
Moreover, a large share of China’s imports from the US consists of agricultural commodities such as soybeans, which the country could easily import at a similar price from Brazil if necessary. The US would then presumably export more soybeans to markets formerly served by Brazilian producers, including in Europe. (This would reduce America’s trade deficit with Europe and might ease US pressure on the European Union in that regard.)
The US has also ratcheted up non-tariff barriers as part of its aggressive trade policy toward China. Most notably, Trump has put Chinese tech giant Huawei on the list of entities to which US firms are forbidden to sell American products. True, Trump has also said that for the time being, US suppliers should obtain the necessary licenses to continue to supply Huawei. But from now on, US technology companies will clearly think twice before entering long-term contracts with Huawei or other prominent Chinese firms that might be at risk of being included on the “entities list.”
In parallel, China’s government and businesses will redouble their efforts to become independent from the US in sourcing key technological components. The mere threat of the entities list will henceforth act as a significant hidden barrier to US-China trade. And because this barrier is also discriminatory (directed only at China), it will have the same high costs as country-specific tariffs.
Economic analysis suggests that bilateral trade wars are unwinnable in an interconnected world. By firing his latest tariff salvo against China, Trump has further raised the stakes in an increasingly damaging dispute. And America is likely to emerge as the bigger loser.