What is the definition of a trade war?

Posted on Friday, May 31st, 2019 MarketBeat Staff

Summary - The idea of free and fair trade is seen as critical to global economic growth. In reality, some nations are better equipped – either by access to resources or the ability to mass produce goods – to deliver products around the world. This sets up global inequities in trade that take the form of trade deficits. In and of itself, a trade deficit is not bad. In fact, some nations rely on access to inexpensive goods to help fuel consumer spending in their own country. However, if these trade imbalances get out of hand, or if they are the result of unfair trade practices, the country that feels disadvantaged may begin a trade war with one or more countries as an economic tool aimed at protecting the goods and services sold in the country.

Like any economic policy, a trade war has its proponents and its critics. Proponents argue that tariffs can protect domestic industries and spur economic growth by creating jobs. In addition, as the current trade war in China points out, a trade war can be used as an attempt to cause countries to change their own trade policies. Critics will argue that trade wars frequently have the unintended consequence of hurting the very countries it was meant to aid. Our trade war with China is also illustrating this as many U.S. companies that relied on Chinese steel to make their products are raising prices as a result of the tariffs.

Introduction

Since early 2018, the words tariffs and trade war have become an almost daily part of our nation’s financial and political conversation. For investors, a trade war is not so much about winners and losers as it is about uncertainty. Markets hate uncertainty, yet that is what the prolonged trade war with China – and other nations – is doing to the broader markets. They go up on news that the two sides are nearing a deal. They go down (make that plummet) when the news about the trade talks turns bad. And it's easy to see why. Billions, if not trillions, of dollars, are at stake. In this article, we'll break apart the idea of a trade war. As you progress through the article, we’ll explain why the current trade war with China is only the latest in a series of trade wars that have taken place throughout our nation’s history and show you why they may – and may not be – effective in achieving their ultimate goal.

What is the definition of a trade war?

A trade war is an economic policy that is instituted when one country responds to a trade imbalance by raising import tariffs on the goods and services from one or more countries. A tariff is essentially a two-way tax. If country A imposes a tariff on sugar from country B, then country B will have to pay country A more money to import its sugar. However, country B will attempt to offset the effect of this tariff by raising the price of sugar making it more expensive for the companies in country A to use country B’s sugar to make its products.

In addition to tariffs, countries can take other measures to place restrictions on imports from foreign companies. Contrary to the conventional notion of a war with at least two opposing sides, a trade war can be unilateral. An example of this is an ongoing trade war between the United States and Japan. The United States placed a tariff on some items, including some vehicles, many years ago. However, to date, Japan has refused to retaliate.

Why do trade wars occur?

At their core, trade wars are born out of a protectionist government policy, which can be defined as a government taking actions and making policies that restrict free and fair international trade. The two most common reasons for a country to take protectionist policies are

  • To protect domestic businesses and jobs from foreign competition
  • To balance a trade deficit (i.e. when one country’s imports exceed the amount of its exports)

Are there advantages to a trade war?

Proponents of tariffs will say that, by making foreign goods more expensive, tariffs can increase global demand for a country’s goods and services. This can fuel job growth within the affected industries. On a macroeconomic level, a trade war can help to correct a trade imbalance. In some cases, if other measures, such as import quotas have not helped correct a trade deficit, a trade war may be an outcome of last resort to punish nations with unethical trade policies.

What are the disadvantages of a trade war?

The primary criticism of a trade war is the law of unintended consequences. Namely, a trade war frequently hurts the consumers and industries they are intended to help. One of the reasons for this is that it can create fewer choices for consumers, which drives up the cost of the goods that are subject to tariffs. For example, when President Trump announced his tariffs on Chinese goods in early 2017, domestic companies – such as Whirlpool Corporation – that rely on less expensive imported steel reported a pessimistic outlook for future earnings based on the projection for higher material costs. Those costs would inevitably be passed along to the consumer who would then be expected to pay more for their home appliances. This could have the effect of discouraging consumer spending which can have the effect of slowing, not expanding, economic growth. In a global economy, economists argue that this example shows how a trade war can skew economic indicators and perhaps make an economy look more robust than it actually is. For example, many U.S. companies that use foreign steel and aluminum modified their supply chains to lock in the prices before the tariffs kicked in, producing a false indication of economic strength. Finally, some critics argue that by issuing tariffs, diplomatic relations between the countries can be damaged which can prevent the cultural exchange between countries.

Does a trade war provide a risk to the global economy?

The primary risk a trade war presents to the global economy is in the collateral damage that can be delivered to other nations. In a global economy, anything that hurts the economy of one country can have a domino effect that sends economic ripples throughout the global economy.

An example of every facet of a trade was is evident in the ongoing (as of this writing) U.S.-China Trade War that started in 2018. In January 2018, President Donald Trump carried through on his pledge to impose tariffs on a range of products including steel, aluminum, and solar panels. This was an extension of what he had pledged during his campaign for President of the United States. At that time, then-candidate Trump had connected with American workers by making a point of critiquing what he saw as unfair trade deals that not included the Trans-Pacific Partnership (TPP) and the North American Free Trade Agreement (NAFTA). Trump even threatened to pull the United States out of the World Trade Organization (WTO). But a particular focus of Trump’s policy was the nation’s growing trade deficit with China.

The tariffs of early 2018 targeted Chinese products in particular. In addition to placing tariffs on $500 billion of Chinese goods including steel and soy products, President Trump threatened large fines over intellectual property rights. As expected, the People’s Republic of China announced their intention to impose a 25% tariff on over 100 U.S. products. For the rest of the year, the trade war became a catalyst for volatility in the stock market as both the United States and China continued to place tariffs on new products. When the initial tariffs kicked in during September 2018, it seemed they had achieved their desired effect for the Trump administration. The Chinese economy was experiencing a slowdown, in part, due to the tariffs and by December the Chinese and American governments agreed to not impose any new tariffs and began negotiations aimed towards a long-term trade deal.

However, just when a deal looked to be imminent, the U.S. announced that we were pulling out of trade negotiations due to China taking a new, hard-line stance that, in part, demanded that the United States lift the current tariffs in advance of a new agreement. This immediately led to a decline in the U.S. markets. As of this writing, it's not clear if there when the trade war will be resolved. It is, however, a good case study in both the advantages and consequences of a trade war. On the one hand, the United States trade deficit with China (a key motivation for the tariffs to begin with) is at its lowest level since 2014. On the other hand, U.S. consumers are paying more for some items and the overall stock market remains very volatile largely as a result of the uncertainty surrounding two of the world’s largest economies.

What are some of the most notable trade wars in U.S. history?

Although the United States current trade war with China is dominating the headlines and has tremendous significance due to the size of both country’s economies, it is far from the only trade war to have an impact on the economy of the United States as well as the global economy.

Of course, students of American history can relate to the fact that our nation’s war for independence was waged largely due to England’s imposition of tariffs (or taxes) on the colonies without the colonies having representation in England. One of the signature moments of this trade war was the Boston Tea Party.

Another trade war that impacted the United States for a couple of years was our Pasta War with some European states that lasted from 1985 until 1987. The United States imposed tariffs on European pasta due to the discrimination against U.S. citrus products in Europe. This was an echo of the larger Chicken Wars of the early 1960s when France and West Germany placed tariffs on imported U.S. chickens which prompted the Kennedy administration to respond with a 25% tax on a variety of European products including brandy and light trucks. These tariffs remain in place today.

However, one of the most notorious tariffs in twentieth-century America was the Smoot-Hawley tariffs of 1930. In an effort to lift the United States out of the emerging Great Depression, the United States passed the Smoot-Hawley act which raised tariffs by 50% on imported goods. Even though the law and the associated tariffs were eradicated by the passing of the Reciprocal Trade Act of 1934, it had accelerated the Great Depression and the nationalistic fervor which was a key reason behind both World War I and World War II.

The final word on a trade war

The United States current trade war with China has brought the words “trade war” back into our national conversation. However trade wars, and the tariffs associated with them, have been a part of our nation since its fight for independence. A trade war is one lever of economic policy that a nation may use in an attempt to correct a trade imbalance with a foreign country. In many cases, these trade wars are targeted at specific products and may get resolved quickly. In other cases, a trade war may last for years even decades, taking on the status of a “cold war” where both countries simply agree to continue paying the higher tariffs without a further escalation. As the global economy makes the economies of nations intertwined to a greater extent than ever, there is increasing debate over whether tariffs are an effective way for nations to handle trade disputes. However, protectionist policies are appealing to the workers of a country who see the low cost of foreign products to be a real and present threat to their jobs.

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