A trade war is a series of economic sanctions and retaliations between nations — a tit-for-tat escalation that can hurt other countries’ economies, so they raise their own tariffs in response. A nation may impose tariffs to reduce its dependence on foreign products and to encourage local production, which is good for the economy. But the downside is that a trade war can trigger retaliation from other countries and escalate political tensions between them.
President Trump has broken with decades of free-trade orthodoxy, threatening to slap new tariffs on strategic adversaries like China and longtime allies like Mexico and Canada. He is betting that US importers will face a difficult time finding alternative suppliers and must pass those costs onto consumers, making everything from electric vehicles to Australian-inspired avocado on toast more expensive.
Developed economies are often at the forefront of trade disputes, as they wield considerable economic power and are highly integrated into global markets. But their actions can have cascading effects, impacting developing economies that are more reliant on their exports.
A disaggregated perspective on the trade war’s effect reveals that while it is true that tariffs can increase domestic production and lead to job creation, the net effect is negative on a dynamic basis. This is due to the fact that higher tariffs lower economic output and incomes, reducing tax revenues. This dynamic effect is even more pronounced when foreign retaliation is taken into account. This is why it is important to understand the broader context of the trade war’s impact.