Are Trade Wars Really Good?

If you do not live in a cave, you probably heard of the customs tariffs on steel and aluminum recently announced by the Trump administration. Among other events, Donald Trump triggered a lot of reactions with a tweet stating that “trade wars are good, and easy to win”. So, how valid is this statement?

First of all, let us have a look at the definition of a trade war, as given by the Business Dictionary:

Conflict between two or more nations regarding trade tariffs on each other. This type of conflict usually arises because the nations involved are trying to improve imports or exports for its own country. Trade wars have the potential of increasing the costs of certain imports if the nations involved refuse to make a compromise.

 

Generally speaking, several reasons can lead a government to start a trade war:

  • It believes the commercial practices of another country are unfair, e.g. this country is accused of dumping
  • The government is under pressure by lobbying groups and/or trade unions to restrict imports
  • The government has a bad understanding of free trade and the consequences of protectionism

Trade wars and protectionism are directly opposed to free trade: one cannot understand the consequences of trade wars without understanding free trade. That’s why I also included the definition of free trade from the Cambridge Dictionary below:

International buying and selling of goods, without limits on the amount of goods that one country can sell to another, and without special taxes on the goods bought from a foreign country.

Many studies have been published concerning the effects of free trade, like this one. The major effects of free trade are these:

  • Access to cheaper goods
  • Increased worldwide competition
  • Increased efficiency (driven by competition)

That being said, let us now talk about the consequences of trade wars.

 

Prices increase

As we said, free trade leads to cheaper goods. Introducing customs tariffs has the opposite effect: tariffs mechanically increase the price of imported goods, which affects consumers as well as domestic companies. Both must either buy more expensive imported goods, or buy – more expensive as well – domestic goods. The consequences are slightly different for consumers and companies:

  • Consumers’ spending power decreases
  • Companies buy more expensive industrial goods. This means finished products are more expensive (thus further decreasing consumers’ spending power). Their competitiveness also decrease, with potentially negative consequences for their employees (we will talk about this later)

 

Domestic companies are less competitive

Competitiveness is a key factor of growth. When companies are competing with foreign actors, they are compelled to optimize their efficiency to remain competitive, which leads to more growth in the country. By introducing customs tariffs, a government artificially increases the competitiveness of its domestic industries. This limits the benefits of foreign competition on domestic growth.

However, this is not the main effect linked to competitiveness. When the price of imported goods – and more specifically industrial goods such as steel – goes up, domestic companies using these goods in their production process have to increase the price of their finished products, thus decreasing their competitiveness. This is a perverse effect of protectionism: by trying to protect specific industries from foreign competition, the government actually weakens the competitiveness of all the industries using the imported goods.

 

Jobs disappear

As we have seen, custom tariffs have consequences on the costs of production of domestic companies. Obviously, these consequences can be pretty bad and lead firms to cut jobs. This shows all the contradictions of trade wars: while they are often initiated to protect jobs in specific sectors (like in the steel sector here), more jobs might actually disappear because of protectionist than are created in the “protected” industries.

 

THE BOTTOM LINE

According to what we have said so far, it appears that protectionism’s negative effects outweigh by far the benefits it can bring on the short run. We can then wonder why a government would want to start a trade war. We can only make a couple of assumptions here:

  • It can be electorally motivated: taking protectionist measures shows the government as an advocate of the country’s workers
  • Protectionist measures can be supported by lobbying groups and industries that can benefit from customs tariffs
  • The government might not fully understand the consequences of starting a trade war

Of course, we are not in the President’s mind and can only make assumptions. However, these three reasons look quite plausible to explain his foreign economic policy.

As a final note, I will just point out that although trade wars are definitely harmful to the economy, free trade is not perfect either. The American steel industry is a good example of the negative aspects of free trade: it is commonly admitted that free trade optimizes economic efficiency by making the inefficient, least competitive industries of a country disappear and replace them with industries where this country has a competitive edge. However, proponents of free trade too often forget that labor is not so flexible in real life: a former worker at a steel factory might not have the skills needed to find a job in other, more “viable” industries. From this perspective, free trade creates a real societal issue that needs to be addressed not with customs tariffs or other counterproductive measures, but with serious discussions about training and labor flexibility.

 

What is your opinion concerning protectionism? Do you think it can be used to “save” the steel industry?