By Subhayu Bandyopadhyay, Research Officer and Economist, and Asha Bharadwaj, Research Associate
The recent U.S. tariffs on China are expected to reduce economic efficiency. First, the higher tariffs will render some of China’s exports to the U.S. uncompetitive, thus reducing imports. The move from a more efficient producer in China to a less efficient domestic source is an efficiency loss.
Second, the tariffs could lead to what trade economists refer to as “trade diversion.” A less efficient producer in, say, Vietnam may become competitive relative to a more efficient Chinese producer due to tariffs, incentivizing the U.S. to switch imports from China to Vietnam. This would also be an efficiency loss for the U.S. as imports would be sourced from a less efficient nation.
While higher tariffs on China are dampening U.S.-China trade, effects on other nations through trade diversion are less clear. The remainder of this piece focuses on this issue.
The figure below considers year-over-year changes in U.S. imports from China and two of its prominent neighboring nations—Taiwan and Vietnam—for the 2016-2019 period.
Imports from China have fallen significantly and consistently through most months of 2019 so far compared to earlier years in the figure. However, imports from Taiwan and Vietnam have gone the other direction. They show consistent and significant increases through most of 2019.
In other words, there is reason to believe that some of the loss in U.S. imports from China have resulted in trade diversion to Taiwan and Vietnam. Although clear identification of such trade diversion effects is beyond the scope of this piece, a recent paper by economist Alessandro Nicita carefully analyzed the trade war’s effects and found significant trade diversion.Nicita, Alessandro. “Trade and trade diversion effects of United States tariffs on China (PDF).” United Nations Conference on Trade and Development, Research Paper No. 37, November 2019.
Usual discussion of trade diversion arises in the context of pros and cons of preferential trading agreements like NAFTA. In these agreements, trade creation effects of lower tariffs between members of the trading bloc have to be weighed against trade diversion losses vis a vis trade with non-members.
In the current trade war, there are losses on both counts:
It is possible that the costs of the current trade war could lead the U.S. and China to negotiate a new and better trading regime, which may justify the trade war. On the other hand, if no such agreement is reached, costly adjustments will have to be made by trading partners, reorienting whom they trade with more intensively.
While the outcome of such a process will be clearer in the future, what we see now is that the trade war has resulted in significant losses for both the U.S. and China, with perhaps some benefits to some other potential U.S. trading partners like Vietnam.
1 Nicita, Alessandro. “Trade and trade diversion effects of United States tariffs on China (PDF).” United Nations Conference on Trade and Development, Research Paper No. 37, November 2019.