Sectoral Impacts of Trade Wars

Abstract

In recent years, we have witnessed rising trade protectionism with broad ranges of tariffs imposed on intermediate products. In this article, we develop an accounting framework to evaluate the sectoral impacts of the current U.S.-China trade war. We find that U.S. final demand and intermediate demand for goods produced by China decline significantly, with the largest losses occurring in the Electronic and ICT (information and communications technology) industry and the Electrical industry. We obtain sizable deadweight losses for the United States, particularly in the Electronic and ICT; Electrical; and Furniture industries. We also find that, with a leakage rate of 20 percent, total losses to U.S. consumers and importers are $3.3 billion, about 0.05 percent of gross U.S. output, whereas the full leakage losses are $10.7 billion, or 0.16 percent of gross U.S. output, which is twice as much as the annual welfare gains from the North America Free Trade Agreement.

Introduction

Not long after the worldwide Great Recession, protectionism began to rise, from the battled renegotiations of the North America Free Trade Agreement (NAFTA), to the recently escalated U.S.-China trade war, to the ongoing Japan-Korea trade war. Rising protectionism concerns some economists, particularly those who view free trade as beneficial to both developed countries (hereafter, the North) and developing countries (hereafter, the South), by advancing world productivity and enhancing global consumer welfare. A particular concern is that recent trade protectionism has included broad ranges of tariffs imposed on intermediate products (for example, in the United States, nearly 90 percent of intermediate imports from China faced increased tariffs in 2018, as computed by Bown, 2019). Such tariffs violate the so-called Diamond and Mirrlees (1971) principle of optimal taxation: Taxing intermediate goods creates much larger economic distortions and is more harmful to economic development.

In this article, we provide an overview of various key findings in the literature on gains from trade and review the literature on trade wars. We then develop an accounting framework to evaluate the sectoral impacts of the current U.S.-China trade war. Using the international input-output linkage between the two countries and isoelastic demands, we compute how much each U.S. sector's demand for goods produced in China declines when the United States raises its import tariffs as it has under the ongoing trade war. The resulting sectoral deadweight losses and full leakage losses are also computed, where the latter considers an extreme case with no tariff revenues redistributed back to consumers or importers. We find that in response to the trade war, U.S. final demand for Chinese goods drops by $39 billion and intermediate demand by $13 billion. Among others, the Electronic and Information and Communications Technology (ICT) industry and the Electrical industry suffer the largest losses, with their demands lowered by $23 billion and $9.5 billion, respectively. U.S. aggregate deadweight losses are about $1.5 billion, with the Electronic and ICT; Electrical; Metal Products; and Furniture industries suffering the greatest total losses. With a leakage rate of 20 percent, total losses to U.S. consumers and importers are $3.3 billion, about 0.05 percent of gross output and two-thirds as much as the annual welfare gains from NAFTA. The full leakage losses are $10.7 billion, or 0.16 percent of gross U.S. output, which is twice as much as the annual welfare gains from NAFTA.