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π Economics

Are trade wars profitable and easy to win?

Antoine Bouët
Antoine Bouët
Professor of economics at University of Bordeaux

Let’s dis­cuss the main basic con­clu­sions we can draw from the the­o­ry and his­to­ry of trade wars.

Lessons from history

(i) In most cas­es, those who start a trade dis­pute suf­fer more from the sub­se­quent retal­i­a­tion. The Haw­ley-Smoot Tar­iff Act is a prime exam­ple. Passed in June 1930, it increased US import duties on 890 prod­ucts from the Har­mo­nized Tar­iff Sched­ule. Com­bined with price defla­tion, this rep­re­sent­ed a sub­stan­tial increase in the rate of pro­tec­tion of the US econ­o­my. Because of the wide vari­ety of spe­cif­ic fees applied through US tar­iffs (US$ per unit), the glob­al drop in prices led to an increase in the rate of pro­tec­tion while fees stayed the same. 

As a result, the Unit­ed States’ main trade part­ners – Cana­da, Britain, Cuba, France, Spain, Italy, etc. – engaged in harsh retal­i­a­tion. Inter­na­tion­al trade plum­met­ed (in val­ue and vol­ume) world­wide, to such an extent that the Repub­li­cans’ (and Pres­i­dent Her­bert Hoover’s) man­age­ment of this cri­sis was a cen­tral issue in the 1932 pres­i­den­tial elec­tion. Demo­c­ra­t­ic can­di­date Franklin D. Roo­sevelt won, and he signed the Rec­i­p­ro­cal Trade Agree­ments Act (RTAA) into law in 1934. This gave the Pres­i­dent the pre­rog­a­tive to nego­ti­ate lib­er­al trade agree­ments. In short, after pass­ing pro­tec­tion­ist leg­is­la­tion and suf­fer­ing retal­i­a­tion from trade part­ners, it was nec­es­sary to ease trade restric­tions, giv­en how cost­ly it had been for all parties.

(ii) In a bilat­er­al trade war between a big and small coun­try, the big­ger coun­try is like­ly to win (or suf­fer almost no con­se­quences) where­as the small­er coun­try will lose sub­stan­tial­ly. This is shown by sev­er­al trade wars that took place in the late 19th cen­tu­ry: the 1886–98 war between France and Italy, the 1892–95 war between France and Switzer­land and the 1893–94 war between Ger­many and Rus­sia, to name a few. Here, it’s impor­tant to under­stand that it’s not so much the size of the econ­o­my that mat­ters but that of total exports by the “small” coun­try to the “big” coun­try, and the impact of the “big” coun­try in the eco­nom­ic activ­i­ty of the “small” coun­try. In 1891, France absorbed 18.6% of Swiss exports. Switzer­land being rel­a­tive­ly small, these exports rep­re­sent­ed a sig­nif­i­cant amount of its GDP. By stop­ping most Swiss imports, France struck a con­sid­er­able eco­nom­ic blow to its neighbour.

(iii) These two exam­ples are not entire­ly per­ti­nent, because first­ly, trade dis­putes nowa­days are only a poten­tial issue for a few prod­ucts, steel and alu­mini­um, and, sec­ond­ly, there are now mul­ti­lat­er­al trade organ­i­sa­tions that offer a res­o­lu­tion frame­work for trade dis­putes. This makes a big dif­fer­ence. To round out this overview, let us exam­ine two more trade wars, the “Chick­en War” (1962–64) and the “Corn War” (1986–87).

The first con­flict was pro­voked when Ger­many adopt­ed the com­mon exter­nal tar­iff cre­at­ed by the Euro­pean Eco­nom­ic Com­mu­ni­ty (EEC). This increased the cus­toms duties paid by Amer­i­can chick­en exporters, who quick­ly lost the Ger­man mar­ket to French and Dutch exporters, to whom these duties did not apply. The US demand­ed com­pen­sa­tion and threat­ened to retal­i­ate by increas­ing tar­iffs on Ger­man trucks, French cognac and Dutch dex­trin. Even though only a small num­ber of sec­tors were affect­ed by the dis­pute, the Gen­er­al Agree­ment on Tar­iffs and Trade (GATT) was invoked as an inter­me­di­ary. With the Euro­peans refus­ing to yield, the inter­na­tion­al insti­tu­tion accord­ed the right to the US to increase cus­toms duties on these Euro­pean products.

The sec­ond dis­pute is sim­i­lar, but it involves Spain join­ing the EEC and the corn sec­tor. Once again, France’s exports were ben­e­fit­ing from the Span­ish mar­ket open­ing up to the detri­ment of Amer­i­can exporters, and once again, it involved cognac, among oth­er things, being sub­ject­ed to threats of Amer­i­can retal­i­a­tion. The EEC con­ced­ed and grant­ed the US an annu­al, reduced-rate quo­ta of corn imports.

Sev­er­al lessons can be learned from these two dis­putes. First­ly, some trade dis­putes (those that only con­cern one or two prod­ucts) do not always descend into trade wars (involv­ing a lot of trade prod­ucts, or even all prod­ucts). Sec­ond­ly, a trade dis­pute is more like­ly to find a “peace­ful res­o­lu­tion” when an inter­na­tion­al insti­tu­tion pro­vides arbi­tra­tion. Nowa­days, the World Trade Organ­i­sa­tion (WTO) pro­vides a pro­ce­dure to set­tle dis­putes. Final­ly, retal­i­a­tion is often enact­ed by exert­ing pres­sure on strate­gi­cal­ly cho­sen prod­ucts that are geo­graph­i­cal­ly con­cen­trat­ed and have polit­i­cal sig­nif­i­cance (cognac being a per­fect example).

The ratio­nale behind these choic­es is based entire­ly on game the­o­ry (using threats to intim­i­date), not eco­nom­ic the­o­ry (pun­ish­ing Amer­i­can cognac con­sumers by remov­ing their access to this prod­uct does not pro­vide any com­pen­sa­tion to Amer­i­can chick­en exporters). Final­ly, it should be not­ed that, in the case of the Corn War, the US did not car­ry out their threat, which is char­ac­ter­is­tic of a good threat. As great chess play­ers say, “The threat is stronger than the exe­cu­tion”1.

The fact that any poten­tial retal­i­a­tion from the Euro­pean Union will occur with­in the WTO’s frame­work is cru­cial, because it favours a solu­tion that does not descend into a trade war. It is also inter­est­ing that the EU is cur­rent­ly threat­en­ing to retal­i­ate against the US, even if such retal­i­a­tion will be reg­u­lat­ed by the WTO and there­fore will only (poten­tial­ly) be invoked after months of pro­ceed­ings. The prod­ucts in ques­tion have been well cho­sen: most bour­bon is dis­tilled in Ken­tucky, the home state of Repub­li­can Mitch McConnell, who was, until recent­ly, the Sen­ate major­i­ty leader; a large num­ber of Harley-David­sons are made in Mil­wau­kee, WI, home of Paul Ryan, the for­mer Repub­li­can speak­er of the House of Rep­re­sen­ta­tives. In short, the Euro­peans seem to have adopt­ed the strat­e­gy of “an eye for an eye, a tooth for a tooth”, favoured by Jacques Delors dur­ing the Corn War.

How would Don­ald Trump have react­ed to the ver­dict of an insti­tu­tion that he has no great love for?

A few unknowns

So, pro­vid­ed this dis­pute stays with­in the frame­work of the WTO, it will not descend into a prop­er trade war. But there are still a few unknowns. The first is how Chi­na will react, since that coun­try has the means to take seri­ous retal­i­a­tion against the US. The clear­est exam­ple is their large soy­bean imports from the US, which account­ed for $14bn in 2017 alone. But there’s also steel and alu­mini­um to con­sid­er: the US aero­space sec­tor react­ed very neg­a­tive­ly, stat­ing that even though the result­ing price increase on these prod­ucts would only have the tini­est of impacts on the price of fin­ished prod­ucts, China’s poten­tial retal­i­a­tion on its imports could deal a con­sid­er­able blow to the indus­try. Chi­na also holds a qua­si-monop­oly on rare-earth met­als, strate­gic min­er­als. Final­ly, the People’s Bank of Chi­na holds large reserves of US dollars.

The oth­er unknown, obvi­ous­ly, is the reac­tion of the Amer­i­can Pres­i­dent to the WTO’s deci­sion: it seems very like­ly that the US could lose griev­ance pro­ceed­ings ini­ti­at­ed by the EU, among oth­ers. How would Don­ald Trump have react­ed to the ver­dict of an insti­tu­tion that he has no great love for?

In any case, Trump sur­prised us all with his lack of under­stand­ing of basic eco­nom­ic mech­a­nisms. He refused to see that the Amer­i­can trade deficit is not caused by for­eign pro­tec­tion­ism but rather by an excess of demand and insuf­fi­cient sav­ings, and that if the US pub­lic deficit con­tin­ues to grow, the trade deficit will too, almost automatically.

Resort­ing to pro­tec­tion­ism while the US were close to zero unem­ploy­ment made no sense, and only con­tributed to cre­at­ing infla­tion­ary pressure.

Pro­tect­ing inter­me­di­ary indus­tries, those that are upstream of strate­gic and labour-inten­sive indus­tries (such as agri­food), is counter-pro­duc­tive in terms of jobs. Final­ly, Trump refus­es to under­stand that his trade part­ners have the means to inflict retal­ia­to­ry mea­sures against his coun­try and will do so. As Jean-Claude Junck­er said, “We can also do stu­pid”2.

This col­umn is the repost of an arti­cle that was orig­i­nal­ly pub­lished in the Paris Inno­va­tion Review on 22/03/2018

1Sieg­bert Tar­rasch, quot­ed by Saviel­ly Tar­takow­er in « Brévi­aire des échecs », Paris, Stock, 1936
2Junck­er state­ment in Ham­burg on 2 March 2018.

Contributors

Antoine Bouët

Antoine Bouët

Professor of economics at University of Bordeaux

In addition to his role as professor of economics, Antoine Bouët is also a research fellow at the research group of theoretical and applied economics (GREThA, University of Bordeaux) and, since 2005, he is a senior research fellow at the International food policy research institute (Washington, DC).