What Is a Trade War?

A trade war happens when one country retaliates against another by raising import tariffs or placing other restrictions on the opposing country's imports. A tariff is a tax or duty imposed on the goods imported into a nation. In a global economy, a trade war can become very damaging to the consumers and businesses of both nations, and the contagion can grow to affect many aspects of both economies.

Trade wars are a side effect of protectionism, which are government actions and policies that restrict international trade. A country will generally undertake protectionist actions with the intent of shielding domestic businesses and jobs from foreign competition. Protectionism is also a method used to balance trade deficits. A trade deficit happens when a country's imports exceed the amounts of its exports.

The Basics of a Trade War

Trade wars can commence if one country perceives a competitor nation has unfair trading practices. Domestic trade unions or industry lobbyists can place pressure on politicians to make imported goods less attractive to consumers, pushing international policy toward a trade war. Also, trade wars are often a result of a misunderstanding of the widespread benefits of free trade.

A trade war that begins in one sector can grow to affect other sectors. Likewise, a trade war that begins between two countries can affect other countries not initially involved in the trade war. As noted above, this import tit-for-tat battle can result from a protectionist penchant.

A trade war is distinct from other actions taken to control imports and exports, such as sanctions. Instead, the war has detrimental effects on the trading relationship between two countries in that its goals are related specifically to trade. Sanctions, for example, may also have philanthropic goals.

In addition to tariffs, protectionist policies can be implemented by placing a cap on import quotas, setting clear product standards, or implementing government subsidies for processes to deter outsourcing.

Key Takeaways

  • A trade war happens when one country raises tariffs on another country's imports in response to increased tariffs from the first country.
  • Trade wars are a side effect of protectionist policies.
  • Trade wars are controversial.
  • Advocates say trade wars protect national interests and provide advantages to domestic businesses.
  • Critics of trade wars claim they ultimately hurt local companies, consumers, and the economy.

Brief History of Trade Wars

Trade wars are not an invention of modern society. Such battles have been going on for as long as nations have conducted trades with one another. Colonial powers fought with each other over the rights to trade exclusively with overseas colonies in the 17th century.

The British Empire has a long history of such trade battles. An example can be seen in the opium wars of the 19th century with China. The British had been sending Indian-produced opium into China for years when the Chinese emperor decreed it to be illegal. Attempts to settle the conflict failed, and the emperor eventually sent troops to confiscate the drugs. However, the might of the British navy prevailed, and China conceded additional entry of foreign trade into the nation.

In 1930, the U.S. enacted the Smoot-Hawley Tariff Act raising tariffs to protect American farmers from European agricultural products. This Act increased the already hefty import duties to almost 40%. In response, several nations retaliated against the U.S. imposing their own higher tariffs, and global trade declined worldwide. As America entered the Great Depression, President Roosevelt began to pass several acts to reduce trade barriers, including the North American Free Trade Agreement (NAFTA).

Beginning in January 2018, President Donald Trump started the imposition of a series of tariffs on everything from steel and aluminum to solar panels and washing machines. These duties impacted goods from the European Union (EU) and Canada as well as China and Mexico. Canada imposed a series of temporary duties on American steel and other products. The EU also imposed tariffs on American agricultural imports and other products including Harley Davidson motorcycles.

By May 2019 tariffs on Chinese imports impacted nearly US$200 billion of imports. As with all trade wars, China retaliated and imposed stiff duties on American imports. According to a report from CNBC, a study by the International Monetary Fund (IMF) shows that the U.S. importers of the goods have primarily shouldered the cost of the imposed tariffs on Chinese goods. Many believe these costs will, in turn, be passed on to the American consumer in the form of higher product prices.

The Pros and Cons of a Trade War

The advantages and disadvantages of trade wars in particular and protectionism, in general, are the subjects of fierce and ongoing debate.

Proponents of protectionism argue that well-crafted policies provide competitive advantages. By blocking or discouraging imports, protective policies throw more business toward the domestic producers, which ultimately creates more American employment. These policies also serve to overcome a trade deficit. Further, proponents believe that painful tariffs and trade wars may also be the only effective way to deal with a nation that behaves unfairly or unethically in its trading policies.

Pros

  • Protects domestic companies from unfair competition

  • Increases demand for domestic goods

  • Promotes local job growth

  • Improves trade deficits

  • Punishes nation with unethical trade policies

Cons

  • Increases costs and induces inflation

  • Causes marketplace shortages, reduces choice

  • Discourages trade

  • Slows economic growth

  • Hurts diplomatic relations, cultural exchange

Critics argue that protectionism often hurts the people it is intended to protect long-term by choking off markets and slowing economic growth and cultural exchange. Consumers may begin to have less choice in the marketplace. They may even face shortages if there is no ready domestic substitute for the imported goods that tariffs have impacted or eliminated. Having to pay more for raw materials hurts manufacturers' profit margins. As a result, trade wars can lead to price increases—with manufactured goods, in particular, becoming more expensive—sparking inflation in the local economy overall.

Real World Example of a Trade War

While running for President in 2016, President Donald Trump expressed his disdain for many current trade agreements, promising to bring manufacturing jobs back to the United States from other nations where they have been outsourced, such as China and India. After his election, he embarked on a protectionist campaign. President Trump also threatened to pull the U.S. out of the World Trade Organization (WTO), an impartial, international entity that regulates and arbitrates trade among the 164 countries that belong to it.

In early 2018, President Trump stepped up his efforts, particularly against China, threatening a big fine over alleged intellectual property (IP) theft and significant tariffs on $500 billion worth of Chinese products such as steel and soy products. The Chinese retaliated with a 25% tax on over 100 U.S. products.

Throughout the year, the two nations continued to threaten each other, releasing lists of proposed tariffs on various goods. In September, the U.S. implemented 10% tariffs. Although China responded with tariffs of its own, the American duties did have an impact on the Chinese economy, hurting manufacturers and causing a slowdown.

In December, each nation agreed to halt imposing any new taxes. The tariff war cease-fire continued into 2019. In the spring, China and the U.S. seemed on the verge of a trade agreement.

However, at the beginning of May, literally less than a week before final talks were slated to begin, Chinese officials took a new hard line in negotiations, refusing to make changes in their company-subsidizing laws and insisting on the lifting of the current tariffs. Angered by this apparent backtracking, the president doubled down, announcing May 5 that he was going to increase tariffs from 10% to 25% on $200 billion worth of Chinese imports, as of May 10. He may have felt emboldened by the fact that the U.S. trade deficit with China had fallen to its lowest level in 2014.

As of May 10, the trade talks between the two nations ended without agreements being met.