TRADE WARS

THEN AND NOW:

STRATEGIES FOR DEVELOPING
COUNTRIES Shreyes Jayaram
Symbiosis School of Economics
2018
 Who’s placing all
these trade
barriers?
No. of Trade Barriers levied in past
10 years

7%
7%

8%
15%
63%

USA India UK Italy France

Source: (“Global Trade Alerts”, 2018).

Who’s placing all
these trade
barriers?
TRADE WARS THEN
 The 2002 U.S.
Steel Tariffs
 In March 2002, the George W. Bush administration placed
tariffs on steel from China, Japan and the EU.

 The tariffs were imposed to protect U.S. steel

manufacturers from what was considered to be a
detrimental surge in steel imports.

 The tariffs ranged between 8-30% rising from the 0-1%

tariffs that existed prior (Ho, 2003).

What was the rationale for

43rd U.S. President George W. Bush
these tariffs?
 The Infant Industry
Argument
Why do countries levy tariffs?
 Tariffs subsidize industries by protecting them from
lower prices in the rest of the world, and providing
them a captive market (Shafaeddin, 2000).

 Thus, the 2002 tariffs protected the American steel

industry from cheaper prices in the rest of the world by
raising prices faced by domestic consumers of steel.

Source: Perry (2016).

The domestic impact of levying a tariff.
 From Tariffs to
●
Trade Wars
However, many times when a country levies tariffs on another country, the other country
responds with retaliatory tariffs.

• When this retaliatory tariff provides impetus for fresh tariffs from the initial tariff-levying country,
we enter a trade war situation (“Trade War”, 2018).

• After the United States levied tariffs on the EU, they responded with a list of tariffs on Harley-
Davidson motorcycles, Tropicana orange juice, textiles, and steel.

Country A RETALIATI Country B

ON
RETALIATION
TRADE WARS NOW
 The Resurgence of
Trade Barriers
 Since the Second World War the
world has seen a trend of
increased globalisation.
Particularly, since the 1980s the
political consensus supported
free trade.

 However, the recent election of

Trump has seen the onset of
“Trump tariffs” and the return of
protectionist policies to general
discourse.
 Current Rationales for
Trade Barriers
According to economic theory, each nation has some “optimal tariff” which maximises their welfare.

Ossa (2014) estimates the Optimal tariff to be 62.4%. A paper published by Vox estimates the optimal
tariff to be 32% (Nicita, Olarreaga & de Silva (2018)).
 Current Rationales for
Trade Barriers
 Krugman (2018) predicts that an increase in Country A/ Free Trade Optimal tariff
Country B
tariffs to optimum levels accompanied with
retaliatory responses would reduce trade by
about 70%, and GDP by 3%. All countries are Free Trade 100, 100 50, 110
worse off.

 Thus, tariffs are substantially lower than the Optimal tariff 110, 50 60, 60
optimal level.

Source: Salvatore, 2013

Levying optimal tariffs Trade can be considered a prisoner’s dilemma

reduces the volume of trade
without improving the terms
of trade making everyone
worse off.
where levying tariffs is the nash equilibrium.
However, communication helps resolve the
dilemma by helping both countries choose free
trade, which makes both better off than the
equilibrium.
 Current Rationales for
Trade Barriers
 The previous game depicts the general economic
consensus, but is misleading.

 A paper by Johnson (1953) shows that sometimes a

country can gain by levying an optimal tariff, even if
there is retaliation. The game theoretical model only
works if both economies are around the same size.

 Large Countries always have powerful incentives to

levy tariffs on small countries.

Source: Johnson (1953)

If one country is large and the other small, the larger
country gains by levying an optimal tariff, even if the other
retaliates.
 Current Rationales for
Trade Barriers
● Simulations by Li, He & Lin (2018) and find that under a situation of unilateral tariffs by the USA on China,
the USA will gain welfare.

A simulation by Guo, Lu, Sheng & Yu (2018) finds that under a situation of trade war, both USA and China
will lose welfare, however, the loss of welfare in China (0.37%) exceeds the loss of welfare in the USA
(0.32%).
 Caught in the
Crossfires
Trade Wars do not just affect their participants.
Many countries that are integrated in the regional and global supply chains will also be affected.

For example, many Asian countries like South Korea, Vietnam and Malaysia export components (electronics)
to China which are used to make products (mobile phones and computers) which are exported to the US. If the
extra US tariffs reduce Chinese production, there will be less demand for components exported by these
countries to China.

The most exposed Asian countries to a reduction of Chinese exports would be Taiwan (8% of its GDP value is
embodied in Chinese exports), Malaysia (6%), South Korea, Hong Kong and Singapore (4-5%) (Khor, 2018).
But another study by Pictet Asset Management predicts that Hungary, Malaysia, Thailand, Vietnam, Chile, and
the Philippines are among the other countries susceptible to a breakdown in trade (Paolini, 2018).
 Caught in the
Crossfires
Trade Wars do not just affect their participants.
Slapping trade taxes onto commodities could result in increases in final producer and consumer prices.
This in turn could cause inflationary pressures, particularly in countries using commodities such as iron,
steel, aluminum and other metals as production inputs.

These tariff increases also threaten food security in developing countries according to simulations by the
International Food Policy Research Institute (Martin & Laborde, 2018).
●

●
 Caught in the
Crossfires
Trade Wars do not just affect their participants.
Trade wars generate fear in international investors minds, typically leading to sell-offs of currencies of
emerging markets.

This weakens currencies of third party nations even if they are not engaged in the trade war, according
to a Reuters poll (“Trade War risk…”, 2018).

●
 So what’s the
difference?
Similarities Differences

Motivated by jobs Significant motivation extended on the basis

of re-negotiating trade agreements

Action leads to reaction (push back to status International Value Chain Integration
quo ante)
STRATEGIES FOR
DEVELOPING
COUNTRIES
 Strategy 1: Offsetting
Collateral Damage
 Trade wars between multiple other nations generate LM’
inflationary pressure in third party nations by increasing the
prices of raw materials like iron and steel. They also trigger
sell-offs of currencies.

IS’
 The solution to both problems is the utilization of
contractionary monetary policy. By increasing interest rates,
the Central Banks of developing countries can offset runs
against the currency by making it more attractive to foreign
Source: author’s own work.
investors, and reduce inflationary pressure. Simultaneous usage of contractionary
monetary policy and expansionary fiscal
policy can raise interest rates without
 Increasing interest rates would tend to decrease output and reducing output.
employment according to Keynesian economics, but this can
 Strategy 1: Offsetting
Collateral Damage
 While developing countries will find it difficult to afford
expansionary fiscal policies, there is no better time for Country Interest Rate
infrastructure spending since interest rates are at historical Asian 3.3%
lows (Krugman, 2016). Development
Bank
Asia Infrastructure 1.5%
 Developing countries can invest in export infrastructure to Investment Bank
lower costs associated with international trade and thereby New Development 3.07%
subsume at least some of the increase in price associated Bank
with tariffs. Japan 1.45%
International Co-
operation Agency
 Export infrastructure includes integrated cargo terminals,
trade promotion centres, etc.
 Strategy 1: Offsetting
Collateral Damage
 According to Report from the ministry of finance Logistics Costs by Country (as a
(“Industry and Infrastructure”, 2018), deficient
% of GDP)
16%
infrastructure severely hurting the competitiveness of 14%
14%
Indian exports. 12%
10%
10%
8%
 An ASSOCHAM study also shows that due to deficient 8%
6%
infrastructure, India runs against a disadvantage of
4%
about 11% of its trade. It noted that India can save up to 2%
$50 billion if logistics costs are brought down from 14% 0%
to 9% of country’s GDP which will also make domestic India U.S EU

goods more competitive in global markets (”Export

Source: ASSOCHAM, Directory 63, 2018.
Finance in India…”, 2018).
 Strategy 2: Retaliation;
Targeting Swing States
Why Harley-Davidson motorcycles,
Tropicana orange juice, and textiles?
The targeted industries are concentrated in the states of
Florida, Wisconsin, Pennsylvania and West Virginia.

The above states are considered swing states or a state

that could be reasonably won by either of the two major
parties in any given election. Source: Winestock & King Jr., 2002
 Strategy 2: Retaliation;
Targeting Swing States
STATES PRODUCT BUSH GORE
 George W. Bush finally removed the steel PENNSYLVA STEEL 46 51
tariffs after 18 months, instead of the originally NIA

proposed 3 years. WEST STEEL 52 46

VIRGINIA

 The idea behind retaliation is to generate FLORIDA ORANGE 49 49

pressure on the initial tariff levying country to JUICE

withdraw tariffs. WISCONSIN MOTORCYC 48 48

LES

Source: Winestock & King Jr., 2002

 Strategy 2: Retaliation;
Targeting Swing States
● Developing countries have smaller economies than
developed countries. Hence, simply levying retaliatory
tariffs will be insufficient to force the developed country
back to status quo ante.

● Politicians are primarily driven by their desire to remain

in office (Bueno de Mesquita et al., 2003). Tariffs
targeting key marginal regions has an impact on their
likelihood of remaining in power. Source: Nate Silver, 2013.

● According to Nate Silver (2011) the best economic

indicator for measuring the impact on elections is the
manufacturing index.

● Anything which reduces manufacturing output in a state

will therefore affect the popular vote margin, which
 Strategy 2: Retaliation;
Targeting Swing States Industry Amount of
 Let’s take the case of a developing country: exports ($bil)
India.
Precious 7
Metals and
 After the recent U.S. tariffs on steel and stones

aluminum from India, India responded with Mineral fuels 2.8

tariffs on almonds, apples, and walnuts, Aerospace 2.1
among other agricultural products.
Machinery 2.1

 Incidentally, these are our major agricultural Agriculture 1.6

imports from the U.S.A, but all three are

Medical 1.4
primarily produced in California, or equipment
Washington state. Source: U.S. Trade Representative, 2018.
 Strategy 2: Retaliation;
Targeting Swing States
Industry Primary States which export State Popular Vote Difference
to India Margin
Precious Metals and Nevada, Arizona, Texas, Michigan 0.3% (R) 13080
stones California, Minnesota
Mineral fuels Texas, Wyoming, Louisiana, New 0.4% (D) 2701
Pennsylvania, West Virginia Hampshire

Aerospace Ohio, Utah, Virginia, Georgia,

Wisconsin 1% (R) 27257
New York, Texas
Machinery Wisconsin, North Carolina, Pennsylvania 1.2% (R) 68236
Louisiana, Oregon, Indiana
Florida 1.2% (R) 114455
Agriculture California, Iowa, Nebraska,
Texas, Illinois Minnesota 1.5% (D) 44470
Medical equipment Florida, Wisconsin, Indiana,
Minnesota, Pennsylvania Nevada 2.4% (D) 26434
 Strategy 3: FTA’s and
Customs Unions
One strategy for developing countries is to diversify trade through
Free Trade Agreements (FTA’s), the rationale being that trade will
be diverted away from third parties but towards other member
parties to the FTA.

However, several economies studies throw these ideas into

dispute. Source: Bong (2017).

Since the creation of ASEAN, intra ASEAN trade has not

significantly changed, although it has massively increased trade
between ASEAN and other parties (Bong, 2017).

A working paper by NITI Aayog also shows that India’s export

growth to FTA parties has not significantly diverged from its Source: Saraswat, Priya & Ghosh (2018).
Strategy 3: FTA’s and
Customs Unions
 Strategy 3: FTA’s and
Customs Unions
Customs Unions are a type of trade bloc with a free trade area
with a common external tariff (GATT, article 24).

The common external tariff enables developing countries to

overcome Johnson’s curse. A customs union united multiple
developing economies. The common tariff increase on the part of
a customs union will therefore have a significantly greater impact
on the terms of trade and volume of trade than that of a single
economy.
Source: Johnson (1953)
If the customs union’s combined
By forming customs unions and levying common external tariffs, economy is large enough, a common
developing economies can put economic pressure on the initial external retaliatory tariff will bring both
countries to the dotted line region.
tariff levying country to either come to the negotiation table or
References

● Bueno de Mesquita, B., Smith, A., Siverson, R. M., and Morrow, J. D. (2003). The Logic of
Political Survival, Cambridge, MA: MIT Press.

● Export Finance in India: Issues and Challenges – 2018. (2018). ASSOCHAM Publications.

● Global Trade Alert. (2018). Retrieved from https://www.globaltradealert.org/

● Guo, M., Lu, L., Sheng, L., & Yu, M. (2018). The Day After Tomorrow: Evaluating the Burden of
Trump's Trade War. Asian Economic Papers, 17(1), 101-120.

● Hill, H., & Menon, J. (2018). ASEAN Economic Integration: Features, Fulfillments, Failures and
the Future. Retrieved from http://hdl.handle.net/11540/1581

● Ho, K. (2003). Trading Rights and Wrongs: The 2002 Bush Steel Tariffs. Berkeley Journal Of
International Law, 21(3).
References

● Industry and Infrastructure. (2018). Retrieved from https://www.indiabudget.gov.in/budget2017-

2018/es2016-17/echap08_vol2.pdf

● Johnson, H. (1953). Optimum Tariffs and Retaliation. Review of Economic Studies, 21, (2),
142-153.

● Khor, M. (2018). Trade War - Developing Countries Should Respond | Inter Press Service.
Retrieved from http://www.ipsnews.net/2018/07/trade-war-developing-countries-respond/

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https://krugman.blogs.nytimes.com/2016/02/27/the-cases-for-public-investment/

● Krugman, P. (2018). Opinion | Thinking About a Trade War (Very Wonkish). Retrieved from
https://www.nytimes.com/2018/06/17/opinion/thinking-about-a-trade-war-very-wonkish.html

● Li, C., He, C., & Lin, C. (2018). Economic Impacts of the Possible China–US Trade War.
References

● Martin, W., & Laborde, D. (2018). Retrieved from http://www.ifpri.org/blog/how-trade-wars-

threaten-food-security.

● Nicita, A., Olarreaga, M., & da Silva, P. (2018). A trade war will increase average tariffs by 32
percentage points | VOX, CEPR Policy Portal. Retrieved from https://voxeu.org/article/trade-
war-will-increase-average-tariffs-32-percentage-points

● Ossa, R. (2014). Trade Wars and Trade Talks with Data. American Economic Review, 104
(12), 4104-46.

● Paolini, L. (2018). Effects of a full-scale trade between US and China - Pictet Asset
Management. Retrieved from https://www.am.pictet/en/hongkong/articles/2018/us-china-trade-
war

● Perry, M. (2016). An economic analysis of protectionism clearly shows that Trump’s tariffs
would make us poorer, not…. Retrieved from https://medium.com/@MarkJPerry/an-economic-
References

● Salvatore, D. (2013). International Economics (11th ed.). J Wiley.

● Saraswat, V., Priya, P., & Ghosh, A. (2018). NITI Aayog. Retrieved from
https://niti.gov.in/writereaddata/files/document_publication/FTA-NITI-FINAL.pdf

● Shafaeddin, M. (2000). WHAT DID FREDERICK LIST ACTUALLY SAY? Some Clarifications
on the Infant Industry Argument. UNCTAD Discussion Papers, no. 149.

● Silver, N. (2011). Which Economic Indicators Best Predict Presidential Elections?. Retrieved
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elections/

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● Trade war risk, rising oil costs seen keeping rupee near record... (2018). Retrieved from
https://in.reuters.com/article/forex-poll-rupee/trade-war-risk-rising-oil-costs-seen-keeping-
Thank