Economic Analysis of US-China Trade War

August 27, 2019

In 2018, President Trump issued two executive orders calling for tighter tariff enforcement and a review of US trade deficits. These orders led to a suite of US tariffs on approximately $50 billion worth of Chinese goods.[1] Throughout the year that followed, China instituted retaliatory tariffs of its own kind in rapid succession. To date, the US has imposed tariffs totaling $250 billion on Chinese imports ranging from steel and aluminum to washing machines and solar panels. Conversely, China has imposed tariffs totaling $110 billion on the US.[2] This ‘trade war’ has drastically changed trade patterns around the world and has inspired protests from many industries in both the US and China.[3] As the war has been in effect for over a year, it is crucial to take stock and evaluate the tariff policies’ economic effectiveness for American consumers.

Effect on Consumers

The tariffs affect consumers through two major avenues: a rise in prices for consumer goods and deadweight loss in the economy. It has also successfully made US industries and manufacturers more competitive with producers in China who can operate at a much lower cost. A study by the National Bureau of Economic Research estimated that the 2018 tariffs increased the average price of goods manufactured in the US by one percent, in the industries that use or compete with targeted imports.[4] Many argue that consumers have not yet dealt with the price increase directly, as larger companies have been able to absorb the costs till now. But a reallocation of costs is inevitable. Long term consequences and the final increase in prices remains to be seen, as companies have yet to adopt mitigation strategies and seek alternative sources for their materials. Doing so will likely increase US prices further, at least for a short period, as industries shift their investments out of China to other nations.

Furthermore, it has been estimated that ~$165 billion will be redirected within 2019, with the current tariffs in effect.[5] Not only this, countries may source materials from countries that have been traditionally costlier but are now more cost-effective than China due to these tariffs. In such cases, prices for consumers will rise, but the tariff revenue will be unaffected, thereby contributing to economic deadweight loss. An article by the NY Fed estimates that the deadweight loss per household in the US will be $620, for a total annual cost of $79 billion.[6] While some of the costs associated with such a shift will be absorbed in the supply chain, the remaining costs will ultimately be passed on to either American consumers through higher prices or by Chinese exporters lowering their costs. However, NBER found little evidence of such changes in trade, which implies that most, if not all of the cost has been imposed on US consumers.[7]

Effect on Industries

Unlike domestic consumers, US manufacturers and businesses have been directly impacted by the tariffs. Largely because much of the targeted commodities have been intermediate goods. An estimated 15% of intermediate goods in the US have been affected between 2007 and 2017.[8] Overall, industries that have been initially impacted include transportation (which imports about $10 billion in parts from China annually), manufacturing, consumer and medical electronic devices, solar panels and retail.[9] Over the past year, many large companies have been able to absorb rising costs by accumulating inventory before tariffs were levied. But this strategy is ultimately unsustainable and will eventually lead to price markups.

These markups also have a profound impact on small businesses who are more sensitive to changes in consumer demand. Furthermore, they may not be able to absorb costs while the economy and consumer preferences slowly shift. As companies start to seek alternative sources for inputs, supply chains and production plans will also change leading to a loss in prior investments in China by US companies and vice versa. Furthermore, a study by the Brookings Institute estimated that about 2.1 million jobs would be disrupted by the following retaliatory Chinese tariffs across 40 industries in the US.[10]

Image: Employment exposed to Chinese tariffs. Source: Brookings Institute

Future Outlook

There are clearly numerous economic variables at play when determining the ultimate economic impact of the US-China trade war. For example, future supply chain reorganization, changes in currency values, as well as the development of US’s trade relations with other countries are but a few significant factors integral to this issue. The long-term consequences remain to be seen as the economy begins to fully react to the tariffs. However, given the initial economic changes to date, economic activity will likely slow and US consumers will face the majority of the costs imposed by tariffs.

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