Abstract
The aim of the study is to examine the effects of the USA and China trade war on both countries and some emerging economies. Two scenarios are examined, one where only US protectionist measures are considered, and another in which Chinese retaliation is taken into account, using the GTAP (Global Trade Analysis Project) Computable General Equilibrium model. The results showed that, on one hand, the trade war would lead to a reduction in US trade deficit and an increase in domestic production of those sectors affected by higher import tariffs and Chinese producers and consumers would bear the lion’s share of the burden of the trade war. But, on the other hand, both countries and the world as a whole would lose in terms of welfare, due to the significant reduction in allocative efficiency, especially in the US, and the loss of terms of trade in the Chinese case.
INTRODUCTION
Since the beginning of 2018, the multilateral trading system has been challenged by unilateral decisions by the United States of America (US) raising import tariffs for certain trading partners, especially China. The backdrop to these US measures is the increase in the country’s trade deficit in recent years, especially with China. According to Comtrade (2018), in 2017, the US trade deficit with China increased to $363 billion, the highest bilateral trade deficit on record. It represents 42% of the total US trade deficit of $861 billion. US President Donald Trump criticizes his country’s huge deficit and attributes it to China’s “unfair” trade practices, such as protectionist measures and infringement of intellectual property rights and patents. Therefore, an investigation was opened by the US Trade Representative (USTR), whose final report was delivered on 11 January 2018 to President Trump. Under Section 232 of the Trade Expansion Act of 1962, the agency found that “the quantities and circumstances of steel and aluminum imports threaten to undermine national security as defined in Section 232.” The agency suggested import tariffs of 24% on all steel products in all countries and 7.7% on all aluminum products in all countries (USTR 2018) The global economy has witnessed a series of trade disputes between China and the US since January 2018, when the US government imposed safeguard tariffs on large residential washing machines, as well as solar cells and modules.1 These conflicts have engendered a full-fledged trade war. Against the backdrop of threats of further tariffs and retaliation, the tension between China and the US, the top two trading countries in the world, inevitably intensifies. The International Monetary Fund (IMF) (2018) simulates the economic consequences of mounting China-US trade tensions and warns that should these trade threats materialise, the GDP of the US and China will be reduced by 0.9% and 0.6%, respectively, leading to a 0.4% fall in long-term world GDP. A report from the European Commission in July 2018 also downgraded its economic growth forecast for the European Union (EU), suggesting that the effect of the trade disputes is not restricted to China and the US (European Commission, 2018). Some journalists and commentators also suggest that the China-US trade war might eventually evolve into a new Cold War, which will severely imperil the stability of the global political and economic environment The prospect of an all-out trade war sparks debates on whether China’s clash with the US on the trade front will derail its rapid growth path. By dint of the successful export-oriented strategy, China has enjoyed impressive economic growth over the past few decades.
TRADE WARS FROM A HISTORICAL PERSPECTIVE
Throughout history, trade wars have been hardly uncommon, with numerous precedents between the US and China. To date, the US has launched five ‘Section 301 investigations’ 3 against China since 1991, probing into areas of intellectual property rights, unfair trade barriers, and clean energy. In these past investigations, both sides threatened to use tariffs as a means of retaliation. However, the aforementioned conflicts were all eventually resolved by diplomatic means, be it through the signing of trade agreements after negotiation or reaching a compromise under the dispute settlement mechanism of the WTO. Before the current round of investigation, the most recent one was conducted in September 2010. The Obama administration initiated a ‘Section 301 investigation’ on China’s subsidy policies and investment in green technologies in response to the petition filed by United Steelworkers.4 The target of the investigation was subsidies given to 154 Chinese firms in wind energy, solar energy, high-performance batteries, and alternative fuel vehicles, which allegedly violated WTO policies. Before the investigation developed into a full-fledged trade war, the US applied for consultations within the WTO’s dispute settlement framework in December 2010, and China agreed to revise the subsidy policies in Tentative Measures for the Administration of Special Fund Used for Industrialisation of Wind-power-generate-electricity Equipment. Apart from China, the US has also engaged in trade wars with Japan and the EU over a spectrum of domains such as textiles, vehicles, color televisions, currencies, and steel. In the 1980s alone, the US initiated 24 ‘Section 301 investigations’ against Japan. Although most trade disputes were peacefully resolved by bilateral negotiations, there were no lack of all-out trade wars, such as that between the US and the EU over steel, which was only settled through WTO’s arbitration.
GTAP OVERVIEW
This model was developed to determine the impact of trade flows in different sectors and regions of the world, generating results of global consistency (Hertel 1997). The GTAP is composed of equations based on microeconomic fundamentals that portray the behavior of families and firms belonging to each of the modeled regions, as well as interregional flows, considering global transportation costs, with a typically neoclassical closure. The model uses a three-level structure in the specification of the production function: at the first level, the production function assumes zero substitutability between primary production factors and intermediate inputs (Leontief technology). As a result, the optimal mix of primary factors is independent of prices of intermediate inputs, while the optimal mix of intermediate inputs is invariant with respect to price of primary factors3 ; at the second level, it involves a constant elasticity of substitution between inputs and between factors of production. Imported intermediates are assumed to be separable from domestically produced intermediate inputs, that is to say that firms first determine the optimal mix of domestic and imported goods and only then decide the sourcing of their imports (Armington assumption); and at the third level, a constant substitution elasticity is assumed between inputs imported from different origins (Hertel 1997).4 The macroeconomic closure of the model is short-term and incorporates the law of constant returns to scale. The investment rate is determined by savings. Prices and quantities of commodities are considered endogenous. Stocks of land, capital and labor and the variables linked to technological change are exogenous. Modeling the maximizing behavior of utility and profits of economic agents, allows the estimation of welfare changes. In order to solve the model, we used the numerical method of Gragg, which reduces possible distortions contained in the linear methods of Johansen and Euler, which allows one to specify a greater number of steps, offering an accurate system solution (Hertel 1997). One of the advantages of general equilibrium models, such as the GTAP, is the possibility of simulating the impacts on welfare. The GTAP also allows for the decomposition of the welfare effects: allocative efficiency, terms of trade and the investment-saving component (I-S). This calculation is associated with equivalent variations of regional and world income, through the income that would be required to reach a certain level of utility. Allocation effects show that a share of regional income from efficiency gains (or losses) is caused by the removal (inclusion) of distortions caused by the incidence of tariffs on trade. Thus, for example, cheaper imported products bring about gains both through increased consumption and in the way domestic productive resources are used. The terms of trade are affected by the variation in export prices related to the cut or increase in tariffs. The I-S is a function of saving and investment prices and the situation as a given region appears in the net saving balance (Monte and Teixeira 2007).
Conclusion
The China-US trade war has received widespread attention, not only because of its labyrinthine nature, but also because of the vastness of the economies involved. Academic researches and professional forecasts indicate that the trade war will have a remarkable impact on China, the US, and even the world economy. Our paper conducts a thorough analysis of the current trade conflict between China and the US by reviewing similar episodes of trade tensions in history. Specifically, by comparing this trade war with a series of trade conflicts between the US and Japan, we conclude that the causes of the trade war are threefold, namely trade imbalances, the midterm elections in the US, and the competition for global economic dominance. Understanding the underlying forces at play allows us to make predictions about how the trade war will evolve. While effects of temporary factors such as the midterm elections may cease, those of more fundamental factors like economic rivalry between the two countries will persist, implying the chances of a settlement in the short run are slim. Our scenario
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