Trade War - Effect of Trade War on Us Economy

1. Introduction

Trade war is a situation in which two or more countries raise tariffs or other trade barriers on each other with the aim to protect their own economies.

The imposition of tariffs and trade barriers by one country may lead to similar retaliation by other countries, resulting in trade war. Trade war has the potential of increasing the costs of certain imports if the countries involved refuse to make a compromise.

2. US President’s power to impose economic protection measures - Section 301 of the Trade Act of 1974

Section 301 of the U.S. Trade Act of 1974 is a self-initiated clause. It authorizes the President to take actions against a foreign government that violates an international trade agreement or is unjustified, unreasonable, or discriminatory, and that burdens U.S. commerce.

If United States Trade Representative - USTR initiates a Section 301 investigation, it must seek to negotiate a settlement with the foreign state in the form of compensation or elimination of the trade barrier and protection of intellectual property rights. Any enforcement actions taken by US Government does not need to seek authorization from the World Trade Organization (WTO).

However, the enforcement actions taken by US Government may lead to retaliation by other countries. As a result, trade war may finally occur.

Effect of Trade War on US Economy

Without trading with other nations, the equilibrium market price of a country exists at a price which equals to domestic demand and domestic supply.

According to the Figure 1[4], P is the equilibrium price of the domestic product while P* is the world price of the product before imposing of tariffs. At price P*, domestic supply is at QD while domestic demand is at QW.

The difference between quantity QD and QW is the amount of imports. The cost of import P* is much lower than equilibrium domestic price. Due to the competitive price of imported products, a large proportion of total quantity supply is imported instead of produced by domestic suppliers.

After imposing of tariffs in Figure 2[4], the world price changes to P’ which the difference between world price P’ and domestic price P is reduced and the quantity of imports is decreased. There would be a loss of consumer surplus as consumers have to purchase at a higher price for same products. At the same time, there would be a gain in domestic producer surplus as producers are protected from cheap foreign imports, the domestic producer would be able to receive a relatively higher revenue compared to the condition without tariff imposition. However, the reduction in consumer surplus is greater than the increase in producer surplus, resulting in a welfare loss generally.

3. Reasons for US Government of imposing tariffs and initiating Trade War 2018

On 1st March 2018, President Trump announced his intention to enforce 25 percent tariff on steel and 10 percent tariff on aluminum imports. On March 22, 2018, Trump had signed memorandum under the Section 301 of the 1974 Trade Act instructing the United States Trade Representative (USTR) to apply tariffs of $50 billion on Chinese goods.

About one-third of the 100 million tons of steel used by American business is imported every year. For aluminium, over 90% of 5.5 million tons used by American companies is also imported. President Trump’s government believes that the surplus of aluminium and steel sold to the US at a subsidized price by the Chinese government is the major cause for deteriorating US aluminium and steel industry. Since almost 1/3 of the employment in these two industries have already been lost compared