Thinking About a Trade War (Very Wonkish)

With Gary Cohn gone, it’s not clear that big business has any real pipeline into the White House (OK, polluters have an open line to Scott Pruitt, and predatory lenders a line to Mick Mulvaney, but these aren’t the groups who will stand up against trade war.)

.. Congressional Republicans, terrified of the Trump base, have proved unwilling to take a stand on anything, even if big money is at stake.

.. trade decisions are being made at Trump’s whim, without input from anyone who knows anything about trade economics (Peter Navarro thinks he understands the economics, which is even worse.)

.. Trump’s version of diplomacy – not just trade actions, but the systematic praise of brutal dictators and disdain for democratic leaders – has created a very angry world out there. Nobody out there wants to give Trump even the appearance of a win, and elected leaders would be punished by their voters if they did.
.. I think, three main questions:

1. How high might tariffs go?

2. How much would this reduce world trade?

3. How costly would the trade war be?

.. an all-out trade war could mean tariffs in the 30-60 percent range; that this would lead to a very large reduction in trade, maybe 70 percent; but that the overall cost to the world economy would be smaller than I think many people imagine, maybe a 2-3% reduction in world GDP... some people would actually gain, but a lot of people, very much including large groups and many communities in the U.S., would take big hits, especially in the short-to-medium run.

.. world’s economies, taking their lead from the U.S., abandon the rules and agreements that currently constrain their tariffs and start setting tariffs unilaterally in their perceived self-interest.

.. The problem is that if everyone does this, you get the costs of reduced trade without the benefit of improved terms of trade, because other countries are doing unto you the same thing you’re trying to do unto them.
.. “optimal tariff warfare”, which is actually more like an arms race than a shooting war, in the sense that there’s (usually) no victor and no resolution, just a lot of wasted resources.
.. Then you have to find an equilibrium (a Nash equilibrium, for readers of “A Beautiful Mind”) in which each country is charging its optimal tariff given what everyone else is doing.
.. If foreigners can easily substitute away from your goods, the optimal tariff is fairly low; if they can’t, it’s high.
.. if that’s right, we’re talking about a really big rollback of world trade.
..  a 70 percent reduction would bring us roughly back to 1950s levels. If Trump is really taking us into a trade war, the global economy is going to get a lot less global.
.. they do say that trade wars are bad, don’t say that they’re catastrophic.
.. the U.S. currently spends 15 percent of GDP on imports.
.. at the bottom of the Great Recession, CBO estimates that we were operating 6 percent below potential GDP. Of course that loss was temporary, while a trade war might be forever.
.. The U.S. currently exports about 12 percent of GDP.
.. if we have the kind of trade war I’ve been envisaging, something like 70 percent of that part of the economy – say, 9 or 10 million workers – will have to start doing something else.
.. the rapid growth of Chinese exports didn’t cost the U.S. jobs on net, it changed the composition and location of employment, producing a lot of losers along the way. And the “Trump shock” that would come from a trade war would be an order of magnitude bigger.
.. the effects don’t seem trivial to soybean farmers already facing sharp price cuts and steel users already facing much higher costs.