What would happen if Trump sparked a trade war with China?

Stock markets took a plunge this week as President Trump announced a slew of tariffs and penalties against China, which according to Trump could amount to tens of billions of dollars.

On the face of it, U.S. companies should be happy about that kind of news. If goods coming in from China are suddenly more expensive, customers will be more likely to turn to the American goods that China competes with. Not only that, but sellers might be able to raise prices.

So what explains the negative reaction from the stock market and widespread denunciation by industry leaders?

The answer: They’re afraid of a trade war, which they worry would make everyone worse off.

What is a trade war?

A trade war begins when one country puts up trade barriers, making it harder for foreign countries to sell goods and services there. Trade barriers can come in the form of tariffs (taxes on imported goods), quotas (limits on the number of goods that can be imported) or strict regulations that shut out foreign sellers.

A trade war ensues when a foreign country retaliates with trade barriers of its own. If the U.S. slaps tariffs on steel from the European Union, Brussels can call foul and impose its own tariffs on American blue jeans, motorcycles and bourbon. If Germany decides to put tariffs on American-grown chicken, as they did in the 1960s, the U.S. could make it harder for Germans to sell trucks to Americans, claiming that Germany is executing unfair trade practices.

When that happens, countries can end up in a punitive back-and-forth, making it harder and harder to trade.

The pain and advantages aren’t spread out evenly. In the example of steel, U.S. steel manufacturers get a boost, while auto manufacturers who rely on steel, plus the targets of foreign tariffs such as bourbon producers, get held back.

That’s why most economists say that protectionist policies meant to insulate a local industry usually end up backfiring, raising prices and hurting domestic producers.

The World Trade Organization has a dispute settlement mechanism to determine if tariffs are legal under international trade law.  When President George W. Bush imposed steel tariffs in 2002, the E.U. and a slew of other countries took the case to the WTO and won. Bush withdrew the tariffs.

What ‘unfair’ trade practices is China accused of?

The U.S. has accused China of a wide range of unfair trade practices.

One is “dumping” steel and aluminum, a practice of producing more Chinese steel and aluminum than the market can handle, either at a loss or through government subsidies. When that extra supply is put on world markets, it brings down the costs and makes it harder for non-subsidized steel and aluminum to compete. China accounts for 49% of all steel production.

China is also accused of intellectual property theft, stealing important industry secrets that other countries and companies spend heavily on developing.

When it comes to tariffs and quotas, China also has a wide variety of policies in place to boost its domestic production.

For many years, China was said to be manipulating its currency, making it cheaper for foreigners to buy its goods and more expensive for Chinese firms to buy foreign goods. Of late, however, it seems to have backed off that practice.

What actions is Trump taking?

Trump has taken several trade actions that are aimed directly or indirectly at China. In January, he imposed targeted tariffs on solar panels and washing machines. In March, he announced across-the-board tariffs on steel and aluminum. Because the U.S. already had targeted restrictions on Chinese steel, however, the move was seen as hurting U.S. allies instead of China. Trump decided to exempt several major sources of foreign steel from the tariffs, at least temporarily.

This week, Trump said he would impose tariffs on $50 billion – $60 billion worth of Chinese products, following a period of public comment.

How might China respond to US trade actions?

China has already threatened to respond to new U.S. tariffs with its own tariffs on some $3 billion-worth of U.S. goods, including pork, pipes, wine and food. It also said it was looking at legal action against the U.S. through the World Trade Organization.

Who wins and who loses?

Economists are fond of saying that there are no winners in a trade war, but it tends to be a little more complex. The domestic protected industry, such as steel, wins out because it has less competition and can raise prices. The other industries that need to buy the product in question, such as automakers who need steel, lose out because their prices go up. Consumers who buy either of the products end up paying more.

If foreign countries impacted by the tariffs respond by applying their own penalties, they can end up hurting American companies that want to export their products. 

Trump argues that he can “win” a trade war by applying pressure and getting foreign countries to back off some of their existing trade barriers. Historically, that hasn’t always been effective. The avenue that countries use to lower their trade barriers are free trade agreements, which Trump is skeptical of.