Two scenarios are considered here: The first includes the tariffs in place on $250 billion worth of imports by the United States under Section 301 of the US Trade Act of 1974, and by China on $110 billion worth of imports from the United States, which were imposed in retaliation for the Trump administration’s tariffs.
This status quo (as of June 1, 2019) was confirmed at the meeting between President Trump and President Xi Jinping of China in Osaka on June 29. The second scenario adds Trump’s threatened but not yet implemented tariffs on nearly all remaining imports from China, with no further retaliation by the Chinese.[3] Trump held this threat in abeyance after his session with Xi in Osaka, but it remains a weapon Washington could wield.
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Under both scenarios, US exports to China and total US exports fall. Diversion of US exports to other markets only partially offsets the overall decline. China, on the other hand, is more successful at diverting exports to other markets, increasing its total exports. Other US trading partners are projected to divert exports to the US market, largely compensating for the loss of Chinese goods. A tiny decline in global trade occurs under the first scenario and slightly more in the second.
Both the United States and China lose welfare in both scenarios, with a larger percentage and absolute loss for China. But these losses are very small as markets adjust to the changes. All other countries gain welfare, benefitting from diversion of trade and changes in world prices. Direct and indirect effects cause a tiny improvement in Chinese GDP and a slight decline in US GDP. In the second scenario, the United States gains from changes in world prices in its favor, but they are not large enough to offset the GDP loss.
In the United States, agricultural, manufacturing, and low-trade service sectors decline in output, while nontraded services increase their output. For China, agriculture and low-trade services decline slightly, while all manufacturing and traded service sectors gain. These results follow the pattern of declines in exports for the United States and increases in exports for China. Again, the results are qualitatively similar, but larger, in the second scenario.
CAVEATS
As indicated above, the effects of the trade war could end up being worse than found in this scenario analysis. The scenarios assume, for example, that other countries not involved in the US-China trade war divert trade to the United States. In fact, they may hesitate to invest in expanding into the US market because of the Trump administration’s hostile attitude toward imports. Were that hesitation to occur, the result would be supply bottlenecks and higher prices in the United States.
The two scenarios also assume that investor uncertainty resulting from the trade war does not spill over into shocks to asset markets, generating a recession. There is some evidence of growing unease among investors, but not yet enough to shake asset markets.
The two scenarios further assume that the rest of the world continues to operate within WTO (World Trade Organization) rules for trade among themselves, and that the trade war does not spread beyond the United States and China. Any shift to protectionism by other countries, following a US decision to operate outside the WTO rules, would be damaging. The evidence so far is that the rest of the world is ignoring US trade policies and proceeding with free trade agreements within the WTO structure. [4] China, for example, has cut its tariffs on imports from all non-US countries, even as it retaliates against US tariffs.
The model used in this scenario analysis captures the costs incurred by producers when shifting exports to, and imports from, different markets. These adjustment costs will erode over time as investment opens new markets. The model does not consider the potential costs of shifting markets back if the tariff war is ended. Such costs might be considerable and, if the trade war continues for some time, the process is probably irreversible—once lost, the markets will not be regained.
SCENARIO ANALYSIS
Here are the results from the two scenarios that were modelled.
Scenario 1 (Current Situation): The United States imposes a 25 percent tariff on $250 billion in Chinese imports, and the Chinese retaliate by raising tariffs on about $110 billion of imports from the United States, with rates differing by commodity between 5 and 25 percent.[6] China exempts most imported intermediate inputs from retaliation—its policy is strategic in that Beijing seeks to minimize the impact of the trade war on Chinese producers. This is the situation as of June 2019.
Scenario 2 (Adds threatened US tariffs): The United States increases the scope of the 25 percent tariff to include what it says is “essentially” all imports from China, which the administration says is approximately $300 billion worth of imported products. China does not respond with additional retaliation.[8] This is the situation if the additional announced US tariffs are implemented.
The empirical results from these scenarios are provided in figures 1-3. Figures 1 and 2 provide information for selected countries and regions and figure 3 for sectoral aggregates in the United States and China. The computable general equilibrium (CGE) model includes 16 countries/regions and 42 sectors. The two scenarios have the same qualitative results, with the second scenario showing larger shocks.
Figure 1 presents results from the two scenarios on trade flows. Scenario 2 results in a large decline in Chinese exports to the United States (14.6 percent). The Chinese successfully divert exports away from the United States, increasing their exports to all other regions, and total Chinese exports rise (1.3 percent in scenario 2). The United States, on the other hand, sees a small decline in total exports (1.3 percent in scenario 2), with the decline spread across all destination regions.