Why Everyone Loses in a Trade War

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ecently, international trade tensions, particularly those between the United States and China, have been a key factor influencing the short-term economic outlook for more than just these two countries. Additionally, these tensions have contributed heavily to heightened volatility in financial markets. So, a key question is why?

First, it would be useful to understand the importance of international trade. As is the case for any business, when you increase your potential customer base, you have a greater opportunity to leverage your business growth. As well, since different countries have their own unique economic strengths and products, it can be mutually beneficial to do business together. One country may be rich in specific natural resources, while another country may have an abundance of something else. Concurrently, another economy may be driven by its manufacturing capacity while another may be focused on intellectual property and technology. Together, each economy and customer base can complement the other; that is as long as everyone is playing fair.

In global trade, fair play is not always commonplace. So, when one participant creates an unlevel playing field, problems arise. And those problems can develop in a number of ways. For instance, if one country manipulates their currency – something that China is currently being accused of doing – significant challenges will likely follow. By artificially devaluing their currency versus the US Dollar, China makes their own goods more affordable to foreign purchasers, raising the likelihood that their own industries will experience greater revenue. At the same time, a weaker Chinese currency means American products become relatively more expensive on an exchange basis and less likely to be purchased by Chinese consumers.

Of course, currencies can fluctuate relative to one another. However, deliberate and artificial manipulation of one’s currency is another story. In addition, another core concern the United States has with China is theft of intellectual property (IP). Many American companies invest heavily in proprietary and patented IP that is the source of their unique place in the world markets. When the Chinese illegally access and use this IP as their own, the adverse impact upon these companies can be significant.

One would hope, in an ideal world, that everyone will play nice together. When they don’t, if negotiations and other means of non-punitive steps do not result in a solution, it is then that some form of more aggressive action may be required. Unfortunately, any steps taken here tend to hurt everyone.

For instance, when the US levies tariffs on Chinese steel, they are in essence not only imposing a tax on that product but also the very American manufacturer they are trying to protect, because now that product is more expensive. In theory this maneuver will make it harder for the Chinese to export their goods. However, when one takes a closer look at the inner workings of such punishment, it becomes clear that the ones doing the actual suffering are not just the Chinese. Many people do not realize that any tariff imposed on foreign goods is not paid by the country or company doing the exporting. It is actually paid by the company importing that product. That’s right, it is the American manufacturer which needed Chinese Steel that pays the tariff. It is paid to the US Government and results in higher manufacturing expenses that will either reduce profits or be passed on to the consumer via higher prices. As well, those higher prices may result in lower sales. Therefore, the American company could see lower profits and lower sales while the American consumer may no longer be able to make their previously planned purchase. Worse yet, if that consumer is employed by one of those adversely impacted American manufacturers, they may even lose their job.

So, here’s the problem. If one country is acting unethically and will not listen to reason, something has to be done. And tariffs are certainly a means to such an end. However, once tariffs are implemented, retaliation often occurs. And that is what we have witnessed as China has also now imposed tariffs on American farming products like soy. As this chapter plays out, it is then not just the Chinese who suffer. First the new tariffs on American exporters make it harder for them to sell their own products overseas. That’s bad. What else?  American importers are losing too. First their import costs go up and their profits go down. Moreover, their revenue will likely fall as well.

Another important point to note: In a trade war, because of retaliatory tariffs, it is often the wealthier nation whose exports fall more than the country they are battling with. That is because American consumers and companies generally have more wealth. If tariffs lead to higher costs for all parties, it is the less affluent counterpart, in this case the Chinese, that will likely end up being less able to purchase the other’s now higher priced goods. That is why trade wars generally lead to larger trade deficits, not smaller ones – something that the United states does not want to have happen. But such a result is inevitable. And that is where the test of one’s resolve comes into play.

In effect, everyone suffers until for one player, or both, the suffering becomes so unbearable that they agree to make a conciliatory change in their behavior. It is basically a very high stakes game of chicken. Ultimately, such conflict may be necessary to force a more even playing field. However, the cost of getting there can be high. The Great Depression of the 1930’s resulted, in part, from a global trade war. And today, the economic expansion that has been in place for nearly 11 years in the United States is now at risk, partly because of unresolved conflicts between the United States and key trading partners. This dynamic only reinforces the concept that we live and operate in a global marketplace. With fair trade, on an even playing field, there is opportunity for all economies to flourish. Any attempts by one country to gain an unfair advantage may create some short-term benefit. But ultimately, their trading counterparts will push back in some manner that seeks to relevel the field. If unsuccessful, the next step is a trade war, like the one we are in. The sooner everyone recognizes the futility of this process, the sooner we will turn back to realizing the opportunities and growth that a cooperative global marketplace can afford all players.