Talk of war is in the air — trade war!
President-elect Donald Trump has pledged to label China a currency manipulator, and he has floated the idea of imposing large tariffs on Chinese imports. This sort of policy is considered beyond the pale in mainstream economics and media circles. It is subjected to epithets such as “protectionism” and “mercantilism.” Almost everyone says it’s a bad idea.
Naturally, major economics media outlets are freaking out. Jim Tankersley of the Washington Post, citing a study from Moody’s Analytics, writes that Trump’s trade war would destroy 4 million jobs and prevent 3 million more from being created, throwing the U.S. into recession.
But it’s no simple matter to predict the effect of trade restrictions on economic activity. We can look at current trade flows and linkages, and we can calculate what would happen if this trade were to simply vanish. But that doesn’t tell us what would take its place. It’s very hard to calculate how well American industry would be able to pick up the slack if Chinese goods became more expensive. It’s wrong to assume that the jobs that currently depend on trade would be replaced by nothing at all.
Economic theory can help a bit. International economists have a pretty reliable set of tools, called gravity models, that predict the amount of trade between countries. These models show that protectionism, in general, reduces trade. But this doesn’t tell us the overall economic impact of that reduction. It might be that large trade volumes make a country only a little better off in terms of real income, so that even a large reduction in trade flows hurts the economy only a bit.
The best way to predict the effect of a Trump-induced trade war would be to look at some historical parallels. The problem is that we don’t have any good recent examples. For most of the post-World War II period, trade openness has gone only one direction — up, up and up.
The parallel that many people cite is the Smoot-Hawley Tariff Act of 1930. At the time, many economists warned that Smoot-Hawley would make the Great Depression worse, and the name still holds power today — in a 1993 debate over the North American Free Trade Act, then-Vice President Al Gore famously handed protectionist businessman Ross Perot a picture of Smoot and Hawley, as if this settled the argument.
But simply invoking Smoot-Hawley isn’t the instant argument-winning moment that many seem to think. First, most of the reduction in trade in the 1930s probably wasn’t because of the tariff at all. A 1998 estimate by economist Douglas Irwin found that while imports declined 30 percent, only a quarter of that decline was caused by the tariff. And again, this doesn’t tell us how much of the decline in output was because of the fall in trade — if some of the trading activity lost to Smoot-Hawley was replaced with domestic production, that further reduces the estimate of the trade war’s real impact.
There are reasons to expect that the negative projections regarding Trump’s trade proposals are overdone. There’s even an outside chance that a mild trade war could even be good for the U.S. economy. “Strategic trade theory” suggests that while severe trade wars are bad, mild tariffs and other barriers can actually benefit the domestic economy.
As is often the case in economics, no one really knows whether that theory is a good one. Just as the Great Recession caused us to discard many of our cherished macroeconomic theories, a Trump-induced trade war might give us reason to rethink conventional wisdom about trade policy. In any case, from a purely economic standpoint, it would be an interesting experiment.
In fact, I think the main risks from trade war are not economic at all. The real danger seems to be that a trade war would lead to worsening relations with China, at a time when tensions over the South China Sea and other military flashpoints are already running high. A trade war might not hurt the U.S., but a real war would be very bad for everyone involved.
Noah Smith is an assistant professor of finance at Stony Brook University and a freelance writer for finance and business publications.