What is a Trade War?
A trade war is an economic conflict between countries. This results in both countries imposing trade protectionism policies against one another in the form of trade barriers. These barriers can be imposed in a number of different ways including but not limited to tariffs, import quotas, domestic subsidies, currency devaluation, and embargos. As each country imposes a trade barrier, the other country will retaliate with another policy which creates the ‘warring’ concept behind trade ‘war’. Trade wars often start when a country’s government believes that there are unfair trading practices that are hurting domestic markets. In an attempt to protect their domestic industry or create jobs they may impose a trade barrier, such as a tariff on a key product imported from the other country. The other country may retaliate and this tit-for-tat battle will escalate into a trade war.
Quick Summary of Points
- A trade war is an economic conflict between countries that involves implementing protectionist policies such as trade barriers
- Trade barriers used in trade wars include tariffs, import quotas, domestic subsidies, currency devaluation, and embargos
- In the short term, trade barriers can protect industries, however, in the long term will generally be negative for the economy overall
How are Trade Wars Fought?
Trade wars are fought by using trade barriers that can come in several forms. Although these barriers can be imposed in different ways, the result is generally the same. The goal of these trade barriers is to lower the number of imports coming in from the country or make it more expensive. The following are some of the common ways trade wars are fought:
Tariffs are one of the most commonly used trade protectionism policies. This involves taxing products that are being imported. Tariffs result in higher costs for imported goods while also creating revenue for the government. The idea behind using tariffs as a protectionist policy is that domestic producers of the good being taxed will benefit from less competition with foreign goods. Economic conflicts involving specifically tariffs are sometimes referred to as toll wars or customs wars.
#2 Import Quotas
An import quota is a restriction on trade that sets a limit on the amount of goods that can be imported for a specific product. Unlike tariffs, quotas will not create revenue for the government however the goal is the same. Quotas on a specific product will decrease competition domestic producers face from foreign markets. The quota is set to protect these domestic producers.
#3 Domestic Subsidies
The idea behind domestic subsidies is that the government can allow domestic producers to lower the price of local goods. This increases the domestic business’ ability to compete with foreign markets on price. The result of lower costs for local producers is the deterrence of outsourcing processes as well as an increase in exports. Domestic subsidies are especially effective when used in countries or industries that have high exports.
#4 Currency Devaluation
Devaluing the domestic currency in relation to foreign currency can also be used as a trade war tactic. By lowering the exchange rate, domestic exports become more competitive in other countries. At the same time, imports from other countries are more expensive now on a relative basis meaning foreign products are less competitive.
An embargo is an extreme policy that officially bans the trade of a certain good with a particular country. This can be used to completely prohibit imports and exports or to just limit the commercial activity of the good. When this policy is implemented it is usually as a form of protest.
What are the Impacts of a Trade War on the Economy?
The effects of trade wars on the economy can be broken down into the short term and the long term. In the short term, imposing trade barriers will generally achieve the goal of protecting domestic businesses. Using tariffs, quotas, or any other barrier will allow local businesses to be more competitive relative to foreign producers. This will create jobs in these growing businesses. However, in a trade war, the other country will retaliate by imposing their own protectionist policies. What often happens is that the domestic businesses being protected can benefit from the policies put into place, however, many other businesses end up suffering as the foreign country will put barriers into place on other goods.
Economists generally agree that in the long term, trade wars hurt the economy, slow GDP, and overall makes the country less competitive in the international market. The idea behind this is the concept of comparative advantage. When the government makes it more costly for products to be imported, some of these higher costs get passed on to the consumer. Even if the domestic industries that are being protected face less competition, they aren’t producing at a lower cost than before the implementation of the protectionist policy. This inefficiently higher cost to consumers of the product lead to lower consumption and overall a slowdown of the economy. In the long term, this can actually lead to fewer jobs created in aggregate.
Are Trade Wars Good or Bad?
There are pros and cons of trade wars and the implementation of trade barriers. As discussed above, in the short term it can be used to protect domestic industries. This can be especially useful in protecting small or growing infant industries. Protectionist policies in this instance can help these industries which are unable to compete with foreign producers but may have the potential to be important to future domestic output. From this short-term outlook, protectionist policies can also increase domestic demand, reduce trade deficits, and increase job growth.
Trade wars over an extended period of time, however, are generally seen as negative. This is mostly for the aforementioned impacts on the economy due to the higher costs of inputs and lowered consumption. As well as this inefficiency created in the market, trade wars can also make industries less competitive. With reduced competition being seen in both countries, each country heads toward a state of autarky. Industries have less need to innovate and so production technologies can stagnate.
Thank you for reading CFI’s resource on trade wars. If you would like to learn about related concepts check out CFI’s other resources: