Trade Wars

What is a Trade War?

A trade war is an economic conflict between countries. This results in both countries imposing trade protectionist 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. This creates the “warring” concept.

Trade wars often start when a country’s government believes that another country is engaging in unfair trading practices that are hurting the first country’s 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.

How are Trade Wars Fought?

Trade wars are fought by using trade barriers that can be presented 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 you’re at war with, or at least make that country’s products more expensive. The following are some of the common trade war tactics:

#1 Tariffs

Tariffs are one of the most commonly used trade protectionist 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 reduced competition with foreign goods. Trade wars specifically involving 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 a specified product that can be imported. Unlike tariffs, quotas do not create revenue for the government. Quotas on a specific product decrease the competition domestic producers face from foreign producers. The quota is set to protect these domestic producers.

#3 Domestic Subsidies

The idea behind domestic subsidies is that, by using them, the government can enable 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 imports and an increase in exports. Domestic subsidies are especially effective when used in countries or industries that have high levels of 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 become relatively more expensive and less competitive in the domestic marketplace.

#5 Embargos

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/or 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.

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, but 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 make a 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 leads 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 that 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 due to higher costs and lowered consumption. In addition to creating inefficiency in the market, trade wars can also make industries less competitive. With reduced competition being seen in both countries, industries feel less need to innovate, so production technologies can stagnate.

Additional Resources

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:

• Tariff
• Import Quotas
• Trade Barriers
• Free Market
• See all economics resources