What is a Trade War?

A trade war is like a game of financial chicken…

In the game of chicken, two cars drive towards each other. The first person to turn their vehicle out of the way before crashing loses. Similarly, a trade war is like a game of financial chicken. One country imposes tariffs on another country, usually aiming to hurt its economy. The other country can do the same, damaging the first nation’s economy as well. This often goes back and forth until one country stops or lifts the sanctions and complies with the other’s wishes. Sometimes, neither side wins and the sanctions remain indefinitely or both agree to remove sanctions at the same time.

A trade war is a financial conflict between two nations. Modern economies import and export significant quantities of goods. The United States alone imports more than $2T worth of products every year. This makes restricting imports and exports a powerful political tool.

When two or more countries disagree on something (like how to protect intellectual property), each nation usually tries to convince the other of its point of view. If disagreements escalate but the governments aren’t prepared or willing for armed conflict, they can use economic tools to pressure the other countries involved. When two or more countries start placing economic sanctions on each other because of a disagreement, it’s a trade war.

During a trade war, one country places tariffs or restrictions on imports and exports from another country. Usually, the other country responds with taxes and trade limits of its own.

For example, if country A is unhappy with country B, it may refuse to import country B’s grain, hurting B’s farmers. Country B responds by placing tariffs on A’s carrot exports, making it harder (ie, more expensive) for A to sell its carrots to the citizens of B.

If tensions between the two countries grow, they may add more tariffs and restrictions on trade, escalating the trade war. In some cases, a trade war can turn into an armed conflict. If tensions ease, the countries can pare back or entirely remove the tariffs to return trade to normal.

A tariff is a type of tax applied to imported goods. Sometimes, tariffs are also called duties.

Governments can levy tariffs on all goods exported by a particular country, all products of a certain type, or target them toward specific industries in specific countries. Tariffs ultimately raise the cost of an imported good and limit the amount of that good that’s imported.

Who pays for tariffs?

When a business imports a good, it must pay any tariffs required to import that good. However, the cost of taxes tends to fall on consumers. When an importer pays a tariff, it usually raises the price of the product to compensate for the cost of the duty. If taxes add $5 to the cost of a widget that the importer usually sells for $100, it may charge its buyer $105 instead to recoup the cost. The widget buyer then raises the price for its products to compensate for its increased supply costs, leaving consumers to bear the burden of the tariff.

Trade wars have a long history, dating back as long as countries have traded with each other.

The Opium Wars are an example of trade wars that resulted in actual armed conflicts. In the late 1830s, the Chinese government banned the importation of opium by the British East India Company. Britain responded to these sanctions with military force, leading to two wars — one from 1839 to 1842 and a second from 1856 to 1860.

An early American trade war started with the Smoot-Hawley Act of 1930. As the Great Depression began, Congress placed tariffs on imports from other countries with the hope of protecting American industries from the Depression and spurring growth. The plan backfired and most other countries responded with tariffs against American goods.

Also in the 1930s, England fought a trade war with the newly independent Ireland. Ireland implemented many protectionist policies by taxing and restricting imports from England, hoping to spur the growth of domestic businesses. England responded with tariffs of its own, including a 20% tariff to recover money paid to Irish farmers. Tensions eased in 1935 and both nations reduced (but didn’t eliminate) trade restrictions.

More recently, in 1993, the European Union gave preferential treatment to banana producers in Carribean nations that were once colonies of European countries. It accomplished this by raising tariffs on bananas imported from Latin America. Many American companies owned banana farms in Latin America and brought U.S. politicians into the situation, leading to multiple cases raised to the World Trade Organization. The EU eventually relented, agreeing to remove the tariffs over eight years, starting in 2009.

One of the most recent trade wars is Trump’s trade war with China.

The trade war began because of President Donald Trump’s belief that China uses unfair practices in international trade, such as manipulating the value of its currency and not respecting intellectual property laws. Beijing argues that the United States’ real goal is curbing its growing economic power.

Trump and Chinese President Xi Jinping met in April 2017 to create a plan for trade talks, agreeing to a 100-day plan for the negotiations. By August 14th, the talks finished and both sides were unable to come to an agreement.

In January 2018, Trump ordered an investigation into Chinese intellectual property (IP) theft and threatened to impose fines on the country. He placed tariffs on Chinese imports in March and April, affecting imports of washing machines, solar panels, and steel from all countries, not just China.

In April of that year, China responded by imposing tariffs on 128 different imports from the United States. The next day, the White House announced plans to retaliate with tariffs on $50B of Chinese goods. China matched those threats in June.

In July 2018, the first set of tariffs went into effect and each nation added additional duties between July and December of that year. On December 1st, the countries agreed to stop imposing new tariffs for 90 days.

In May 2019, Trump announced plans for new tariffs, and the trade war began again. That June, the two sides met at a G20 meeting and agreed to restart trade talks. Trump added more tariffs after two days of failed negotiations and China responded by halting all purchases of American agricultural exports.

The trade war continued to escalate with additional tariffs until the two sides reached an agreement in January 2020. China agreed to increase the amount it imports from the US and strengthen its laws surrounding intellectual property. In exchange, the Trump administration agreed to reduce some of its new tariffs on Chinese goods.

One of the primary benefits of a trade war is that it allows countries to influence other nations without resorting to physical violence. Economic sanctions can have significant adverse effects on a country but won’t lead to the large scale death and destruction that a real war would.

Trade wars can also benefit domestic industries. By imposing tariffs on certain goods, a government can encourage local businesses to increase the production of a product and protect them from being undercut by international competitors.

One significant downside of trade wars is that they tend to increase the price that consumers pay for a product. When importing something is more expensive, sellers tend to raise prices to compensate for the increased costs.

It can also negatively impact some domestic businesses. If a business relies on imports of raw materials, increased costs could reduce its profits or make it unviable, leading to the loss of jobs.

Typically, trade wars affect stocks negatively. In today’s globalized economy, most businesses import at least some of their products and face increased costs when a country imposes tariffs and trade restrictions. The stock market also tends to react negatively to uncertainty, so the ambiguity of whether a government will impose more tariffs can cause stock prices to drop.