When a nation raises tariffs or other trade barriers to protect domestic firms from competition, it enters into a trade war. This is the opposite of free trade, which aims for low tariffs and open markets. It can have severe economic consequences and even lead to political instability, as shown by the Smoot-Hawley Tariff of the Great Depression that exacerbated global economic problems and helped spawn extremism that led to World War II.
In the current trade war with China, President Trump set a series of tariffs on Chinese imports beginning in January 2018, prompting retaliation by Beijing. His administration also imposed nontariff barriers such as export restrictions on certain technologies seen as having dual-use commercial and military applications, investment restrictions, and antitrust investigations of Chinese companies.
The tariffs have caused many sectors of the US economy to shrink, including durable goods manufacturing and mining. These losses are mainly due to relative price shifts, which make American products less competitive in foreign markets. Moreover, employment in these sectors declines because consumers switch to substitutes that are not subject to tariffs.
Before accounting for behavioral effects, the higher taxes amount to an annual tax increase of about $600 per household on average, a significant burden on middle-class households. But the impact is much more substantial if we factor in behavioral effects and take into account the drop in consumption by households owing to lower incomes and rising prices. We estimate that the total economic cost of the trade war to the US economy reaches $2 trillion, or about 1 percent of GDP.
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