A trade war is a game of chicken that has already escalated beyond what many expected. And it’s unlikely to end soon.
While it’s true that tariffs protect domestic industries by preventing foreign competitors from undercutting local firms on price, they also raise the cost of imports to consumers. As a result, economic growth slows. And that’s especially true for the US, where households are the largest source of imported goods.
On top of that, the uncertainty sparked by tariffs is a significant deterrent to investment. Unless companies can make sure they’ll not be hit with additional tariffs in the future, they are unlikely to build plants or invest in expansion.
The extent of retaliation by trading partners also affects the magnitude of real GDP losses. For example, if other countries don’t mirror US tariff increases, manufacturing employment booms more rapidly during the protection period and then experiences a much larger nominal wage adjustment when protection ends – triggering involuntary unemployment.
Furthermore, trade wars strain diplomatic ties. For instance, the Airbus-Boeing dispute pushed relations between the U.S. and Europe to their worst levels in decades. And they can weaken global institutions like the World Trade Organization that promote free trade and resolve disputes. That’s particularly true if governments behave unilaterally, as Trump has done with his tariffs. As a result, it’s hard to see how the current trade war can end without a serious disruption to global economic growth.
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