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A US Trade War With Mexico And China

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The end of 2016 and the beginning of 2017 saw a melodramatic change in the global trade picture. After the British referendum supporting the exodus of the United Kingdom from the European Union, the US presidential election followed with the victory of Donald Trump, who made many protectionist accounts during the campaign, particularly intimidating China, Mexico, and Germany with import duties. He announced that he would “impose tariffs of 35 percent on Mexican imports and 45 percent on Chinese imports to protect American jobs from unfair foreign competition”. One of his first choices was in fact to sign a policymaking order withdrawing the United States from the Trans-Pacific Partnership; however, this move was mostly symbolic because the deal had not been ratified by the US Congress. This paper assesses potential trade wars between the United States and China and the United States and Mexico. With the help of a static multi country, multisector general equilibrium model, we evaluate 18 situations of trade wars; these situations vary the function of the trading partners involved in a trade war with the United States (either China, Mexico, or both) and the form that retaliations could take. Trade wars have been a vastly debated topic in the economic literature recently. Overall, the literature concludes that:

  1. In global trade wars, all countries lose in terms of welfare;
  2. A trade war between a large country and a small country3can result in gains for the large country but losses for the small one;
  3. A trade war cannot lead to gains for all countries involved, and cooperation may lead to a better solution for all countries.

These assumptions have received both hypothetical and empirical support. The appraisal in this paper is based on a static multiregional, multisector computable general equilibrium (CGE) model based on the most recent data on rates, trade, and production, known as Modeling International Relationships under Applied General Equilibrium for the African Growth and Development Policy Modeling Consortium, or MIRAGRODEP. This methodology has the major advantage of being economically consistent through taking into account each country’s limited productive resources, the interdependence between economic sectors and trading countries, and income effects. We carefully select the regions and sectors included in this modeling exercise in order to account for the trading partners and sectors that could be the most affected by these policy scenarios. For this study, we select China and Mexico as target countries for the change in orientation of US trade policy. During the US presidential campaign, Trump proposed various increases in import duties for both countries. We select an augmentation in import duty of 35 percentage points for imports coming from both China and Mexico. For Mexico, this is equal to the increase Trump often advanced during the campaign, which was commented upon by many experts; for China, it is less. We use the same augmentation factor for both countries so as not to create an additional source of differentiating impact on the Chinese and the Mexican economies.

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In all cases, we apply the augmentation of the import duty to all products coming into the United States from these trading partners, with the exceptions of oil, energy, and mineral products, which US authorities often consider to be of strategic importance.To determine the degree of retaliation these two trade partners might impose, we adopt five scenarios:

  1. China, Mexico, or both implement the same augmentation of import duty on products imported from the United States as the one adopted by the United States on its imports from these countries
  2. China, Mexico, or both implement an import duty on all imports from the United States such that the tariff revenue newly collected on these imports6 is equal to the tariff revenue newly collected by US authorities on these countries’ exports
  3. China, Mexico, or both implement an import duty on all imports from the United States such that the country’s (countries’) terms of trade with the United States are the same as they were in the baseline or as close as possible
  4. There is an optimum tariff scenario wherein each country imposes the tariff that maximizes its representative agent’s welfare, based on the initial tariff imposed by its trading partners
  5. We establish a Nash equilibrium between the belligerents – that is, the best response in terms of welfare for each country based on the optimum tariff implemented by the belligerents.

Our study reaches several conclusions, two of which are worth mentioning here. First, even for the United States, initiating a trade war is not the right policy for improving domestic welfare and gross domestic product (GDP). Even a unilateral augmentation of protection vis-à-vis trading partners such as China and Mexico at the magnitude Trump propounded as a candidate does not lead to an increase in domestic welfare and GDP for the United States. Second, trade wars could be significantly detrimental for these trading partners, particularly Mexico, which is smaller than the United States in economic terms and whose exports are concentrated toward the United States.

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