Economic Impacts of Trade War Threats

Concerns about a potential global trade war have been building since early March when President Donald Trump announced plans to impose tariffs on imports of steel and aluminum in an effort to bolster support for American industries and workers. New University of Maryland-led research suggests this move by the President and the uncertainty caused by the United States’ position on trade could hurt American consumers and businesses.

In research recently published through the National Bureau of Economic Research, UMD Economics Professor Nuno Limão and two UMD alumni—Kyle Handley (Ph.D. ECON ’11) and Jeronimo Carballo (Ph.D. ECON ’15)—used census data to evaluate the last period when the threat of a global trade war was widespread; following the economic crisis of 2008. Limão and colleagues found that the policy uncertainty in foreign markets led U.S. exporting firms to exit many of those markets following that crisis, particularly in countries with volatile economies. While the researchers show some of that uncertainty has receded, they warn the country could now be headed down a similar path.

“President Trump’s plan to impose tariffs on steel and aluminum has already prompted other countries to threaten retaliation and has translated into tangible stock market declines for companies using those products as inputs,” Limão said. “Our research suggests that even if the U.S. steps back from the brink, its actions are already undermining the credibility of the world trade system and could come at a high cost to U.S. consumers and producers.”

Professor Limão and his co-authors also find that the uncertainty effect for U.S. firms was largely absent for products they exported to Canada, Mexico and other countries with which the U.S. has a preferential trade agreement (PTA). These agreements provided valuable insurance during the period of uncertainty following 2008 and the U.S. export share in those countries increased. Limão points out that one of the major concerns about the recent steel and aluminum tariffs is that, unlike past measures, they do not exempt most PTA members, if any, which may lead those countries to retaliate in kind.

Limão and Handley—now an assistant professor at the University of Michigan Ross School of Business—also wrote a book chapter last year on what to expect from Trump’s trade policies. Among other things, the authors noted the danger of invoking national security to support trade measures—precisely the argument used by Trump to justify the 25% tariff on steel imports. Related research by Limão and Handley finds that China’s inclusion in the World Trade Organization reduced U.S. policy uncertainty and generated significant benefits for U.S. consumers. They calculate that even a modest increase in the probability of the U.S. increasing its tariffs on all its trade partners would increase prices for U.S. consumers because foreign firms would reduce their exports to the U.S.

Limão, Handley and Carballo’s research was recently featured in the Wall Street Journal, Washington Post and CNBC.

two men shaking hands