Trump trade war unlikely to cause an economic catastrophe

Talk of war is in the air — trade war!

President-elect Donald Trump has pledged to label China a currency manipulator, and has floated the idea of imposing large tariffs on Chinese imports. This sort of policy is considered beyond the pale in mainstream economics and media circles. It is subjected to epithets like “protectionism” and “mercantilism”. Almost everyone says it’s a bad idea.

Naturally, major economics media outlets are freaking out. Jim Tankersley of the Washington Post, citing a study from Moody’s Analytics, writes that Trump’s trade war would destroy 4 million jobs, and prevent 3 million more from being created, throwing the US into recession. Bob Davis of the Wall Street Journal is worried as well, as is CNN. China experts such as Michael Pettis and Bloomberg View’s own Christopher Balding think Trump’s understanding of Chinese policy is wrong. Bloomberg BusinessWeek warns that the trade war would be disastrous for aircraft maker Boeing Co.

But it’s no simple matter to predict the effect of trade restrictions on economic activity. We can look at current trade flows and linkages, and calculate what would happen if this trade were to simply vanish. But that doesn’t tell us what would take its place. It’s very hard to calculate how well American industry would be able to pick up the slack if Chinese goods became more expensive. It’s wrong to assume that the jobs that currently depend on trade would be replaced by nothing at all.

Economic theory can help a bit. International economists have a pretty reliable set of tools, called gravity models, that predict the amount of trade between countries. These models show that protectionism, in general, reduces trade. But this doesn’t tell us the overall economic impact of that reduction. It might be that large trade volumes make a country only a little better off in terms of real income, so that even a large reduction in trade flows hurts the economy only a bit.

The best way to predict the effect of a Trump-induced trade war would be to look at some historical parallels. The problem is we don’t have any good recent examples to go by. For most of the post-WW II period, trade openness has gone only one direction.

The parallel many cite is the SmootHawley Tariff Act of 1930. At the time, many economists warned that SmootHawley would make the Depression worse, and the name still holds power today — in a 1993 debate over the NAFTA, then-Vice-President Al Gore famously handed protectionist businessman Ross Perot a picture of Smoot and Hawley, as if this settled the argument.

But simply invoking Smoot-Hawley isn’t the instant argument-winning moment that many seem to think. First, most of the reduction in trade in the 1930s probably wasn’t because of the tariff at all. A 1998 estimate by economist Douglas Irwin found that while US imports fell 30%, only a quarter of that decline was caused by the tariff. And again, this doesn’t tell us how much of the decline in output was due to the fall in trade — if some of the trading activity lost to Smoot-Hawley was replaced with domestic production, that further reduces the estimate of the trade war’s real impact.

Recent experience shows trade can fall on its own after a big financial crisis and recession, without any assistance from policy. Trade plunged in the aftermath of the financial crisis of 2008, and has been declining ever since. This happened without any big surge in protectionist policy. Often it’s the natural workings of the business cycle, not the visible hand of Congress, that affects trade volumes the most.

It’s important to remember that even as trade has fallen, the global economy has recovered. Chinese growth and Indian growth remain solid; the US has done okay. So a reduction in trade doesn’t need to be the death knell of growth.

These suggest the negative projections for Trump’s trade proposals is overdone. There’s an outside chance a mild trade war could be good for the US economy. “Strategic trade theory” suggests while severe trade wars are bad, mild tariffs and other barriers can help the domestic economy.

As is often the case in economics, no one really knows whether that theory is a good one. Just as the Great Recession of 20072009 caused us to discard many of our cherished macroeconomic theories, a Trumpinduced trade war might give us reason to rethink conventional wisdom about trade policy. From a purely economic standpoint, it would be an interesting experiment.

I think the main risks from trade war are not economic at all. The real danger seems to be a trade war would lead to worsening relations with China at a time when tensions over the South China Sea and other military flashpoints are running high. A trade war might not hurt the US, but a real war would be very bad for everyone involved. This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.