What Is a Trade War?

Tariffs are taxes that governments impose on imported goods. The goal of a tariff is to make products that come from other countries more expensive and encourage consumers to buy domestic alternatives. While this might sound beneficial for local businesses, the real-world consequences are more complex and often affect consumers, businesses, and the broader economy in unexpected ways.

The Ripple Effect of Tariffs on Prices

When a government imposes a tariff on imported goods, the immediate effect is an increase in the cost of these products. Importers, the businesses that are buying the goods to bring into their home country, face higher expenses and often pass at least some of these costs onto consumers. For example, in 2018, the U.S. imposed a 50% tariff on imported washing machines which resulted in a 12% increase in the price of washing machines.^[1] As a result of tariffs, consumers may find themselves paying more for everyday items. 

Impact on Employment and Wages

While tariffs aim to protect domestic jobs by making imported goods more expensive, they can have unintended consequences on employment. Industries that rely on imported materials may face increased production costs due to tariffs, leading them to cut costs elsewhere, potentially resulting in wage reductions or job losses. For instance, a U.S. car manufacturer that imports parts might scale back production or reduce its workforce to offset higher costs, affecting jobs in the automotive sector. Oxford Economics estimated that U.S. tariffs imposed on Chinese goods in 2018 resulted in the loss of 245,000 jobs in the U.S. and a decrease of $675 of purchasing power per household.^[2]

Innovation and Economic Growth

Tariffs can also influence a country’s innovation. By shielding domestic industries from international competition, tariffs may reduce the incentive for these industries to innovate and improve efficiency. This lack of innovation can hinder economic growth, as businesses are not motivated to enhance their products or processes. In contrast, open markets encourage companies to continuously improve to maintain a competitive edge.^[3]

Even the threat of tariffs can create uncertainty that leads to businesses delaying investments or purchases until there is more clarity about what the tariff policy will be.^[4] Federal Reserve economists found that trade policy uncertainty in 2018 contributed to businesses being less willing to spend money on physical assets such as machinery, equipment, and infrastructure.^[5]

Modern Implications of a Trade War

A protectionist trade policy is carried out when a government creates rules to limit imports from other countries. One of the most common tools of protectionism is a tariff. When the U.S. imposes a tariff on another country’s goods, the other country often responds by placing their own tariffs on American goods, making it more costly for U.S. businesses to sell their products abroad. This back and forth retaliation is known as a trade war. It creates a cycle in which businesses in affected industries face higher costs, making it harder for them to sell their products abroad. The negative effects of a trade war are likely to offset the positive effects of higher tariffs.^[6]

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