What are Trade Wars and How Do They Affect Economies, Businesses, and Individuals?

In recent months, there has been much coverage in the business press as well as the general press about Trade Wars between the United States and China as well as between the United States and the European Union and Canada and Mexico.

The immediate trigger or the event for these trade wars has been the decision of President Trump to levy tariffs and duties on goods and services that the United States imports from China and the EU.

In addition, there has been talk of much stiffer penalties and levies on goods and services that the United States imports from countries around the world.

While the Equity Markets have not yet reacted strongly to these announcements, it is a matter of time before the tariffs and levies begin to bite and then, the effects on the globalized world economy would be hard to predict.

How Would Trade Wars Affect Different Stakeholders

Talking about the world economy being globalized, it is indeed the case that in a highly competitive world economy interconnected and integrated by globalization and driven by Free Trade, such decisions would indeed affect economies worldwide in addition to creating problems for global corporations that operate across jurisdictions and ordinary individuals as well.

For instance, most of the goods and products that giant retailers such as Wal-Mart stock are made in China and imported into the United States. Thus, any decisions involving levies of tariffs and duties would push the cost of these goods and hence, result in higher prices for the American consumers.

Similarly, global corporations that operate in multiple economies worldwide would see their profits going down as their basic business model that entails making goods and products where they are cheaper and selling them where they are costlier would take a hit since they no longer can enjoy and reap the benefits of arbitrage that Free Trade provides.

How Free Trade is Supposed to Work in Theory

Indeed, arbitrage and Free Trade work in theory by ensuring that nations export goods and services that they are good at and where it is cheaper to make them and then import goods and services from countries that are likewise good at them and reap the benefits of what is known as the Theory of Comparative Advantage.

According to this theory that was proposed by the earlier era economist, David Ricardo, nations benefit through Free Trade by exporting and importing goods and services according to the reasons mentioned previously and thus, in theory at least, Free Trade results in a win-win situation for everyone.

How Free Trade Actually Works

Having said that, it is also the case that in practice, things are not so neat and organized as there are bound to be protections for domestic firms by the host nations so that these firms do not lose out because of cheap products imported from elsewhere.

Indeed, as the experience of India shows, the way in which Chinese goods have been flooding into the country thereby threatening the businesses of local firms has led to much outcry and outrage and despite the periodic attempts of the Indian government to rectify the situation by Anti Dumping levies and tariffs and through regulating Chinese imports, there has not been much improvement in this regard.

While the Indian experience is one such example of how Free Trade also results in distortions of the economies, the main grouse that the United States in recent years has been having is that China is taking unfair and undue advantage of the low duties and tariffs in the US and at the same time, not reciprocating by restricting imports from the US.

Where Does America First and Make America Great Again Fit in

Indeed, President Trump who campaigned on a promise to Make America Great Again is now making goods on that promise by imposing tariffs and duties as well as railing against what he views as the erosion of American manufacturing capabilities.

In addition, the other grouse is that China is insisting on technology transfer whenever American corporations set up manufacturing plants and factories in China which means that unless actions is not taken soon, the US might very well end up being secondary to China in the global race for wealth.

Benefits of Free Trade

However, while this might seem like Free Trade being unfair, one has to keep in mind the fact that globalization has indeed helped in lifting Billions of people worldwide into the Middle Class and thereby has created prosperity for many.

Moreover, the fact that the American consumer has been the prime beneficiary so far by not having to pay high prices for goods and services means that once such prices go up due to tariffs and levies, then it would be interesting to note how they would react.

Thus, there are no easy answers to how Free Trade should work in practice and hence, it is indeed the case that unless all nations agree on some basic principles to be followed in the global trading arena, this present situation will continue.

Hence, there is a need for dialogue rather than confrontation and this is where multilateral institutions such as the WTO or the World Trade Organization can help since they are forums for all countries to air their grievances and seek redress.

Conclusion

To conclude, the nations of the world are too tightly integrated to let Free Trade collapse and hence, it is very much likely that the present confrontation would lead to a rebalancing rather than crashing the system and at best, this is an aberration, and at worst, this can lead to more instability in the global trading system.