Trade Wars

It begins when one country retaliates against another country. 

A trade war begins when one country retaliates against another country by raising import tariffs or imposing restrictions on its imports. For example, a government may initiate it if it perceives that a competitor has unfair trading practices.

Trade Wars

Trade unions or industry lobbyists exert pressure on domestic politicians to make imported goods less appealing to consumers, driving international policy towards a trade war. The causes and effects of trade disputes include:

Causes

  • A misunderstanding about the widespread benefits of free trade. 

  • A side effect of controversial and protectionist policies.

  • Protection of national interests that are advantageous to domestic businesses.

Effects

  • It can hurt local companies, consumers, and the economy.

  • It begins in one sector and then spreads into and affects other sectors. 

  • It originates between two countries and can spread to other countries that were not initially involved. This "tit-for-tat" battle over imports results from a protectionist mindset.

  • These actions differ from sanctions or measures taken to control imports and exports.

  • Since the goals are specifically related to trade, it negatively affects the trading relationship between the two countries. Sanctions, for instance, can also be philanthropic.

It is a consequence of protectionism. Government policies that restrict international trade are known as protectionism. A country will take protectionist measures to shield its domestic business and jobs from foreign competition.

Protectionist measures are also helpful for balancing trade deficits. Trade deficits occur when a country's imports exceed its exports. Tariffs are taxes or duties imposed on goods imported into a nation.

It can devastate the consumers and businesses in a global economy, and the ripple effect can influence many aspects of both economies.

In addition to tariffs, protectionist policies can be implemented by limiting import quotas, setting clear product standards, or implementing government subsidies to discourage outsourcing.

The advantages and disadvantages of trade wars are the subjects of intense and ongoing debate. Protectionists argue that well-crafted policies provide competitive advantages.

Advantages

  • Protects domestic companies from unfair competition

  • Increases demand - for domestic goods

  • Promotes local job growth

  • Improves trade deficits

  • Punishes nations that adopt unethical trade policies

According to critics, protectionism harms the people it is intended to protect by choking off markets and slowing down economic growth and cultural exchanges. As a result, consumers are likely to have fewer options.

Disadvantages

  • Increased costs can induce inflation

  • Reduced choice causes shortages in the marketplace 

  • Discourages trade

  • Slows economic growth

  • Damages diplomatic relations and cultural exchanges

No domestic substitute for the imported goods causes shortages. Profit margins of manufacturers suffer when raw materials are more expensive. Consequently, increases in prices of manufactured goods spark inflation in the local economy.

Impacts on the Economy

It can have both short- and long-term effects on the economy. 

Short term

  • The goal of protecting domestic businesses can be achieved by imposing trade barriers. 

  • In response, the other country will impose its protectionist policies.

  • The policies put in place to protect domestic businesses can be beneficial. However, many other businesses may suffer because foreign countries will place barriers on other products.

Long term

  • It hurts the economy, slows GDP, and makes a country less competitive globally. 

  • When the government makes it more expensive to import goods, some of these higher costs get passed on to consumers. 

  • Although domestic industries that are protected face less competition, this doesn't necessarily translate into goods being produced at a lower cost.  

  • Inefficiency leads to higher costs for consumers, leading to lower consumption and an overall economic slowdown. As a consequence, fewer jobs are created over the long term.

Good or Bad?

There are several ways in which domestic industries can be protected in the short term. It is prudent to protect small and growing industries representing the country's future. 

The ability of an industry to innovate affects a nation's competitiveness. The pressure and challenges can help beat leading competitors. Strong domestic competitors, aggressive suppliers, and demanding customers give them an edge.

Good or Bad

In an era of global competition, the role of nations has become more significant. Increasingly, competition is based on the creation and assimilation of knowledge, and the government significantly influences that. 

Creating and sustaining competitive advantages is a highly localized process. Competitive success is influenced by national values, cultures, economic structures, institutions, and histories. 

Every country has a distinct pattern of competitiveness; no nation can or will dominate every industry. Ultimately, home environments shape nations' success in particular industries because they are forward-looking, dynamic, and challenge-oriented.

Protectionist policies can be used to help industries unable to compete with foreign producers but possess a great deal of potential to be an essential part of future domestic industries.

On a short-term basis, protectionist policies can also lead to increased domestic demand, reduced trade deficits, and increased job creation.

This can have a negative impact in the long run because the costs are higher, and consumption is lower. 

Trade wars can also make industries less competitive by creating inefficiency in the market. As a result of reduced competition, industries have less incentive to innovate, and production technology stagnates.

Example

Donald Trump's trade war with the world in 2018 entailed multiple battles with China. The US legal rationale Trump used was that imports were a national security threat. Accordingly, he imposed tariffs and quotas on imported goods.

Both nations released lists of proposed tariffs on different goods, threatening each other. China responded with its tariffs, but the American duties caused a slowdown in Chinese manufacturing.

In retaliation, China halted all imports of farm products by state-owned firms. The nation's central bank weakened the Yuan above the seven per dollar reference rate for the first time in more than a decade, raising concerns about a currency war.

Seeing this was mutually destructive, the United States and China signed a trade deal on Jan. 15, 2020. Still, the subsequent COVID-19 pandemic threatened a further escalation of trade tensions between the two nations.

Continuous retaliation by trading partners and the prospect of further escalation affected trade, investment, and possibly the global economy. With changing conditions, Biden must decide whether to maintain US tariffs and trade barriers.

Trade Retaliation

Tariffs are restrictions a country imposes that can adversely affect another country's exports, also known as retorsion. Trade barriers are used to fight trade wars.

These barriers can be imposed in different ways, and the result is generally the same. Trade barriers are intended to:

1. Lower the number of imports coming in from the country you're at war with,

2. Make that country's products more expensive. 

Trade retaliation tactics include 

  • Tariffs

One of the most common trade protectionist policies is a tariff. It involves taxing imported goods. Tariffs increase the cost of imported goods and generate revenue for the government.

The idea behind tariffs as a protectionist policy is that domestic producers of goods will face reduced competition from foreign producers. 

Some trade wars involving tariffs and customs are known as toll wars or customs wars.

  • Import Quotas

Import quotas limit the amount of a product imported through trade. Unlike tariffs, quotas do not generate revenue for the government.

Quotas limit the competition faced by domestic producers from foreign producers for a specific product. Quotas are set to protect domestic producers.

There are government-imposed limits (quotas) on how much of a certain good can be imported into a particular country. The purpose of such quotas is to protect domestic industries and vulnerable producers.

  • Domestic Subsidies

In theory, domestic subsidies enable the government to lower the price of local goods. As a result, domestic businesses can better compete with foreign markets.

By lowering local producers' costs, imports are deterred, and exports increase. Domestic subsidies are especially effective in countries or industries with high export levels.

  • Currency Devaluation

Deflation of the domestic currency can be used as a trade war strategy. Lowering the exchange rate makes domestic exports competitive, while imports become relatively more expensive.

  • Embargos

An embargo is a policy that forbids the trade of a certain good with a particular country. It can be used to prevent imports or exports from limiting the commercial activity of a good. The policy is usually implemented to protest.

History of Trade Wars

These are not a product of modern society. These have been prevalent ever since nations started trading with one another. 

History

Colonial powers, for instance, fought with each other over the right to trade exclusively with overseas colonies in the 17th century.

Such trade battles have a long history in the British Empire. The opium wars with China in the 19th century are one example. 

For years, the British had been sending opium from India into China before the Chinese emperor banned it.

The emperor sent troops to confiscate the drugs after failed attempts to settle the conflict. The British navy prevailed, and China agreed to allow additional foreign trade-in.

To protect American farmers from European agricultural products, the United States passed the Smoot-Hawley Tariff Act in 1930. As a result, import duties reached almost 40%. 

Several nations retaliated by imposing higher tariffs on the United States, and global trade declined around the world. 

During the Great Depression, aided by disastrous trade policies, President Roosevelt passed several acts to reduce trade barriers, including the Reciprocal Trade Agreements Act.

In January 2018, former President Trump imposed a series of tariffs on everything from steel and aluminum to solar panels and washing machines. 

Goods from the European Union (EU), Canada, China, and Mexico were also subject to these duties. In retaliation, Canada also imposed a series of temporary duties on American steel and other products. 

Additionally, the EU imposed tariffs on American agricultural imports and other products, including Harley Davidson motorcycles.

Nearly $200 billion of Chinese imports were subject to tariffs by May 2019. As with all trade wars, China retaliated and imposed stiff tariffs on American imports.

A study by the International Monetary Fund (IMF) shows that US importers of goods have borne the brunt of the tariffs imposed on Chinese goods. 

Costs are ultimately passed on to the American consumer through higher prices, which is the exact opposite of what the trade war is intended to achieve.

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Further Reading

Tariffs are taxes that are applied by the government on goods and services that are imported into the country. In the international trade process, tariffs are very common. The main reasons for imposing tariffs are as follows:

  • A reduction in imports by increasing the price of goods and services 

  • There is a need for the protection of domestic producers.

The government of a country may implement a protectionist trade policy by imposing tariffs and limiting the entry of foreign goods and services into its marketplace to help boost domestic production.  

Currency

There are usually two types of tariffs that you can find in the marketplace: 

  • Specific: A single unit of a good is subject to specific tariffs. For example, a TV imported into the country may be subject to a $100 tariff.

Another example of a tariff is the tax imposed on an imported good. A 5% tariff, for instance, would be a 5% tax added to the price of wheat paid by an importer of wheat from abroad.

  • Ad valorem: Tariffs based on a percentage of a good's total value are known as ad valorem tariffs. This could be as much as 10% of the value of an imported TV.

There are several reasons why governments impose tariffs on imported goods. Some of these are:

  • To protect domestic producers.

Governments sometimes need to protect domestic producers and industries against cheap imports. Moreover, supporting domestic producers prevents an increase in unemployment in the country.

  • To protect domestic consumers.

Some cheap imports may put consumers at risk. Some imports may contain elements that may potentially harm consumers. The government makes these goods more expensive to discourage excessive consumption of these items.

  • To preserve national security.

When it comes to industries with strategic significance to a country's national security, the government may be concerned with overreliance on imports. Therefore, the government may take steps to eliminate this over-dependence. 

  • To protect infant industries.

Tariffs may be used to protect emerging and growing industries. There is no doubt that domestic products will be more appealing to consumers, and companies in emerging industries will grow as a result.

Import Quotas

Quotas are put in place to:

  • To protect domestic industries and vulnerable producers. 

  • To prevent a country's domestic market from becoming overrun with foreign goods, which are often cheaper as overseas production costs are lower. 

  • Some foreign manufacturers may purposely seek to drive domestic producers out of business by selling large quantities of a product below cost, thus capturing the entire domestic market and crippling local vendors. 

  • However, quotas are generally harmful to consumers as they deprive them of access to more competitively priced goods than local alternatives. 

1. Voluntary Export Restraint (VER)

A voluntary export restraint (VER) is a quota a country places on its exports to a partner country. If two nations share a trade agreement, imposing trade quotas will be viewed as protectionist or hostile, harming trade relations.

Trade partners can negotiate VERs and agree to refrain from flooding the market of the partner with cheap products. 

Usually, these agreements are worked out when the trade agreement is initially negotiated and are an effective way to prevent trade disputes.

The VER is typically a limit on how many units a nation can export to another. VERs need to be updated to remain effective as the economic climate changes. 

2. Hidden Quotas

Nations can limit the importation of goods without explicitly imposing trade quotas on other countries. For example, governments may place strict quality control restrictions on all goods coming into the country. 

Despite appearing to be a best practice move, there are other consequences.

  • A lack of quality may prevent goods from entering a nation in large numbers. This restricts the supply of that goods. The government could have achieved a similar result by imposing an import quota. 

  • Government-imposed import quotas limit the number of goods imported into a country. In general, quotas are used to protect domestic industries and vulnerable producers.  

  • Concealed quotas and propaganda campaigns also reduce demand. An example would be a government spreading rumors that certain imports are harmful. Such claims may not be based on science, but they can reduce demand for a short time. 

  • Other economic factors may affect demand or supply. The government cannot control such events as they rarely intervene in a shift in supply and demand but can deter imports, boost prices, or reduce sales. These effects are like import quotas.

Trade Barriers

Trade barriers protect a nation's domestic economy against imported goods and services. Trade barriers generally benefit governments, domestic producers, and national interests at consumers' expense.

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Trade barriers are also erected to protect domestic producers or to advance political agendas. Other reasons for implementing trade barriers and tariffs include:

1. Anti-dumping provisions

The term "dumping" is used to describe how foreign producers dump their products on the home market at lower prices than domestic producers. Foreign producers may dump their products into another economy for two reasons.

  • There is a possibility that the goods can be produced at a lower cost abroad due to lower input costs such as labor or raw materials than home soil. A foreign company makes profits even if it advertises lower prices than domestic producers. 

When a firm or an individual buys a good or a service produced more cheaply abroad, living standards in both countries increase. 

In addition to buying abroad for economic reasons, there are other reasons why consumers and firms benefit. It may, for instance, better suit their needs than similar domestic offerings, or it may not be available domestically. 

  • Dumping can be a deliberate move by large multinational companies to gain market share. Compared to smaller competitors, they can take losses in the short term due to the larger cash reserves and greater liquidity. 

The term "dumping" refers to exporting a product at a lower price in a foreign market than its domestic market. The main advantage of dumping is the ability to flood the market with unfairly low prices.

By driving market prices below what domestic producers can tolerate, competitors are forced to shut down. When home producers disappear, the foreign entity will be able to adopt monopoly pricing and see its profits rise.

OPEC can produce oil at a lower cost than other organizations in the oil industry. OPEC's ability to supply the market with large quantities of oil can depress oil prices. This practice jeopardizes the profitability of competing oil suppliers.

A government can place trade tariffs to protect domestic suppliers and raise prices on dumped goods. If the tactic is not aggressive enough, governments can impose sanctions and ban companies from doing business in the home country.

2. National defense suppliers

Defense industries in many nations rely on a worldwide network of suppliers to build and maintain national defense mechanisms.

As with most highly developed industries, most nations' defense sectors rely on a worldwide network of suppliers for the maintenance and development of national defense mechanisms. 

To prevent such situations, governments may impose trade tariffs on foreign-made national defense systems to make them unattractive to domestic producers. 

Even though these practices force domestic suppliers to pay more for goods, they will prevent them from becoming overly dependent on foreign suppliers.

The supply of artillery, ammunition, planes, boats, etc. should not become overly reliant on other nations.

In an international conflict, the supplying economy could easily cease to supply national defense goods to the enemy, thus jeopardizing the home nation's ability to protect itself.

Governments may impose trade tariffs on foreign-made national defense systems to make them less attractive to domestic providers. 

The practice may force domestic suppliers to pay more for goods, but it will prevent them from becoming overly reliant on foreign suppliers.

3. Early-stage industries

Early-stage industries are vulnerable to dumping. A certain industry may be developed in a given nation, but it may only start-up in newer economies. These industries are dominated by small players that cannot compete on price with foreign entities.

If an industry becomes a major contributor to the economy, governments are incentivized to protect it by imposing trade tariffs on predatory foreign players. Alternatively, governments can subsidize the domestic market to allow competition.

Free Market

Grains

Pure market economies have no barriers between sellers of different goods. Essentially, one can sell anything they want at any price. However, in reality, there is no such economic system.

Import/export taxes and other restrictions such as age limits are barriers to a free market.

As a whole, capitalist economies, which are established by most democracies, including the United States, are mixed systems combining free market and command economies

Characteristics of a Free Market

A free-market economy is characterized by the following:

  • Private ownership of resources

Free economies exist because most resources are owned by individuals or private companies, not the government. 

The owners, therefore, control the means of production, allocation, exchange of products, and labor supply.

In a free-market economy, financial institutions are crucial. Banks and brokerages exist so that individuals and companies can exchange goods and services and make investments. 

The financial institutions then make a profit by charging interest or fees.

  • Freedom to participate

In a free-market economy, anyone can participate. Producing or consuming a product is entirely voluntary. 

A company or person can produce or purchase as much or as little of a product as they want.

Benefits of a Free Market

A lack of government influence allows companies and individuals a wide range of freedom.

  • Freedom to innovate

Entrepreneurs can develop new ideas based on consumer needs in a free market economy. 

They can offer new products and services whenever they want. Entrepreneurs rarely rely on government agencies for consumer information.

Entrepreneurs identify popular trends based on their research. Innovation among private companies can lead to competition as each firm tries to improve its products based on its features.

  • Customers drive choices

Here consumers decide which products succeed and which fail. When consumers have a choice between two products, they evaluate their features and choose the one that offers the best value for money.

Also, the consumer has a great deal of influence over the price set for a product. Therefore, producers need to strike a balance between a price point that will earn them a profit and affordable for the average customer.

Drawbacks of a Free Market

Despite its benefits, a free economy also comes with a few drawbacks:

  • Dangers of profit motives

Some producers are driven only by profits in free-market economies. A business's primary goal is profit, but workers' and consumers' needs always come first. 

A company shouldn't ignore environmental standards and ethical conduct to make supernormal profits.

In the early 2000s, companies such as WorldCom and Enron were guilty of unethical behavior. 

In 2010, the Deepwater Horizon oil spill, one of the worst environmental disasters in US history, occurred because the company used substandard cement and other cost-saving measures.

  • Market failures

A free-market economy can sometimes spiral out of control. The Great Depression of the 1930s and the 2008 real estate crash are examples of market failure. 

Market failures can lead to devastating outcomes such as unemployment, homelessness, and lost income.

Researched and authored by Saif Ali  | LinkedIn
Reviewed and Edited by Parul Gupta | LinkedIn

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