Professor Nuno Limao on Trade War Threats and the Value of Agreements
In March 2018 the U.S. president announced plans to impose tariffs of 25% on steel and 10% on aluminum on all countries, and then added that “trade wars are good, and easy to win”. This has translated into tangible stock market declines. But even if the U.S. steps back from the brink its actions are already undermining the credibility of the world trade system, as anticipated last year by Professor Limão and former UMD student, Kyle Handley, in “Trade under T.R.U.M.P. policies.”
This heightened U.S. trade policy uncertainty can have high costs for U.S. consumers. In “Policy Uncertainty, Trade and Welfare: Theory and Evidence for China and the U.S.” Professors Handley and Limão show that China’s accession to the World Trade Organization reduced U.S. policy uncertainty and thus generated significant benefits for U.S. consumers. Moreover, they calculate that even a modest increase in the probability of high protection by the U.S. against all its partners is equivalent to one third of the cost U.S. consumers would face if all imports were banned.
The announced steel and aluminum tariffs lead other countries to threaten retaliation and will increase the uncertainty U.S. exporters face in foreign markets. Canada, South Korea and Mexico are three of the four most affected steel exporters. These countries have preferential trade agreements (PTAs) with the U.S. and are typically exempt from such measures. The lower uncertainty associated with PTAs is one reason why they lead to new exports to these markets that have considerably increased trade integration (Limão, 2016).
The ongoing U.S. renegotiation of these PTAs and its threat of a trade war is increasing the uncertainty that U.S. exporters will face in foreign markets. Professor Limão and two UMD former students, Jeronimo Carballo and Kyle Handley, show how U.S. exporting firms (and thus its suppliers and workers) are hurt by foreign uncertainty, particularly in a global economic crisis. In “Economic and Policy Uncertainty: Export Dynamics and the Value of Agreements”. They find that the interaction of foreign income and policy uncertainty exacerbated the reduction in trade in the 2008 crisis—a period when the threat of a global trade war was widespread. These effects were mitigated by U.S. PTAs that provided insurance against adverse policy shocks when demand volatility increased.