How to Lose a Trade War

By Paul Krugman

Opinion Columnist

• July 7, 2018

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President Trump talking about fair trade at the Group of 7 summit last month.CreditDoug Mills/The New York Times

Trump’s declaration that “trade wars are good, and easy to win” is an instant classic, right up there with Herbert Hoover’s “prosperity is just around the corner.”

Trump obviously believes that trade is a game in which he who runs the biggest surplus wins, and that America, which imports more than it exports, therefore has the upper hand in any conflict. That’s also why Peter Navarro predicted that nobody would retaliate against Trump’s tariffs. Since that’s actually not how trade works, we’re already facing plenty of retaliation and the strong prospect of escalation.

But here’s the thing: Trump’s tariffs are badly designed even from the point of view of someone who shares his crude mercantilist view of trade. In fact, the structure of his tariffs so far is designed to inflict maximum damage on the U.S. economy, for minimal gain. Foreign retaliation, by contrast, is far more sophisticated: unlike Trump, the Chinese and other targets of his trade wrath seem to have a clear idea of what they’re trying to accomplish.

The key point is that the Navarro/Trump view, aside from its fixation on trade balances, also seems to imagine that the world still looks the way it did in the 1960s, when trade was overwhelmingly in final goods like wheat and cars. In that world, putting a tariff on imported cars would cause consumers to switch to domestic cars, adding auto industry jobs, end of story (except for the foreign retaliation.)

In the modern world economy, however, a large part of trade is in intermediate goods – not cars but car parts. Put a tariff on car parts, and even the first-round effect on jobs is uncertain: maybe domestic parts producers will add workers, but you’ve raised costs and reduced competitiveness for downstream producers, who will shrink their operations.

So in today’s world, smart trade warriors – if such people exist – would focus their tariffs on final goods, so as to avoid raising costs for downstream producers of domestic goods. True, this would amount to a more or less direct tax on consumers; but if you’re afraid to impose any burden on consumers, you really shouldn’t be getting into a trade war in the first place.

But almost none of the Trump tariffs are on consumer goods. Chad Bown and colleagues have a remarkable chart showing the distribution of the Trump China tariffs: an amazing 95 percent are either on intermediate goods or on capital goods like machinery that are also used in domestic production:

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Is there a strategy here? It’s hard to see one. There’s certainly no hint that the tariffs were designed to pressure China into accepting U.S. demands, since nobody can even figure out what, exactly, Trump wants from China in the first place.

China’s retaliation looks very different. It doesn’t completely eschew tariffs on intermediate goods, but it’s mostly on final goods. And it’s also driven by a clear political strategy of hurting Trump voters; the Chinese, unlike the Trumpies, know what they’re trying to accomplish:

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What about others? Canada’s picture is complicated by its direct response to aluminum and steel tariffs, but those industries aside it, too, is following a far more sophisticated strategy than the U.S.:

Except for steel and aluminum, Canada’s retaliation seemingly attempts to avoid messing up its engagement in North American supply chains. In broad terms, Canada is not targeting imports of American capital equipment or intermediate inputs, focusing instead on final goods.

And like China, Canada is clearly trying to inflict maximum political damage.

Trade wars aren’t good or easy to win even if you know what you’re trying to accomplish and have a clear strategy for getting there. What’s notable about the Trump tariffs, however, is that they’re so self-destructive.

And we can already see hints of the economic fallout. From the Fed’s most recent minutes:

[M]any District contacts expressed concern about the possible adverse effects of tariffs and other proposed trade restrictions, both domestically and abroad, on future investment activity; contacts in some Districts indicated that plans for capital spending had been scaled back or postponed as a result of uncertainty over trade policy. Contacts in the steel and aluminum industries expected higher prices as a result of the tariffs on these products but had not planned any new investments to increase capacity.

So Trump and company don’t actually have a plan to win this trade war. They may, however, have stumbled onto a strategy that will lose it even more decisively than one might have expected.

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