Trade Wars

What is a Trade War?

A trade war is a diplomatic stance where one country raises its tariff on imports from another country. It is a way of discouraging purchases from the international markets, safeguarding the interests of local traders.

It often results in an imbalance between imports and exports of a nation. However, these policies promote domestic production, increase national employment, reduce the balance of payment, and create unfavorable conditions for the enemy nation. Trade wars are often an initiative against unfair trading policies.

Trade War Explanation

The trade wars are initiated by increasing the tariffTariffA tariff is levied by a government on the import of goods or services from another country. The charges increase government revenue, restrict trade with other countries, and protect domestic manufacturers from stiff competition.read more on imports from another country. The motives could be logical or hostile. A war erupts when the target country also retaliates by obstructing cross-border trade. This could be in the form of increased tariffs or any other action which indirectly affects the enemy nation.

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The history of trade wars can be traced back to the 17th century when the colonial powers went against each other to control the overseas sale of goods. The Opium Wars of 1839 and 1842 are also similar examples. In 1930, the US government passed, The Smooth-Hawley Tariff Act to safeguard the interest of their farmers. The increased tariffs were aimed at European agricultural products.

Similarly, in -1962, there was a Chicken war. The US was up against West Germany, France, Belgium, Italy, Netherlands, and Luxembourg, who increased tariffs on US-bred chicken. In the 1980s, the US and Japan waged the automobile trade war to improve American automobile and electronics manufacturing industries.

Trade wars affect the global economy as it directly or indirectly impacts other connected countries. They can result in a worldwide recession. However, it can be solved unilaterally. Alternatively, the countries can involve the World Trade Organization to settle or restrict unfair trade practices.

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Video Explanation of the Trade War

Weapons of Trade War

It is a non-violent form of retaliation; the weapons used for fighting the trade wars include:

1. Tariffs: The Government imposes heavy taxes and duties on imported goods. By doing so, the government promotes products from the domestic market over the international market. 
2. Embargoes: An embargoEmbargoAn embargo is a political decision taken by countries where the government passes an order to restrict the free trade of goods & services between two nations for a specified period and may include restricting all types of goods & services or trading of particular interest like oil.read more is an extreme step where a nation prohibits the purchase of certain goods from another country. It is a ban on import-export of specific commodities.
3. Import Quotas: It is another trade war tactic where the nation imposes a particular limit on imports from the target country. Again, this is a step toward promoting local manufacturers. Domestic manufacturers can potentially capture the market, replacing foreign products.
4. Subsidies: To promote production and exports, the government offers subsidiesSubsidiesA subsidy in economics refers to direct or indirect financial assistance from the government to an individual, household, business, or institution to promote social and economic policies.read more to the local manufacturers. Goods become economical and domestic production is ramped upRamped UpRamp Up in economics refers to the boosting of a company’s production.read more.  
5. Currency Devaluation: Some nations devalue their currencyDevalue Their CurrencyCurrency devaluation is deliberately done in order to adjust the established exchange rates by the government and it is mostly done in the cases of fixed currencies. This mechanism is used by economies with a semi-fixed or fixed exchange rate, and it should not be confused with depreciation.read more value to reduce exchange rates. This move makes the export of goods and services more economical for the the country’s allies. Besides, it discourages imports by making them costly for the domestic consumers.

Trade War Example

The “banana wars” is the culmination of a six-year trade quarrel between the US and the EU. The US complained that an EU scheme broke free trade rules. Allegedly, the EU gave Caribbean banana producers special access to European markets

Back in 1993, Europe levied heavy import duties on the cross-border purchase of Latin American bananas from African and Caribbean nations. It caused a considerable loss to the Americans engaged in the cultivation and export of bananas.

The US filed a complaint against the EU with the World Trade Organisation (WTO). In 1997, the US won, the EU was instructed to alter its rules. As a result, the tariffs on each tonne of Latin American bananas were gradually reduced from 176 euros to 114 euros.

Causes

Trade wars are either strategically planned or abrupt decisions of a nation’s government. It is initiated for the following purposes:

#1 – To Protect Domestic Economy

One of the primary reasons for initiating a trade war is to support domestic manufacturers. Often local firms cannot compete against international competition.

#2 – To Create Employment Opportunities in Domestic Country

The governments check imports to reduce unemployment and improve living standards.

#3 – To Safeguard a Nation’s Intellectual Property

If intellectual property rights, trade, or other secrets are infringed, the government restricts imports.

#4 – To Reduce Balance of Payment Differences

In order to protect the country, either the tariffs are increased or imports are restricted. This is done when exports are less than imports. Such a trade deficit results in the devaluation of the currency.

#5 – To Develop Unfavourable Conditions by restricting exports

When two nations are at war, raising tariffs on export can cause unfavorable conditions for the enemy country. This is done when the enemy country largely depends on imports.

#6 – Diminish Trade Deficit

Reducing the trade deficitTrade DeficitWhen the total sum of goods or services that a country imports from other countries is higher than the total sum of goods or services that a country exports to other countries, this is referred to as a trade deficit, which is the opposite of the balance of trade theory.read more improves the stability of the economy. When the total import from outside is higher than total exports, it is called a trade deficit. This is because countries make profits by exporting and selling and want to minimize purchases.

In order to reduce the deficit, the government restricts imports from outside. But, again, the motive is to ensure that the domestic products meet the local needs.

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Effects of Trade War

Let us now understand the consequences of a trade war:

On Global Economy

The global economy may suffer a worldwide recession, as explained below:

1. Global Price Rise: When tariffs on imports increase, exports depending on those raw materialsRaw MaterialsRaw materials refer to unfinished substances or unrefined natural resources used to manufacture finished goods.read more also become expensive. As a result, these products become too expensive in the international market.
2. Increase in Inflation: The upsurge in prices results in global inflation. This can potentially cause a recession. Share prices could plummet, impacting international markets.
3. Threat to Global Economy: In a cold war between two countries, the supporting nations may also restrict imports from the common enemy. This can seriously impact global economy.
4. Slows the Economic Growth: War between two nations hinders the economic growth of the affected countries as well. Raw materials are not always available locally. During the war, raw material becomes expensive or inaccessible; this is what causes an economic downturn.
5. Fall in Global Stock Market: When the world’s largest economies are engaged in trade wars, it affects international markets. There is a worldwide slump.

On Domestic Economy

These wars affect local businesses, citizens, lifestyles, earningsEarningsEarnings are usually defined as the net income of the company obtained after reducing the cost of sales, operating expenses, interest, and taxes from all the sales revenue for a specific time period. In the case of an individual, it comprises wages or salaries or other payments.read more, and employment. Following are the consequences faced at a domestic level:

1. High Cost of Raw Material: If the local companies import raw material from an enemy nation, then a high import tariff can increase the cost of productionCost Of ProductionProduction Cost is the total capital amount that a Company spends in producing finished goods or offering specific services. You can calculate it by adding Direct Material cost, Direct Labor Cost, & Manufacturing Overhead Cost. read more.
2. Poor Quality and Expensive Products: In the absence of foreign competition, the local customers are with fewer options. They now have only domestic manufacturers and might have to compromise on quality. Despite the dip in quality, prices can rise as the domestic sellers now have a monopoly.
3. Lack of Employment Opportunities: It may result in jobs loss and affect the economyEconomyAn economy comprises individuals, commercial entities, and the government involved in the production, distribution, exchange, and consumption of products and services in a society.read more, mainly affecting the companies chiefly dependent on imports.
4. Results in Inflation: Since the local product prices go up, there is a risk of inflationRisk Of InflationInflation Risk is a situation where the purchasing power drops drastically. It could also be explained as a situation where the prices of goods and services increase more than expected. Inflation Risk is also known as Purchasing Power Risk.read more.

Frequently Asked Questions (FAQs)

Recommended Articles

This has been a guide to what is trade wars & its definition. Here we explain how trade wars impact the economy along with its causes, effects and examples. You can learn more about economics from the following articles –

• Real GDP Per Capita
• Net Importer
• Net Exports
• Non-Tariff Barriers
• Duty vs Tariff