Supply Chains and Trade War (Very Wonkish): ...last month the IGM Forum weighed in on the issue of supply chains and trade war — the issue that the current trade war, unlike previous trade conflicts, is taking place in a world where much trade consists, not of shipments of consumer goods, but of shipments of inputs used in production. The panelists more or less unanimously agreed that the prevalence of global supply chains increases the cost of trade war. But is the consensus right?
Well, although I yield to nobody in condemning the stupidity and corruption behind Trump trade policy, I’m a bit skeptical about the supply chain concern. Or maybe the best way to say this is that there are three possible stories about how supply chains might increase the costs of trade war, and while two of them are right, I suspect that many economists are buying into the third, which isn’t.
So, what difference does a supply-chain trading system make?
One thing it does is create the possibility that protectionism will be bad mercantilism — that even in its first-round effects it will actually destroy more domestic jobs than it creates, because it creates a competitive disadvantage for domestic downstream producers. ...
Another thing the rise of global supply chains has done is to increase both total trade and the gains from trade. As a result, there is more to lose from a trade war than there was a generation ago.
But what I think many economists have in mind is something more than that.
Standard trade theory tells us that the costs of a tariff — the reduction in real income — may be calculated, approximately, as
Real income loss = 0.5*tariff rate*reduction in imports
This formula suggests only moderate costs even from a major trade war. Suppose that worldwide tariff were to rise to 40 percent, and world trade were to fall by 15 percent of world GDP, a 50% reduction. Even so, world real income would fall only 3 percent.
Now, what I think many economists are suggesting is that this kind of analysis understates the losses when much of that trade is in intermediate goods. But I’m pretty sure they’re wrong, at least in the medium to long run.
Let me sketch out a model here....
That said, a trade war in a supply-chain world would cause a lot of disruption, because it would lead over time to a major restructuring of industry. This would create a lot of losers, as well as some winners, perhaps more than a trade war would have in the past. But I don’t think the notion that the total loss in real income would be bigger than conventional analysis suggests holds up. Trump’s policy moves are destructive, based on ignorance, but we shouldn’t overstate their cost.