From Protection to Retaliation: The trade war effect

Abstract:

This paper explores the welfare costs of trade impediments imposed during Trump’s presidency. These crucially depends on the accurate identification of trade elasticities—the import demand elasticity and the inverse export supply elasticity. I propose a novel instrument to identify these: retaliatory tariffs imposed on sectors different from those targeted by the trade partner. Under WTO rules, countries must match the tariff rate imposed by the trade partner but can choose which products to target. By focusing on price-elastic goods, countries maximize punishment by driving away demand from foreign competitors. Using 2018 Canadian retaliation against the U.S., I estimate an inverse export supply elasticity of zero and an import demand elasticity of 5.2, significantly higher than the commonly reported value of around 2.5. This suggests that trade policies tend to target extremes of the elasticity distribution: revenue-raising tariffs on inelastic goods and retaliatory tariffs on elastic goods. By constructing an interval for the average demand elasticity between 2.5 and 5.2, I estimate the U.S. welfare costs to range between $11 and $22 billion, potentially doubling prior estimates.