What Could Happen in a Trade War?

New research predicts results of escalation in tariff battles

Released: 5-Aug-2014 10:00 AM EDT
Source Newsroom: University of Chicago Booth School of Business
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Citations American Economic Review

Newswise — What would have happened if a trade war had broken out after the Great Recession?

New research from the University of Chicago Booth School of Business lays out a framework for how to answer that question.

In his paper "Trade Wars and Trade Talk with Data," forthcoming in American Economic Review, Ralph Ossa, associate professor of economics, looks at tariffs that would be levied if there were no fear of retaliation; retaliatory tariffs in a worldwide trade war; and tariffs that are negotiated cooperatively.

Ossa said an interesting result he found is that we have already reaped most of the possible gains with tariff negotiation — if you compare the worst-case scenario of all-out trade war and the best-case scenario of perfectly smooth negotiations — and tariffs are relatively low.

What you have left are politically sensitive industries (for example, agriculture) and non-tariff barriers, like regulations.

Non-tariff barriers create opportunities for negotiation. "Now one thing you could achieve with such a trade agreement, for example, is to mutually recognize your standards," he says.

So if a car passes regulatory muster in the U.S., it also would in the European Union, and vice versa. The difficulty is reaching regulatory agreement among the 160 members of the World Trade Organization, or WTO.

There are two interpretations of the paper, Ossa writes: Either that the framework is a maintained hypothesis or a tested hypothesis. "In the former case, they can be viewed as answers to questions of immediate policy relevance. … In the latter case, they can be interpreted as suggestive of the plausibility of some of the leading models of trade policymaking."

A lot of Ossa’s thinking was inspired by the Great Depression, during which there was a full-blown trade war with crippling tariffs.

"And during the Great Recession, there was a lot of worry in the media that something similar might happen, that basically things might get out of control and we might end up in a trade war. I figured that we don’t really have any sense of what would actually happen in such a trade war other than the historical experience."

"Trade Wars and Trade Talk with Data" is a start, and Ossa hopes that others take the framework he has laid out and build off of it.

"Basically no one has made these calculations before, no one has taken the basic models of trade policy and tried to work out what the quantitative predictions are — if you calculated what the trade war would look like, what the ideal trade negotiations would look like if you worked it out," he says.

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