Thread

Excuse the title, /r/economics is driving me nuts. Also, I tried to outline all my assumptions here. (Key word: tried)

R1:

The thread is on an article titled China Would Outlast U.S. in Trade War, Billion-Dollar Fund Says. This isn't particularly bad, but it's a little misleading to approach the thread with this title in mind.

Firstly, what is a trade war? Well, without any fancy econ terms, let's start with an actual war. In an actual war, there's generally a number of states with a victor at the end, which usually gets the spoils. Much confusion about trade wars stems from assuming this is applies to trade wars as well. Again, without any fancy econ terms, we can describe a trade war as a bunch of people banging their heads against a wall where the winner is defined as the last person not to give up. It's important to keep this in mind when saying a country will "outlast" another in a trade war. There are no "spoils" that go to the victor, maybe just a concussion; even more simply, the economy is not zero-sum but does go up/down, and trade wars make it go down.

The top comment of the thread states:

This opinion makes no sense. Sounds like someone is being paid to give it. Less then 30% of China's GDP is tied to internal consumption. Their main export partner is the US. A trade war would result in their economy seizing up, massive job losses, social upheaval and ofcourse their massive credit bubble imploding at once. The US on the other hand would see the opposite. It would see massive job growth as industry moved back. No job losses. No social upheaval. It would be a boon.

This is literally zero-sum thinking. First, let's start with the short-term effects of a trade war.

• Exports will decrease: This is because in a trade war, we can expect both sides to put up tariffs. Regarding the graph, the reason the price after tariffs seems lower is because that's the new price US exporters must face. That is, suppose the world price is $110 and a 10% tariff is implemented; an exporter must then sell their goods for $100 dollars if their customers still will only pay $110. It's a bit more complex than this and a more detailed explanation on this be found here. Given that 7.7% of the US's exports are to China and China is our 3^rd largest goods export market, one could say we export a significant amount to China. If we have a trade war, we would see a reduction in the quantity of US goods supplied to foreign markets, due to tariffs the Chinese would impose on our goods. The reason it would be a reduction of exports to foreign markets and not just Chinese markets is because the Chinese already offer the highest price for our goods. If they implement a tariff, we have to either face the tariff or find a different country that will inevitably offer less money; this must occur because if a country was currently offering more than the Chinese for our goods, we'd already be exporting to them. This is why the blue line is labelled "world price after tariffs" since that's the best price possible to get in the world after the tariffs are implemented. In short, a trade war will result in all US-to-China exporters having to deal with a lower world price and thus will export a lower quantity into the world markets.

• GDP will decrease: Output is defined as Y = C I G NX. The reason we have net exports here is to discount imports from being included in the gross domestic product. That is, changes in imports, cet par, have no effect on the GDP. However, looking back to the graph of exports, notice that the total quantity produced by our suppliers actually goes down; thus, we see AD fall. Additionally, due to reduced availability of cheap Chinese goods, we would see a price shock, which causes AS to fall. As a result, of AD falling and AS falling, we would see short-run output decrease.

• Same for China: For the exact same reasons as detailed above, we'd see the same problems occur in China. Tariffs on Chinese goods will cause their exports to fall, and general trade restrictions will cause their output to fall in the short-run. So, the two largest exporting countries in the world will contract at the same time. As Krugman says here:

All of this says that while China itself is in big trouble, the consequences for the rest of us should be manageable. But I have to admit that I’m not as relaxed about this as the above analysis says I should be. If you like, I lack the courage of my complacency. Why?

Part of the answer is that business cycles across nations often seem to be more synchronized than they “should” be. For example, Europe and the United States export to each other only a small fraction of what they produce, yet they often have recessions and recoveries at the same time. Financial linkages may be part of the story, but one also suspects that there is psychological contagion: Good or bad news in one major economy affects animal spirits in others.

The short-run impacts can be mitigated with fiscal and monetary policy, which can be used to shift the AD curve. It'll be tough since we're still around the ZLB and there won't be much fiscal space given Trump's economic policy. Now, if this trade war lasts, we'd see the long-term impacts:

• Loss of Welfare for Both Countries: The key take away from this is that, with trade, both countries can consume a more preferable amount of goods they import AND export; whether we import/export good X or good Y on this graph, it doesn't matter, because both countries are better off. Here's what we export to China and here's what we import from China; all of these things we are able to acquire a more optimal amount of because we can trade them. Again, it doesn't matter whether we export them out or import them in, trade allows us to go past our PPF and allows both countries to consume a larger aggregate amount; a simple example here. A long-term trade war prevents us from achieving greater welfare by limiting trade; although there are tariff amounts that may improve national welfare, a trade war will generally go past this point. Even if China finds someone else to export to or if the US finds someone else to import from, the terms of trade will be worse for both countries. So, both the exporter and the importer lose out in terms of welfare since their PPF in a trade war will fall.

• Return to Natural Rate of Unemployment: In the long-run, free trade or autarky has no effect on reaching full employment due to the self-correcting mechanism. And, in the short-run, central banks tend to stabilize employment around NAIRU anyways. There won't be "massive job loss" or "massive job growth" as OP describes in either country; there will be changes in sectoral employment, however.

In total, both countries have a lot to lose. However, I doubt /r/economics will ever stop exporting reasons why we're #winning.