The world is walking into a global trade war. Political leaders in China, the United States, and Europe are abandoning the principles of comparative advantage and free trade. Instead, they are embracing tariffs, import quotas, and silent protectionist policies to curry favor with their respective voters.
China is by far the most egregious violator of free trade norms. China subsidizes the production of goods that it sees as strategically important, and it protects domestic production from foreign competition which offers superior value. The chairman of the Chinese Communist Party, Xi Jinping, has stated that lithium-based batteries, electric vehicles, and the solar power sector are “pillars of the Chinese economy.” China provides these industries with cheap capital and in many cases free land.
China also subsidizes important basic industries such as steel and aluminum. China now has significant excess capacity in the mentioned industries. In violation of the norms of the World Trade Organization, China exports that excess capacity into the global market.
Now China is focusing on the global semiconductor industry. China lags behind the U.S. in semiconductor technology but is competitive in commodity semiconductor markets. China is in the early stages of flooding the global market with commodity chips. U.S. semiconductor companies like Micron are being directly harmed by China’s mercantilist trade policies. The U.S. response to China’s push into basic semiconductors is woefully deficient.
In some sense, the U.S. does not have clean hands here. Former President Donald Trump embraced protectionist trade policies during his one term in office. During his administration, the average tariff on Chinese imports into the U.S. increased from 3% to 20%. China responded to Trump’s tariffs by reducing imports of U.S. agricultural products where the U.S. has a clear comparative advantage. That said, China is a deadly adversary of the U.S., and because China violates the rules of the WTO, the U.S. is correct to engage in protectionism against China.
Under President Joe Biden, the tariffs against China remain in place. But Biden, through green subsidies embedded in the Inflation Reduction Act and through quotas on the import of European-sourced steel, violates international trade law and causes Europe to respond with its own protectionist trade policies.
On Oct. 1, 2023, the European Union introduced its Carbon Border Adjustment Mechanism. Under CBAM taxes, tariffs will be imposed on imports of iron, steel, aluminum, cement, electricity, fertilizers, and hydrogen. U.S. exporters will be harmed, and the U.S. will respond if the tariffs are indeed imposed. Fortunately, the CBAM protocols do not take effect until 2026.
Top line: in a global trade war, everyone loses. Consumers lose, nations lose. Consumers pay more for goods and services produced more efficiently in other countries. Resources are misallocated. Under the iron economic law of comparative advantage, the U.S. is better off economically when it produces the highest-value goods and services and imports lower-value goods and services. With protectionism, scarce resources are diverted from the higher-value goods and services to lower-value products. The U.S. economy is harmed.
But politicians embrace protectionist trade policies because voters like tariffs and quotas. Voters do not understand that the negative effects of protectionism are spread widely while the benefits are narrow. Sadly, trade wars are not new. In 1930, Congress passed the Smoot-Hawley Tariff Act. It was intended to help farmers and businesses. Instead, it deepened the Great Depression.
Again, everyone will ultimately lose in a global trade war.
James Rogan is a former U.S. foreign service officer who later worked in finance and law for 30 years. He writes a daily note.