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The model employed here assumes that US tariffs will raise prices for American consumers and for producers who import intermediate inputs from China, and that Chinese tariffs will disrupt the supply chains of US exporters and producers. Several studies and news reports indicate that these effects are already happening for American consumers and businesses.
The model projects that in the next three to five years and beyond, US and Chinese industries will adjust, diverting trade to other markets, and other countries will divert exports to US and Chinese markets to fill the void. US agriculture and manufacturing will lose, while Chinese manufacturing will gain, expanding production and trade. In terms of aggregate welfare, which is measured by the total of all goods and services available in the economy (also known as “aggregate final demand”), both countries lose, although the magnitudes of the losses are small.
By contrast, the “winners” are all other countries that benefit from shifts in markets and world prices. In addition, the analysis indicates that imposing more tariffs on China, as President Donald Trump has threatened, would exacerbate all these effects.
These main conclusions do not account for several factors that could worsen the outlook for the United States in particular. There could be shocks to various asset markets, for example, as well as increased uncertainty that suppresses investment on all sides. In addition, China has lowered tariffs on imports from countries other than the United States, a step that could inflict more harm on US exports than this model shows.
Two scenarios are considered here: The first includes the tariffs in place on $250 billion worth of imports by the United States under Section 301 of the US Trade Act of 1974, and by China on $110 billion worth of imports from the United States, which were imposed in retaliation for the Trump administration’s tariffs. This status quo (as of June 1, 2019) was confirmed at the meeting between President Trump and President Xi Jinping of China in Osaka on June 29. The second scenario adds Trump’s threatened but not yet implemented tariffs on nearly all remaining imports from China, with no further retaliation by the Chinese. Trump held this threat in abeyance after his session with Xi in Osaka, but it remains a weapon Washington could wield.
Under both scenarios, US exports to China and total US exports fall. Diversion of US exports to other markets only partially offsets the overall decline. China, on the other hand, is more successful at diverting exports to other markets, increasing its total exports. Other US trading partners are projected to divert exports to the US market, largely compensating for the loss of Chinese goods. A tiny decline in global trade occurs under the first scenario and slightly more in the second.
Both the United States and China lose welfare in both scenarios, with a larger percentage and absolute loss for China. But these losses are very small as markets adjust to the changes. All other countries gain welfare, benefitting from diversion of trade and changes in world prices. Direct and indirect effects cause a tiny improvement in Chinese GDP and a slight decline in US GDP. In the second scenario, the United States gains from changes in world prices in its favor, but they are not large enough to offset the GDP loss. [...]