A trade war is a concept describing the relationship between two or more countries which purposely impose a variety of trade disadvantages upon each other to limit the effects of trade and usually arises from a misunderstanding of the benefits of free trade or a political power play.
Countries negatively affected by free trade will often use protectionist measures against lower priced imports threatening domestic producers; counter-action is taken by rival countries. The economic effects of such policies include decreased levels of imports and exports, damaged industries and higher unemployment rates. The political effects include WTO sanctions and disrupting relations with other countries.
The most common trade war is observed in the China currency war, as China increases a tariff or quota on a certain import, and (as a reactionary measure) the other country does the same. This situation is detrimental to both consumers and countries uninvolved in the trade war because prices generally increase. In the case of subsidies, exports become artificially cheap harming the industry of domestic competitors.
Poor countries are more prone to the negative effects of trade wars since they lack the financial capabilities to respond with counter measures. Furthermore, trade within a narrow basket of goods makes them more vulnerable.
China Currency War
China currency war derives from currency manipulation whereby countries will devalue their currencies to reduce the overall price. By making the other country’s currency appreciate relative to your own, you can have a clear price advantage for exporting goods.
This method has several severe disadvantages, as it damages the purchasing power of the citizens by increasing the price of imported goods and services. Furthermore, China currency war can lead to a drastic reduction in prices–the proverbial race to the bottom. However, both internal and external effects lead to inflation.
The reason why all roads lead to inflation is that exchange manipulation requires government control of some sort. Since currency valuation depends on the availability of the currency in the international market (the more there is the cheaper the currency), a government is required to either buy another country’s currency (take it out of the international market) or inject its own currency into the market.
Manipulating the value of a currency might be tempting, but currency wars are very costly in the long run.
Removing other countries currency is very expensive and typically leads to a capital account problem in the long-term. Unlike purchasing another country’s currency (which gives the currency seller more money), injecting your own currency into the international market adds no value to the global ecosystem.
In the end, devaluation will lead to increased import prices. Under some circumstances, governments will compound problems restricting the outward flow capital, leading to overinvestment in industries inflation resistant.
America and China have lobbed accusations against each other since 2008, claiming (behind closed doors) that the other was a currency manipulator: America through its quantitative easing (QE) program and China through purchasing other countries’ currencies.
China Customs War
A customs war – better known as a tariff war – is when a conflict between two countries involving raising taxes and tariffs. This is by far the most common kind of trade war, since its effects are usually limited to certain industries and counter measures usually also remain limited to a specific industry.
China has regularly been accused of accessing foreign markets through penetration pricing (the act of pricing their exports extremely low). For instance, a country may implement various export subsidies to encourage exports such as tax discounts, cheap financing or direct subsidies.
In reaction, foreign countries will implement a high tax on these exports, or even outright ban them. Recently these accusations were mainly connected to the steel industry and related industries of China that suffer from overcapacity.
Counter measures were enacted by introducing high tariffs against these products by the EU and the US. The US, for instance, imposed a 256% tariff on Chinese steel. A recent example for a non-tariff restriction conflict can be seen between South Korea and China: China currency war has led to 26 non-tariff imposed against South Korea; the country with the next largest number of restrictions is Indonesia with 5.
Unfair export subsidies are often treated as trade secrets by connecting them to other tax discounts or similar.
The World Trade Organization (WTO) was created to try and encourage free trade between countries, as well as acting as a mediatory body between two countries that are having a dispute. With the majority of countries in the world, custom wars are generally not a common occurrence. Accusations arise frequently especially against China: China has been regularly accused of China currency wars.
The WTO has regulations in place with special provisions for China. For example, if a country makes an accusation against China for unfairly “dumping” products in their country, they do not need market prices for the products from China to support their cause. Instead they are able to use prices from other nations like India to support their claim.