Who is paying for the trade war?

So far, US firms have absorbed much of the cost. More pain for consumers may be coming.

Credit: Gary Neill

Brian Wallheimer | Oct 19, 2020

Sections Economics Public Policy

Collections Trade

US president Donald Trump’s goal of lowering the American trade deficit kicked off a tit-for-tat tariff war with Canada, the European Union, and, most prominently, China. The United States imposed tariffs of 10–50 percent on about $326 billion of annual imports from China, including washing machines, solar panels, aluminum, and steel. China retaliated, slapping its own tariffs on US automobiles, airplanes, and soybeans, among other items. 

Two years in, has the US avoided damage from this trade war? No, suggests research by Harvard’s Alberto Cavallo and Gita Gopinath, Chicago Booth’s Brent Neiman, and the Federal Reserve Bank of Boston’s Jenny Tang

US consumers may be unscathed by a trade war if foreign suppliers reduce the prices of their goods by the same amount as the US-imposed tariffs. For example, imagine the US levied a 25 percent tariff on Chinese steel, and Chinese steelmakers responded by reducing steel prices by 25 percent to keep their products competitive. In this hypothetical scenario, the burden of the tariff would fall entirely on China in the form of reduced profits, with US importers paying the same price and the US government earning more revenues.

If, instead, Chinese steelmakers left their prices unchanged, the steel would simply become 25 percent more expensive for US buyers. Facing an increase in their costs, firms in the manufacturing and retail sectors would have to either raise prices for their consumers or accept thinner profit margins.

In fact, Cavallo, Gopinath, Neiman, and Tang find that foreign producers didn’t lower their prices much at all in response to the Trump administration’s tariffs. The researchers analyzed Bureau of Labor Statistics data on the prices of goods coming from countries with the new tariffs and tracked those products to store shelves. As of this past April, the tariffs hadn’t forced China or other countries to lower prices significantly, and the data show that American retailers were bearing the brunt of the taxes, at least in the short run.

The researchers estimate that foreign companies dropped their prices only about 1 percent in response to a 20 percent US tariff. That left 19 percent for US importers to pay. US-based exporters, however, had to lower their prices by about 5 percent on goods subject to a retaliatory tariff of 15 percent, they find. 

The research suggests the asymmetric response of US import prices and US export prices reflects differences in the types of goods targeted by the tariffs. US companies may have few places to look for alternatives to the Chinese products they import, which means Chinese suppliers may not face competitive pressures to lower prices to offset tariffs. But China does have alternative sources to the US for soybeans, for example, which puts US suppliers under greater pressure to lower prices.

The impact of these rising import costs on consumer prices has thus far been mild, the researchers find. They used data from two major multichannel retailers to estimate that a 20 percent tariff resulted in only a 0.7 percent increase in the prices of affected products, meaning the merchants were absorbing much of the higher tariff by realizing thinner profit margins.

Importers can avoid charging higher prices or dampening their profit margins by sourcing goods from nontariffed countries, and that seems to be happening, the researchers write. China’s share of tonnage shipped to those retailers before the tariffs was 80–90 percent, according to the study, but the share dropped to 60–70 percent after the tariffs. 

There’s also evidence that between the time Trump announced the tariffs and the time they went into effect, US importers front-loaded their purchases to beat the new duties. As retailers work through inventory and restock goods that are subject to the tariffs, they may have to increase prices to shore up profit margins, the researchers speculate. The trade war may yet hit the US consumer even harder.