GED STUDY: How Could U.S. Protectionism Impact Global Trade?

The inauguration of Donald Trump as President of the United States has raised the risk that U.S. trade policy could increasingly adopt protectionist measures. In a former blog post we discussed the theoretical effects of such a policy. Now we are able to present the results of simulation calculations which quantify the possible long-term effects of a withdrawal from the North American Free Trade Agreement and a general economic isolation of the United States from the rest of the world. Simply click on of one of the downloads above for the full version Study or Focus Paper versions of our findings or continue with this blogpost for a brief overview of the main results.

Some methodological remarks

The calculations were prepared with the simulation model of the ifo institute (Munich). It involves a static, general equilibrium model for international trade. Trade flows are influenced by customs duties and non-tariff trade barriers (e.g. technical requirements, documentation obligations, etc.), among others. The model covers 43 individual countries and the rest of the world.

The results of the calculations are to be interpreted as follows: The starting point is the economic actual situation in 2014 (base year). In each case, the scenarios calculate a hypothetical situation for the world in which various protectionist measures are implemented. Consequently, an alternative world will be modelled for 2014 in which all the framework conditions are identical with the exception of protectionist measures adopted. The protectionist measures increase the costs of cross-border trade.

The adjustments companies and consumers make to the change in trade costs have effects on the trade flows and the production structure. These effects have consequences for income per capita and gross domestic product (GDP). In this model, both indicators do not include customs revenue. Since monetary aspects are not included in the model, the metrics involve real figures.

In reality, an adjustment to a change in trade costs takes time. Experience with existing free trade agreements shows that a dismantling of trade barriers requires 10-12 years to have its full impact. It is therefore plausible to assume that the reintroduction of trade barriers would also entail an adjustment period. Hence, the changes in real income per capita and real GDP have to be interpreted as long-term losses or gains resulting from the application of protectionist measures.

Withdrawal from NAFTA

In this scenario, it is assumed that the United States reintroduces trade barriers in the North American free trade zone. The amount of the import duties collected by the United States from Canada and Mexico corresponds to the customs duty rates that apply to all members states of the World Trade Organization (WTO). The amount of non-tariff trade barriers corresponds to the costs that were eliminated in the regional free trade agreements concluded to date and are now reintroduced.

The increase in trade costs for imports from Canada and Mexico to the United States changes trade flows within all countries of the model. Changes in trade flows and the associated adjustments in the production of goods and services have an impact on the annual real income of citizens. Real per capita annual income would for example fall by roughly US $125 in the long run in the United States. Only in Canada the loss of income would be greater at roughly US $730 per resident. Many other countries could even gain slight advantages if there is a decline in cross-border trade between the United States, Canada and Mexico. The corresponding increases in income would be hardly noticeable, however (see figure 1).

Protectionist U.S. Trade Policy with Respect to the Rest of the World

In another scenario, we assume that the United States adopts protectionist measures against all WTO countries. This case assumes a 20 percent increase in all customs duties. If a certain product is currently subject to five percent import duties, the customs duties in this scenario rise by 20 percent and are therefore six percent. Individual higher increases in customs duties are being discussed for selected countries. But since this scenario involves a measure that affects all countries, a conservative rise in customs duties is applied.

In addition to this, we also assume a 20 percent rise in existing non-tariff trade barriers. In the study, we work with four sub-scenarios:

1. 20 percent increase by the United States in customs duties on imports.
2. 20 percent increase by the United States in customs duties on imports and also a 20 percent increase in customs duties by all WTO countries on imports from the United States as a countermeasure.
3. 20 percent increase by the United States in customs duties on imports and non-tariff trade barriers, respectively.
4. 20 percent increase by the United States in customs duties on imports and non-tariff trade barriers, respectively, and also a 20 percent increase in customs duties on imports and non-tariff trade barriers, respectively, by all WTO countries for the United States as a countermeasure.

The largest economic damages for all countries arise in the fourth sub-scenario. In that case, long-term loss of real annual income per capita in the United States would be US $1,300. In Canada it would be roughly US $1,800 less (see figure 3). A loss of income in the amount of roughly US $160 per resident would be expected for Germany. No individual country could see rises in income in this scenario.

Summary and Outlook

The results of the simulation calculations show that the U.S. administration’s plan to secure jobs and prosperity in the United States through protectionist measures is a fallacy. In the long run, all measures examined would have a negative impact on the U.S. economy and lead to losses of real income per capita and GDP. Above all in the likely case that the countries affected by the trade-restricting measures would also introduce protectionist trade measures for the United States, there would be a very high loss for the U.S. economy.

And things could to be even worse: The simulation model does not take into account dynamic effects and the parameters applied are conservative in nature. For this reason, these results represent the lower bound of the long-term impact that a protectionist U.S. trade policy would have on income and production.

Hence the U.S. government should generally distance itself from the threatened protectionist trade policies in its own interests. The withdrawal of the border adjustment tax, which is also analysed in the study, is a first step in the right direction and shows that the U.S. government under Trump is not acting without economic reason.