The world cannot afford a full-scale trade war
The idea of globalisation and free trade has gained prominence in the world over the past three decades. Despite some limitations, globalisation and free trade regime are seen as beneficial for economic development, poverty reduction, and enhanced integration among countries. Recently, with the emergence of a trade war between the US and its leading trade partners, especially China, the question appears to be whether globalisation has started walking in the opposite direction. It is true that until very recently, nobody had anticipated such an unprecedented event. After the formation of the GATT in 1948 and eventually with the emergence of the WTO in 1995, trade agreements and rules have prevented such a trade war. It is also important to mention that WTO rules have compelled even powerful countries to honour international agreements on trade rules. Needless to say, a trade war is not consistent with the global development initiatives such as the 2030 Agenda of Sustainable Development Goals (SDGs).
What would be the effect of this war between the US and its leading trade partners in the global market? The effect depends on how long this war will last and how intense it will get. Its effect can be both short- and medium-term and even long-term. In the short term, the imposition of substantial additional tariffs by the US on imports from its leading trade partners, especially China, and vice versa will significantly affect the volume of bilateral trade between them. This may lead to a rise in exports from some countries to the US, as the US would then seek cheaper imports from those countries. If the trade war continues in the medium to long-term and intensifies, with the involvement of more countries, there is a high risk of a global economic recession as the trade war would affect consumer demand in the major economies of the world, especially in North America and European Union.
In order to explore the effects of a large-scale trade war between the US and China, we have simulated a scenario using the global general equilibrium model, namely the GTAP model. This scenario considers a targeted 10 percent tariff on US imports from China and a targeted 25 percent tariff on China's imports from the US. The simulation results show that all major economies in the world would suffer export losses because of this trade war. The largest loss in exports would be for China as its exports would decline by 2.7 percent, which is equivalent to USD 61 billion. In case of the US, the export loss would be 2 percent, which is equivalent to USD 31 billion. The EU's export loss would be 0.14 percent, which is equal to USD 27 billion. Four major economies in South Asia would also experience a decline in exports. Bangladesh, India, Pakistan and Sri Lanka would encounter losses in their exports by 0.2 percent, 0.04 percent, 0.06 percent and 0.57 percent—which are equivalent to USD 72 million, 120 million, 13 million and 63 million respectively. It can be mentioned that the size of the aforementioned losses can grow if more countries get engaged in the trade war. All these might contribute to a prolonged global recession, which is not conducive to the attainment of SDGs by 2030.
It is, however, important to note that the length and depth of the trade war are yet to be clear, which is creating a lot of uncertainties around the global trade regime. An uncertain trade regime is not conducive to developing countries like Bangladesh that have become trade-dependent over the years. When the global trade regime is guided by some rules and principles, as those rules and principles have been achieved over the past six decades through the GATT and WTO processes, all countries in general and the developing countries in particular are benefited from those rules and principles. However, with the escalation of the on-going trade war, the effectiveness of those rules and principles is at stake. In particular, the role of WTO is greatly undermined, which can lead us to an uncertain global trade regime. If the US pulls out of the WTO, the global trade regime will probably face the biggest challenge after the Second World War.
During the trade war, some other parallel scenarios can emerge too. For example, since Chinese exports to the US market are facing escalated tariffs, Chinese firms may consider relocating their factories to other countries to avoid the additional tariff burden. This may lead to soaring foreign direct investment (FDI) from China to other developing countries. The major contenders of this FDI would be countries from South Asia and Southeast Asia. However, much of the success in attracting those Chinese FDI would depend on the status of the domestic business environment, infrastructural constraints, and several political economy issues including quality of institutions in the host country and geopolitical relations the host country has with China and other neighbouring countries.
Another worrying scenario could emerge if the US—which imposed additional tariffs on imports from China based on the logic of a huge negative trade imbalance—also imposes additional tariffs on imports from developing countries like Bangladesh based on the similar logic. This will certainly have a shocking effect on those developing countries' exports to the US.
The world cannot afford a full-scale trade war. It is now essential to reemphasise the importance of a rules-based global trade regime. The need for re-energising the WTO is increasingly felt given the emerging challenges and complexities in the global trade regime.
Dr Selim Raihan is Professor, Department of Economics, University of Dhaka, Bangladesh, and Executive Director, South Asian Network on Economic Modeling (SANEM).