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Trade Wars with Trade Deficits

Author

Listed:
  • Pau S. Pujolas
  • Jack Rossbach

Abstract

This paper examines optimal tariff-setting in the context of bilateral and aggregate trade imbalances. Using an illustrative model, we show that larger trade deficits behave similarly to more inelastic foreign demand, enhancing a country’s ability to alter its terms of trade and benefit from a trade war. Consequently, trade imbalances can increase optimal tariff rates. We quantitatively evaluate a hypothetical trade war between United States and China — the countries with the greatest bilateral trade imbalance — using a multi-region, multi-sector applied general equilibrium model in which we compute optimal tariffs, a first due to computational complexity. We find the United States gains from a trade war with China, albeit minimally, equal to 0.016 percent of real income. Nevertheless, we find both countries sustained minor welfare losses from their recent trade dispute, in which tariff increases were negatively correlated with optimal tariffs changes. We show after service sectors and input-output linkages are accounted for, both countries are better off in a world with free trade.

Suggested Citation

  • Pau S. Pujolas & Jack Rossbach, 2024. "Trade Wars with Trade Deficits," Department of Economics Working Papers 2024-09, McMaster University.
  • Handle: RePEc:mcm:deptwp:2024-09
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    File URL: http://socialsciences.mcmaster.ca/econ/rsrch/papers/archive/2024-09.pdf
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    More about this item

    Keywords

    Trade War; Tariffs; Applied General Equilibrium; International Trade;
    All these keywords.

    JEL classification:

    • F11 - International Economics - - Trade - - - Neoclassical Models of Trade
    • F13 - International Economics - - Trade - - - Trade Policy; International Trade Organizations
    • F14 - International Economics - - Trade - - - Empirical Studies of Trade
    • F17 - International Economics - - Trade - - - Trade Forecasting and Simulation

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