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| How Increasing Tariffs Affects the U.S. Trade Deficit and Global Welfare: An Analysis Based on a Two-Country Dynamic General Equilibrium Framework Incorporating the Dollar Standard |
| LIU Kai
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| School of Economics/Institute of China's Economic Reform & Development, Renmin University of China |
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Abstract During recent years protectionism has come to dominate U.S. trade policy. The U.S. has tried to narrow its long-standing large trade deficit and to protect its industries by imposing tariffs on other countries, refusing to support multilateral trading systems, and by other means. Relevant data show that since the collapse of the Bretton Woods system and the establishment of the Jamaican system in the 1970s, the global economic imbalances that are exemplified by the U.S. trade deficit have continued for more than 40 years. Although these imbalances have shown some volatility, in essence they are a set of long-term phenomena. In addition, the U.S. has maintained a long-term trade deficit with almost all of its main trading partners, not just China, and thus the U.S. trade deficit is also a structural phenomenon. In fact, the dollar-standard characteristic of the current international monetary system is one of the root causes of the long-term U.S. trade deficit. The questions explored in this paper are as follows. If the important role of the dollar standard in determining the persistent U.S. trade deficit is taken into account, can the U.S. tariffs draw down the size of the U.S. trade deficit, and how do these tariffs affect the welfare of global residents？ What would happen if other economies retaliated against the U.S.？ In the face of a U.S.-sponsored trade war, could weakening the dollar standard boost the welfare of other economies？ To answer these questions, this paper constructs a two-country dynamic general equilibrium model that incorporates the characteristics of the dollar standard. Based on this model, the paper analyzes the impacts of U.S. tariffs and the trade war on both the U.S. trade deficit and on global welfare, while discussing the relevant transmission mechanism in detail. Under the benchmark model setting, if the U.S. unilaterally imposes an extra 20% tariff, it will reduce the U.S. trade deficit-GDP ratio by about 0.40 percentage points. In addition, the U.S. long-term steady-state GDP will fall by about 2.50%, while the overall GDP of other countries will fall by about 1.10%. U.S. welfare will rise by about 0.60%, and the welfare of other countries will fall by about 1.20%. The unilateral increase in tariffs imposed by the U.S. will curb global trade and production, and worsen the distribution of global welfare through unfair terms of international trade. When other countries take retaliatory measures, that is, when the trade war breaks out, the welfare of other countries will not deteriorate further, but U.S. welfare will fall sharply, and the relative scale of the U.S. trade deficit will not change much. The “prisoner's dilemma” feature of the trade war game can, to a certain extent, explain the occurrence of the trade war. Weakening the dollar standard can help to promote fairness in international trade, which can weaken the negative impacts of the trade war, raise the level of global welfare, and effectively narrow the U.S. trade deficit. This paper offers two main contributions to the existing literature. First, it analyzes the long-term effects that the U.S. tariffs and trade war have on the U.S. trade deficit and on global economic imbalances. This analysis involves constructing a quantitative macroeconomic general equilibrium model, which has been lacking in the existing literature. Second, this paper discusses the impacts of the U.S. tariff and trade war with full consideration for the factor of the dollar standard, which is one important factor that has been neglected in the existing literature. Therefore, this paper's analysis is better aligned with the reality of the world economy than previous studies.
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Received: 19 April 2019
Published: 30 December 2020
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