What is the economics of trade wars?

A trade war occurs when nations escalate tariffs and other trade barriers against each other in a tit-for-tat pattern. Each side imposes tariffs claiming retaliation is justified; the other side retaliates, raising tariffs further. The result is a downward spiral in which both nations lose, but neither can unilaterally reverse without appearing weak. The 2018–2020 U.S.-China trade war became the largest and most economically significant trade war since Smoot-Hawley (1930). The U.S. imposed tariffs on Chinese goods; China retaliated on American agricultural products and machinery; both sides escalated. This article explains how trade wars work, why they form despite mutual harm, what the 2018–2020 trade war did, and what economic theory and evidence tell us about their consequences.

Quick definition: A trade war is a protectionist escalation in which countries impose tariffs on each other's goods, triggering retaliation. Both sides lose overall, but neither can gain by backing down unilaterally. The result is deadweight economic losses shared across both economies.

Key takeaways

• Trade wars arise when political pressure for protection (from import-competing industries) overwhelms economic logic (that tariffs reduce overall welfare).
• A tariff raises prices for consumers and downstream producers; the exporting country retaliates; both nations lose export markets and face higher import prices.
• The 2018–2020 U.S.-China trade war saw the U.S. impose tariffs averaging 15–25% on $370 billion of imports; China retaliated on $110 billion of U.S. exports.
• Estimated costs: the U.S. lost $42 billion annually in real income; China's growth fell an estimated 0.3–0.5 percentage points; global trade fell 1–2%.
• Trade wars can persist because each side fears that backing down unilaterally signals weakness, even though both would benefit from de-escalation.

Why trade wars happen: the prisoner's dilemma of protectionism

The temptation to cheat

Imagine two nations with free trade between them. Steel mills in Nation A face cheap competition from Nation B. Politicians in Nation A propose a tariff to protect those mills. From Nation A's perspective, a tariff solves a local problem: steel mills stay open, workers keep high-wage jobs. The costs—consumers pay more for steel, other industries using steel as input face higher costs—are diffuse and delayed.

This logic of concentrated benefits, diffuse costs drives protectionist pressure. From a global perspective, a tariff lowers total welfare: consumers' losses exceed producers' gains. But a politician accountable to steel-mill workers sees local benefit and pushes for tariffs.

The retaliation problem

But here's the catch: when Nation A imposes a tariff on Nation B's goods, Nation B's exporters lose sales and their government faces pressure to retaliate. Nation B imposes a tariff on Nation A's exports (say, agricultural goods). Now Nation A's farmers face reduced exports and pressure to escalate further.

Both nations end up worse off than under free trade—consumers in both face higher prices, exporters in both face reduced markets—yet each feels justified in its tariff because the other side retaliated. This is a prisoner's dilemma: both would be better off cooperating (no tariffs), but each fears that cooperating while the other defects (imposes tariffs) is suicidal. The rational response is to defect (impose tariffs) first.

The result is a self-fulfilling cycle. A tariff, intended to help one industry, triggers retaliation, which harms other industries, which demand escalation, which triggers further retaliation. By the time either side realizes mutual harm, reversing course appears weak.

Why unilateral disarmament fails

Nation A could unilaterally drop its tariff, signaling willingness to cooperate. This would likely trigger a German response—reciprocal tariff reductions. But if Nation B interprets the move as weakness and maintains tariffs, Nation A's exporters suffer while gains to Nation A's consumers (lower import prices) are modest. The political cost (blame from harmed exporters) exceeds the benefit. Unilateral moves only work if both sides coordinate; absent coordination, defection (maintaining tariffs) is safer.

This explains why trade wars, once started, are hard to stop. Neither side wants to "lose" by backing down first. International negotiations (at the WTO, bilateral talks) are needed to coordinate a simultaneous de-escalation. Without such coordination, both sides get stuck in a tariff trap.

The 2018–2020 U.S.-China trade war: a case study

Origins: protectionist pressure and geopolitics

The 2018–2020 trade war emerged from multiple sources:

Economic grievances: The U.S. trade deficit with China had grown from $70 billion (2000) to $370 billion (2018)—the largest bilateral deficit in the world. Politicians and commentators blamed unfair Chinese practices: intellectual-property theft, forced technology transfer, state subsidies to Chinese firms, and currency manipulation. These complaints had merit; China did practice these things. But the trade deficit also reflected macroeconomic factors: high U.S. consumption relative to savings, high Chinese savings, and China's low-wage advantage.

Political pressure: The Trump administration came to office promising to fix trade deficits and protect manufacturing. The 2016 election had exposed rust-belt anxiety; voters blamed imports for job losses. Renegotiating NAFTA and confronting China were central campaign promises.

Geopolitical calculation: The U.S. also sought to contain China's technological rise. China's advances in semiconductors, artificial intelligence, and telecommunications were seen as strategic threats. Tariffs were partly protectionist (protecting U.S. steel and semiconductors) and partly strategic (slowing China's technology development).

The escalation

In January 2018, the Trump administration imposed tariffs on solar panels and washing machines (safeguard duties to protect domestic manufacturers). In March 2018, the Commerce Department recommended tariffs on steel and aluminum, citing national security. The U.S. imposed 25% tariffs on steel and 10% on aluminum in April 2018.

In May 2018, the U.S. imposed 25% tariffs on $50 billion of Chinese goods (machinery, semiconductors, autos). China retaliated with 25% tariffs on American agricultural products ($34 billion worth), targeting soybean, pork, and corn—products from Trump-supporting regions.

The escalation continued:

• July 2018: The U.S. targeted another $16 billion of Chinese goods. China retaliated.
• September 2018: The U.S. imposed 10% tariffs on the remaining ~$200 billion of Chinese imports (70% of total Chinese exports to the U.S.). The tariff rate was 10% initially but rose to 25% by 2019.
• December 2018: The U.S. and China announced a 90-day trade negotiation period, temporarily pausing escalation.
• May 2019: Negotiations stalled; the U.S. raised tariffs on $370 billion of Chinese goods to 25%.
• August 2019: China retaliated with its first tariffs on a major U.S. export: crude oil, a sector China had previously exempted. China also announced plans to devalue the yuan, making its exports cheaper.

By 2019, the U.S. had imposed tariffs on $370 billion of Chinese goods (about 92% of Chinese imports to the U.S.). China had imposed tariffs on $110 billion of U.S. goods (about 60% of U.S. exports to China).

The tariff rates

U.S. Action	Chinese Goods Affected	Tariff Rate	Effective Date
Steel/aluminum safeguard	~$50 B	25% / 10%	April 2018
First China list	~$50 B	25%	July 2018
Second China list	~$16 B	25%	August 2018
Third China list	~$200 B	10% → 25%	September 2018 → 2019
Remaining China goods	~$370 B	5–25%	2019–2020

The effective tariff rate on Chinese goods to the U.S. rose from ~3.5% (pre-2018) to ~15–20% (2019–2020) across the affected categories.

Economic impacts: measured and estimated

Immediate effects on prices and trade

Tariff pass-through to consumers: When the U.S. imposed 25% tariffs on Chinese goods, prices for American consumers rose. A report by the Federal Reserve Bank of New York found that 90–100% of the tariff increase was passed through to U.S. importers and consumers. A Chinese-made shirt that cost $10 before tariffs now cost $12.50. Washing machines, televisions, tool, toys, and electronics all became more expensive.

Trade volumes: U.S. imports from China fell from $506 billion (2017) to $438 billion (2020), though some decline was due to COVID-19. The tariff impact was partially offset by import shifting: as Chinese goods became more expensive, importers shifted some orders to Vietnam, Mexico, and India. This substitution effect meant the tariff-induced price increase was less severe than it otherwise would have been.

Firm-level adjustment: American importers (retailers like Walmart, manufacturers using Chinese components) faced higher costs. Some raised prices; some absorbed costs, reducing margins; some shifted sourcing to tariff-free countries. For firms in tariff-vulnerable sectors (apparel, consumer electronics, furniture), the tariffs were a 15–25% cost shock with little advance notice.

Real income and welfare losses

National Bureau of Economic Research study (2019–2020): Economists Arnaud Costinot, Dave Donaldson, Justine Chaney, and others estimated the welfare impact of the 2018–20 tariffs:

• U.S. real income loss: ~$42 billion annually (0.2% of GDP). This reflects the net of tariff revenues collected ($30 billion annually) minus the deadweight loss from higher prices, reduced consumption, and retaliation.
• Chinese real income loss: Estimated ~1% of real income from the combination of lower export demand and tariffs on imports from the U.S.
• Global welfare loss: Estimated $100+ billion annually (the sum of losses across all nations), reflecting reduced trade and efficiency losses.

The U.S. collected tariff revenue (~$30 billion), but this was a transfer from consumers and firms to the government, not a net gain. The economy lost more in consumer and producer surplus than it gained in tariff revenue.

Employment effects

Manufacturing employment: The trade war occurred during strong labor-market conditions (unemployment <4% in 2018–19). Manufacturing employment growth did not reverse; instead, wage growth in manufacturing slowed. The tariffs raised input costs for manufacturers using tariffed goods, offsetting any employment gains in protected sectors.

Agricultural employment: U.S. farm income fell sharply in 2018–19 due to Chinese retaliation on agricultural goods. USDA data shows farm net income fell 15–20% in 2018–19 compared to the prior year. The Trump administration provided $28 billion in farm subsidies over 2018–2020 to offset trade war losses—a transfer funded by tariff revenue and general tax revenue, but not a replacement for lost export markets.

Retail employment: Tariffs on consumer goods raised input costs for retailers and manufacturers of final goods. Instead of supporting employment, tariffs shifted employment composition slightly from retail/services toward production, but the net effect was negligible or slightly negative.

Inflation effects

Trade wars raise prices, the opposite of the deflationary effect of globalization. The 2018–20 tariffs contributed an estimated 0.2–0.5 percentage points to U.S. inflation in 2019–2020. This was not the primary driver of inflation (that came later with fiscal stimulus and COVID-related supply shocks), but it was measurable. Higher inflation weakens real purchasing power, especially for low-income households less able to absorb price shocks.

Comparative analysis: trade wars in history

Smoot-Hawley and the Great Depression (1930–33)

Smoot-Hawley raised U.S. tariffs from ~38% to ~45%; other nations retaliated; global trade collapsed 70%. By comparison, the 2018–20 trade war was smaller: U.S. tariffs on affected goods rose from ~3.5% to ~15–20%, and global trade fell only ~2%. The 2018–20 war occurred in a stronger macroeconomic context (no financial crisis, tight labor markets, strong corporate profits), limiting its damage. But the pattern was similar: protection triggered retaliation, harming both sides.

Tariff patterns during recessions

Trade wars often occur during economic downturns, when protectionist pressure peaks. The 2008–09 financial crisis saw a wave of tariff increases despite WTO commitments to avoid protectionism. The 2020 COVID recession similarly triggered tariff-raising threats. Recessions concentrate job losses in specific sectors, raising political pressure for protection. But tariffs during downturns are especially harmful because they reduce trade further, slowing recovery.

The asymmetry problem

A striking feature of the 2018–20 trade war was asymmetry: the U.S. imposed tariffs on $370 billion of imports; China retaliated on $110 billion of U.S. exports. Why did China's retaliation seem smaller?

Because U.S. exports to China were much smaller: only $151 billion (2018), mostly agricultural goods, machinery, and semiconductors. China, as a large exporter to the U.S., had fewer U.S. goods to tariff in retaliation. To maximize retaliation impact, China tariffed high-value exports and imports, but the absolute volume was limited.

This asymmetry mattered politically. U.S. agricultural regions saw direct damage (lost soybean exports to China); Chinese firms also suffered but China's economic growth was less concentrated in U.S.-export sectors. The political pain in the U.S. was sharper, though aggregate Chinese economic loss was comparable or greater.

A diagram of trade-war dynamics

Common mistakes

1. Believing tariff revenue equals net gain. The U.S. collected ~$30 billion in tariff revenue in 2018–20, but this was offset by $42 billion in real income loss. Tariff revenue is a transfer from consumers/firms to government, not a measure of economic gain. The economy lost even though the government gained.

2. Assuming retaliation is not credible or will not happen. Every trade war underestimates retaliation. Trading partners have an incentive and the means to retaliate; assuming they won't is naive. China tariffed American soybeans within weeks; Canada and Europe did the same on bourbon and Harley-Davidson motorcycles.

3. Thinking tariffs protect jobs in the long run. Tariffs may preserve employment in one sector but destroy it in others. Tariffs on steel protected steel workers but raised costs for auto makers and construction firms, harming employment there. Aggregate employment effects are typically small or negative.

4. Ignoring supply-chain complexity. Many "Chinese imports" are components for American firms' supply chains or goods assembled in China using parts from Japan, Korea, Taiwan, and the U.S. Tariffing Chinese goods disrupts these chains, raising costs for American manufacturers and slowing innovation.

5. Conflating trade deficits with economic losses. The U.S. trade deficit with China reflects macroeconomic factors (savings rates, investment, exchange rates), not unfair Chinese policy. Tariffs don't eliminate deficits; they just shift them. The U.S. trade deficit fell modestly in 2018–20 (as imports declined) but remained large because U.S. savings remained low.

6. Believing one-sided tariffs are possible. In an integrated global economy, you cannot tariff imports without triggering retaliation. The 2018–20 war proved this: China was not a weak trading partner willing to absorb U.S. tariffs; it retaliated swiftly and effectively, imposing costs on Americans.

FAQ

Why did Trump administration start the 2018–20 trade war if it was economically harmful?

Multiple reasons:

• Campaign promises: Trump had promised to fix trade deficits and confront China. Delivering visible action was important politically.
• Genuine grievances: China did practice intellectual-property theft, forced technology transfer, and (arguably) currency manipulation. The administration believed tariffs would coerce change.
• Geopolitical calculation: Slowing China's technology rise was a strategic goal, not just economic protection.
• Underestimation of retaliation: The administration may have believed China would not retaliate severely or would capitulate quickly under tariff pressure. This proved wrong.
• Sunk-cost fallacy: Once tariffs were imposed, escalating further (rather than backing down) seemed politically safer.

Could negotiated tariff reductions have avoided the trade war?

Possibly. If the U.S. and China had negotiated bilateral market-access agreements (e.g., China reduces tariffs on U.S. autos and agriculture; the U.S. reduces tariffs on Chinese electronics), both could have benefited without a trade war. But negotiations were complicated by structural issues: China's state-owned enterprises, non-tariff barriers, and intellectual-property environment made genuine reciprocal opening difficult. Whether negotiators could have bridged the gap without tariffs is counterfactual; what happened was tariffs and retaliation.

Did the trade war achieve any of its goals?

Mixed results:

• Tariff reduction: China made some market-opening concessions in 2020 ("Phase One" deal), but limited and non-binding in many cases.
• Technology transfer: No measurable reduction; if anything, China accelerated self-reliance in semiconductors and AI in response.
• Trade deficit: The bilateral trade deficit with China fell from $371 billion (2018) to $310 billion (2021), mostly due to import shifting to other countries and temporary reduction in trade. But the overall U.S. trade deficit widened.
• Manufacturing: No significant reshoring; manufacturing employment fell after 2019, though COVID-related factors played a role.
• Political benefit: The trade war was popular with Trump's base, even as economists opposed it. It signaled willingness to confront China, which appealed to voters frustrated with globalization.

Why hasn't global trade collapsed as in Smoot-Hawley?

The 2018–20 tariffs were smaller in scope (affecting ~$370 billion of the ~$4 trillion global trade) and didn't trigger systemic financial collapse as Smoot-Hawley did. Additionally, supply-chain integration meant tariffs increased costs but didn't halt trade. Firms shifted sourcing and production; trade adapted rather than collapsed. The reduction in trade (~2% of global growth) was significant but not catastrophic.

Could the U.S. negotiate out of the trade war unilaterally?

Not without cost. If the U.S. dropped tariffs unilaterally, Chinese tariffs on American goods would remain, harming U.S. exporters. Negotiated simultaneous reduction is needed. In January 2020, the U.S. and China signed a "Phase One" deal: China agreed to increase purchases of U.S. goods (~$200 billion over 2 years), and the U.S. halted further tariff escalation (but kept existing tariffs). This partial de-escalation persisted into 2021–22, though tensions remained.

Will future trade wars be larger or smaller?

Likely the same magnitude or smaller. The 2018–20 war was significant but constrained by:

• Global supply-chain integration: firms can shift sourcing, limiting tariff effectiveness.
• WTO discipline: nations are reluctant to trigger formal dispute proceedings that could backfire.
• Financial interdependence: escalation risks financial instability, which can deter both sides.
• Public and business opposition: tariffs face resistance from consumers and firms hurt by higher costs.

But geopolitical tensions (U.S.-China rivalry, potential EU-U.S. conflict over climate and tech) make future trade wars plausible. The next war might involve more targeted tariffs on strategic sectors (semiconductors, rare earths, batteries) rather than broad-based tariffs like 2018–20.

Real-world examples

Soybean farmers and Chinese retaliation (2018–19): China tariffed American soybeans in retaliation for U.S. tariffs. U.S. soybean prices fell 30–40%; farmers' incomes fell. Soybean exports to China collapsed from 14 million tons (2017) to 6 million tons (2018). The Trump administration provided $28 billion in farm subsidies over 2018–20, largely funded by tariff revenue. This transfer was politically necessary to prevent farm revolt but economically inefficient—it created government expense without replacing lost export markets.

Washing machine and solar tariffs (2018): The Trump administration imposed 20–50% tariffs on imported washing machines and solar panels to protect domestic makers. Prices for consumers rose; appliance makers faced higher input costs. A washing machine that cost $500 cost $600+. The tariffs preserved some manufacturing jobs in these sectors but at high cost to consumers and downstream industries.

Auto sector supply-chain disruption (2018–20): U.S. autos are heavily integrated in North American supply chains, with parts crossing the border multiple times. Steel and aluminum tariffs raised input costs for auto makers; Chinese component tariffs did the same. Auto makers responded with automation and selective price increases. Auto employment fell slightly; prices rose modestly.

Pork exports and Chinese retaliatory tariffs (2018–19): China tariffed U.S. pork in retaliation. U.S. pork exports fell sharply; prices fell. But China simultaneously purchased more pork from the EU and Brazil at higher prices, indicating the tariff was punitive (China sacrificed cheaper U.S. pork for more expensive alternatives to harm U.S. farmers). This "own-goal" by China illustrates the mutual damage of trade wars.

Related concepts

• How tariffs affect prices and consumption →
• The history of protectionism →
• The Smoot-Hawley tariff explained →
• What causes recessions →

Summary

Trade wars occur when protectionist pressure overcomes economic logic, leading nations into tariff escalation from which neither can unilaterally escape. The 2018–2020 U.S.-China trade war exemplified this dynamic: political pressure for protection and geopolitical rivalry motivated initial U.S. tariffs; China retaliated; both sides escalated; both economies lost. The U.S. imposed tariffs on $370 billion of Chinese goods; China retaliated on $110 billion of U.S. exports. Estimated real-income losses reached $42 billion annually for the U.S. and comparable magnitudes for China. The trade war was smaller than Smoot-Hawley but followed the same pattern: concentrated benefits to protected industries; diffuse costs to consumers and export-competing industries; mutual economic loss. Trade wars persist because backing down politically signals weakness, trapping both sides in a harmful equilibrium. Coordinated negotiations, as in the "Phase One" deal, offer partial de-escalation but rarely fully resolve underlying tensions. Understanding trade-war economics clarifies why economists oppose tariffs as policy tools: they may solve local political problems but destroy overall prosperity. Prevention requires institutions (like the WTO) that can coordinate simultaneous tariff reductions and enforce commitments, so neither side fears unilateral disarmament.

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