Import tariffs have a negative impact on the targeted country. Retaliation will in turn have negative consequences for the country which started the tariff hikes. Even in the absence of retaliation, there will be negative consequences. Household spending will suffer from a loss of spending power due to an increase in inflation following higher import prices and/or a switch to domestically produced goods. For the same reason, aggregate corporate profits may suffer. Companies may also cut back their investment because of increased uncertainty. Empirical research confirms these outcomes.
The “little squabble”[1] between the US and China on trade has moved back to the front page. It has been there before, causing havoc in markets, before becoming less of an issue, following the truce between Trump and Xi Jinping on the occasion of the G20 in Buenos Aires in December last year. Understandably, investors are eagerly hoping, with increasing impatience, for a new meeting, with a similar outcome, at the G20 on 28-29 June in Osaka. The softness of data this week in China and the US (in both cases, retail sales and industrial production were disappointingly weak) show that the negotiating parties are not exactly in a strong cyclical position. As a reminder, US Q1 growth was strong but of poor quality[2] whereas China only managed to surprise positively in the same quarter because it had taken enough measures to stop the growth slowdown.
Import tariffs, by construction, have a negative impact on the country which is targeted: export volumes and/or profit margins suffer[3]. Retaliation measures will in return hit the country which started the tariff hikes and third countries may also be hurt due to trade diversion. However, even in the absence of retaliation, the country which started will face negative consequences.
Consider US households: unless the price elasticity of their demand would be huge, they will lose spending power because of more expensive imports from China.
Switching to consumer goods produced in the US will have a similar impact: they were more expensive than imports from China to start with and increased domestic demand may entice US producers to raise their prices. As a consequence, households may even be forced to switch to other, cheaper brands, in order to avoid having to pay more, something which would lower their consumer satisfaction.