If trade tensions between the United States and certain trading partners escalate into a full-blown trade war, what should developing countries do? Using a global, general-equilibrium model, this paper first simulates the effects of an increase in U.S. tariffs on imports from all regions to about 30 percent (the average non-Most Favored Nation tariff currently applied to imports from Cuba and the Democratic Republic of Korea) and retaliation in kind by major trading partners—the European Union, China, Mexico, Canada, and Japan. The paper then considers four possible responses by developing countries to this trade war: (i) join the trade war; (ii) do nothing; (iii) pursue regional trade agreements (RTAs) with all regions outside the United States; and (iv) option (iii) and unilaterally liberalize tariffs on imports from the United States. The results show that joining the trade war is the worst option for developing countries (twice as bad as doing nothing), while forming RTAs with non-U.S. regions and liberalizing tariffs on U.S. imports (“turning the other cheek”) is the best. The reason is that a trade war between the United States and its major trading partners creates opportunities for developing countries to increase their exports to these markets. Liberalizing tariffs increases developing countries’ competitiveness, enabling them to capitalize on these opportunities.
Tariffs introduced by the United States throughout 2018 and the retaliatory response of trading partners now affect close to $450 billion of global trade, accounting for 13 percent of U.S. imports of goods and 2.5 percent of global goods trade. If all proposed increases in U.S. tariffs were to be implemented, average applied tariffs in the United States would more than quadruple from the current average of 1.6 percent to 6.7 percent, reaching rates not seen since the 1960s.
Faced with protectionist measures, numerous trading partners (China, Canada, Mexico, EU, Turkey, etc.) retaliated against higher U.S. tariffs, while others (the Republic of Korea, India, etc.) did not. In fact, apart from the trade disputes with the United States, there is no evidence of a worldwide increase in the number of protectionist measures. On the contrary, the average number of trade restrictive measures implemented by G20 economies has been declining and remains below 2012-2015 trends (WTO 2018). Most major economies have continued liberalization efforts, pursuing market access opportunities under regional trade agreements (RTAs). Since the beginning of 2017, there have been 10 RTAs that entered into force such as those between the EU and Canada, Canada and Ukraine, China and Georgia, etc. After U.S. withdrawal from TPP negotiations, the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) was signed by the remaining 11 member countries in March 2018. Soon afterwards, leaders from more than 40 African nations endorsed a framework for establishing an African Continental Free Trade Area (CFTA). China also recently announced unilateral cuts in import tariffs on close to 1,600 products.
In light of these developments, policymakers in the rest of the world, and especially among developing countries, are grappling with the potential impact of, and the appropriate policy response to, U.S. protectionist measures. They are faced with the “trader’s dilemma”: should they join the trade war, stay out, or do something different, including continuing to pursue regional trading arrangements?
Other studies of recent trade tensions have focused on directly affected countries or on estimating the general costs of rising protectionism at the global level. Kutlina-Dimitrova and Lakatos (2017) examine the wide-ranging costs of potential increases in worldwide barriers to bound tariff rates and estimate that these could translate into an annual decline of global trade of 9 percent — more than was experienced during the global financial crisis of 2008-09. Robinson and Thierfelder (2018) argue that the disintegration of the North American trade bloc and a subsequent NAFTA trade war could result in significant damage to all three member countries – the United States, Mexico, and Canada – with the United States becoming more isolated in the global economy. Chepeliev et al. (2018) argue that retaliatory tariffs implemented by Canada and Mexico on U.S. agricultural exports in response to U.S. steel and aluminum tariffs will reverse the modest export gains from the newly negotiated USMexico-Canada Agreement (USMCA). Analyzing a scenario of a U.S. trade war with China and Mexico, Bouet and Laborde (2018) find that trade wars will not improve U.S. welfare and will harm China and Mexico as well as the global economy. Rutherford et al. (2018) estimate that the welfare costs of a trade war could be substantial, with losses concentrated in the United States and China, and small effects on other countries. Likewise, Zandi et al. (2018) establish that potential global trade wars will entail losses in U.S. GDP and jobs. If the trade tensions raise global uncertainty and lead to depressed investments in developing countries, Freund et al. (2018) estimate that the income losses in developing countries could range between 0.9 percent for South Asia and 1.7 percent for Europe and Central Asia.
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