Tariff Wars, Unemployment, and Income Distribution

Abstract

We propose a multi-country model with occupational choice, heterogeneous firms, unemployment, and revenue-generating tariffs to study the aggregate and distributional consequences of tariff wars in a unified framework. Motivated by the 2018 global tariff, we calibrate the model to fit a global economy with four countries, the United States, the European Union, China and the Rest of the World. If governments maximize aggregate welfare, the average optimal tariff and the average Nash-equilibrium tariff are about 16 percent. Multilateral trade negotiations lead to zero cooperative tariffs and free trade. No country can win a trade war. If governments adopt a political-economy perspective and maximize a weighted sum of entrepreneurial and worker interests with weights incorporating factual autonomous rate tariffs, then trade talks lead to positive cooperative tariffs in the range of 14 percent for the U.S. to 43 percent for China, and tend to increase unemployment and income inequality.