Trade Tensions and Trade Policy Uncertainty

Abstract

The trade tensions between the United States and its trading partners, which started in 2018, have raised uncertainty about future trade policy. In this chapter, trade policy uncertainty is modeled as an increase in the discount rate of exporting firms using the firm heterogeneity module of the WTO Global Trade Model (GTM). Three insights from the literature are combined to model increased trade policy uncertainty in a Computable General Equilibrium (CGE) model: (i) a theoretical framework on trade policy uncertainty in a setting of firm heterogeneity; (ii) gravity estimates on the trade effects of tariff uncertainty as measured by “water” in the tariffs; (iii) estimates on optimal tariffs in case of a trade war. The expectation that tariffs could rise to the noncooperative (trade war) level increases current trade policy uncertainty and thus reduces firm entry into export markets. The effects of a trade war itself are also explored. The analysis leads to three main findings. First, the macroeconomic effects of uncertainty about trade policy are considerable, whereas the effects are much more limited if the hike in uncertainty is constrained to uncertainty about trade policy between the United States and its trading partners. Second, the effects of a trade war itself are in general an order of magnitude larger than the effects of uncertainty. The negative real Gross Domestic Product (GDP) effects of uncertainty about trade policy in the global trade war scenario range between 0.22% and 1.07%, whereas the tariff war itself could reduce real GDP by between 0.76% and 2.37%. Third, global trade is projected to be moderately affected by trade policy uncertainty with trade falling by up to 5%, whereas a trade war would reduce the value of trade by double digit numbers in most regions.