S2 Ep25: The threat to global prosperity

Episode Summary

Executive Summary: The episode examines whether the US-China trade war is a temporary dispute or a structural threat to global prosperity. Drawing on a CEPR/VoxEU book, it argues that tariffs are costly, especially for smaller open economies, and that global value chains, policy uncertainty, and weakened multilateralism amplify the damage. While the near-term outlook is grim, some speakers hold out hope that the conflict could eventually spur WTO-style reform.

Main Topics: Origins and escalation of the US-China trade war (Priority: 5/5): The discussion frames the trade war as a major bilateral tariff conflict between the world’s two largest economies, with negotiations stalled and the dispute beginning to draw in other countries. Weaknesses in the multilateral trading system (Priority: 5/5): Speakers argue that the current conflict exposes pre-existing cracks in multilateral trade governance and questions whether the US still has incentives to support open rules-based trade. Who bears the costs of a global trade war (Priority: 5/5): Model-based analysis suggests that smaller, more trade-dependent economies would suffer much larger real-income losses than large economies if bilateral conflict became global. Empirical evidence on tariff pass-through and market effects (Priority: 4/5): Studies in the book find that US tariffs were fully passed on to American buyers and that tariff announcements caused substantial stock-market declines for firms tied to China through direct and indirect channels. Global value chains and shifting investment patterns (Priority: 4/5): Because modern production is fragmented across borders, tariffs create complex winners and losers and may redirect sourcing and investment toward countries outside the tariff zone or back to the US. Trade policy uncertainty and long-run damage (Priority: 4/5): Beyond tariffs themselves, uncertainty about future trade policy is presented as a major drag on investment, exports, and trust between governments and firms. Prospects for reform after the conflict (Priority: 3/5): Despite pessimism, one speaker suggests trade wars can eventually motivate countries to rebuild and improve the multilateral system, as happened after the 1930s.

Key Arguments: The US may now have stronger incentives than before to move away from multilateralism and use tariffs bilaterally to pressure trading partners. If a bilateral trade war escalates into a global one, smaller countries are hit hardest because they rely more heavily on international trade. Tariffs mainly destroy gains from trade; in the worst case they can wipe out a large share of real income gains from openness. Empirical studies cited in the book find that US tariffs were fully passed through to domestic consumers, contrary to simple theory that large-country tariffs would lower foreign export prices. Global value chains make trade-war outcomes more complex: tariffs can help domestic producers in one sector while raising costs for downstream firms and consumers. Tariff persistence can reshape investment decisions, encouraging firms to source from non-targeted countries or shift production to the US. Trade policy uncertainty itself discourages investment and trade, and can have lasting effects even if tariffs are later rolled back. Although the medium-run outlook for the WTO-centered system is poor, crises can sometimes trigger future institutional reform.

Data Points: Tariff war duration: One year in - Describes how long the US-China trade war has been underway at the time of the episode Trade-war coverage: Hundreds of millions of dollars worth of merchandise - Scale of bilateral tariff conflict between the US and China Number of papers in the book: 11 - The VoxEU/CEPR book contains eleven chapters examining causes, effects, and system cracks Share of real income from trade gains: Around one quarter - Ral Vosser estimates gains from trade make up about 25% of countries’ real income Loss of trade gains in worst case: Around one quarter of trade gains wiped out - Model result for a fully escalated global trade war Real income loss for China/EU/US: Around 2% - Estimated impact on large players in the worst-case global trade-war scenario Real income loss for Canada/Mexico: Around 7% - Estimated impact on medium-sized open economies in the worst-case scenario Real income loss for Switzerland: 14% - Estimated impact on a small open economy in the worst-case global trade-war scenario Tariff pass-through to US consumers: 100% - Both empirical studies discussed found the full cost of US import tariffs was borne by US purchasers Three-day market reaction window: March 22nd - Window around Trump’s announcement of the first wave of tariffs used in the event-study analysis S&P 500 decline: Around 4.5 percentage points - Overall market decline during the three-day window around March 22nd Extra stock decline for firms directly tied to China: 0.8 percentage points more decline - Directly exposed firms experienced additional losses relative to the overall market decline Extra stock decline for firms with 10 percentage points more China sales: More than 1 additional percentage point - Firms with greater revenue exposure to China saw larger valuation losses

Pivotal Quotes: "Right now, it's not clear how the U.S. and China are going to manage to get back together to negotiate this problem away." — Meredith Crowley: Explaining why the trade war now looks like a long conflict with uncertain resolution "Smaller countries are much more affected than large countries simply because small countries are much more exposed to international trade." — Ral Vosser: Describing why a globalized trade war would hit open economies hardest "100% of the cost of those import tariffs are being passed on to purchasers within the United States." — Meredith Crowley: Summarizing empirical findings on tariff incidence in the early phase of the US-China tariff war

Implications: Listeners should expect prolonged uncertainty, higher consumer costs, and possible supply-chain relocation away from China. The episode suggests the bigger risk is damage to the multilateral system itself, though a future reform push may emerge from the conflict.