In a trade war, nations impose taxes (or tariffs) on each other’s goods in an attempt to protect domestic industries. This is known as protectionism, and it can lead to a tit-for-tat escalation of levies on billions of dollars in goods. For example, Nation A may impose a 20% tariff on autos imported from Nation B. Nation B could respond by suppressing its currency to make its autos more competitively priced in the domestic market.
In the long run, a trade war can damage the global economy by raising consumer prices and reducing economic growth. This is because trade restrictions impede the specialization that maximizes global productivity. In addition, a trade war can undermine global supply chains and reduce international investment, leading to business disruptions and slowing economic development. Developing countries are often the most vulnerable, because they depend on exports for economic growth and are especially sensitive to rising production costs from higher tariffs.
The US-China trade war began in early 2018 with a series of Trump administration tariffs, which impacted everything from steel and aluminum to solar panels and washing machines. China responded with a variety of tariffs, including on soybeans, pork and cotton. The Chinese government also placed additional export controls on rare earth minerals, which will likely lead to higher prices on many US-made products. In response, both economies could experience a slowdown in their respective GDPs. This is particularly problematic because it comes as monetary stimulus is beginning to wear off and oil prices are high, reducing investment.