The US-China Trade War and Global Reallocations

By Pablo Fajgelbaum

Pablo Fajgelbaum

In 2018-19, a major trade conflict started between the US and China. The US imposed tariffs on about $350 billion worth of Chinese imports, and China retaliated by levying tariffs on an additional $100 billion worth of imports, a retaliatory action allowed by WTO rules. Despite an agreement in January 2020 to halt further tariff hikes, the existing ones remain. The scale of this trade dispute is substantial. US tariffs affected around 18% of its imports, equivalent to 2.6% of its GDP, while China’s retaliation impacted 11% of its imports, equivalent to 3.6% of its GDP. The conflict’s magnitude and scope outstripped the 1930 Smoot-Hawley Tariff Act, the most notable protectionist move in over a century of US trade policy.

The escalation of tariff changes between the US and China in 2018-19 has had significant economic impacts on these two countries, as shown by previous research. In the paper “Trade War and Global Reallocations”, Professor Fajgelbaum and his coauthors P. Goldberg, P.J. Kennedy, A.K. Khandelwal, and D.Taglioni, examine how “bystander” countries’ exports changed in response to the tariff changes. In particular, they consider export responses of the largest 48 exporters to the US, China, and the rest of the world. They examine the heterogeneity in tariff responses by implementing an empirical specification that makes the elasticities of exports to US-China tariffs vary by importer, exporter, sector, and size of trade flows.

The research reveals that the US-China trade conflict impacted bystander countries in sometimes surprising ways. The average country boosted its exports to the US in products targeted by increased US-China tariffs, consistent with standard trade diversion effects. More surprising is that many countries also increased their exports to the rest of the world, while their exports to China remained largely unaffected by the tariffs. Overall, the findings suggest that the trade war generally enhanced trade opportunities for many countries, rather than just causing shifts in trade patterns across destinations.

The authors also show that the responses varied significantly across countries. For instance, some countries’ responses suggested that they substitute Chinese exports, while others responded as complements. Countries such as Vietnam, Thailand, Korea, and Mexico emerged as major export “winners” –in the sense of growing their exports– in global markets for products where US-Chinese trade declined. Meanwhile, a set of countries including Ukraine, Egypt, Israel, and Colombia, saw a decline in exports.

When digging deeper into the determinants of this heterogeneity, the authors find that variation in tariff elasticities by country largely drives the variation across countries, rather than pre-war product specialization patterns or variation in tariff elasticity by sector or size of trade flows.

Our study also underscores the interplay between supply and demand heterogeneity in the elasticities, indicating a substantial interdependence across export destinations. The paper develops a framework to categorize countries’ export responses based on the signs of their demand substitution with US and China and the slope of supply curves. For instance, countries such as Mexico, Malaysia, and the Czech Republic export goods that can substitute those from China and complement those from the US. Their exports benefited from the trade war due to the substitution effects and because they were operating along a downward sloping supply curve. These countries might have viewed the trade war as an opportunity, investing in new facilities, trade infrastructure, or trade and investment facilitation.

Alternatively, these countries might have enjoyed better credit reallocation conditions or they might have already been well integrated into global trade, allowing them to seize new exporting opportunities across various sectors.

In sum, the analysis reveals three main insights. First, there is large cross-country variation in the extent to which the trade war tariffs affected countries’ exports. Second, and somewhat surprisingly, for a subset of countries, global exports among products taxed by the US or China grew faster than untaxed products. Third, the analysis finds an important role for country factors in driving the responsiveness to tariffs, as opposed to more standard explanations related to sectoral scale elasticities and specialization patterns. This suggests that country-specific reforms and institutions may be important determinants for driving how countries’ exports respond in this new era of globalization.