In 2018, the United States and China began imposing tariffs on hundreds of billions of dollars of each other's goods. Stock markets swung wildly. Companies scrambled to restructure supply chains. Economists debated the consequences. The trade war was a stark reminder that global trade, so central to modern prosperity, can be disrupted by political decisions.
Trade disputes are not new. They have been a feature of international relations for centuries. But in an interconnected global economy, the effects of trade wars ripple far beyond the countries involved. This article explains how trade wars work, why they happen, and what they mean for the global economy and for your investments.
What Is a Trade War?
A trade war occurs when countries impose tariffs or other trade barriers on each other in retaliation. One country raises tariffs on imports. The affected country responds with its own tariffs. Escalation follows.
Watch this short video for a clear overview of trade wars:
Video: Trade wars explained by Vox
Tariffs are taxes on imported goods. They raise the price of foreign products, making them less competitive compared to domestic goods. Tariffs are meant to protect domestic industries from foreign competition. But they also raise costs for consumers and for businesses that use imported components.
Trade wars can escalate quickly. Once one country imposes tariffs, retaliation often follows. Over time, this back-and-forth can affect industries, consumers, and the global economy as a whole.
Why Countries Engage in Trade Wars
Countries use tariffs and trade restrictions for several reasons:
Protecting Domestic Industries
When domestic industries face competition from cheaper imports, they may lobby for tariffs. Steel and aluminum tariffs, for example, aim to protect domestic producers from foreign competition. The trade-off is that steel-using industries (like auto manufacturing) pay higher prices.
Addressing Trade Imbalances
Countries with large trade deficits sometimes blame unfair trade practices. The United States' trade deficit with China, for example, was a major justification for tariffs. The idea is that tariffs will reduce imports and shrink the deficit, though in practice, the effects are more complicated.
Strategic Competition and National Security
Tariffs can be used as tools of strategic competition. Restricting access to technology or critical goods can weaken a competitor's economy or military. The U.S. restrictions on advanced semiconductor exports to China are an example of the strategic use of trade policy.
Political Incentives and Domestic Pressure
Trade policy is often driven by domestic politics. Tariffs can appeal to voters in industries facing foreign competition. They can be used to pressure other countries on non-trade issues like security or human rights.
How Tariffs Impact the Economy
Tariffs have several effects that ripple through the economy:
Higher Prices for Consumers
Tariffs are taxes on imports. Ultimately, consumers pay them in the form of higher prices. When tariffs were imposed on washing machines in 2018, prices rose by about 12%. When tariffs were imposed on steel, prices rose for everything from cars to canned goods. The burden of tariffs falls disproportionately on lower-income households, who spend a larger share of their income on goods.
Disruptions to Global Supply Chains
Modern supply chains stretch across borders. A product might be designed in one country, sourced from multiple others, assembled in another, and sold globally. Tariffs disrupt these carefully optimized networks. Companies must either absorb the costs, pass them to consumers, or restructure their supply chains all of which take time and money.
Retaliation and Escalation
When one country imposes tariffs, others often retaliate. The U.S. tariffs on Chinese goods prompted China to impose tariffs on U.S. agricultural products, hurting American farmers. European tariffs on U.S. motorcycles and bourbon targeted politically sensitive industries. Retaliation means that the industries that thought they were being protected can end up being hurt.
Economic Uncertainty and Slower Growth
Perhaps the most damaging effect of trade wars is uncertainty. When trade policy is unpredictable, businesses delay investment. They do not know where to build factories, which suppliers to use, or whether their products will face tariffs next year. This uncertainty slows economic growth.
Case Study: The U.S.-China Trade War
The trade war between the United States and China, which began in 2018, is the largest in modern history. It offers important lessons.
What happened: The U.S. imposed tariffs on over $350 billion of Chinese goods. China retaliated with tariffs on over $100 billion of U.S. goods. The tariffs covered a wide range of products from steel and aluminum to consumer electronics, agricultural products, and industrial machinery.
Effects: Studies found that the tariffs raised prices for U.S. consumers and businesses, reduced trade between the two countries, and led to a modest decline in U.S. GDP (NBER study on U.S.-China trade war tariffs). Some trade shifted to other countries like Vietnam and Mexico. American farmers, targeted by Chinese retaliation, lost export markets and required government bailouts.
Resolution: The "Phase One" trade deal in 2020 paused further escalation, but many tariffs remained. The trade war demonstrated that even the world's two largest economies cannot easily separate their economic ties without causing significant disruption.
How Trade Wars Affect Your Investments
Trade wars affect different investments in different ways:
Stock Market Winners and Losers
Trade wars create winners and losers. Companies that rely heavily on imported components (like automakers and electronics manufacturers) are hurt by tariffs. Companies that export to countries imposing retaliatory tariffs are also hurt. Companies that compete with imports may benefit from reduced competition. But the overall effect is negative, since trade wars reduce economic growth and increase uncertainty, which weighs on stock markets.
Sector-Level Impacts
- Technology: Companies with global supply chains (like Apple) are vulnerable. Semiconductor companies face restrictions on exports to key markets.
- Manufacturing: Industries that rely on imported materials (steel, aluminum, electronics) face higher costs.
- Agriculture: Farm exports are often targeted in retaliation. American soybeans, corn, and pork are vulnerable.
- Defense: Some companies benefit from strategic competition as governments increase military spending.
Currency Movements and Safe Havens
Trade wars affect currency markets. A country imposing tariffs often sees its currency weaken as its exports become less competitive. The currency of the targeted country may also weaken as its economy slows. The U.S. dollar, as the world's reserve currency, can strengthen during trade uncertainty as investors seek safety.
What Investors Should Watch During Trade Disputes
If you are an investor, here is what to watch during trade disputes:
- Tariff announcements: Which goods are targeted? Which countries are involved?
- Retaliation: How do affected countries respond?
- Company guidance: How are companies adjusting supply chains and pricing?
- Consumer prices: Are tariffs showing up in retail prices?
- Economic data: Is trade uncertainty affecting investment and growth?
The Real Cost of Protectionism
Trade wars are ultimately about politics, not economics. The economic case for free trade is overwhelming: trade allows countries to specialize in what they do best, lowers prices for consumers, and spreads innovation. When countries erect trade barriers, they hurt themselves as much as their trading partners.
That does not mean trade wars will not happen. They will. Politics often trumps economics. But understanding how trade wars work helps you navigate their effects. Diversification across countries and sectors can reduce your exposure to trade disputes.
History suggests that even the most heated trade wars eventually give way to pragmatism, as countries have too much to gain from trade to permanently cut themselves off.