The Impact of Trade Wars on Global Markets

As tensions rise between the US and China, worries about a potential trade war have been circulating among investors. To understand the reasons behind these worries, we must first and foremost be aware of the effects of a trade war on global markets. Global markets are places where goods, services, and labor are exchanged worldwide. An ideal global market requires product and service standardization so that goods and services can be traded freely across the globe. Market participants must also have trust and confidence in the global market.

What is a trade war?

What first comes to mind when you hear ‘trade war’? Are you more inclined to think of explosions and conflict or imports and exports tracked by numbers on a screen? Believe it or not, it is a combination of both. A trade war occurs between two countries when one country retaliates against another by raising import tariffs or restricting the other country's imports. This can include import quotas, domestic subsidies (subsidies for local businesses to compete with other countries’ low prices), currency devaluation (lowering the exchange rate so that domestic exports become more competitive in different countries and imports less so), and embargos (the ban for the trade of a particular good). 

In other words, it is usually a ‘peaceful’ and more ‘economic’ version of a war. Trade wars are generally considered a side effect of protectionism, where the primary purpose is to protect national interests and provide advantages to domestic businesses. Another main objective is to balance trade deficits that occur when a country's imports exceed the amounts of its exports. However, critics of trade wars believe they ultimately negatively affect local consumers and the economy.

It is important to note that a trade war is not the same as sanctions. Trade wars harm the relationship between two countries because their goals are explicitly related to trade. Sanctions, on the other hand, have philanthropic-related goals.

In a trade war, how will global markets be affected?

Economic Impact on GDP Growth: 

Trade wars can have a detrimental impact on global economic growth. As countries impose tariffs on each other's goods, trade volumes decline, supply chains are disrupted, and businesses face increased costs. These factors can lead to a slowdown in economic activity and reduced GDP growth. Trade war-induced uncertainties can also discourage domestic and international investment, further dampening economic prospects.

Supply Chain Disruptions:

Trade wars disrupt global supply chains due to companies facing higher costs for imported inputs and uncertainty regarding future trade policies. Manufacturers and businesses may be compelled to seek alternative suppliers or adjust their production processes and locations, which can be costly and time-consuming. Disruptions in supply chains impact businesses directly involved in international trade and reverberate throughout entire networks of suppliers and customers, affecting a wide range of industries.

Increased Consumer Prices and Inflation:

Trade wars can cause higher consumer prices and inflation. As tariffs are imposed on imported goods, businesses pass on the extra costs to consumers as part of the price of goods to continue making the same profit. This phenomenon is widespread for industries heavily reliant on imports or global supply chains, such as electronics or automobiles. When prices rise, the less consumers can afford, potentially leading to reduced consumption and lower economic activity.

Unsuccessful Protectionism:

Although enforcing trade restrictions can decrease domestic industries' competition, these companies still aren’t producing at a lower cost than before the implementation of the protectionist policy. As a result, the high production costs still get passed to consumers, leading to lower consumption and a slowdown of the economy.

Uncertainty among Investment Decisions:

All the effects of trade wars mentioned above create mass uncertainty, making it challenging for businesses and investors to plan for their path forward. This, along with uncertain trade policies, volatile exchange rates, and potential retaliatory measures between countries, can deter investors from investing or expanding business in the country’s markets. Companies may delay investment projects, reduce capital expenditures, or redirect investments to less affected markets. This uncertainty affects businesses directly involved in international trade and has broader implications for economic growth and job creation.

Why is this important?

Trade strongly contributes to global efficiency. A country opening up to trade allows capital and labor to shift toward industries where they are used more efficiently. This provides society with a higher level of economic welfare. In the event of a trade war, we, as consumers, must understand the impact that trade wars have on global markets to prepare ourselves best and to make the best investment decisions. 

Reference List

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Corporate Finance Institute. (2024). Trade Wars. [online] Available at: https://corporatefinanceinstitute.com/resources/economics/trade-wars/ [Accessed 14 Mar. 2024].

International Monetary Fund. (2019). International Trade: Commerce among Nations. [online] Available at: https://www.imf.org/en/Publications/fandd/issues/Series/Back-to-Basics/Trade#:~:text=Trade%20contributes%20to%20global%20efficiency,higher%20level%20of%20economic%20welfare. [Accessed 14 Mar. 2024].

‌International Trade Council. (2022). Effects of Trade Wars on Global Economy and International Trade. [online] Available at: https://tradecouncil.org/effects-of-trade-wars-on-global-economy-and-international-trade/ [Accessed 13 Mar. 2024].

Investopedia. (2024). Trade Wars: History, Pros & Cons, and U.S.-China Example. [online] Available at: https://www.investopedia.com/terms/t/trade-war.asp [Accessed 13 Mar. 2024].

Study.com. (2024). The Global Marketplace: Definition & Overview - Lesson | Study.com. [online] Available at: https://study.com/academy/lesson/the-global-marketplace-definition-lesson-quiz.html#:~:text=A%20global%20market%20is%20where,confidence%20in%20this%20global%20market. [Accessed 14 Mar. 2024].