Trump seems to believe that tariffs are an end unto themselves because they are bringing wealth into the country by forcing China to pay billions of dollars into the U.S. Treasury.

An escalation in tariffs is likely to increase uncertainty, slow down business investment and increase unemployment, and ultimately drag on growth. But it might also raise prices; the cost of the tariffs so far has been passed through to U.S. consumers.

Trump has credited his previous tariffs with bringing Beijing to the table, but China has retaliated by slapping tariffs on U.S. agricultural products. Those tariffs and other retaliatory levies from the European Union, Canada and Mexico have sent economic shock waves through communities that helped Trump secure his 2016 victory. But these latest round of negotiations broke down, and then Trump responded by more than doubling existing tariffs on $200 billion of Chinese imports, from 10 percent to 25 percent. He has also threatened to add tariffs to an additional $325 billion in Chinese goods that aren’t currently taxed.

Trump has two goals; the first is to reduce the United States’ huge goods trade deficit with China, which was $419 billion in 2018 and, most economists discount the importance of this. If the deficit declines through temporary purchases of China from the United States, the effect may fade with time.Trump’s second goal is more significant. It is related to the concerns regarding the theft of U.S. intellectual property and trade secrets by China, forced technology transfers, competition policy, access to financial services and currency manipulation. Here, the talks have failed. Addressing his belief that tariff will transfer wealth from China because foreigners pay the tariffs he has been imposing.  Over the course of 2018 Trump imposed tariffs on about 12 percent of total U.S. imports and economists from Columbia, Princeton, and the New York Federal Reserve released a paper, “The impact of the 2018 trade war on U.S. prices and welfare,” and it concluded that foreigners paid none of the bill, U.S. companies and consumers paid all of it and the losses to U.S. consumers exceeded the revenue from the new tariffs, so the tariffs reduced American welfare overall.

These price hikes led to substantial changes in behavior. Imports of the tariffed items fell sharply, partly because consumers turned to domestic products, but also in large part because importers shifted their sourcing to countries that aren’t currently facing Trump tariffs. For example, a number of companies already seem to have begun buying goods they previously bought from China from Vietnam or Mexico instead.

Consider the following example for understanding how tariff works and removing the misconceptions about usage of commercial policy: pre-tariff, the U.S. imports some good from country X that costs $100. Then there is imposition of a 25% tariff, raising the price to consumers to $125. If just keep importing that good from country X, consumers lose $25 per unit purchased – but the government raises an extra $25 in taxes, leaving overall national income unchanged.(Leaving aside distortions)

Suppose, however, that importers shift to a more expensive source that isn’t subject to the tariff; for example, that they can buy the good from another Country Y for $115. Then consumers only lose $15 – but there is no tariff revenue, so that $15 is a loss for the nation as a whole. But if they turn to a domestic supplier – say a U.S. company that will sell the product for $120. How does this change the story?

Here the crucial thing is that producing a good domestically has an opportunity cost. The U.S. is near full employment, so the $120 in resources used to produce that good could and would have been employed producing something else in the absence of the tariff. Diverting them into producing what we used to import means a net loss of $20, with no revenue offset.

In the case of a large country like the U.S. imposes tariffs, one effect — if USA doesn’t face foreign retaliation — is a rise in the price of U.S. exports, either through a rise in the dollar or by drawing resources away from export to import-competing sectors. This price rise is a gain for America (although not for export-oriented sectors like agriculture.) And this “terms of trade” effect can mitigate or even reverse the overall losses as tariffs distort the economy. If (when) foreigners retaliate, however, the terms of trade effect goes away, and USA is back to tariffs just being a tax on domestic consumers.

On one side, the short-run costs of trade war tend to be overstated. On the other, the long-term consequences of what’s happening are bigger than most people seem to realize. The trade war will inflict significant direct and collateral damage on both sides, although this may not immediately be apparent, given that the U.S. economy is performing well and the Chinese economy has not slowed down as quickly as expected. A deeper concern is that the trade war could morph into broader open economic warfare, affecting all aspects of the economic relationship between the two countries, investment flows, business relationships, and even flows of tourists and students between the two countries could be adversely affected.

The Trump administration is going about its trade war with China all wrong. Its strategy and tactics are muddled. If President Trump were a general watching the battle unfold, what he’d see is his troops getting slaughtered, while the enemy, though suffering casualties, was holding most of its positions.

What the United States should have done is create a global coalition of major trading countries — itself, the European Union, Japan and other advanced societies — that would negotiate limits on subsidies, coerced technology transfers and a level playing field for competition between domestic and foreign firms. If China violated the rules and refused to join, the other countries could take action against its exports.

But this sensible approach was virtually eliminated when Trump decided to pull out of the Trans-Pacific Partnership, a trade agreement that could have done just that. Instead, USA has a system that, through high tariffs, imposes the equivalent of a tax on American citizens to implement a trade policy that favours China.