Trump's trade war to be costlier than feared

US President Donald Trump's trade war with China will be more costly, and more damaging, than even the best forecasters predict. The employment impact in the United States, moreover, is almost surely to be net-negative; that is, more jobs will be destroyed than will be created.

Why are the consequences likely to be so dire?

The reason is because old-fashioned trade wars through the use of tariffs do not correspond to the contemporary world of globalized supply chains.

Supply chains consist of production facilities that produce customized goods and services－customized inputs of hardware and software－to factories across borders. From 60 to 70 percent of these trade flows consist of intermediates, which are inputs to other stages of the production process, depending upon the industry. The largest internal flows of hardware and software take place in computers, semiconductors and electronics in general, but such internal flows are also significant in the automotive sector, in industrial products, and in medical devices.

These customized inputs cannot be readily shifted back to the home country, such as the US, as might have been the case with the imposition of tariffs 50 years ago. The transfer of production capability back to the home country at the margin may not be zero, but it will still be small.

Instead, most of these customized inputs must continue to be exported despite the tariffs, leading to higher cost inputs in the US. This makes the enterprises less competitive, and will reduce job creation, not expand job creation, in the US.

The UN Conference on Trade and Development and the World Trade Organization estimate that 80 percent of all trade today takes place within multinational corporations or within networks orchestrated by MNC parent companies. These MNC activities pay higher wages and benefits, produce more value added, generate more exports, and involve higher levels of research and development than average company activities. Thus the setback to MNCs and their supply chains will be particularly costly to economic growth and welfare.

The leading forecasters in the US are not unaware of this supply chain phenomenon, of course, but the standard trade models they use for their forecasts do not take this into account.

In the end, Trump's trade war using tariffs is not only going to reduce global trade, it will also cause net job loss in the US. And the magnitude of this damage will be larger than expected.

The author is a non-resident senior fellow, Peterson Institute for International Economics. He contributed this article to China Watch, a think-tank platform powered by China Daily.