Peace Through Strength in Trade Wars

H istorically, the U.S. has been successful in adopting a Reagan-style policy of generating peace through strength. Indeed, the possession of large-scale nuclear arms has been such a powerful tool to gain influence that these weapons have not been used in 80 years. A similar principle may well be useful in trade wars, whereby deterrence is achieved not by the threat of a strong military but by the threat of restricted trade with a strong economy. In both the military and economic cases, the U.S. has a big stick that can generate peace and influence without being used.

A major difference between peace through strength in regular wars and in trade wars is that the latter is much cheaper. To maintain a strongly deterrent military, the U.S. spends about 14 percent of the federal budget, or in excess of 3 percent of GDP. On the contrary, our strong economy is already in place; therefore, the threat of restricted trade is nearly free for the U.S. to make. Such a threat shouldn’t be perceived as a geopolitical free lunch. There may of course be negative consequences, such as the creation of bad will, but that is true of unrealized military threats as well.

The U.S. can pursue deterrence via the threat of restricted international trade because the U.S. economy involves mostly domestic trade between U.S. citizens rather than trade with foreigners. Many other countries’ GDPs are far more dependent on trading with us than our GDP is on trading with them, generally speaking. This general degree of U.S. self-reliance is evident in our levels of import and export, which represent about 13 percent and 11 percent of our GDP, though great differences across industries exist. Often-debated imports from China only represent about 2 percent of GDP, although some industries, such as minerals, are essential. This is in contrast to many of our trading partners whom we might want to influence, whose exports to the U.S. are significant. For example, the U.S. accounts for about 80 percent of Mexican exports and 61 percent of Canadian exports, or about 33 percent and 28 percent of their respective GDPs.

Threats of tariffs were successfully used as deterrents during the first Trump administration. We had France back off digital taxes on our tech companies by threatening tariffs of as much as 100 percent on its wines. Similarly, border disputes with Mexico were settled by unrealized tariff threats. Most recently, a threat of tariffs successfully urged Colombia to accept Colombians who were deported from the U.S. Such threats have also been used to more closely align EU tariffs with U.S. tariffs, which are relatively lower. And there’s more to be done in this regard. For example, Germany imposes tariffs on our cars that are four times higher than our tariffs on German cars.

Many complained about the uncertainty of the execution of these threats, but that is a feature and not a bug. For in trade wars, as in regular ones, leaving uncertain the way in which a plan might be executed is often desirable. Indeed, the recent Middle Eastern cease-fire agreement, reached at least in part because of Trump’s uncertain threat that otherwise “all hell will break lose,” is roughly analogous to the way the possibility of hefty tariffs alone might “encourage” international cooperation. Tariffs may of course sometimes cause great harm, when imposed. Indeed, their great potential harm is what makes them a useful threat: If France didn’t stand to be greatly harmed by wine tariffs, it would not have backed off its proposed digital taxes. This is directly analogous to U.S. military actions — they are certainly harmful when conducted, but their great potential harm makes them a powerful threat that thereby limits their eventual use.

The harm from implemented, as opposed to threatened, tariffs raises the inevitable question of who would ultimately pay for them, we or foreigners. This would depend, in part, on the availability of viable domestic substitutes to the taxed product. Also, foreign exchange markets can serve as a stabilizing buffer on the harm imposed. But, regardless of who pays, it appears that the countries that quickly fall in line in response to our tariff threats believe they are at risk of paying a hefty price, whether that’s true or not. For peace through strength in trade wars, the perceived harm of threatened tariffs to foreign governments may be more important than the actual harm tariffs would cause if used.

As with all taxes, the harms tariffs impose on various parties, such as consumers, shareholders, and workers, vary by degree and depend on market conditions. But Democrats argue that taxes such as tariffs on foreign firms are all borne by U.S. consumers while domestic taxes on U.S. firms are primarily borne by affluent shareholders. During a Senate confirmation hearing last week, Finance Committee Ranking Member Ron Wyden’s opening remarks centered on the often-repeated claims that Trump’s 2017 corporate tax cuts helped only billionaires but that tariffs are borne by the U.S. middle class through higher prices. Either Democrats implicitly agree with Trump that foreigners, in particular foreign billionaires, pay the cost of tariffs, or they agree that consumers and workers benefit from the Trump corporate tax cuts at home.

The overall point is that those who believe in Reagan-style peace through strength with regard to regular wars need to consider using our strength as a trading partner for the same purpose. In either case, the goal should be deterrence achieved by leveraging our strength without — obviously, as in the case of nuclear weapons — having to deploy it. In many cases, the cheaper threat of restricted trade with an existing economy may be preferable to the costlier one of maintaining a military capability.