Trade tariffs targeting final versus intermediate goods and the 2018-19 US-China trade dispute

This paper examines whether the short- and medium-term dynamic effects of tariff increases on intermediate goods differ from those on final consumer goods. To this end, the paper develops a three-country model with rigorous trade theory micro-foundations and some of the most common New Keynesian features and adapts it to the US, China, and the rest of the world. The results show that unilateral tariff increases can have opposite short- and medium-term effects on GDP, consumption, investment, and the trade balance depending on whether they are imposed on intermediate or final goods. The paper also identifies the mechanisms behind these effects. Simulations of the actual tariff increases during the trade dispute in 2018–19 show that the focus of US tariffs on intermediate goods is likely to have had a negative impact on US GDP and consumption. However, the simulations show more significant damage to the Chinese economy in all cases. Furthermore, the simulations show an improvement in the US bilateral trade balance with China but only a short-term impact on the overall trade balance.