The Invisible Trade War

Here’s a riddle: When does a country extending favorable tariffs effectively pay the costs of a trade war without actually being in a trade war? When exporters can’t be sure how expensive it will be to do business in that country tomorrow. In other words, a country doesn’t have to impose tariffs to depress trade and economic activity. It merely has to keep its options conspicuously open.

The proof comes from the research of economists Kyle Handley and Nuno Limão, from the Universities of Michigan and Maryland, respectively. The pair, who presented their work at a 2015 Becker Friedman Institute conference on policy uncertainty, developed an economic model of trade policy uncertainty that they could take directly to the data—in this case, data on Chinese exports to the U.S. in the years before and after China’s accession to the World Trade Organization (WTO).

What they found was a direct link between policy uncertainty and market participation. Long-running uncertainty about future tariffs limited Chinese exports to the US in the 1990s and kept domestic prices roughly half a percent higher than they could have been.

Quantifying The Common Sense

For three days in August 2014, residents of Toledo, Ohio were forced to use bottled water for drinking, brushing teeth, food prep, even bathing children. Cyanobacteria from algal blooms in Lake Erie—blooms fed by phosphorus traced to agriculture runoff in the lake’s Western Basin—had poisoned the municipal water supply.

Policymakers knew they had a problem with Lake Erie as early as 2009, when the EPA’s first-ever National Lakes Assessment revealed that more than 20 percent of lakes in the U.S. have high levels of phosphorus or nitrogen. It’s fairly easy to defer action on a report. It’s impossible to ignore nearly half a million people without drinking water. But exactly what actions are necessary?

The question of what actions to take, and what they're long term successes or failings might be, would be greatly enhanced when examined through the lens of economic modeling.

Catch Up On the Complete Series 

Policy Uncertainty,
The Dog that Barked

We may not be able to avoid uncertainty, but data and history point to some common sense ways we can limit its negative economic effects. 

Calculating the Cost of Policy Uncertainty, in Dollars and Cents

Calculating the price of policy uncertainty in real dollars—in market value destroyed, in higher costs of capital to firms—may make us think hard about how to decrease it.

The Becker Friedman Institute for Research in Economics advances inquiry that illuminates our choices, our economy, our society, and our future.

One research initiative examines the impact of policy uncertainty, and this series that shares insights from the initiative's scholars. To view accompanying videos or learn more about this project, please visit our website.