Supply chain linkages and financial markets: Evaluating the costs of the US-China trade war

On 22 March 2018, the Trump administration started a trade war with China by issuing a presidential memorandum, which proposed to impose 25% tariffs on over $50 billion worth of Chinese imports. On 10 July 2018, it raised the stakes by imposing tariffs of 10% on an additional set of Chinese imports worth $200 billion. Both times, the Chinese government retaliated immediately, imposing tariffs on US imports of similar value. Two recent studies find that US tariffs on China have led to a significant welfare loss (about $7.8 billion, or 0.04% of US GDP) and significant increases in consumer prices in the US, due to an almost complete pass-through of the tariffs to US prices (Amiti et al. 2019, Fajgelbaum et al. 2019).

In a recent study, we evaluate firms’ equity market responses to the various trade war announcements by both the US and Chinese governments in 2018 and 2019 (Huang et al. 2018). We find that within an industry, firms’ reactions to the announcements are heterogeneous, depending on their direct and indirect exposure to US–China trade. More specifically, US publicly listed firms that are more dependent on exports to and imports from China showed lower equity returns but higher default risks in the threeday window around 22 March – the day President Trump signed the first executive memorandum imposing tariffs on Chinese exports. Chinese publicly listed firms that are more reliant on the US as a market for final sales (but not inputs) were also affected significantly more than firms with no direct exposure within the same industry. We also find that firms’ indirect exposure to US–China trade through domestic input-output linkages impacted their responses to the announcement.

These findings suggest that the structure of US–China trade is much more complex than is suggested by the simplistic view that the trade war against China will shift profits from China to the US and only harm Chinese companies that depend on the US markets. Consumers and firms in both countries that are indirectly linked to supply chains involving US and Chinese companies will also be affected. Tariff-induced increases in production costs can be amplified along supply chains until the final stage, when goods are sold to consumers.