The Cost of the US-China Trade War: A Stock Market Approach joint with Mary Amiti, and Sang Hoon Kong

Abstract:

The welfare impact of protection in standard models is composed of a terms-of-trade effect, an efficiency effect, and a profit effect. Existing studies of the US-China trade war have imposed a zero-profit constraint on the data and have typically found the impact of protection to have small effects relative to national income. We relax this constraint by allowing for the possibility that the trade war reduces the return on investments in firm-specific capital. We show that one can use this approach to exactly decompose aggregate stock market returns on days when protection is announced into a macro component and trade component. We estimate that the US tariffs and Chinese retaliation reduced the present discounted value of firm profits by 576 billion dollars or 1.9 percent of the total US market capitalization. These results suggest that ignoring the impact of trade on firm profits misses an important channel through which trade affects incomes.