Long-Run Effects of Trade Wars

David Baqaee and Hannes Malmberg

No 33702, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: This short note shows that accounting for capital adjustment is critical when analyzing the long-run effects of trade wars on real wages and consumption. The reason is that trade wars increase the relative price between investment goods and labor by taxing imported investment goods and their inputs. This price shift depresses capital demand, shrinks the long-run capital stock, and pushes down consumption and real wages compared to scenarios when capital is fixed. We illustrate this mechanism by studying recent US tariffs using a dynamic quantitative trade model. When the capital stock is allowed to adjust, long-run consumption and wage responses are both larger and more negative. With capital adjustment, U.S. consumption can fall by 2.6%, compared to 0.6% when capital is held fixed, as in a static model. That is, capital stock adjustment emerges as a dominant driver of long-run outcomes, more important than the standard mechanisms from static trade models — terms-of-trade effects and mis- allocation of production across countries.

JEL-codes: F0 F1 F30 F40 (search for similar items in EconPapers)
Date: 2025-04
New Economics Papers: this item is included in nep-opm
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