As 2018 wears on, talk of a trade war has refused to fade. China and the United States are planning to slap tariffs on tens of billions of dollars of their bilateral trade. Both have placed new limits on foreign direct investment from the other, with murmurings of broader controls in the offing. U.S. tariffs on aluminum and steel from much of the world remain firmly in place. And the United States continues to haggle with Canada and Mexico over renegotiating the North American Free Trade Agreement, even as U.S. President Donald Trump periodically threatens to withdraw from the accord altogether.
Some analysts argue that this is all so much sound and fury, signifying nothing. The possibility of a U.S.-Chinese trade war will almost certainly fade away, they maintain, and when it does, the world economy will continue on as if nothing had happened.
That optimism misses the very real costs of current U.S. policy. Even if the United States avoids a full-blown trade war, the country is already incurring economic damage by raising uncertainty about future economic policy and eroding its authority in international policy making.
There is substantial academic research demonstrating that companies respond to greater policy uncertainty by hiring fewer workers and cutting investments in physical capital and research. The economic intuition is simple: investments are inherently risky things. Greater uncertainty makes them even more so, by raising the odds that something goes badly wrong in the wider economy and prevents the company from realizing the hoped-for returns. Uncertainty today reduces growth tomorrow, even if disaster is averted.
Since Trump was elected president, many measures of policy uncertainty have jumped. Take the widely used monthly U.S. Policy Uncertainty Index created by the economists Scott Baker, Nicholas Bloom, and Steven Davis, which tracks discussions of policy uncertainty in major U.S. newspapers. From 1985 (when the index began) through October 2016, the index averaged a value of about 109. Since Trump’s election, it has
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