Escaping the Trade War: Finance and Supply Chains 2023

Escaping the Trade War: Finance and Supply Chains 2023

The paper 'Escaping the Trade War' by Felipe Benguria and Felipe Saffie analyzes the impact of the 2018-2019 trade war on US exports. It explores how US exporters reorganized their global supply chains in response to retaliatory tariffs, particularly from China. The study highlights the role of financial constraints and relationship stickiness in shaping export dynamics. Key findings reveal that high-leverage industries experienced a more significant decline in exports to China but a greater increase in exports to other markets. This research is essential for economists and policymakers interested in international trade and supply chain management.

Key Points

  • Analyzes the impact of the 2018-2019 US-China trade war on exports
  • Explores the role of financial constraints in export dynamics
  • Highlights how relationship stickiness affects trade reallocation
  • Finds that high-leverage industries faced larger export declines to China
,
  • newtopiccyclegrowin
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Escaping the Trade War:
Finance and Relational Supply Chains in the
Adjustment to Trade Policy Shocks
*
Felipe Benguria
†
Felipe Saffie
‡
December 2023
Abstract
The impact of the 2018–2019 trade war on total US exports depends on the direct effect
of foreign retaliatory tariffs as well as on the ability of US exporters to reorganize global
supply chains and redirect exports to other markets, away from retaliating countries. We
document that the sharp decline in US exports to retaliating countries was compensated by
a gradual increase in exports to other markets. We then develop a model of export real-
location to study the role of financial constraints and the persistence or stickiness of trade
relationships as underlying mechanisms shaping both the direct impact of retaliatory tariffs
and the extent of the reallocation toward alternative markets. In line with the predictions
of the model, we find that in industries with high leverage, Chinese retaliatory tariffs led to
a stronger decline in US exports to China but a larger increase in exports to the rest of the
world. We find a similar pattern among industries with less persistent trade relationships.
Finally, we document that other potential mechanisms do not appear to be economically
and/or statistically significant in shaping the response to tariffs.
*
We are very thankful to the organizers and participants at the NBER conference “International Fragmentation,
Supply Chains, and Financial Frictions” hosted by the Central Bank of Chile. We are especially thankful to
our discussant in this conference, Jos
´
e De Gregorio. This paper subsumes parts of an earlier working paper
“Dissecting the Impact of the 2018-2019 Trade War on US Exports.”
†
Department of Economics, University of Kentucky (fbe225@uky.edu).
‡
Darden School of Business, University of Virginia (saffieF@darden.virginia.edu).
1
1 Introduction
Starting in 2018, the US has been engaged in an unprecedented trade war involving broad
rounds of tariffs imposed on its trading partners (especially China) and equally broad retal-
iatory tariffs on US exports. An event of this magnitude is unseen in the post-war era, and
constitutes a major departure from a decades-long trajectory toward free trade. This trade war
constitutes an exceptional testing ground for the effects of trade policy.
In this paper, we assess the overall impact of the trade war on US exports. This overall
impact depends both on the direct effect of retaliatory tariffs on exports to retaliating countries
and on the extent to which exports can be rerouted to alternative markets. While the literature
has focused on the direct effect, our goal is to understand the full impact of the trade war on
US exports. In addition, a key goal of this paper is to understand the mechanisms behind both
the direct effect of tariffs and the rerouting of exports. We show that finacial conditions of
exporters (specifically, leverage ratios) and the stickiness of trading relationships play a key
role in shaping the response of US exports to tariffs.
To guide our analysis, we develop a theoretical model of US exporters facing foreign tariffs
and derive precise testable implications that we can map to the data. We consider a model of
US exporting firms selling to two markets, China and the rest of the world. In the original
Melitz [2003] model, as well as in other canonical models of international trade, a tariff in one
market does not affect a firm’s exports to other markets, because marginal cost is constant. For
this reason, we focus on an environment with an increasing marginal cost, as in Almunia et al.
[2021], in which China’s retaliatory tariff leads not only to a decline in exports to China, but
also to an increase in exports to the rest of the world. We incorporate the role of relationship
stickiness by adding a structure of firm–to–firm trade, a per–relationship fixed cost, and a
cost of terminating existing relationships. Under this structure, exporters are unwilling to
terminate unprofitable relationships in response to higher tariffs, and consequently exports
are more responsive to tariffs when relationship stickiness is low. We also incorporate the role
of finance following Manova [2013]. Exporters have a working capital requirement for their
fixed costs which is financed by borrowing. Under a higher leverage ratio, an exporter’s fixed
cost is higher, and an increase in China’s tariff has a higher probability of leading to terminating
relationships and reducing export volumes. Thus, this financial channel magnifies the decline
in exports to China. At the same time, the increasing marginal cost mechanism can lead to a
2
larger increase in exports to the rest of the world through this financial channel. Finally, the
elasticity of substitution, which is the only determinant of the response of a firm’s exports to
tariffs in the original Melitz [2003] model, also plays a role in our model. Exports to China fall
by more in response to an increase in China’s tariff when the elasticity of substitution is high
(i.e. when products are less differentiated).
Our empirical analysis starts by documenting the impact of foreign retaliatory tariffs on
US exports to retaliating countries. Beyond the average response documented in recent work
[Amiti et al., 2019, Fajgelbaum et al., 2020], we show there is a large degree of heterogeneity
in the impact of tariffs across both destinations and sectors. The effect of Chinese and Cana-
dian tariffs on trade volumes was at least twice as large as the effect of tariffs imposed by the
European Union. At the same time, retaliatory tariffs led to a larger decline in exports of indus-
trial supplies followed by agricultural goods and consumer goods, but there was little impact
on exports of capital goods. Consistent with much of the literature, we find no significant
adjustment in export prices in response to retaliatory tariffs.
We then extend our analysis to focus on the reallocation of exports away from retaliating
countries and toward alternative markets. We find a gradual reallocation of exports away from
China in product categories facing larger increases in Chinese tariffs. This reallocation led to
an increase in exports primarily to East and South Asia and to Europe. We find that this reallo-
cation of exports was directed primarily to countries to which the US exports a similar export
basket than the one it exports to China. To establish the total effect of the trade war on US ex-
ports, we estimate product–level regressions of foreign tariffs on US exports. We find that the
sum of the large and negative direct effect and the increase in exports through the reallocation
toward other markets add up to a small effect on US total exports. This effect on total exports
is not statistically significant except in the very short term, given that reallocation is gradual.
Nevertheless, a breakdown into sectors shows that total exports of industrial supplies do fall
as a result of the trade war.
Next, we document the mechanisms that explain both the direct effect of retaliatory tariffs
and the reallocation effect. To examine the role of financial conditions, we construct industry–
level leverage ratios from COMPUSTAT during the period prior to the trade war. Consistent
with our model, we find that in high–leverage industries, Chinese tariffs lead to a larger decline
in exports to China and a larger increase in exports to the rest of the world. To provide further
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FAQs of Escaping the Trade War: Finance and Supply Chains 2023

What are the main findings regarding US exports to China during the trade war?
The study finds that US exports to China significantly declined due to retaliatory tariffs imposed during the trade war. High-leverage industries experienced a sharper drop in exports, with a ten percent increase in tariffs correlating to approximately a ten percent decline in exports. This decline was more pronounced in sectors with less persistent trading relationships. The paper emphasizes that financial constraints played a critical role in this dynamic, as firms with higher leverage were less able to absorb the impacts of tariffs.
How did US exporters adapt their supply chains in response to the trade war?
US exporters adapted by reallocating their exports away from China to other markets, particularly in East and South Asia and Europe. The paper documents a gradual increase in exports to these regions as firms sought to mitigate the impact of Chinese tariffs. This reallocation was influenced by the financial conditions of exporters and the stickiness of existing trade relationships. The findings suggest that exporters with lower relationship stickiness were more agile in redirecting their trade flows.
What role does financial leverage play in the response to trade tariffs?
Financial leverage is crucial in determining how US exporters respond to trade tariffs. The study shows that industries with higher leverage ratios faced larger declines in exports to China when tariffs were imposed. This is because firms with high leverage are more financially constrained and less able to absorb the costs associated with increased tariffs. Consequently, these firms were also more likely to terminate less profitable relationships with Chinese importers, leading to a more significant reallocation of exports to other markets.
What is the significance of relationship stickiness in trade dynamics?
Relationship stickiness refers to the difficulty of terminating existing trade relationships, which can significantly impact export responses to tariffs. The research indicates that industries with higher relationship stickiness experienced smaller declines in exports to China. This is because firms were less willing to sever ties with Chinese importers, even when facing higher tariffs. The findings highlight the importance of maintaining long-term trade relationships in mitigating the adverse effects of trade policy shocks.

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