21st century trade wars

We use the GTAP data in a GTAP-in-GAMS framework to calculate the economic effects of trade policies proposed by candidate Donald Trump in his successful campaign to become President of the United States. We calibrate a multi-sector multi-regional equilibrium with Melitz (2003) technologies in the manufacturing and business services sectors. We calculate optimal bilateral tariffs against China and Mexico and consider their optimal responses. In a more detailed look at Mexico we consider the 35 percent U.S. tariff on Mexican imports that Trump proposed during the campaign, and the 20 percent tariff on Mexican imports that was suggested shortly after he took office. We model optimal Mexican responses as well as responses that would be consistent with its World Trade Organization (WTO) disciplines. We find that retaliatory tariffs by Mexico are limited by economic fundamentals, which means that WTO authorized retaliation is not incentive compatible. China starts with higher than optimal tariffs, so retaliation compound welfare losses. This exposes significant challenges for the world trading system should a large player, like the U.S. under Trump, pursue an aggressive protectionist agenda.