What Is A Trade War?

If Saskatoon And Regina Were Countries, Here’s How A Trade War Might Unfold.

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A trade war occurs when two or more governments impose a series of escalating barriers to trade to protect local companies.

Here’s how such a war might unfold.

Let’s say Saskatoon and Regina are neighbouring countries. Their citizens can purchase freely from either country. Companies in both cities manufacture electric cars; competition is fierce. To encourage immigration, Regina’s government decides to grow its economy and attract workers by subsidizing local electric vehicle manufacturers that invest in research and development. Companies normally increase prices when costs increase, but with the subsidy, Regina manufacturers can sell a better product (improved through R&D) at the same price as vehicles manufactured in Saskatoon.

Saskatoon’s electric car manufacturers protest in the streets! They can no longer compete! Saskatoon’s government tries to negotiate, but Regina refuses to change the subsidy. Saskatoon retaliates and imposes a 25% tariff on electric vehicles imported from Regina: for every Regina-built vehicle sold in Saskatoon, the Saskatoon government collects a 25% tax. But Saskatoon does not actually collect much money, because Regina electric vehicles are now more expensive than those manufactured in Saskatoon. Most Saskatoon residents now buy from local manufacturers. Facing declining sales, Regina manufacturing companies are forced to lay off employees.

Regina manufacturers pressure the Regina government to fight back against this unfair tariff. Regina imposes a trade quota on saskatoon berries. This drastically reduces the volume of berries that can be imported into Regina from Saskatoon. Berry producers in Saskatoon are caught off guard. They have commitments to fill with bakeries in Regina, but cannot export the product. The laws of supply and demand apply, and the price of Saskatoon berries soars in Regina.

Berries are rotting in the fields of Saskatoon. With no customers, some berry producers go out of business, but savvier entrepreneurs know never to waste a crisis. They begin selling in Calgary, targeting Albertans who had fled Saskatchewan in the 1990s. Sales skyrocket. The madness continues. Saskatoon imposes new trade restrictions to defend its manufacturers, claiming it needs to ensure the safety of residents: companies selling electric vehicles in Saskatoon must now submit a lengthy form verifying that the batteries do not leak acid. Regina companies, burdened by red tape, give up on the Saskatoon market.

Politicians decide to begin negotiations. Both sides make concessions, and they emerge with the Saskatoon-Regina Free Trade Agreement (SRFTA). Barriers to trade are lifted, but the economic landscape is forever changed. The berry sector now has fewer competitors, but they are much larger companies that serve multiple export markets. Laid-off Regina employees found other employment, and without access to its skilled labour, Regina’s electric vehicle industry never fully recovered. Entrepreneurs from both cities, however, are undeterred. They launch new ventures and companies expand aggressively into new markets, happy to leave the great trade war of 2018 behind.

First published in the September 2018 edition of The Business Advisor.