Trade wars offer fragile gains, then losses for non-targeted economies
A new European Central Bank working paper finds that non-targeted countries initially benefit from trade diversion in bilateral trade wars. However, these gains are temporary and reverse once tariffs extend to their own goods.
Euro area's fragile gains from US-China tariffs
The 2025 U.S.-China tariff escalation, which raised average U.S. tariffs on Chinese goods by almost 37 percentage points and Chinese tariffs on U.S. goods by around 11 percentage points, generates large and asymmetric welfare losses for the two protagonists.
Output, investment, and consumption decline persistently in both economies.
The euro area, initially only marginally affected, may experience small temporary gains as demand is redirected toward its producers.
However, these gains fade as global demand weakens.
The study uses a three-country New Keynesian model with trade in final and intermediate goods, incomplete asset markets, and asymmetric monetary regimes to quantify these spillovers.
The reversal of third-country benefits
Third-country gains are fragile and reverse once tariffs extend to euro-area goods.
In such a scenario, the euro area's welfare turns negative, and output contracts as the cushioning effect from trade diversion disappears.
China's downturn deepens further, while the United States records only limited additional welfare improvements.
The paper also analyzes the euro area's welfare-maximizing tariff response, finding that retaliatory tariffs deliver only modest domestic improvements at the cost of large additional losses for the U.S. and China.
This highlights the intrinsically multilateral nature of trade policy.
A stark warning for open economies
This study delivers a crucial, albeit sobering, message for open economies like the euro area.
It effectively dismantles the comforting illusion that trade wars between major powers can yield lasting benefits for bystanders.
Policymakers must now confront the reality that protectionism, once unleashed, rarely stays contained and demands a more coordinated, rather than retaliatory, global response.
Source: The third-country effects of trade wars
IN: