Working Paper - The Economics of Decoupling
The rest of the world, in particular the EU, should be relaxed about the prospect of a China-US trade war. A working paper by Daniel Gros
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FileThe economics of decoupling.pdf (680.45 KB)
Who gains, who loses?
This paper analyses the welfare consequences of decoupling, defined as a complete ban of imports, in a three-country version of the standard Krugman (1980) model of trade in differentiated products under monopolistic competition.
The main results are:
1. The rest of the world always gains from any form of decoupling.
2. Even in a unilateral decoupling (e.g. US stops imports of Chinese goods, but China remains open), both sides involved lose. But the country that shuts off imports from one partner loses more than the intended victim.
3. The losses for both sides are greater in a symmetric, tit-for-tat decoupling (i.e. when both sides shut off imports from the other). The country that is the victim of a unilateral decoupling thus has no incentive to respond with tit-for-tat.
4. The country that initiates the decoupling does not gain from forming a coalition with the rest of the world as long as the intended victim does not engage in tit-for-tat.
The first result implies that the rest of the world, in particular the EU, should be relaxed about the prospect of a China-US trade war. If two countries decouple symmetrically from each other, exporters from the EU (and in general the rest of the world) obtain an advantage in the markets of both countries engaged in decoupling.
The second result is that unilateral decoupling not only brings costs for the country that shuts off imports, but these costs are larger than those of the intended victim. Decoupling is thus counterproductive if it is intended to weaken the trading partner relative to the home economy.
The simple reason for this result is that if the US shuts off imports from one partner (China), it limits the choice of consumers and invites higher-priced imports from the rest of the world (e.g. Europe). By contrast, the consumers in the intended victim, China, or in general the country whose imports are targeted by the ‘decoupler’ retains a wider choice of imports as long as it does not engage in tit-for-tat. This is the reason why the cost of decoupling is higher for the country that initiates it.
Tit-for-tat, i.e., responding to another country’s decoupling by shutting off imports from that source, only increases the loss. There is thus no incentive (except grandstanding and the usual game theoretic considerations) to engage in tit-for-tat.
The fourth result implies that the US has no economic incentive to force the EU to decouple from China, as this does not change the loss from access to Chinese goods that the US suffers anyway
IEP@BU does not express opinions of its own. The opinions expressed in this publication are those of the authors. Any errors or omissions are the responsibility of the authors.
