Trade Wars, Technology and Productivity

If international trade is strictly trade in intermediate goods, would the common presumption, that small, less developed economies (the South) lose from trade wars still be true? We address this question by constructing a dynamic general equilibrium model in which the North and the South trade technology-embodied intermediate goods. We show that the detrimental effects of the trade war are mitigated by the fact that producers in the South can adjust their choice of imported intermediate goods and their investment in domestic technologies. We establish sufficient conditions under which the steady-state trade equilibrium length of the production line and the range of domestic production in the South both expand in response to a tariff war. It thereby creates a novel channel of scale-scope trade-off: The South counters the losses from trade protection in the volume and value of trade (scale) with an upward movement along the value chain (scope). As a result, average productivity in the South and aggregate technology used by the South both turn out to be higher.