5. Trade Imbalance and Protectionist Policy on Imported Intermediate Inputs

In this chapter, we analyze changes in trade balance in response to protectionist policy on imported intermediate inputs. Our analysis is conducted in a non-scale growth model, which features endogenous labor supply, leisure choice, and an imported intermediate input in the domestic production. From our model results, we find that an increase in the price of the imported intermediate input will lead to lower productivity and lower output, which in turn will have an adverse effect on the trade balance. But the reduced consumption following the import tariff will have a positive effect on the trade balance. The net impact on the trade balance depends on the relative forces of these offsetting factors. Hence, trade protectionism on imported intermediate inputs will not necessarily reduce the trade deficit in the domestic economy. The policy implication is that President Trump’s trade protectionist policy on imported intermediate inputs from China will probably not work.