Trade War, Processing Trade, and Global Value Chains [Click here for the latest version]
Abstract: This paper studies the impact of the 2018-2019 trade war in the presence of processing trade and global value chains. In contrast to the U.S., approximately 40% of Chinese imports are processing imports of intermediate inputs used in export-oriented products. Most notably, processing imports pay zero tariffs, even during the trade war. Using monthly Chinese customs data from 2017 to 2019, I estimate the effects of China's retaliatory tariffs and find significant reductions in non-processing imports from the U.S., whereas there is no significant effect on processing imports. Motivated by the reduced-form estimation, I incorporate China's duty-free policy on processing imports in a quantitative general equilibrium model with sectoral linkages, trade in intermediate goods, and sectoral heterogeneity in production to quantify the welfare and trade effects of the trade war. The model shows that the duty-free policy reduced China's welfare loss by 44%. It also shows that China's imports and exports would have decreased significantly more if processing imports had not been exempted from the tariffs. The significant changes in welfare and trade effects primarily come from industries in which processing trade is prevalent. I also find considerable spillover effects on U.S. sectoral outcomes.