The Impact of the U.S.-China Trade War on Profitability and Investment

This paper presents evidence that the U.S. trade war with China is having a significant negative impact on corporate investment. We identify the link between trade policy and corporate investment rates by merging together two seemingly separate literatures. The first is a literature that has used a specific-factors framework to show that fluctuations in the prices of tradable goods causes movements in abnormal returns of listed firms. The second is a literature that builds on Tobin’s q as a theory of corporate investment. In this setup, investment is linked to firm expected future profitability as measured by the market value of equity relative to the book value. Putting these two channels together yields a mechanism through which import protection can affect investment—namely, protection lowers expected firm profits and this lowers the incentives of firms to invest.

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