Trade Creation and Trade Diversion Effects of U.S.-China Tariff War: A Structural Analysis of Trade Reconfiguration, Industrial Response, and Price Transmission in Pakistan

Abstract

This study examines the consequences of the U.S.–China tariff war on Pakistan’s external sector performance, with particular emphasis on trade creation, trade diversion, industrial restructuring, and domestic price transmission mechanisms. It employs a structural trade framework alongside panel econometric techniques to assess how global trade realignment has influenced Pakistan’s export expansion and import substitution patterns. Using bilateral trade statistics, sectoral industrial indicators, and price index data, the analysis quantifies the extent to which Pakistan has either capitalized on diverted trade flows or faced intensified competitive pressures.The empirical strategy integrates a structural gravity model, a difference-in-differences approach, and price transmission analysis to capture trade, production, and inflationary dynamics in a unified framework. The results suggest that Pakistan has experienced limited but notable trade diversion gains, particularly in labor-intensive export sectors such as textiles and basic manufacturing. However, these gains remain constrained by persistent structural bottlenecks, including energy shortages, low productivity, and weak integration into global value chains, which restrict long-term industrial upgrading.Furthermore, the findings reveal that tariff-induced global price shocks are partially transmitted into domestic inflation through import price channels and exchange rate pass-through effects, thereby amplifying macroeconomic vulnerability. Overall, the study concludes that while the U.S.–China tariff war has created selective export opportunities for Pakistan, the absence of strong structural foundations limits the sustainability of these gains. The research contributes to international trade literature by linking external tariff shocks with structural transformation outcomes in a developing economy context, offering important policy implications for export diversification, industrial competitiveness, and macroeconomic stability.

Keywords: Trade Creation, Trade Diversion, U.S.–China Tariff War, Trade Reconfiguration, Industrial Response, Price Transmission