Could a Trillion-Dollar Trade War Actually Occur?

On July 6, the United States started imposing a 25 per cent import tariff on $34 billion of Chinese imports on a list of 818 products. On the same day, China retaliated by imposing an identical tariff on an identical value of US imports.

Each side has prepared further product lists that would cover an additional $16 billion of imports. President Trump warned that if China retaliated, it would trigger further import duties. True to his word, whilst boarding Air Force One to the NATO Summit in Brussels, he authorized another 10 per cent on an additional $200 billion worth of Chinese imports and stated that he would add yet another $200 billion if China matches him. If that were to happen, nearly all US imports from China ($506 billion) and perhaps all Chinese imports from the US ($130 billion) (for a total of $636 billion) would be subject to tariffs.

 If the United States proceeds to impose 20 per cent import tariffs on imported cars, the EU and other exporters might impose around $300 billion of retaliatory tariffs (roughly equivalent to US imports of cars, light trucks and parts). More than $42 billion in car imports came from the EU in 2017, with nearly half of that coming from Germany. These figures don’t count the retaliatory tariffs imposed by many other countries, including Canada, Mexico, Russia, Japan and India.

 Could we see a $1 trillion+ trade war that would have a significant impact on the world economy? Yes, we could and for several reasons.

 This trade war isn’t going to go away soon

 First, President Trump has at his disposal several statutes that give him nearly unlimited discretion about when to impose tariffs, including for reasons of “national security.” While invoking national security at a time of peace and in relation to imports of cars, steel or aluminum from allies is certainly questionable, it is highly unlikely that any court challenge in the United States would succeed. It is also unlikely that the broad statutes the President is invoking will be amended by Congress, even if the mid-term elections bring about a Democratic majority in the House of Representatives.

 Second, President Trump has said he believes that trade wars are “good and easy to win.” Many observers have made the error of dismissing such statement as mere posturing. It is quite likely, however, that he believes this to be true. All his economic advisers who would have counseled against the tariff wars (such as Gary Cohn) have all left; those who remain, such as Peter Navarro, White House director of trade and industrial policy, and Robert Lighthizer, the US Trade Representative, will all urge the President to be tough.

Like any good fallacy, there is a kernel of truth to the statement about trade wars being easy to win: the massive US trade deficit that makes other countries (especially China) more reliant on exporting to the US than vice-versa. The White House may not appreciate that China has long ceased to be a trade-reliant economy: net exports account for just 2% of Chinese national income.

 President Trump’s history of statements about the EU indicate that he holds it in lower regard than China: whereas China is a large, powerful and unitary state capable of swift and decisive action, the EU appears to be a weak, divided and ineffective group of states that can be divided and conquered. The White House does not appear to appreciate the EU’s real negotiating power as the sole negotiator on behalf of 28 countries representing a major economy and trading bloc. The EU might undermine that leverage if it agrees to the German automobile manufacturers’ proposal of a transatlantic zero tariff on cars as this would represent a side deal benefiting only some EU member states at a time when the US has a gun pointed at the EU’s head.

 Third, the current aggressive trade policy appears to be selling well, at least in the critical rustbelt swing states that brought President Trump to victory in the Electoral College. An increasing number of companies (mostly multinational) and trade associations have been voicing their concerns, as well as some representatives from exporting states that would be hard hit. But the President appears to believe that “looking tough” on trade is what his constituency wants, and, after all, it is precisely what he promised during the campaign. Moreover, there is little risk that those Republican states where vulnerable EU-owned car companies are located (South Carolina, Alabama, Mississippi and Tennessee) and which depend on international export markets for commodities like soybeans (such as Nebraska, North Dakota, Iowa, Missouri) will abandon the GOP. This domestic electoral calculus is the only thing that matters. The risk that the tariffs could destroy many more jobs than it creates (by raising input costs and damaging export competitiveness) is secondary.

 Fourth, it may be that the White House is expecting that the impact of a tit-for-tat trade war will be delayed until after the mid-term elections and possibly even until after the national elections in November 2020. Even if impact is felt sooner than that, it would not be hard to blame other countries (“free riders” on the American economy). There are also signs that the White House is preparing to cushion the impact on US farmers through subsidies and intervention in the commodity markets. Manufacturers have generally benefited from a very positive economy and strong profits; those who speak out against the tariff war will be subject to naming and shaming. That has led most manufacturers to stay silent.

 Fifth, the import tariffs on cars appears likely, not only in order to address a significant reason for the EU’s significant trade surplus with the United States and in order to target Germany in particular, but especially because the tariffs are a tool to place greater pressure on Canada and Mexico to agree to significant changes to the North American Free Trade Agreement, including rules of origin that would force far greater value-added production in the United States. Without the 20% import tariffs, car exporters from both countries might opt to simply pay the existing 2.5% import tariff rather than to move production across the border.

 Finally, the White House may calculate that the impact of the tariffs will be masked by the “sugar rush” of tax cuts and deregulation that have helped turbo-charge the US economy. Other measures to appeal to the loyal base of Trump supporters, including the nomination of a conservative member of the Supreme Court to replace Justice Anthony Kennedy, may also contribute to ensuring a united Republican party in support of the President.

 Knock-on effects…

 This is all happening at a time when antitrust/competition policy is also coming under scrutiny. The dominance of narrowly defined consumer welfare as the key criterion of competition analysis is increasingly questioned as authorities and courts grapple with globalization and the digital economy, finding themselves called upon to promote fairness and defend democracy.

 In Europe, competition policy has always been a driving force of the EU’s market integration agenda and has never been reluctant to look beyond allegedly scientific economics. However, the broad transatlantic consensus that the primary focus of competition policy was on promoting competitive markets rather than creating, boosting or defending local companies is now under threat from a toxic mixture of circumstances. Trump’s America, post-Brexit EU and post-EU UK will all be tempted to use trade, investment and competition policies in a more directive way to guide and correct what are seen as imbalances and create or defend local champions, facilities and technologies.

 A trade war will contain many battles and some of them will be fought on the battlefields of competition policy. Among likely victims will be competitive markets and the international consensus about the merits of competition which the transatlantic world developed and exported widely around the world. That is not good news for today’s consumers or tomorrow’s innovators.  Large countries or blocs of countries will think they have the scale and strength to deliver such redirected policies. Small and medium-sized industrial countries and the world of emerging markets will have to be very agile to avoid the toxic fallout.

 

Anthony Gardner is a Senior Adviser at Brunswick Group, having previously served as the US Ambassador to the EU 2014-2017, whilst Sir Jonathan Faull is Partner and Chairman of European Public Affairs, having been with the European Commission previously. Jonathan’s most recent roles at the Commission included Director-General Financial Stability, Financial Services and Capital Markets Union, as well as Director-General of the Task Force for strategic issues related to the UK Referendum. These notes are their personal views.


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