A trade war is unlikely, but agreeing on trade rules may become even more difficult

11.9.2018 Forecast Publications, Economic Forecasts, Separate Articles Ilkka Kiema

Last spring, U.S. President Donald Trump announced that the United States would impose import tariffs of 25 percent on steel and 10 percent on aluminum. For the European Union, the tariffs entered into force at the beginning of June. Later that month (22 June), the EU imposed retaliatory tariffs on a range of U.S. products. The United States has also targeted technologically advanced Chinese goods alleged to infringe the intellectual property rights of American firms, and China has responded with retaliatory tariffs on a range of U.S. products.

Trump’s erratic behaviour and hostility toward free trade have raised fears of a global trade war, in which reciprocal tariffs and counter-tariffs could, in the worst case, escalate uncontrollably. At times, developments this year have even been compared with events during the Great Depression of the 1930s. In 1930, the United States enacted a new tariff law (the so-called Smoot–Hawley Tariff Act), to which other countries responded with retaliatory tariffs, leading to an escalating spiral of trade barriers. Between 1929 and 1932, world trade is estimated to have declined by around 30 percent, partly because of tariffs and partly because of the collapse in demand caused by the depression itself. ¹

A global escalation of tariff barriers is unlikely

It is nevertheless implausible that the current tariff increases would lead to a similar spiral as the U.S. tariff law of 1930. This is also reflected in economic forecasts produced after the tariffs entered into force, which have become only slightly more pessimistic than earlier projections. For example, in its July economic forecast, the European Commission estimated EU economic growth this year to be 0.2 percentage points lower than in its spring forecast published two months earlier. This revision has at times been interpreted as reflecting the Commission’s assessment of the direct and indirect effects of the new tariffs on European economic growth.

The impact of the new tariffs on global economic growth is likely to remain modest compared with the effects of the Smoot–Hawley tariffs, if only because the role of the United States in the world economy is less central than it was in the 1930s. Unlike in the 1930s, U.S. isolationism may actually strengthen support for free trade elsewhere. China, for example, has actively sought to improve trade relations with the EU following the introduction of tariffs and has proposed closer cooperation with the EU in developing the World Trade Organization (WTO). Although the EU is unlikely to align itself with China against the United States, trade between the EU and China may nevertheless increase as a consequence of higher tariff barriers.

Greater openness in the world economy and increasingly extended production chains also mean that the negative effects of tariffs are transmitted more rapidly to American companies themselves. For example, Ford Motor Company and General Motors lowered their profit forecasts in July and justified the revised outlook by citing higher aluminum and steel prices. China and the EU have also attempted to target their retaliatory tariffs at U.S. states where support for Trump is stronger than average, thereby affecting sectors such as the automobile industry and soybean production — the latter not usually regarded as a major U.S. export industry.

President Trump’s ability to implement his tariff agenda is also constrained by internal opposition within the Republican Party. Of his more radical objectives, only the tax reform approved in December 2017 has so far been realised, largely because it reflected goals long supported by Republicans independently of Trump. By contrast, the wall on the U.S.–Mexico border — a central theme of Trump’s election campaign but not traditionally part of Republican priorities — appears unlikely to materialise. Documents recently published by The New York Times Company also suggest that some officials appointed by Trump were actively trying to prevent him from acting on impulses regarded within the administration as especially harmful.

Tariff decisions weaken the value of international agreements

The most damaging consequences of Trump’s policies may therefore not arise primarily from the direct and indirect effects of tariffs on trade. An even greater danger may stem from the paralysis of international institutions.

The Trump administration justified the steel and aluminum tariffs on grounds of “national security,” which is one of the exceptions included in WTO free trade agreements that allows members to deviate from ordinary free trade rules. Following the U.S. tariff decision, some commentators even claimed that the WTO was effectively dead: if the justification offered by the United States is accepted, then almost any future trade restriction could potentially be defended on national security grounds.

Comprehensive international agreements under the WTO framework can, of course, be partly replaced by bilateral or regional agreements negotiated between individual countries or blocs such as the EU. At best, such narrower agreements may produce arrangements better suited to national circumstances and accepted through more democratic procedures. However, bilateral agreements can also create problems when firms’ production chains are long and span multiple countries across the world. (AI translation)