Broadening trade wars: could Trump take aim at the EU, again?

28 Aug 2019

M&G Investments: Broadening trade wars: could Trump take aim at the EU, again?

27 Aug 2019 by Kirsty Clark

After half a century of post-war global trade integration, where we witnessed an increase in the total trade of good and services from 39% of global GDP in 1990 to 61% in 2008, rising populism and protectionist policies have led to an increase in tariff and non-tariff barriers to cross-border trade; driving this figure down to 58% of global GDP today.

In particular, President Trump’s America First policies have reversed the trend of greater integration, with the President challenging existing free trade deals in an effort to increase domestic competitiveness. The ratcheting up of protectionist threats from the US led to an escalation of global trade tensions in 2018; most notably between the US and China. Since then, the two countries have been playing the ultimate game of ‘tug-of-war’ in trade negotiations, with neither side conceding ground.

President Trump imposed his first round of tariffs on Chinese imports in mid-2018 in a bid to rebalance the sizable trade deficit the US has with China, which amounted to $419 billion in 2018, and stands at $167 billion year to date.

He recently announced additional tariffs on $300 billion worth of Chinese imports, delaying the start date of some of these until mid-December, in a move aimed at eliminating some near-term pain for Christmas shoppers in US. Beijing retaliated by instructing state-run firms to refrain from buying US agricultural products, and by allowing the Chinese yuan to weaken against the US dollar. Just before the latest G7 summit kicked off, China also announced additional tariffs on another $75 billion worth of US goods, while President Trump urged US companies to seek alternatives to China. Equity markets initially sold off on the back of the news, before stabilising as Trump talked up the possibility of some progress. Still, with both sides digging their heels in, investors may want to settle in for a protracted stand-off.

While President Trump is not one to back down from a confrontation, he is having to tread a fine line. In the run up to the 2020 presidential elections, it’s unlikely that he will be keen to risk a meaningful slowdown in the US economy. So we may see him maintain a firm tone, but moderate his actions to help keep the economy on an even keel, and voters on side.

Should the US and China fail to reach an agreement in the near term and remain in a protracted holding pattern, Trump will be looking for alternative ways to optically defend his America First agenda. As a result, he could turn his attentions to other countries and regions, not least the EU with whom the US has the largest trade deficit after China – $169.3 billion in 2018¹.

The impact of US trade policy on the EU to date has predominantly been an indirect (if substantial) one, with the prolonged US-China trade spat weighing on demand for EU exports and weakening economic growth in the region.

However, in June 2018, Trump also imposed 25% direct tariffs on EU steel imports (and 10% on aluminium imports), citing ‘national security’ concerns, which prompted a WTO complaint and retaliatory tariffs from the EU on ca €2.8 billion worth of politically-sensitive US goods.

Until recently, the prospect of a large EU-US trade deal has supported a fragile truce between Brussels and Washington, and kept a lid on any material escalation of trade tensions. Trump’s direct tariffs, and threats of more to come, risk destabilising this.

A degree of acrimony between the US and the EU has been bubbling beneath the surface for the best part of 15 years, triggered by an industry dispute resting on accusations of illegal aircraft subsidies being given to both US aircraft maker Boeing and its European rival Airbus.

The WTO appellate body has so far ruled that both the US and the EU have provided questionable support to the underlying businesses, but it is yet to rule on the harm caused by the anti-competitive behaviour, which will determine the amount of countermeasures the two sides can impose.

While the animosity between the rival aircraft makers shows no sign of abating, the prospect of countermeasures in the form of tariffs on a wide range of products, threatens to turn an industry dispute into a broader trade dispute.

President Trump piled on more pressure last year by threatening to slap tariffs on all EU auto imports – responding to pre-existing EU tariffs of 10% on far fewer US auto imports which exceed current US tariffs. Further threats in April this year to impose a fresh round of tariffs on $11 billion worth of EU imports and, in July, on an additional $4 billion worth of European products have reignited concerns about an escalating US-EU trade war. The EU, for its part, said it would impose retaliatory tariffs – targeting €35 billion worth of US imports (up from €20 billion) – if the President follows through on his threat to impose tariff hikes on EU autos and auto parts, which it views as illegal under WTO rules. Machinery and transport equipment accounted for more than 41% of EU goods exports in 2018, and the US is by far the largest export market for EU cars².

The customs union presents its challenges for President Trump in trying to target individual EU countries. However, he can impose tariffs on ‘typical’ goods, autos in this case, which would disproportionately impact one country, Germany. It is the EU’s largest exporter of cars, responsible for over 55% of EU total car exports in 2018³.

The US has long singled out Germany for maintaining the world’s largest current account surplus, $298 billion in 2018, and for its sizable bilateral goods trade surplus with the US, $68 billion in 2018.

Last year global car sales slowed for the first time in a decade amid the intensifying trade war between the US and China, having a disproportionately-large impact on Germany as a core European exporter. Admittedly, the German auto industry has also been grappling with the shift from diesel to electric cars and slowing demand due to changing demographic trends, not to mention the 2015 emissions scandal and the subsequent flurry of regulations. However, escalating trade wars have exacerbated the already challenging conditions for automakers. The additional threat of direct tariffs from the US, combined with the fallout from the ongoing US-China trade conflict, poses a not insubstantial risk for German manufacturers.

It may be that the President delays his decision on auto and auto parts tariffs if an EU-US trade agreement is not forthcoming, to keep the threat as leverage in further negotiations. It could potentially be a way to get agriculture included in any deal which would help combat China’s retaliatory tariffs on US farm goods, while also providing an opportunity to write in additional clauses (e.g. addressing US concerns about currency manipulation).

President Trump’s attempts to divide the EU and strong-arm individual European countries have been unsuccessful to date, with the bloc presenting a unified voice in trade discussions. What’s more, EU member states remain committed to shared initiatives, such as the Paris Climate Accord, which could become a significant stumbling block in any further EU-US trade negotiations. However, escalating trade tensions following a relatively benign ‘truce’ period, European economic weakness, and the prospect of the UK using US support as leverage in Brexit negotiations, are all factors that risk destabilising current alliances within the bloc.

The bilateral trade negotiations have hit a stalemate a year after a joint statement on efforts to reach a trade agreement. The gulf lies in the EU’s focus is on reducing trade barriers on industrial goods while, as mentioned, the US is keen to include agriculture and other potential poison pills.

The danger for both parties lies in an escalation of ‘tit-for-tat’ punitive and retaliatory tariffs, with Trump targeting EU engines of growth and the EU looking to capitalise on Trump’s pre-election concerns by hiking tariffs on politically-sensitive goods.

While it’s difficult, ‘tweet-to-tweet’, to predict Trump’s next move, sabre-rattling has often been his approach out of the gate. However, any tariff hikes on EU auto imports will also impact workers in US-based EU auto plants. According to the German Association of the Automotive Industry, German car companies are responsible for around 120,000 jobs at some 300 US-based factories. US government officials and trade bodies have also voiced their concerns about such a move, so it would certainly be unpopular if Trump were to implement these tariffs (particularly on national security grounds) without attempting to negotiate with the EU to de-escalate the tensions.

It is likely that European countries and EU authorities will attempt to find ways to improve relations with the Trump administration, offering limited concessions on peripheral issues such as aligning regulatory standards. Other moves to appease the US could include increasing military spending or employing fiscal stimulus to boost domestic demand and lower Germany’s trade surplus.

It’s worth noting that the forthcoming changes at the helm of key EU institutions could alter the dynamic in future discussions. Incoming European Commission President, Ursula von der Leyen (an ally of German Chancellor Angela Merkel) has signalled that she will maintain a strategy of defending the EU’s commercial interests and upholding the global trading order, while Christine Lagarde’s approach to monetary policy in the face of Trump’s growing watchlist of potential ‘currency manipulators’ remains to be seen, but she may very well rely on her political skills to help navigate potential challenges when she takes over in November.

As global trade uncertainty continues to weigh on European economic growth, the EU has been working towards greater global integration; expedited trade deals with three of its top 20 partners; Canada, Japan and Mercosur (the South American trading bloc that currently includes Argentina, Brazil, Paraguay and Uruguay), and continues to work towards agreements with Australia and New Zealand following successful deals with Singapore and Vietnam. Still, these agreements combined are not enough to offset trade with the bloc’s largest partners; the US, China and the UK (when stripped out of th EU). However, as trade disputes rumble on, EU leaders will be hoping that this progress goes some way to restoring domestic confidence – and stabilising the services sector – to help offset the downward pressure on export-dependent manufacturers.

With the dual threat of an escalating US-EU trade war and the potential for a disorderly Brexit looming, EU authorities may have little choice but to accept some further trade disruption while trying to limit the fallout. Meanwhile, if the US-China stand off intensifies and moves from a trade war to a currency war, competitive currency devaluations could compund Europe’s economic woes.

¹ Eurostat, 2019   

² Eurostat, 2019

³ Eurostat, 2019

 


The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.


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