Why trade wars have no winners

This article is brought to you thanks to the collaboration of The European Sting with the World Economic Forum. Author: Anahita Thoms, Partner, International Trade Practice, Baker McKenzie, Germany

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Public support for free trade is shrinking and the long-standing political consensus that trade liberalization is beneficial is under attack. The US in particular has recently shifted towards protectionism by imposing tariffs and continuously threatening its largest trading partners, in particular the EU and China. Brexit, too, is partly driven by a protectionist attitude: although the UK intends to enter into Free Trade Agreements (FTAs) with other countries, the move away from the single market is itself a rejection of free trade within the EU.

Despite the potential of the Trump Administration’s trade strategy to attract voters in poor, deindustrialized regions who feel left behind by globalization, it puts the enormous achievements of the last decades – both in the US and globally – at risk. Expanded trade between 1950 and 2016 has increased US gross domestic product (GDP) by $7,014 per capita and $18,131 per household. The increased costs of imports as a consequence of the 2018 trade dispute, on the other hand, have resulted in annual consumer and producer losses of 0.37% of GDP and an aggregate welfare loss of 0.04% of GDP.

Have the benefits of globalization been sufficiently equitably distributed in the US? There is a question about whether successive administrations have done enough to mitigate or slow the disruption caused by globalization in local communities, for example, when a traditional industry such as steel-making declines because it can be done more efficiently in another country.

To date, the US government’s own domestic fiscal and industrial policies – not free trade or globalization – have determined whether the economic benefits of globalization have been shared widely throughout society or whether they have increased inequality. They have determined whether a rust belt town dependent on a declining industry receives funding, retrains workers or offers tax breaks to attract new investment to diversify and evolve its economy. Public anger is backed by data showing America’s low and middle-income households have seen little of the huge economic growth unleashed by free trade in recent decades. It may be politically expedient to suggest China has somehow forced Americans to buy too many of their goods rather than look at policy at home, but this directs public perception and anger in the wrong direction, deliberately or otherwise.

American businesses, workers and consumers do not benefit from protectionism. Although protectionism can shield domestic jobs in individual sectors, repeated claims that high tariffs will protect domestic jobs or even create jobs need to be treated with great caution since secondary effects may lead to job losses in other sectors. Higher tariffs increase trade costs, leading to a lower disposable income per household. For example, in 2009 the US Administration under President Obama temporarily increased tariffs on Chinese car and light truck tyre imports. Within two years, employment in the US tire manufacturing industry grew with 1,200 new jobs, but tyre prices increased. This reduced US household purchasing power, resulting in approximately 3,500 job losses in the retail sector.

The Trump administration often points to the US trade deficit with the EU and China, which it wants to tackle. This message may be of benefit in terms of politics but is too simplistic. The notion that trade deficits are bad in principle ignores that importing cheap intermediate goods makes US manufacturers more competitive on the global market, boosting exports to elsewhere. Furthermore, foreign firms exporting to the US may be owned by US investors or work with US-owned service providers such as law firms or auditors, redirecting profits to the US. Lastly, domestic consumers benefit from imports as competition and increased product variety lower prices.

We must not forget that trade disputes are not a one-way street, but always imply the danger of retaliatory measures. Such measures caused a $15.28 billion reduction in US exports of goods in the second half of 2018 alone. Additionally, the US has become vulnerable, because retaliatory measures by a number of countries have many US exports to be taxed in global markets. Reciprocal retaliatory measures may lead to escalation, which is the greatest danger to global growth. The 1930 Smoot-Hawley Tariff Act raised tariffs on more than 20,000 goods, inducing large trading partners to take retaliatory action. This diminished two-thirds of world trade, aggravated the Great Depression and contributed to the creation of a feeding ground for totalitarianism around the world. The risks here are not small.

According to current estimates, an escalation in protectionism worldwide would lead to a permanent loss of 4% of GDP for the EU and 3% for the US. A large share of the US’ Euro-area imports are intermediate goods used in manufacturing and then re-exported to other countries. An escalation would destroy the complex supply chains formed in recent decades. Where intermediate goods cross borders multiple times before the final product is made, applying tariffs increases the price of the final product and hits manufacturers hard, while consumers bear the negative consequences of higher prices.

We must not be naive but rather recognize that unfair foreign practices need to be fought off. This legitimate aim can justify protectionist measures to a certain degree, but trade disputes won’t do the job. In particularly critical fields, we must protect our key strategic industries through effective foreign investment reviews. Elsewhere diplomacy is the only way forward and whenever a forum for debate is needed, the right place is a reformed World Trade Organization (WTO).

Protectionist policies in the US are a major concern for the EU, because the US is a particularly important trading partner. In 2018, 21% of the EU’s exports in goods went to the US and 13% of imports came from the US.

In stark contrast to the US, the EU holds on to its belief in free trade. It is not free of protectionist voices, however such policies do not shape the EU’s current strategy. Rather, in line with its Market Access Strategy, the EU successfully tackles trade and investment barriers through diplomatic actions, dispute settlement in the WTO and, most importantly, new trade agreements. Recently, the EU has concluded agreements with, Singapore, the Mercosur states (Argentina, Brazil, Paraguay and Uruguay), Japan and Vietnam. These agreements will, however, only partly make up for the disruptions caused by Brexit and the US strategy. Owing to the long-standing trading relationship, new trade agreements cannot easily compensate for the damage that might be done to complex supply and value chains formed across the Atlantic Channel.

The EU is driven by the understanding that trade and globalization have increased prosperity for the vast majority of families, businesses and workers.

For historical reasons, the EU is also very much interested in using trade to maintain stability. Trade relations helped to limit the danger of economic competition degenerating into geopolitical rivalry in the post-World War II order. The exchange of goods also promotes an exchange of cultures and humanizes trading partners. Trade disputes, on the other hand, may escalate, putting international security at risk.

Trade disputes do not produce winners in the long-term, although calculations are often presented to the contrary. A recent calculation by the Ifo-Institute found that Germany and other EU economies may benefit if the US implements further tariffs on Chinese imports. These findings were somewhat superficially cited in major newspapers, however, the calculation did not take into account the negative effects of investor uncertainty nor the possibility of a devaluation of the Chinese currency.

Of course, in individual cases, certain countries may temporarily benefit from bilateral trade disputes since the flow goods may be diverted. Vietnam’s exports to the US, for example, have increased by 40% this year, because Chinese businesses have relocated their distribution to Vietnam in order to circumvent US tariffs. However, there is always the danger that the beneficiary may also be targeted, which would not only put an end to such beneficial side-effects but further escalate the trade dispute.

It would be short-sighted to declare the (short-term) beneficiaries of trade tensions winners, since they too are affected by dangers for the global economy as a whole. Such dangers can particularly result from uncertainty. Businesses planning to enter into new markets or already conducting international business are likely to decrease their investment activity. In the US, for example, tariff worries caused 30% of manufacturers and 25% of goods producers to reassess their capital expenditure plans in 2018. International trade flows in intermediate goods may be affected disproportionately in response to uncertainty shocks. Uncertainty may also lead to risk reassessment, reducing investment and potentially hindering productivity. These effects are visible already: the Organization for Economic Co-operation and Development (OECD) forecasts that uncertainties concerning current trade disputes will lead to a reduction in business investment growth from 3.5% in 2017 and 2018 to 1.75% in 2019 and 2020. It would be naive to assume that countries temporarily benefitting from a diversion of trade flows would not be harmed by such effects in the long-term.

The current challenges to the world economy are worrying and it is unclear whether satisfactory solutions can be found in the near future. The International Monetary Fund (IMF) and the OECD, therefore, rightly call for policy actions to reduce trade tensions. In order to boost public support for free trade, it is particularly important to counter the short-sighted notion that trade disputes produce both winners and losers and acknowledge the role that national governments have played, with their fiscal policies that did not spread the benefits of globalization fairly and failed to soften the disruption to older industries. The truth is that, in the long-term, trade tensions will only produce losers as the implied dangers could demolish the progress of recent decades.