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Shoot yourself in the foot first, then I’ll do the same!

Shoot yourself in the foot first, then I’ll do the same!

By Daniel Gros, Director of the Centre for European Policy Studies.

Brussels – The first salvo in the transatlantic trade war has now been fired by the United States, which is imposing stinging tariffs on steel imports from the European Union (as well as from Canada and Mexico). It was an unprovoked attack, to which the European Union has vowed to retaliate. Moreover, US President Donald Trump has announced an investigation into whether car imports threaten national security. Any tit-for-tat response could thus quickly escalate from steel to the automotive industry, which is vital for Europe.

Unfortunately, it seems that emotions and short-term political posturing, rather than economic logic, is dictating the EU’s reaction. For starters, there is a key inconsistency in the discourse of the EU (and other US trading partners). The EU argues that tariffs on steel imports mainly hurt the US itself, and most economists would agree. But this also implies that counter-measures taken by the EU will mainly hurt Europe.

Because the selective tariffs threatened by the Commission will affect finished products, not inputs like steel, the damage inflicted on EU consumers by European countermeasures will be smaller than the damage inflicted on the US economy by Trump’s steel tariffs. But increasing tariffs remains an act of self-harm. Economists are fond of observing that the argument for counter-measures against protectionism abroad is like saying: “If you shoot yourself in the foot, I will do the same.”

The proper response to Trump’s claiming that a larger US steel industry is in the national interest should be: “Mr. President, if you insist that national security requires your country’s industry to receive lower volumes of high-quality European steel, we can help. We will organize a cartel of our producers and ask them to increase the price they charge to US consumers.”

Technically, this would amount to the EU agreeing to what is euphemistically called a “voluntary export restraint” (VER). From a strictly economic point of view, this represents an attractive alternative to tariffs for the exporting country. With the import tariffs on steel just announced, the US will at least obtain some revenue. For steel, the sums involved would be moderate. For example, a generalized import tariff of 25% on steel products could yield almost $4 billion per year, even if imports were to fall by almost half (to $16 billion). This is negligible relative to the US fiscal deficit, which might reach close to $1 trillion this year. But if the EU had agreed on a VER, European producers would have received that $4 billion from higher sales revenues, and for them this sum would have been a very important shot in the arm, allowing them to invest in higher productivity and more sustainable production.

In other words, to the extent that Trump just wants allies to reduce their exports to the US, this can be accommodated by EU producers increasing prices and pocketing the higher revenues – never mind that US consumers of steel would thereby be subsidizing foreign steel producers.

Instead of blustering and showing off long lists of products on which the EU will now impose tariffs, European leaders should signal to the US that they are willing to organize a VER for their steel producers. This is the approach successfully pursued by Korea, whose steel producers do not face a tariff, because they are reducing their exports by charging higher prices and can thus expect much higher profits.

Of course, the immediate objection is, “We are not Korea. The EU is too big to be pushed around like this.” But the harsh reality is that Europe depends on the US security umbrella, and there is little indication that counter measures by the EU will deflect Trump from his erratic course. Cool economic logic should come before misplaced political pride.

The fact that a VER could also satisfy US demand also means that the conventional wisdom underlying trade negotiations does not apply in this case. That wisdom, supported by the “game theoretic” models beloved by economists, suggests that retaliation is indeed the best strategy. But this is true only in a “normal” negotiation where both partners use the threat of tariffs as their main bargaining tool. When one partner (the US) offers to eliminate its tariff in exchange for export restraint, the game is over: this is an offer that is too good to refuse.

The EU has just rejected such an offer, partly owing to a sentiment of wounded pride, but also because EU competition rules might make it difficult to organize a cartel of European steel producers. Moreover, the EU has long fought in the World Trade Organization to make VERs illegal. But these legal and diplomatic niceties can and should be overcome to arrive at a solution that makes economic sense for the EU.

Steel is the issue today, cars might be in the near future, and who knows what other sectors will come after that. Instead of engaging in a costly strategy of escalation with their biggest trading partner, Europe’s leaders should swallow their pride and humor Trump when he insists on running the US economy into the ground.

Copyright: Project Syndicate, 2018.


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