Andrea Fracasso, professor of Economic Policy at the School of International Studies and the Department of Economics and Management of the University of Trento.
The tariffs imposed by the White House on the rest of the world are a shock of historic proportions. This, and the lack of clarity about the reasons behind them, has made the situation difficult to interpret. There are many bold statements and many unanswered questions. In this article, I will try to address the issues that have emerged in the debate, with an introduction to help understand the individual aspects that follow below.
Introduction: With the WTO-centered multilateral trading system in place, countries have reduced tariffs on almost all goods (and some services) through rounds of multilateral negotiations, balancing the overall interests of partners rather than bilateral interests. Such multilateral liberalization is based on the imposition of identical tariffs on all trading partners, with the sole exceptions of the preferential treatment conceded to less developed countries and to partners in free trade areas. The World Trade Organisation system has also bodies that deal with trade disputes, and its rules allow for the imposition of contingent defensive duties against harmful and unfair practices (such as dumping).
The system of tariffs is thus the product of several rounds of multilateral negotiations in which each country has agreed to reduce its tariffs in a number of sectors (thereby favouring access to its markets for foreign exporters) in return for reductions in other countries’ tariffs in sectors of interest to its own exporters. It is the combination of different interests and different sectoral specialization that makes international trade beneficial for all the partners.
What matters, thus, is not the bilateral trade balance between pairs of countries, but the overall creation of equal market access opportunities. The current international framework is the result of extensive multilateral negotiations and reflects an agreement that countries have considered to be mutually beneficial. It should come as no surprise that this has allowed the United States and Europe to maintain their high income levels while it has enabled many emerging economies to grow.
The Europeans are ‘screwing us, it’s so sad’ (President Trump). Really?
According to President Trump, the Europeans have been taking advantage of his country, as evidenced by the European trade surplus in goods (but not in services).
In fact, bilateral trade imbalances are a normal part of international trade. For the Americans to be able to buy a lot of, say, wine from Italy, they need to generate income by selling, say, IT services to Japan. Similarly, the income generated by selling Italian wine to Americans allows Italians to buy the latest generation of mobile phones from Asia. And so on. The ability to buy from the best and most efficient producers in the world increases everyone’s income and consumption possibilities. This is the essence of international specialization associated with free trade.
Has the rest of the world ripped off the Americans?
So, leaving aside bilateral imbalances, one could say that the overall trade deficit of the United States with the rest of the world points to a problem. This is indeed possible.
The analysis must then turn to the determinants of this persistent and large imbalance. The Trump administration claims that it is due to a lack of “reciprocity”, i.e. poor treatment of American goods and companies abroad. This is a possible determinant of the deficit, but is it enough to explain the situation?
Economic theory tells us that if a country invests more than it saves (as the United States has been doing for decades), it must necessarily run a current account deficit with the rest of the world. On the other hand, if it saves more than it invests, as China or Germany do, it will inevitably run a surplus. Constant and persistent imbalances between domestic investment and savings create trade imbalances. These are situations that cannot be fixed by higher tariffs, but that could be addressed by realigning exchange rates and reviewing public and private spending in all countries.
Americans are right to say that certain European countries and China have a (too) high saving rate, but the United States has such (too) low saving rate because it can easily and cheaply attract capital from the rest of the world. This system has long favoured the growth of the United States at the expense of a financial position that is exposed to the rest of the world.
So, if it is reasonable to argue that America’s financial exposure to the rest of the world is excessive and that an adjustment process is inevitable, the quality and the speed of this adjustment are not irrelevant. And this unilateral American move is, to say the least, destabilizing.
Is the multilateral system outdated and in need of adjustment?
The conditions underlying the WTO agreements have changed over the decades. China is no longer a low-income country, but it is still not functioning as a market economy. The European Union has expanded. The United States has encouraged the development of services at the expense of manufacturing, especially after the real estate bubble that led to the subprime crisis in 2007. Many emerging economies have grown and have learnt to compete for the production of complex manufacturing goods .
Better tools to enforce the respect of the agreements are necessary because the current dispute settling mechanism is not very effective.
It is therefore reasonable to argue that the multilateral trading system needs reform, as the Americans have been demanding for quite some time. However, it should not be forgotten that it is the American multinationals that have relocated the most to countries that ‘benefit’ from the loopholes in the agreements. This suggests caution in apportioning responsibility for the current stalemate in the reform of the system.
Is this the end of international trade as we know it?
The unilateral imposition of high tariffs that vary from country to country, motivated by an unlikely case of national emergency, dismantles the essence of the multilateral system. It reintroduces a logic based on bilateral negotiations and it renders all commitments untrustworthy. In short, it’s a huge obstacle to the functioning of the trade system as we know it.
This is an enormous problem, not a provocation, as some would have us believe. Any country could feel justified in reneging on agreements, discriminating against foreign companies and exerting pressure on other countries’ internal decisions (a form of economic coercion). If bilateral confrontation based on this logic prevails, we won’t be able to get by with a few mutual bilateral concessions. If the multilateral system dies, the law of the jungle will return.
Will tariffs bring manufacturing back to America?
Supporters of the US presidency claim that the United States will be able to bring manufacturing back to America. Even assuming that this is desirable (and anyone working in a law firm, bank or artificial intelligence company could easily argue otherwise), it is highly unlikely that this will happen in all areas.
It is indeed possible that many non-American companies will decide to move production to the United States so as to serve American consumers without them having to pay tariffs on imported goods. However, the United States will not be able to produce everything, especially given the high consumption rate. The attempt to produce low value-added activities currently located in other countries will reduce overall efficiency and increase costs, making US production less competitive. In the attempt to expand, some sectors will compete with others for labour and capital. If some sectors gain, many will lose. And consumers, especially the poorest, will certainly have to pay more for basic consumer products.
It is not clear whether these tariffs will be maintained over time, or whether they will be used strategically to win concessions elsewhere. It follows that foreign companies will be cautious before moving production to America, unless this has already been decided. Hence, the same American ambiguity is a serious obstacle to its re-industrialization plans. And if this process is delayed, imports will continue unabated.
Moreover, if the rest of the world were to block the exports of certain raw materials and products to the US, as China has decided to do, the re-industrialization process could be made impossible even sectors that are currently flourishing. It is no coincidence that the United States itself has provided for a long list of exceptions to allow the free import of strategic goods.
One finale observation. If re-industrialisation were to accelerate, the increased investment in new production facilities in America would increase (rather than decrease) imports and the American trade imbalance in the short term. Unless, of course, investment in services collapses. In either case, it would be the opposite of what the President wants.
Exorbitant privilege, goodbye?
The overall impact of the tariffs will depend on the dollar. Only a depreciation of the US currency will increase the impact of the tariffs. Reduced capital flows and lower use of the dollar in international transactions are necessary elements for a large depreciation of the dollar. But if the US administration succeeds in getting other countries to revalue their currencies, it will jeopardize the US central role in the global financial system. And this is the opposite of what the US has been trying to achieve over the last century.
Many doubt that it is in the US interest to give up its “exorbitant privilege” (i.e. the possibility to exchange foreign goods for dollars, that the partners accept as a store of value). Will America lose control of the capital market in exchange for an increased production of shoes?
A magic formula for calculating tariffs?
The Administration published the formula used to determine the tariffs levied on imports from the different countries. A formula that combines various economic elements, but that makes very little sense.
This formula incredibly assumes the absence of general economic effects from the imposition of tariffs, but this cannot be the case as the events in the global stock exchanges remind us. The formula considers only goods, while it ignores services and other current account transfers. Above all, it is a formula that betrays the fallacy that any bilateral imbalance in the exchange of goods is problematic and must be corrected (actually, closed).
Finally, this formula optimistically assumes a large reduction in the border prices of goods imported from abroad because the exporters are expected to reduce their prices so that US consumer prices can increase by only 25% of the tariff. Assuming this is correct (but unlikely), the formula does not take into account that such terms of trade effect would reduce the trade deficit. This would require lower tariffs. So even if one wanted to follow the (fallacious) logic of the exercise, the formula would need be reconsidered.
Are the tariffs reciprocal?
The US Administration claims that any bilateral US trade imbalance is due to a lack of fair treatment to the detriment of the US products. A disadvantage that results from higher tariffs and restrictions abroad. This is the reason why the Administration claims that the tariffs are designed to restore a fairer treatment and are “reciprocal”.
In reality, as I explained earlier, bilateral imbalances do not necessarily stem from unequal treatment and lack of reciprocity, but from the characteristics of economic specialization. Even the overall imbalances with the rest of the world depend as much on macroeconomic factors as on relative restrictions and distortions.
Retaliation, domestic support or export promotion?
Faced with the US decision, the European political landscape is divided over the appropriate response. As this is an act of serious pressure, it is difficult for the EU not to respond. However, the imposition of European tariffs on American goods would end up creating in Europe the same problems I described for America.
One possible solution is to define a package of proportionate and diversified retaliatory measures. Some tariffs could penalize imports of US goods that are important to those who support the President, but that can be easily substituted in Europe. There might be measures on services and business activities in the EU, as well as forms of taxation on multinationals and digital activities. President Trump has already stated (two months ago) that he would consider such measures to be a hostile act. It is not an easy decision for the EU. In any case, it should be made clear that any EU retaliatory measures would be immediately lifted as soon as the US tariffs are removed.
Some suggest providing support to European businesses while they cope with the shock. This is sensible, but only in the short term. It is clear that for many companies it will be hard to adapt to the changes caused by the US tariffs, but State aid cannot replace American demand in the long term. Similarly, it is correct to suggest a temporary boost to European public expenditures, even though this cannot reach or be enough to help all sectors. We have to accept that American tariffs will eventually reduce income and consumption in the rest of the world. If trade increases opportunities and incomes, tariffs reduce them.
The proposal to help domestic companies to export more towards foreign countries different from the US makes sense. On closer inspection, however, it is a fallacious move from a multilateral perspective. If all countries tried to make up for their lost exports to America, the end result would be a widening of the dispute and, probably, an escalation of tariffs. It is a contradiction to claim, as some have done, that one must avoid escalation, while at the same time trying to “forcibly” increase exports to third countries.
This strategy could work only if global trade was liberalized further and global demand was increased.
Does the real danger for EU come from other countries?
Some European observers claim that it is not the US tariffs the real danger for Europe, but rather third countries that will try to flood the European market to compensate for lost sales in the US. This is a possibility. But if anything, it is an aggravating factor in the American decision, not a mitigating one.
Some are suggesting a review of green economy regulations in the EU because of their negative impact on production costs. While it is necessary to consider the relevance of this issue, it should be remembered that European technical requirements imply that only the most productive companies can serve the EU. These requirements can thus limit imports of low-cost, low-quality products from the rest of the world. In a less discriminatory way than US-like European tariffs. Again, there is a balance to be struck. Two wrongs don’t make a right.
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