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  • 2018/05/07
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Trade war : the price to be paid

A transformation of the current multilateral system - albeit centred around the US, but currently deemed unfavourable to its interests - toward a multipolar system characterised by specific bilateral agreements, through which the most powerful country economically and politically can establish a balance of power more favourable to itself - this is what the Trump administration wants. Faced with this new challenge, the European Union (EU) must address an existential question: will it participate in this new project aiming to redesign the world order, will it be forced to endure it, or does it have the will and sufficient political capital to reaffirm the old order? The decision will need to be taken quickly, as the Trump administration has the EU up against a wall. The US has in fact announced (or rather already signed and enacted in the Trade Expansion Act) tariffs of 25% and 10%, respectively, on steel and aluminium imports. It has also announced that, in the event of a retaliation by the EU, additional duties would be introduced, notably targeting European car exports. Mr Trump has nevertheless made a step towards its allies, granting an extended temporary exemption up until end-May, to allow them to organise their various interests and establish a common position, which, preferably, would be aligned with the US stance in order to form a united front against China. All this while demonstrating a will to reduce the trade surplus with the US, notably that of the euro zone, i.e. in reality that of Germany.

The why and how of the US sanctions

The US recorded a trade deficit of 567 billion dollars, or 3.3% of its GDP, in 2017. The Trump administration has tackled the issue using the argument of a threat to the US economy and national security. The impact of international competition on domestic industries, its consequences in terms of unemployment, decline in public revenues, loss of skills, have been cited as factors weakening the economy and national security. The US Department of Commerce has thus studied the level of production required to achieve this national security target and the level of imports compatible with this level. Two sectors in particular were targeted by the reports: steel and aluminium. Regarding the steel sector, which is currently estimated to operate at 72% of its capacity in the US, the objective of the Trump administration is to raise the utilisation rate to 80%, which would imply an increase in production from 82 million to 90.6 million tons and a drop in imports from 36 million to 22.7 million tons. This could be achieved with a tax of 24% applied to all steel imports. Concerning aluminium, the capacity utilisation rate of production is reported to be at just 39%, and the taxation rate required to raise it to the target of 80% would be 7.7%. This helps to understand where the respective tariffs of 25% and 10% announced on US steel and aluminium imports came from. The Trump administration has announced that if the EU were to retaliate against the steel and aluminium tariffs, the US would react by slapping a 35% tax on vehicle imports. It is nevertheless interesting to note that no similar study to those carried out by the Department of Commerce on the steel and aluminium sectors has been done to date on the auto sector.

For now, the US has been concentrating on its main trading partner, China, in the aim to limit Chinese steel and aluminium imports in favour of steel produced domestically. Canada and Mexico are for the time being exempt from the additional customs duties on steel and aluminium applied to China, South Korea and Brazil, while Europe only benefits from a temporary exemption up until the end of May. These rather broad exemptions will make it difficult to achieve the production objective targeted by these taxes, which were calculated for a wider scope of application. Thus, either the US is aiming for a voluntary restriction of imports by the countries concerned, under threat or in the framework of new trade agreements, or its true purpose is something else. Beyond the rhetoric of domestic policy aiming to reassure the conservative electorate of the “Rust Belt”, the objective may be to rewrite the rules of the World Trade Organisation (WTO), deemed overly favourable to China, by getting other countries to join the US in its combat. Europe is thus up against a wall with regard to its choices for the global role that it wishes to see played by China, and the action by the US administration is part of a logic to redraw its alliances over the long term. More than steel, what really concerns the Trump administration is the Chinese expansion into high technology sectors with higher value added.

The weight of the European Union in the US trade deficit

The European Union is the United States’ number two trade partner, and accounts for over 102 billion dollars in the US trade deficit, far behind China ($337bn), out of a total deficit of around 567 billion dollars (3.3% of GDP) in 2017. The European countries contributing the most to this deficit are Germany, with 66%, Italy (34.1%) and France (13.9%), offset by a surplus with the UK (13.5% of the deficit).

What strategy can Europe adopt?

In the event that the exemption is not renewed, the EU has said it is ready to lodge a complaint with the World Trade Organisation in order to obtain compensation, a process that could take at least 18 months, on the condition that the dispute settlement body is able to function (the appointment of one of the judges has been blocked by the US). If it does not obtain any results this way, the EU could, before retaliating, try to use delaying tactics and in an initial step attempt to put political pressure on the US in order to dissuade it from applying its policy. The European Union has a strong argument in this strategy: the sympathetic ear of domestic opponents to this protection programme, Republican members of Congress representing the exporting States and business leaders.

But what can the EU do to avoid this escalation? With its pragmatism at the service of national interest, Germany has already announced it is ready to abandon the tariffs that the EU imposes on auto imports, machinery and equipment, and food and pharmaceutical products coming from the US, thereby paving the way to forced negotiations outside the multilateral system of the WTO. France is positioned as the advocate of multilateralism and normative power, in the aim of bringing together all countries, including non-European, that are affected by the custom duties. Its objective is to defuse the conflict, by providing the US President with the guarantee of firm action against Chinese dumping practices in the context of a cooperation that is already in place, notably in the framework of tripartite negotiations with Japan regarding the overcapacity in the steel sector.

The EU has already put in place new trade defence legislation, which is an integral part of the Juncker programme for “a Europe that protects”. It aims to reinforce the fight against imports that are subject to dumping or public subsidies resulting in significant market distortions. The EU focused on China in its first report because the lion’s share of the EU’s anti-dumping activity concerns imports coming from this country. It is with this type of action, in compliance with the rules of the WTO, that the EU seeks to converge with the US action.

What is the price to pay?

It is vital for the EU to succeed in getting its two main trading partners, China and the US, to the negotiating table. In a world in which the two giants would clash, the EU risks being marginalised.  The question remains whether or not Europe will succeed in forming a common position, bearing in mind that the different countries have diverse interests in China. China remains the number one supplier of goods to the EU, while the US is its number one export market. But trade in services and direct investments are much more developed with the US. The risk of a withdrawal by the US is the end of multilateralism. In this case, the EU would have to manage its foreign trade relationships increasingly through trade agreements, which at present already cover 45% of its foreign trade.

What are the others doing?

For the time being, Europe is keeping a close eye on the reactions of other countries while awaiting the fateful date at the end of May, when its exemption to the trade tariffs expires.The United States has specified the 1,333 products affected by the new tariffs, i.e. more than 50 billion dollars in Chinese products, representing 10% of US imports. Beijing’s reaction was quick: taxes of 25% on 128 US products, including soya, aircraft, cars and chemicals products, for a total of 50 billion dollars in US exports to China, i.e. Almost a third of the total.

On another front, South Korea has accepted to reduce its steel exports to the US as part of a new free trade agreement. Likewise, negotiations with NAFTA countries appear to be accelerating toward an agreement in principle. A pick-up of negotiations with the 11 Asian partners in the framework of the TPP also appears to be on the cards.  If the EU opts for retaliation, any preferential treatment granted to the US outside of a free trade agreement would have to apply to all WTO members according to the “most favoured nation” rule, which would have significant consequences for European trade. It thus becomes clear that negotiations are in the interest of both parties. Hence the invitation from the EU President, Donald Tusk, to the United States to resume talks over the Transatlantic Trade and Investment Partnership (TTIP).

Paola Monperrus-Veroni and Philippe Vilas-Boas, Group Economic Research

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