Very nearly all economists favor free trade, and most have been disturbed by the tariffs that President Trump instituted and proposed to escalate. Even though most recognize that many countries — in particular China – do not practice free trade, it is feared that President Trump’s actions could lead to retaliation that would further increase trade barriers and harm all of us.
Thus far, the President has only imposed tariffs applicable to all countries on aluminum and steel, and Canada, Mexico and the European Union retaliated with tariffs on an equal value of U.S. goods. (South Korea, Australia, Brazil and Argentina were permanently exempted) He imposed additional tariffs on $50 billion of Chinese goods, with the stated purpose of retaliation for theft of intellectual property. China retaliated with equal tariffs on a large number of U.S. goods, and the U.S. further retaliated with a proposal for tariffs on $200 billion worth of Chinese goods.
The motivation for the administration’s current trade policy remains something of a puzzle. At times, President Trump’s statements sound like old fashioned populist protectionism, an affliction that has broken out at intervals throughout American history. At the other pole, his advisors suggest that it is an historic effort to move the entire world toward a much freer system of trade. Most of the time, the President appears to trying to get the upper hand by threatening tariffs in bilateral negotiations covering a much wider range of issues. Sometimes it appears that an amicable agreement is forthcoming, then the pendulum swings to threats of even tougher measures.
Complicating all this is that President Trump does not approach problems in a linear fashion, but seems to favor a chaotic approach using many tactics on several different fronts at the same time. Therefore, he may not have any interest in the predictable outcome of some action, but rather sees it as creating an opportunity to make a gain in an entirely different direction. Rather like the play on which the Eagles defeated the Patriots in the Super Bowl.
In order to get a handle on both motivations and likely outcomes, it is useful to distinguish between Europe and China. In the case of Europe, threats of tariffs are fraught and difficult to see succeeding. In the case of China, tariffs could produce some short-term economic disruption, but China is a huge offender in the global trade system and would almost certainly come out the loser in a trade war with the United States.
President Trump has challenged European leaders on many fronts, including trade, currencies, defense, and purchases of Russian natural gas.
President Trump’s trade advisor Lawrence Kudlow has justified tariffs on our allies as an effort to move the entire world toward a system of freer trade. Nor is there any question that European governments subsidize and protect favored industries and impose taxes and tariffs on imports from the U.S. that we do not reciprocate. But it will be very difficult to convince Europe to abandon its statist approach to industrial policy and its territorial approach to taxation.
Those policies are deeply ingrained in European politics. From French farmers to the Europe-wide Airbus industry, the subsidies that Trump wants to change are as deeply engrained as our ethanol subsidies. The VAT system that eliminates taxes on exports and taxes all imports is equally embedded in EU tax policy. Perhaps recognizing this, President Trump responded differently to European retaliatory measures than he did to Chinese, taking no action when the EU put them in place.
Since there are many other issues in play in U.S – European relations, President Trump’s actions may well be intended to change Europe’s position in national security areas or in economic policy toward China rather European trade policy per se.
European countries are not living up to their pledges on defense spending or equitably sharing the burden of defending Europe against Russia. Most past administrations pressured Europe to pay its share and Trump’s efforts are no different, except possibly in how hard he is willing to push.
To make matters worse, by building a pipeline to get more Russian natural gas, Europeans make themselves vulnerable to economic blackmail and strengthen Russia relative to the rest of the West – including us.
In addition, European countries have not yet made up their minds about whether to respect renewed U.S. sanctions against Iran. Should European financial institutions provide credit to entities trading with Iran in violation of U.S. sanctions, it would be within the power of the President to block access of those European financial institutions to the worlds most important financial market – ours. Though not directly related, his rattling the sabers of tariffs could be seen as a signal that he would not back away from that showdown.
Turning to China, the fact to keep in mind is that we import four times as much from China as they import from us.
Dumping – or selling exports for less than they cost to produce – and currency manipulation are often cited as unfair trade policies of the Chinese government that sustain this surplus. However, our issues with China actually have relatively little to do with China’s surplus in merchandise trade with the U.S. The most important issue is probably China’s widespread theft of intellectual property, unpunished if not sanctioned by the Communist Party.
China also blocks U.S. investment in China in a variety of ways, some explicit like regulations on where and how foreign companies may invest and some informal, including the lack of protection for minority investors under Chinese “law.” Chinese courts remain almost feudal in their favoritism toward native Chines parties to lawsuits, especially those related geographically or demographically to the court.
These practices harm companies from all technologically advanced countries that deal with China.
Outside trade and investment per se, China’s foreign policy is directly opposed to U.S. interests. Its patronage of North Korea is the only reason the Kim regime still exists. China’s efforts to expand its influence and territory in the South China Sea now threaten all maritime trade and world peace.
Unfortunately for China, the very trade surplus that Chinese policies have created means that we could do a great more harm to China in a tariff war than they could do to us. China’s economy is in general more vulnerable to an economic shock than ours, and the financial sector that invested in the industries whose exports would be cut off by tariffs is particularly fragile. Inducing changes in those areas is also clearly part of the Trump strategy.
For a while, after announcing the first round of tariffs, President Trump appeared to be developing good personal relations with Chairman Xi and some help with North Korea. But ultimately China’s reaction to the recent imposition of tariffs was hostile. China retaliated with its own tariffs and cancelled purchases of soybeans. President Trump then raised the stakes, proposing tariffs on $200 billion of Chinese goods. On Saturday he moved the number up to the full $500 billion of Chinese exports to the U.S. He is counting on having the deeper pockets in this poker game.
It might not be a risk I would take, but it is not unreasonable for President Trump to use his advantage in a bilateral trade war to exert pressure on Chinese trade and foreign policy in this way. If his actions toward Europe, including proffered exemptions from tariffs, induce those allies to join with the U.S. in putting trade pressure on China, his hand would be strengthened even more.
If tariffs soften Europeans up on issues other than China, that would likewise be all to the good. Serious economic and political risks would only appear if the current rather minor tiff with Europe over aluminum and steel is escalated. That seems unlikely right now, but extending tariffs to automobiles and other goods could start a trade war we would both lose.
David Montgomery is retired from a career of teaching, government service and consulting, during which he became internationally recognized as an expert on energy, environmental and climate policy. He has a PhD in economics from Harvard University and also studied economics at Cambridge University and theology at the Catholic University of America, David and his wife Esther live in St Michaels, and he now spends his time in front of the computer writing about economic, political and religious topics and the rest of the day outdoors engaged in politically incorrect activities.