To retaliate or not to retaliate — that is the question amid Trump’s chaos TRADE WAR
Threat of recession would force US president to change course, but perhaps calling his bluff is the answer
The leader of the world’s most powerful country is a dangerous ignoramus. So how should the rest of the world respond? What makes this so difficult to answer is that Donald Trump has created chaos. It is so difficult to negotiate with him because nobody knows what he and his team want. This is just not normal.
The administration’s trade actions and announced intentions are, in this context, important in themselves and indicative of the wider dysfunction.
The US has imposed tariffs on imports of solar panels, washing machines, steel and aluminium. If one adds two rounds of tariffs on China under Section 301 of the US Trade Act of 1974, the affected trade comes to about 7% of US imports.
If one allows for the threat of retaliation against retaliation, which could affect an additional $400bn of imports from China, as well as the possibility of tariffs on $275bn of imports of cars and parts, total affected imports reaches $800bn, or about a third of US imports of goods. The US actions have already caused retaliation.
The administration has justified the actions already in effect on steel and aluminium by reference to national security. The same rationale is being used in an investigation of US imports of cars, launched in May. Fears over such abuse of the security exceptions are why the World Trade Organisation’s (WTO’s) rules are restrictive. Such exceptions are enumerated as relating to “fissionable materials”, or “the traffic in arms, ammunition and implements of war and to such traffic in other goods and materials as is carried on directly or indirectly for the purpose of supplying a military establishment”, or “taken in time of war or other emergency in international relations”.
US actions on steel, aluminium and, even more absurd, cars clearly violate the WTO rules. But if Canada is a threat, which country is not? If cars are a security concern, what is not?
“Protection will lead to great prosperity and strength,” Trump said in his inaugural address. He meant it, alas.
The rationale for the Section 301 action against China is more obscure. Sometimes, the action seems intended to force China to eliminate its bilateral surpluses with the US. Sometimes its aim seems to be to halt its “Made in China 2025” programme. Sometimes it seems intended to remedy coerced technology transfer.
The first aim is ridiculous; the second aim is non-negotiable; and the third is reasonable, but hard to achieve.
As if this were not confusion enough, Larry Kudlow, ostensibly Trump’s principal economic adviser, has suggested the president is a freetrader and that the aim is really to eliminate tariffs. In fact, like a two-year-old, Trump is a “disrupter” without clear objectives. If he had wanted to rebalance the relationship with China, he would not have withdrawn from the Trans-Pacific Partnership and he would not have assaulted his own allies. He would instead have confronted China with a powerful global coalition. Instead, he has started fights with everybody.
Protection also tends to spread because users of protected inputs will call for it, because unprotected sectors will demand it and because trade will be diverted from protected markets. China’s exports, for example, will shift from US to EU markets. The EU might feel forced to act against imports, too. So where might all this end? Paul Krugman, one of the world’s leading trade economists, argues that if this were to become a generalised trade war of all against all, world trade might shrink by 70%.
Yet, surprisingly, world output might not fall by more than 3%. Such numbers rest on the assumptions of “computable general equilibrium” models, which ignore the disruption and uncertainty, as the structure of the world economy is reconfigured. They also fail to account for the lost dynamism, as global competition is reduced. Last but not least, they miss the increase in ill will such a protectionist war would cause. Global co-operation would surely be shattered.
Yet Trump has insisted that “trade wars are good and easy to win”. The argument that a deficit country will “win” in a trade war is not absurd. Ultimately, in any retaliation war, the other side will run out of trade ammunition sooner, simply because their imports are smaller.
But retaliation could go beyond trade, to investment, for example. Once retaliation is taken into account, and the consequences of higher tariffs on exchange rates, the benefit for aggregate domestic output is likely to be very small even for a country with huge deficits.
Every economist knows that the effective way to reduce a trade deficit in a country near full employment is a recession. That is presumably not the US objective, but it could be the result of the uncertainty created by its policies.
Perhaps the biggest question is how other players should respond to the aggression from the White House. Trump likes conflict. He might not respond to retaliation as a normal person would. He might even welcome the rise in protection that a spiral of retaliation would deliver.
At the same time, only retaliation might persuade him to change course. Furthermore, the gathering clouds of a trade war just might shock US business into effective action. The judgment of how far to pursue the cycle of retaliation, then, is no easy one. Personally, I would retaliate, more because the alternative looks weak. Another thing the rest of the world should do is strengthen their co-operation. But the most exciting, and risky, thing other high-income countries could do is to take up Trump’s offer of tariff-free trade. Why not at least call his bluff? Who knows? It might even work.