Why Europe Is a Reluctant Trade Warrior

(Bloomberg Opinion) -- Many question whether the European Union has the raw power – as well as the willpower -- to engage in the trade war President Donald Trump has started with much of the rest of the world. But the matter is more complex for Europe than who can emerge victorious from an exchange of blows.

A purely economic cost-benefit analysis would probably show that it makes sense for Europe not to react to Trump’s moves at all. If Europe does engage in a costly tit-for-tat exchange, it’ll be to defend a global trade system whose failure, according to a recent estimate by economists Alessandro Nicita, Marcelo Olarreaga and Peri da Silva, would lead to a 32 percentage point increase in average tariffs.

From a business standpoint, a yawn would be Europe’s best answer to Trump’s steel and aluminum tariffs. The move is only directed against 6.6 billion euros ($7.7 billion) of European exports to the U.S., about 1.7 percent of the total goods exports. Steel accounts for most of the affected volume, and the tariffs are expected to reduce European exports of steel by about 1 percent of the EU’s total production – but then, European demand is projected to increase by 1.4 percent this year, so the drop will hardly be life-threatening. The EU’s unweighted average customs duty is 5.2 percent; Trump’s tariffs don’t raise the U.S. average, at 3.5 percent before they were announced, to that level, so the EU can continue enjoying more advantageous terms of trade and let Trump have his way with steel and aluminum.

Responding, on the other hand, could prompt Trump to escalate and, as he has threatened, slap punitive tariffs on European cars. That could result in more serious damage, especially to Germany. If he imposes a tariff of 35 percent, the maximum that Trump has mentioned, a model developed at Bruegel, the Brussels-based think tank, suggests a drop of more than 5 billion euros in EU export revenues, most of it absorbed by Germany.

That, of course, is just 20 percent of the penalties imposed by the U.S. on Volkswagen alone in the course of dieselgate, and it’s not an existential threat to the German car industry, but it’s a nasty sucker punch. I’m not sure German exports would drop by as much as Bruegel predicts: After all, for many Porsche, Mercedes, Audi and BMW buyers a high price is an incentive, not a drawback. But BMW, for example, whose South Carolina factory is the biggest U.S. car exporter by value, fears that Trump’s global trade war could cause China to raise its tariffs on U.S. car imports and hurt the German company in a kind of ironic boomerang effect – as a U.S. producer, not a German one.

Then again, not responding could give Trump a taste of blood, and he’d hit out at car imports anyway. But even in that case, it’s not clear whether Europe would benefit more from a forceful response than from a meek one. If the EU drops its car import tariffs from 10 percent to the current U.S. level, 2.5 percent, the U.S. car industry wouldn’t benefit much because it doesn’t have a strong offering to match Europeans’ taste in cars. Sure, the lower price segment would become more competitive thanks to cheaper offerings from Korean and perhaps Chinese producers, but premium European carmakers probably wouldn’t suffer and budget ones would only have an incentive to increase efficiency, delivering a net benefit to Europe.

Given this calculus, it’s tempting to conclude that Europe’s bark – all the angry words from French President Emmanuel Macron, German Chancellor Angela Merkel and European Commission President Jean-Claude Juncker – will be worse than its bite. European leaders are sick and tired of Trump, who has been an exasperating, unpredictable and unfriendly negotiating partner to them, fitting no definition of an ally. But the Europeans, especially Merkel, aren’t just being emotional about it: They are reluctant to abandon the existing trade rules and allow them to be replaced by an unpredictable might-based system. This isn’t merely about commercial interests; its about principles and rules.

This means the EU must challenge Trump’s moves at the World Trade Organization, pointing out that his national security rationale for imposing tariffs is laughable among close military allies and that the U.S. is merely engaging in protectionism. While the U.S. will argue that it has the right to define its own national security interests, the outcome of the dispute will at least show whether WTO arbitration works in such obvious cases. If it turns out that it doesn’t, the EU will only have its market power to depend upon in trying to force the U.S. to play by any rules at all.

American skeptics who doubt that the EU has the unity to do that point to the numerous political rifts within the EU and the weakness of some European governments. However, they, like Trump, appear not to realize that European nations’ deference to the Brussels bureaucracy in matters of trade is real. The U.K., which counted on the EU to fracture in Brexit talks, has discovered that the hard way. Europe delegates trade negotiations to experts who work for the EU; and their commitment to a rules-based system is strong.

The EU will likely not rush to impose the tit-for-tat tariffs on blue jeans, bourbon and Harley Davidson motorcycles that it has threatened. The prospect of an attack on items produced by pro-Trump electoral districts didn’t deter Trump, and there’s no economic reason for the EU to retaliate. But it will press the WTO case and prepare for the free-for-all that its failure might open up. In a world not constrained by current rules, according to the model produced by Nicita, Olarreaga and da Silva, EU import tariffs would rise by 25 percent compared with 14 percent for the U.S., showing the EU actually has greater market power. And yet, for now, Europeans are still hanging on grimly to the hope that a free-for-all can be avoided.

©2018 Bloomberg L.P.