If you want to know how to respond to Donald Trump’s trade tariffs, just think back to what happened between the EU and the UK after the Brexit referendum. The EU thought it could pressurise the UK either into reversing Brexit or accepting a bad deal. The EU, as the larger power, believed it had a stronger position — and the media concurred.

But the EU had a big trade surplus against the UK, and so had more to lose from a trade war. And this is how it played out. The single biggest victim of Brexit was not the UK economy, but German industry. Germany’s spectacular decline started in 2018, kicked off by Brexit and followed by a string of supply shocks including the pandemic and then Russia’s war in Ukraine. Trump’s tariffs will be next. The overarching lesson here is that if you are the surplus country, no matter how large you are, you should not engage in trade warfare.

But that’s exactly what’s happening. After Trump imposed a 25% tariff on goods from Canada and Mexico, and a 10% tariff on China over the weekend, all three countries threatened retaliation. Justin Trudeau, the outgoing Canadian prime minister, has already announced a 25% counter tariff on $155 billion worth of US imports; Claudia Sheinbaum, the Mexican president, ordered her trade ministry to implement sanctions on US goods; China wants to bring a lawsuit in front of the World Trade Organisation. They are all outraged by Trump’s assault on the multilateral trading system and are ready to come out all guns blazing.

Europe, meanwhile, stands ready. Trump has not yet imposed any tariffs here. Not yet. But he has already said, ominously: “The European Union has treated us so terribly.” And there are bound to be repercussions. Given the temperament of the President, there is no point in trying to predict what he will do. But the tariffs will surely come. In the coming weeks, if not days.

Economically, his tariff war will act like a tax on US consumers. The increased costs are inevitably borne by the consumers. But, as a form of rebalancing, it will raise a lot of revenue for the US treasury and together with the shrinking of the federal government, may well end up lowering the budget deficit and strengthening the US current account balance. Of course, there will be repercussions that could push in the other direction: the dollar might rise; the world might plunge into recession. But the truth is we have no experience of what happens when the largest economy on earth, with the dominating global reserve currency, imposes massive tariffs on its trading partners. Many economists reckon the tariffs will increase inflation and slow growth. “They will almost surely be inflationary,” said Joseph Stiglitz, the renowned economics professor.

But I would be cautious about such predictions. Macroeconomists lost their credibility as forecasters over Brexit and the first Trump presidency with their wild predictions. They are now simply expressing political views dressed up as empirical science.

In my eyes, Trump is too much focused on bilateral trade balances, rather than on the underlying dynamics of what causes them. And the underlying global economic imbalances are massive. In 2023, the EU ran a surplus against the US in the trade of merchandise goods of $209 billion. For 2024, the total will be the in the order of £230 billion. China’s trade surplus with the US was $279bn and will probably have surpassed $300bn for the year as a whole. Canada’s surplus with the US was $64.3 billion [note: the data are from census.gov. there are lots of different statistics out there, measuring different things]. The world has been fretting about these imbalances for more than two decades now and yet nothing much has changed. Germany and China, the world’s biggest export surplus countries, will never voluntarily cut down on their surpluses unless threatened at gunpoint.

“The worst response would be to stick with the same old model, and the same dependencies, and to embark on a trade war it cannot win.”

This is partly because they frame their surpluses as a sign of economic success. The Germans like to believe that this has something to do with the quality of their goods, lauding themselves as “Export Weltmeister” — a meaningless category that comes without prizes. This is merely a celebration of dependency. Having relied on Russia for gas, and China for its exports, Germany has now also become dependent on the US. But, then, running trade surpluses against other countries is the only economic strategy the current generation of Germans has ever known.

The problem here, then, is that a country’s current account, which consists mostly of trade, has an exact mirror image in the financial account, which measures the difference between savings and investment. And it is better to think about the strength of German and Chinese economies in these terms, not trade. This tells what is going on underneath the hood, which is that they don’t know how to spend their savings. This is where their imbalance lies.

The better response to Trump’s trade tariffs, then, would not be to fight back, but to fix that underlying problem — the lack of domestic investment and consumption. Why not make it more attractive for companies to invest their surpluses at home? Why not deregulate the economy, especially the tech sector, support new businesses, reduce corporate taxes; attract the best talent from abroad; and get people off the welfare and sickness payrolls? The powerful response to Trump would be to focus on solving these twin problems — the imbalance and the dependency.

The worst response would be to stick with the same old model, and the same dependencies, and to embark on a trade war it cannot win. Canada, more dependent on the US than anyone else, will be crushed if it follows through with Trudeau’s policies. His response plays well with fellow liberals, but it achieves nothing economically — and Trump will no doubt double down if Canada retaliates.

The fear here is that the obtuse EU does the same. In anticipation of a Trump presidency, the European Commission has already prepared a sanctions hit list. During Trump’s first term, it put a tariff on Harley Davidson motorbikes. The EU already imposes a 10% protectionist tariff on all car imports. The irony here is that in this trans-Atlantic relationship, we Europeans are fuming at Trump for doing what we have been doing all along.

Europe is still in massive denial at what is about to hit. It likes to think it can change Trump’s mind. Friedrich Merz, Germany’s opposition leader, and the man predicted to be the next chancellor, thinks he can negotiate a trade deal with Trump. The Irish hope that they can stay below Trump’s radar since he could destroy the Irish economic model at the flick of a switch by removing a simple tax loophole on intellectual property rights for US companies that manufacture in Ireland. Meanwhile, Ursula von der Leyen, the EU Commission president, hopes to appease the President with a promise to buy more gas from the US. This is not how it will work. Trump will impose the tariffs. And that will be that.

Trump has learned from his past mistakes when dealing with the Europeans. They lied to him during his first term, and made promises they did not honour, including assurances that they would meet the Nato defence spending target of 2% of economic output. Back then, the Europeans had convinced themselves that Trump was just a phase, a fluke caused by a lopsided electoral system. Emboldened by their successful defiance of Trump back then, the Europeans concluded they could do it again.

I think they are wrong. Once they realise this, they will move to the second stage of grief — anger — where they will be stuck for a long time. They will try to retaliate, lose, and get even angrier.

There are parallels with the European approach to the war in Ukraine. Even as they support Ukraine, they don’t have an agreed war goal, let alone a strategy. They treat the conflict as a morality play. Underestimating Vladimir Putin and the resilience of the Russian economy, they overestimated the power of sanctions.

This complacency has, over the past years, become the defining character trait of the centrist European liberal, matched only by an unshakeable belief in their own virtue. And today, they are similarly underestimating Trump. They remind me of the Bourbons, they have learned nothing and forget nothing.

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Source: UnHerd Read the original article here: https://unherd.com/