The US-EU trade deal

He has no idea what he is doing

Analysts and economic journalists – many of whom really ought to know better – have been falling over themselves bemoaning the outcome of the recently concluded US-EU trade deal. Almost without exception, they argue that US President Donald Trump got the better of the EU after the US ‘succeeded’ in imposing a 15% tariff on EU imports.

Yet, curiously, the International Monetary Fund (IMF) just upgraded its global growth outlook relative to its last forecast in spite of numerous tariff increases since Trump took office. In the recently published Global Economic Outlook update, the IMF said the upgrade was justified on the grounds that the world has proven more resilient to Trump’s tariffs than expected.

So what is going on? Are tariffs good or bad for global growth? And, if they are good for some countries and bad for others, who, exactly, gets hurt by tariffs? Given the enormous ignorance about tariffs please allow me to make a few very simple points, which should go a long way towards answering these questions.

As a macroeconomist, it is my humble opinion that the world economy is doing better than expected, because most countries have not been hurt very badly, if at all, by US tariffs. This should not really surprise anyone, least of all trained economists, because economists are taught in the second year of their undergraduate courses that tariffs hurt the protectionists far more than the countries whose goods and services are targeted by tariffs.

In other words, Trump’s US-EU trade deal - with its 15% tariff on American imports from Europe - mainly hurts the US economy, not the EU. The same has been true for Trump’s other tariff adventures.

“Hold on!”, I hear you object, “tariffs of 15% on imports from Europe will surely hurt European exporters, right?”

Well, no. Tariffs may introduce some initial inconvenience for European exporters, but they will ultimately be fine. The reason is simple: US demand for imports is determined by US aggregate demand, not by the relative prices of imports from one region versus another region. As long as the US maintains a stable level of aggregate demand - which it is doing due to Trump’s recent massive fiscal stimulus package - the EU will continue to supply the US market, only doing so by diverting its exports to the US market via third country intermediaries.

This phenomenon is called trade re-routing.

If you want to see how trade re-routing works in practice look no further than China, whose exports have been targeted far more heavily by US tariffs than the EU. As I illustrated in an earlier blog post about Trump’s tariffs, China’s exports to the US actually went up after tariffs, leaving China’s trade surplus versus the US higher than before tariffs.

Contrary to Trump’s repeated claims that tariffs will make America great again, tariffs will hurt the US far more than the EU. The reason you hear negative statements about the deal from credible European political heavy weights, such as Poland’s Donald Tusk (see here) is that EU has a strong incentive to create the impression that the deal favours Trump, since Trump falls for flattery every time.

The reality is that Trump’s tariffs directly tax Americans. American importers rather than European exporters pay the tariff, so American growth gets hit. Also, Trump’s tariffs are specifically designed to raise funds to pay for tax cuts for the ultra-rich, which results in a deeply regressive tax structure. This increases income inequality, which in turn hurts the US long-term growth potential by preventing talented individuals at the lower end of the income spectrum from realising their potential.

Finally, tariffs undermine American competitiveness. American businesses now depend on state tariff protection rather than on healthy productivity growth to maintain market share. Experience from everywhere in the world tell the same story; countries that protect their domestic industries behind tariff barriers end up creating tariff-dependent industries rather than lean and mean competitiveness machines. It is only a question of time before the protected companies become rent-seekers, whose very survival depends on continued access to government support.

Proponents of Trump’s US-EU trade deal insist the deal is still net positive for the US, because it includes various (rather vague) concessions. Granted, concessions do form part of the deal, but EU is likely to wiggle out of most, if not all of them. Indeed, the ink on the trade deal had barely dried before EU officials backed away from their commitment to invest hundreds of billions in the US on the grounds that European investment is a private sector activity, which is outside of the remit of the EU. Many other issues were simply kicked down the road.

If you don't believe me, then take the view of a Nobel Prize winning trade economist, Paul Krugman, whose take on Trump's deal is very similar to mine.

The US-EU trade deal is a US own goal. Praise should be heaped on the EU for not succumbing to the temptation to impose counter-tariffs. After all, the fact that the US acts against its own national interest is not a good argument for the EU to do the same. Trump’s trade deal with the EU is no different from his previous misguided tariff adventures; when the dust settles it will be evident to all that the main impact is simply higher taxes for Americans.

The End