PARIS SCIENCES & LETTRES (PSL)
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Are trade wars good and easy to win?

On March 8, 2018, Donald Trump confirmed the imposition of additional tariffs of 25 percent on US imports of steel and 10 percent on US imports of aluminum, despite the threats of retaliation from trading partners and the fears of subsequent trade wars expressed by many observers and experts. According to the US President, “Trade wars are good and easy to win.” Yet the history of international trade relations tells a very different story, and the economic theory of trade wars concludes that such wars are in fact costly and difficult to win.

20
March 2018
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Executive Summary

What History says about trade wars

Let us examine the main conclusions of the history of trade wars.

(i) Trade retaliation punishes the initiators of a trade war. In order to illustrate this point, experts often present the example of the Hawley Smoot Tariff Act. On June 1930, this Act increased tariffs in the US on 890 products. The protection rate of the US economy then rose substantially, due both to this law and to a deflation in world prices: as US customs applied many specific rights (US $ per unit), the decline in world prices increased the protection rate for a constant duty. Major US trading partners, including Canada, England, Cuba, France, Spain, and Italy responded with severe reprisals against the US. World trade plunged, both in value and in volume, and the US share of world trade also diminished sharply. With Herbert Hoover as President, the Republican response to the crisis became the central theme of the presidential election in 1932, with strong criticism being directed at the Hawley Smoot Tariff Act. Franklin Delano Roosevelt, a Democrat, won the election, and in 1934, the Reciprocal Trade Agreement Act was adopted. This new law gave the US President the prerogative to negotiate trade liberalization treaties. In a nutshell, after the adoption of protectionist legislation and trade retaliation by partners, trade liberalization agreements needed to be negotiated because the ensuing trade wars had been costly for everyone.

(ii) In a bilateral war between a large and a small country, the large country can gain (or remain unaffected) and the small country can lose a lot. A few cases of trade wars at the end of the nineteenth century illustrate this point: the trade war between France and Italy in 1886-1898, the trade war between France and Switzerland in 1892-1895, and the trade war between Germany and Russia in 1893-1894. It is important to stress that it is not so much the economic size of the country that counts, but rather the share that the “large country” takes in total exports from the “small country” and into its economic activity. In 1891, France absorbed 18.6 percent of Swiss exports; Switzerland was a small and open country, and these exports to France accounted for a large share of its Gross Domestic Product. By almost halting imports from Switzerland, France inflicted considerable economic harm on its neighbor.

(iii) While important, these two previous historical lessons are not entirely sufficient to draw lessons for today’s US trade wars. First, today's trade conflict only involves a few products (steel and aluminum); in addition, there is a multilateral trade organization that offers a procedure for resolving trade disputes. These factors make a big difference, which is why I will supplement this survey of trade wars with two additional examples: the chicken war (1962-1964) and the corn war (1986-1987). The first conflict was caused by Germany’s adoption of the Common External Tariff of the European Economic Community (EEC). This adoption increased the tariffs paid by US chicken exporters, who quickly lost the German market; this benefited French and Dutch exporters, who were not subject to these taxes. The US threatened trade retaliation on German trucks, French cognac, and Dutch dextrin. The conflict was subject to intermediation by the General Agreement on Tariffs and Trade (GATT); as the Europeans refused to cede, the US could, in agreement with this international institution, raise tariffs on European products. This example is relevant to today’s context because the conflict concerned only a few sectors and because it involved intermediation from an international body.

The second conflict was similar but concerned the entry of Spain into the EEC and the maize sector. Again, France's exports benefited from the opening of the Spanish market to the detriment of US exporters; again, cognac and other European products faced threats of American retaliation. In this case, the EEC granted the United States an annual import quota with a reduced duty.

Some lessons

Several lessons can be learned from these two conflicts. First, trade disputes (disagreements relating to only one or two products) do not necessarily need to degenerate into trade wars (conflicts involving many traded or even all products). Second, a trade dispute is more likely to come to a “peaceful outcome” if the dispute is arbitrated by an international court. Today, the World Trade Organization (WTO) offers such a dispute settlement procedure. Third, trade retaliation is often exerted on strategically selected products, often involving geographically concentrated groups with significant political lobbying weight (cognac presents a fine illustration). The rationale here stems from game theory (the execution of the threat must hurt the initiator) and not economic theory (punishing American cognac consumers by depriving them of this product does not compensate US chicken exporters). Fourth, in the context of the maize war, the US threat was not executed, which is the hallmark of an efficient threat. The great chess players say: “A nice threat is stronger than its execution.”[1]

A nice threat is stronger than its execution.

The fact that the European Union has mentioned potential retaliation to the new US tariffs within the WTO framework is critical, because it provides the opportunity to reach a solution before the conflict degenerates into a trade war. Retaliation will only be applied after a period of several months and only if the Dispute Settlement Unit litigates the dispute in favor of the Europeans. In addition, the products indicated by the European Union for potential retaliation (including bourbon and Harley Davidson motorcycles) are well chosen. Most bourbon is distilled in Kentucky, the state of Mitch McConnell, leader of the Republican majority in the Senate, and many Harley Davidson motorcycles are built in Milwaukee, Wisconsin, the home of Paul Ryan, the Republican speaker of the House. In short, Europeans seem to have adopted a ‘tit-for-tat’ strategy advocated by European Commission President Jacques Delors at the time of the maize war.

Nevertheless, there remains some uncertainty. First, China has significant retaliatory capacities against the US. China imports soya from the United States for considerable amounts: USD 14 billion in 2017 alone. In the US itself, the aviation sector reacted very negatively to the new tariffs, stating that while the rise in the price of steel and aluminum would only marginally affect the price of its airplanes, China's potential retaliation on its imports of US jets could inflict considerable harm on the industry. The rare earth sector could also be negatively impacted, as China largely controls global production of these strategic minerals. Finally, the Chinese central bank holds major US dollar reserves.

Another source of uncertainty stems from the potential reaction of the US President to a WTO decision in support of US trading partners. How will Donald Trump respond to a negative verdict from an institution that he criticizes so much?

In conclusion, Donald Trump has again shown a deep lack of understanding of basic economic mechanisms:

He does not understand that the US trade deficit is caused not by foreign protectionism but above all by excessive absorption and/or insufficient savings in the US; if the US public deficit increases again, the trade deficit will rise almost mechanically.

Imposing protectionism while the US is close to full employment does not make sense, as this will mainly lead to inflationary pressures.

Protecting upstream industries with downstream strategic (airplanes) or labor-intensive industries (agri-food) is counterproductive.

Trading partners have retaliatory capacities against the US, and will use them; as Jean-Claude Juncker, President of the European Commission, said, “One can also be stupid.”[2]

 

[1] My translation from Siegbert Tarrasch, quoted by Savielly Tartakower, in Bréviaire des échecs, 1936, Paris, Stock.

[2] Statement by Jean-Claude Juncker in Hamburg, Germany, on March, 2nd 2018.

Antoine Bouët
Senior Research Fellow, GREThA-University of Bordeaux and International Food Policy Research Institute (Washington, DC)