Are we on the verge of a new Cold War? This question has been frequently asked due to recent tensions between the US and China, the UK and Russia, the EU and Russia, the US and Russia, and many more complicated relationships around the globe. Perhaps the question should rather be: how can we avoid a trade war? Because once the world slips into protectionism, currency wars, and an all-out trade war, the situation will deteriorate quickly. Where are we now? Where are we going next? And what has history taught us?
The logic behind trade wars
As President Trump has initiated tariffs on steel and aluminum and is even interfering in the free market by exercising control on mergers and acquisitions – as the protection of Qualcomm from Broadcom shows – both the EU and China have promised to retaliate. The US and the EU are imposing heavy sanctions on Russia, while OPEC and its allies attempt to influence the oil prices to stimulate their profits. Several powers in the world are actively raising barriers to block free trade. The question is: to what end?
The answer won’t be found in economics. Economies that in the past have tried to close themselves, impose tariffs, and manipulate the market have always suffered major crises afterwards. Think about the Asian crisis, multiple Mexican crises, and the entire South American continent in the 1980s. Even further back in the past the Smoot-Hawley Tariff Act worsened the Great Depression and initiated a trade war. But also, before the existence of the EU, the now Member States would bother each other mostly with currency manipulation. In the end, although these were only one-sided or bilateral trade wars, it created a game of losers.
Economic theorists have many opposing views on tons of issues. The one thing they agree about, however, is that free trade will stimulate everyone that takes part in it. To repeat a metaphor that is (too) often used: everyone gets a piece of the pie and we increase the size of the pie by opening up to international, free trade. From Smith to Keynes and from Friedman to Minsky, they all believed in free trade.
This means that the subtitle is rather misleading; there is no logic. No economic one that is, because there is political logic behind a trade war. The broader public has gained much economic advantage over the past years thanks to free trade. But once the pie got bigger, so did the (perceived) differences between groups, which led to the commonly accepted story of the poor getting poorer and the rich getting richer. Political spin doctors are brilliantly twisting the tradition ‘us versus them’ rhetoric to gain public trust and win (or retain) voters. Trump ‘protects’ the traditional American steel industry. The EU battles the Russian enemy and heroically counters American protectionism. China stays true to its roots and leads the way. All have managed to spin the trade issue into a political advantage. But no matter how clever, these wins are short-lived if pushed too far.
The current state of play
After President Trump decided to impose protectionists measures to “protect the US economy”, the EC came with a list of American imported products to boycott, worth 3.5 billion USD. The EC President Jean-Claude Juncker went even further by telling German media that the targeted goods are produced in the home states of key Republican leaders. But this is only the most recent development. Long before, then-President Obama imposed tariffs on Chinese steel, and the EU protects its farmers for as long as it can remember.
The irony lies in the fact that the EU lost its mind over American import tariffs on steel – which have been reversed for now. Not too long ago, the EU imposed measures to protect the internal market from the dumping of Chinese steel. These tariffs were to protect traditional European voter bases in the Czech Republic (Moravia Steel), Germany (ThyssenKrupp and powerful trade union IG Metall), and the Netherlands (Tata Steel). Another side of the trade war emerged even earlier when Russia decided to annex Crimea and the EU retaliated with sanctions – although these sanctions were a ‘light’ version as the EU depends on Russian gas.
Free trade was the ultimate goal in the late 90s and early 2000s, but now trade is also used as a base of power. A trade war is an escalation of this base of powers, as all the parties involved use trade, and mostly the restrictions to trade, to limit the other and support themselves. In this current state of play, trade wars are far more likely to occur because trade is no longer a goal as such. It is a weapon, like the atom bomb, hacks, or bullets.
What could be next
Based on what we see thus far and on what history has taught us, we can sketch a most likely deemed (or doomed) scenario, with a focus on the role of the EU.
History taught us that the beginning of a trade war is a sort of tit for tat in a negative way. You impose tariffs on my steel? I impose tariffs on yours. You boycott my sugar? I boycott your wood. The most infamous example of a total trade war escalation is probably the Smoot-Hawley Tariff Act of 1930, which managed to prolong the worst economic crisis of the 20th century for even longer. The eventual downwards spiral of the illustrated tit for tat play will then flow into other sectors, leading to a form of isolationism, as happened during the Great Depression. But with the tools at disposal nowadays this could lead to the Russians cutting off the EU from gas, the British manipulating the sterling for own gain, the Chinese dumping American bonds to push the country into oblivion, and so forth.
One could imagine the following chain of events taking place. After the American tariffs, the EU, with President Juncker looking to prove himself on the international stage, would probably retaliate once the temporary exemption is lifted. China, as the emerging new world power, would soon follow to make the US feel who’s in charge. Not much later, the US would respond with even more tariffs. The EU, haunted by populism and a sense of ‘us’ versus ‘them’, would call for further action. Even worse, it is imaginable that a public outcry would appear to also push the Chinese back due to their rather exceptional trade policies – combining capitalism, communism and a one-party regime. This escalation would eventually lead to countries dumping each other’s bonds and crashing the highly intertwined, global financial system. Purchasing power will drop globally and economies will crash.
This brief illustration of what might happen shows only the tip of the iceberg. Considering that this trade war comes at a time when tension around the South Chinese Sea is high, Russia and the EU have a very troubled relationship, and the US and China are deciding who should be the new leading power on a global level, an intense geopolitical situation has entered the deadly cocktail. One way or another, this trade war could eventually lead to effects outside of economics in the form of civil unrest, energy scarcity, and total isolation. The game of losers would be bigger than ever before because the world is more connected than ever before.
The EU torn apart or a champion in-the-make?
In this game of losers, which a trade war would result in, the EU probably has the most to lose on the one hand and can emerge strongest on the other. It has the most to lose as the EU is the biggest trading block in the world and it highly depends on free trade. For as long as its Member States can remember, trade has been a part of everyday life and economic progress. As the EU is the largest trading partner for many, a trade war would hit the European economy severely. At the same time, the EU has most to lose as its internal monetary union is unfinished. As the North-South division in economic terms exemplifies itself best in a conflict over the preferred direction of monetary policy, a trade war may force monetary policy in the direction that half of the Union can’t keep up with. This would constrain the other half even more since it would then have to take care of a half-failing economy.
The EU can also emerge strongest from a trade war. It can rely on the largest internal market worldwide, and its neighbourhood policy – however thin it may be – is focused on trade deals and economic benefit. Therefore, it will manage to retain a certain level of trade. Moreover, since several EU Member States are also export-champions of high-end products, other countries would be deprived of these goods in case of a trade war. This would lead to a situation in which the EU is missed more by its trading partners, than it is missing them.
Trade wars lead to isolation and isolation leads to economic catastrophe, likely followed by civil unrest. Whether or not a global trade war will actually take place, the world is moving terrifyingly close to it. This would lead to a game of losers in which no one would win. What logic was there again to start a trade war?
Author: Koen Durlinger