Why Trump’s trade war calls for dignified restraint from China and Europe, not tariff retaliation
Dani Rodrik says Europe and China should be telling the US president that they refuse to be drawn into a trade war and will stick with policies that work for their economies
Trump’s knee-jerk protectionism does little to help the working class that helped elect him. Disaffected congressional Republicans and unhappy corporations that have supported him on other matters may yet rein him in. But those who, like me, thought Trump’s bark would be worse than his bite on trade are having second thoughts about where all this might lead.
But before we get too carried away with doomsday scenarios on trade, we need to consider other countries’ incentives as well. Trump may well want a trade war, but he cannot have it on his own. A trade war requires other economies to retaliate and escalate. And there are compelling reasons why they should not do so.
In the usual scenario, trade retaliation occurs because countries have economic reasons to depart from low tariffs. The canonical experience unfolded during the early 1930s, when countries were caught in the Great Depression with high unemployment and inadequate policy remedies. Counter-cyclical fiscal policy was not yet in vogue – John Maynard Keynes’ General Theory was published only in 1936 – while the Gold Standard rendered monetary policy worse than useless.
Under the circumstances, trade protectionism made some sense for each country on its own, as it shifted demand away from foreign goods and thus helped support domestic employment. (Of course, for all countries taken together, protectionism spelt disaster; one country’s expenditure shift was more than offset by others’ own shifts. )
Economists also consider another scenario that focuses on the so-called terms-of-trade effects of tariffs. By restricting trade volumes, a large country or region can manipulate the prices at which it competes in world markets to its advantage. An import tariff, in particular, would tend to depress the world prices of imported commodities, while raising their tariff-inclusive prices – with the home treasury reaping the difference in tariff revenues.
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If Europe, China and other trade partners were to retaliate in response to Trump’s tariffs they would simply reduce their own gains from trade without reaping any of the advantages of protectionism. And they would be doing Trump a favour by lending surface plausibility to his complaints about the “unfairness” of other countries’ trade policies vis-à-vis the US. For the rest of the world, raising trade barriers would be a case of cutting off one’s nose to spite one’s face.
Besides, if Europe and China want to uphold a rules-based multilateral trade regime, as they say they do, they cannot mirror Trump’s unilateralism and take matters into their own hands. They need to go through the World Trade Organisation and wait for formal authorisation to reciprocate, without expecting a quick resolution or that Trump will have much respect for the eventual ruling.
In short, both self-interest and principle counsel restraint and no (immediate) retaliation. This is the time for Europe and China to stand tall. They should refuse to be drawn into a trade war, and say to Trump: you are free to damage your own economy; we will stick by policies that work best for us.
Provided other countries do not overreact, Trump’s protectionism need not be as costly as many accounts make it sound. The value of trade covered by the measures and countermeasures resulting from Trump’s trade policies has already reached US$100 billion, and Shawn Donnan of the Financial Times reckons that this figure could soon reach more than US$1 trillion, or 6 per cent of global trade. This is a large number. But it assumes retaliation, which need not occur.
Economists typically make the point in reverse, when they argue against focusing excessively on the losers from freer trade, and they decry the tendency to overlook the beneficiaries on the export side. They should not be prone to the same fallacy now, by ignoring that US protectionism will surely generate some beneficiaries as well in other countries.
Trump’s protectionism may yet result in a global trade war, with eventual economic consequences that are far more serious than the self-harm it entails at present. But if that happens, it will be as much the result of miscalculation and overreaction on the part of Europe and China as of Trump’s folly.
Dani Rodrik, professor of international political economy at Harvard University’s John F. Kennedy School of Government, is the author of Straight Talk on Trade: Ideas for a Sane World Economy. Copyright: Project Syndicate