Trade wars on the horizon
European heads of state will discuss the EU response to Donald Trump's steel and aluminum tariffs at the European Council meeting next week. Council President Donald Tusk already countered Trump's tweet – "trade wars are good and easy to win" – by saying "trade wars are bad and easy to lose." But analysts believe the EU will try to negotiate an exemption from the new tariffs given the risk of further escalation.
Failing that, commensurate EU tariffs on US goods may be likely. An actual trade war is unlikely, however. The market impact should remain muted for now, as the economic impact is likely to be limited, even in the case of an EU retaliation. This may change, however, if global trade tensions escalate especially around the US investigation on alleged intellectual property (IP) theft by China.
The EU's general strategy in confronting Trump during his term has been to stand its ground. Hence, one would expect the EU to retaliate credibly to increase the perceived cost of future trade measures. This helps explain the EC's first reaction to the latest tariffs – namely, that it will respond "firmly," such as by applying new tariffs on US goods and joining others in a challenge at the WTO.
In this particular instance, however, there are important mitigating factors in play. For one, EU leaders are aware that the US is in a midterm election year. According to the Pew Research Center, antipathy toward free trade is particularly high among Republican voters, and only 36% currently think that free trade agreements have been good for the US, down from 57% in 2009. With this in mind, EU leaders are probably assuming that the hardline US posture may be temporary, which may then limit the scope of harsh EU counter-tariffs (particularly non-WTO-compliant ones).Another important mitigating factor is interest groups in the EU. With the threat of tariffs on European cars, pressure has increased on politicians to find a compromise. Accordingly, German Chancellor Angela Merkel struck a more conciliatory tone following the initial reaction of the European Commission. She stated that "I am counting first of all on talks and there will be ample opportunity for that," considering that the new US tariffs allow for exemptions. The immediate impact of the steel and aluminum tariffs on the EU economy is likely to be limited. That said, there appears to be broad consensus in the EU to make it clear that further protectionist trade measures from the US would come at a cost to the country. Already, European Commission President Jean-Claude Juncker has said, “We will put tariffs on Harley-Davidson [motorcycles], on bourbon, and on blue jeans – Levi’s.” These would amount to a 25% tariff on US imports worth EUR 2.8bn.However, due to the political backdrop and the threat of an escalation (such as a potential 25% tariff on European cars), the EU is likely to seek an exemption to the new US tariffs before triggering retaliatory measures. To this effect, Merkel has said that "when these unilateral actions cannot be avoided, then of course we have to think about how we can respond in kind." In addition, the US may appreciate the EU's support in potentially confronting China on IP trade issues. Overall, the worst-case scenario is a WTO-compliant response by the EU, which should prevent a US-EU trade war. We can expect European leaders to conclude at the European Council meeting on 22–23 March that new WTO-compliant tariffs should only be applied in case an exemption from the steel and aluminum tariffs cannot be negotiated.