Are trade wars profitable and easy to win?

Let’s dis­cuss the main basic con­clu­sions we can draw from the the­ory and his­tory of trade wars.

(i) In most cases, those who start a trade dis­pute suf­fer more from the sub­sequent retali­ation. The Haw­ley-Smoot Tar­iff Act is a prime example. Passed in June 1930, it increased US import duties on 890 products from the Har­mon­ized Tar­iff Sched­ule. Com­bined with price defla­tion, this rep­res­en­ted a sub­stan­tial increase in the rate of pro­tec­tion of the US eco­nomy. Because of the wide vari­ety of spe­cif­ic fees applied through US tar­iffs (US$ per unit), the glob­al drop in prices led to an increase in the rate of pro­tec­tion while fees stayed the same. 

As a res­ult, the United States’ main trade part­ners – Canada, Bri­tain, Cuba, France, Spain, Italy, etc. – engaged in harsh retali­ation. Inter­na­tion­al trade plummeted (in value and volume) world­wide, to such an extent that the Repub­lic­ans’ (and Pres­id­ent Her­bert Hoover’s) man­age­ment of this crisis was a cent­ral issue in the 1932 pres­id­en­tial elec­tion. Demo­crat­ic can­did­ate Frank­lin D. Roosevelt won, and he signed the Recip­roc­al Trade Agree­ments Act (RTAA) into law in 1934. This gave the Pres­id­ent the prerog­at­ive to nego­ti­ate lib­er­al trade agree­ments. In short, after passing pro­tec­tion­ist legis­la­tion and suf­fer­ing retali­ation from trade part­ners, it was neces­sary to ease trade restric­tions, giv­en how costly it had been for all parties.

(ii) In a bilat­er­al trade war between a big and small coun­try, the big­ger coun­try is likely to win (or suf­fer almost no con­sequences) where­as the smal­ler coun­try will lose sub­stan­tially. This is shown by sev­er­al trade wars that took place in the late 19^th cen­tury: the 1886–98 war between France and Italy, the 1892–95 war between France and Switzer­land and the 1893–94 war between Ger­many and Rus­sia, to name a few. Here, it’s import­ant to under­stand that it’s not so much the size of the eco­nomy that mat­ters but that of total exports by the “small” coun­try to the “big” coun­try, and the impact of the “big” coun­try in the eco­nom­ic activ­ity of the “small” coun­try. In 1891, France absorbed 18.6% of Swiss exports. Switzer­land being rel­at­ively small, these exports rep­res­en­ted a sig­ni­fic­ant amount of its GDP. By stop­ping most Swiss imports, France struck a con­sid­er­able eco­nom­ic blow to its neighbour.

(iii) These two examples are not entirely per­tin­ent, because firstly, trade dis­putes nowadays are only a poten­tial issue for a few products, steel and alu­mini­um, and, secondly, there are now mul­ti­lat­er­al trade organ­isa­tions that offer a res­ol­u­tion frame­work for trade dis­putes. This makes a big dif­fer­ence. To round out this over­view, let us exam­ine two more trade wars, the “Chick­en War” (1962–64) and the “Corn War” (1986–87).

The first con­flict was pro­voked when Ger­many adop­ted the com­mon extern­al tar­iff cre­ated by the European Eco­nom­ic Com­munity (EEC). This increased the cus­toms duties paid by Amer­ic­an chick­en export­ers, who quickly lost the Ger­man mar­ket to French and Dutch export­ers, to whom these duties did not apply. The US deman­ded com­pens­a­tion and threatened to retali­ate by increas­ing tar­iffs on Ger­man trucks, French cognac and Dutch dex­trin. Even though only a small num­ber of sec­tors were affected by the dis­pute, the Gen­er­al Agree­ment on Tar­iffs and Trade (GATT) was invoked as an inter­me­di­ary. With the Europeans refus­ing to yield, the inter­na­tion­al insti­tu­tion accor­ded the right to the US to increase cus­toms duties on these European products.

The second dis­pute is sim­il­ar, but it involves Spain join­ing the EEC and the corn sec­tor. Once again, France’s exports were bene­fit­ing from the Span­ish mar­ket open­ing up to the det­ri­ment of Amer­ic­an export­ers, and once again, it involved cognac, among oth­er things, being sub­jec­ted to threats of Amer­ic­an retali­ation. The EEC con­ceded and gran­ted the US an annu­al, reduced-rate quota of corn imports.

Sev­er­al les­sons can be learned from these two dis­putes. Firstly, some trade dis­putes (those that only con­cern one or two products) do not always des­cend into trade wars (involving a lot of trade products, or even all products). Secondly, a trade dis­pute is more likely to find a “peace­ful res­ol­u­tion” when an inter­na­tion­al insti­tu­tion provides arbit­ra­tion. Nowadays, the World Trade Organ­isa­tion (WTO) provides a pro­ced­ure to settle dis­putes. Finally, retali­ation is often enacted by exert­ing pres­sure on stra­tegic­ally chosen products that are geo­graph­ic­ally con­cen­trated and have polit­ic­al sig­ni­fic­ance (cognac being a per­fect example).

The rationale behind these choices is based entirely on game the­ory (using threats to intim­id­ate), not eco­nom­ic the­ory (pun­ish­ing Amer­ic­an cognac con­sumers by remov­ing their access to this product does not provide any com­pens­a­tion to Amer­ic­an chick­en export­ers). Finally, it should be noted that, in the case of the Corn War, the US did not carry out their threat, which is char­ac­ter­ist­ic of a good threat. As great chess play­ers say, “The threat is stronger than the exe­cu­tion”¹.

The fact that any poten­tial retali­ation from the European Uni­on will occur with­in the WTO’s frame­work is cru­cial, because it favours a solu­tion that does not des­cend into a trade war. It is also inter­est­ing that the EU is cur­rently threat­en­ing to retali­ate against the US, even if such retali­ation will be reg­u­lated by the WTO and there­fore will only (poten­tially) be invoked after months of pro­ceed­ings. The products in ques­tion have been well chosen: most bour­bon is dis­tilled in Ken­tucky, the home state of Repub­lic­an Mitch McCon­nell, who was, until recently, the Sen­ate major­ity lead­er; a large num­ber of Har­ley-Dav­id­sons are made in Mil­wau­kee, WI, home of Paul Ryan, the former Repub­lic­an speak­er of the House of Rep­res­ent­at­ives. In short, the Europeans seem to have adop­ted the strategy of “an eye for an eye, a tooth for a tooth”, favoured by Jacques Delors dur­ing the Corn War.

How would Don­ald Trump have reacted to the ver­dict of an insti­tu­tion that he has no great love for?

So, provided this dis­pute stays with­in the frame­work of the WTO, it will not des­cend into a prop­er trade war. But there are still a few unknowns. The first is how China will react, since that coun­try has the means to take ser­i­ous retali­ation against the US. The clearest example is their large soy­bean imports from the US, which accoun­ted for $14bn in 2017 alone. But there’s also steel and alu­mini­um to con­sider: the US aerospace sec­tor reacted very neg­at­ively, stat­ing that even though the res­ult­ing price increase on these products would only have the tini­est of impacts on the price of fin­ished products, China’s poten­tial retali­ation on its imports could deal a con­sid­er­able blow to the industry. China also holds a quasi-mono­poly on rare-earth metals, stra­tegic min­er­als. Finally, the People’s Bank of China holds large reserves of US dollars.

The oth­er unknown, obvi­ously, is the reac­tion of the Amer­ic­an Pres­id­ent to the WTO’s decision: it seems very likely that the US could lose griev­ance pro­ceed­ings ini­ti­ated by the EU, among oth­ers. How would Don­ald Trump have reacted to the ver­dict of an insti­tu­tion that he has no great love for?

In any case, Trump sur­prised us all with his lack of under­stand­ing of basic eco­nom­ic mech­an­isms. He refused to see that the Amer­ic­an trade defi­cit is not caused by for­eign pro­tec­tion­ism but rather by an excess of demand and insuf­fi­cient sav­ings, and that if the US pub­lic defi­cit con­tin­ues to grow, the trade defi­cit will too, almost automatically.

Resort­ing to pro­tec­tion­ism while the US were close to zero unem­ploy­ment made no sense, and only con­trib­uted to cre­at­ing infla­tion­ary pressure.

Pro­tect­ing inter­me­di­ary indus­tries, those that are upstream of stra­tegic and labour-intens­ive indus­tries (such as agri­food), is counter-pro­duct­ive in terms of jobs. Finally, Trump refuses to under­stand that his trade part­ners have the means to inflict retali­at­ory meas­ures against his coun­try and will do so. As Jean-Claude Jun­ck­er said, “We can also do stu­pid”².

This column is the repost of an art­icle that was ori­gin­ally pub­lished in the Par­is Innov­a­tion Review on 22/03/2018