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How to Take Advantage of Donald Trump's Strategy of Chaos

BLOG - 21 June 2018

Among candidate Donald Trump's goals, challenging the trade deals signed by the United States, and imposing tariffs to reduce the trade deficit stood out. It does not matter to the 45th President that the US trade deficit is rooted in the national savings deficit and in the facility to fund it thanks to the dominant monetary role of the dollar. Since the eviction of his economic advisor, Gary Cohn, and the rise within the White House inner circles of his trade advisor Peter Navarro, author of the pathetic pamphlet Death by China, Donald Trump is determined to check off every item on his list, so that he can say to his electorate when the time comes: "See, I do keep my promises". And if that requires taking a few liberties with facts, as illustrated recently with Canada, a neighbour with which the United States' trade surplus was turned into a deficit thanks to the magic of a presidential tweet [1], then so be it!
 
For the United States' trade partners, i.e. almost the entire planet, the first challenge is to get a clear understanding of the state of affairs caused by the US strategy. I would neither define it as a "trade war" - it is a permanent state - nor as the end of an ideally multilateral era - the failure of the Doha Round occured in 2006 - but rather as a form of institutional chaos, the instability of which makes any analysis and forecasting difficult. Let us not forget: a few months ago, the Bulletin of the Atomic Scientists, which since 1947 has been measuring the risk of a catastrophic end to humanity with the gap separating us from fateful midnight, advanced its clock to two minutes to midnight, as it had in 1953, justifying this move with the rising tension between the United States and North Korea. Since then, Trump has sung the praises of dictator Kim Jong-un...
 
Three key axes nonetheless emerge from the chaos engineered by the US President

1. Customs tariffs: a small stimulus before a big backlash

The increase in tariffs on steel (25%) and aluminum (10%), which in the end were maintained for Canada and the EU, is in the short term a bonus for American producers who will be able to both gain market shares and increase their prices. Similar measures on other products (e.g. cars) would have the same effect. But with the US economy at full employment – there are more than six million unfilled vacancies, above the 2001 peak - the macroeconomic result will be more inflationary than real. At their 13 June meeting, the members of the Federal Open Market Committee (FOMC) raised the Fed funds rate target by 0.25 percentage point, as well as their forecasts: they are now betting on two further increases this year, and three next year [2]. All things being equal, the Fed's action should boost the dollar’s appreciation. Good news for US competitors, bad news for emerging economies in the dollar zone, for whom funding conditions are tightening.
 
Yet at the end of the day, global trade as a whole will be affected. The first tariff countermeasures from trade partners have already seen the day. Canada dramatically increased tariffs on US dairy products (+270%), and will soon be followed by a 25% European tax on several US imports, including pleasure boats and motorbikes. China immediately responded to the White House's green light to a 25% surtax on $50 billion worth of Chinese imports, by adding a 25% tax on a list of 545 products, ranging from soy to SUVs. If the escalation stopped here, the impact on global trade would remain benign. In a recent study using a detailed sectoral model of world trade, CEPII, a French research center focusing on global economy, indicates that, while sectoral consequences (e.g. on steel in China and Europe) should be significant, and while the redistribution of market shares (in favor of Europe, in disfavor of China) could also be visible, the overall macroeconomic impact would be too small to quantify.
 
Unfortunately, once trade sanctions start escalating, the odds are they will continue to do so, if only for domestic reasons. Moreover, in the case of broader protectionism, hitting for example all US imports from China, the impact could be very substantial. In the study mentioned above, CEPII estimates that bilateral trade between China and the US, i.e. the largest flow in world trade, could be slashed by 60-%, thus probably leading to the collapse of global trade, and to a global recession.

2. Uncertainty over international trade and contracts will dampen investment

Even if the situation does not reach this point, it is very likely that President Trump's strategy of sustained chaos will be pursued until the next presidential election in 2020. Since the goal here is to show voters that his campaign promises have been kept, the most likely trade policy scenario is a succession of aggressive decisions and compromises presented as victories. This is what happened for instance with the meeting with Kim Jung-un, which followed from vivid tensions artificially created and entertained by verbal escalation.

Not only will the increases in custom duties directly impact world trade, but business investment will be the main collateral victim of the new international chaos. Over the last 20 years, production lines have become globalized, thus allowing for a significant reduction in costs, and therefore in final prices. Uncertainty over the future of trade, over the localization of industry, but also over the validity of already signed private - think of companies that have signed contracts with Iranian partners - increases the opportunity cost of investment, and therefore will reduce it worldwide. Less investment means less growth and more inflation in the short term, as well as less productivity in the long term, which means fewer resources to distribute.

3. The political resonance of US protectionist measures will foster emulation

The Italian Minister of Agriculture, member of the Northern League, just announced that his government would ask Parliament not to ratify the trade agreement with Canada (CETA), as he believes, among other things, that the cheese brand "Parmesan" would not be sufficiently protected. There is still a long way to go, and the CETA agreement also offers advantages for Italian SMEs specializing in high-end and luxury goods, which is precisely where the country's comparative advantages lie. Yet the most threatening risk is political contagion. Indeed, if Italy questions the CETA agreement, it will be harder for France, another country with a long protectionist tradition (along with Spain), to ratify it. Not to mention the pending agreements with Japan or Mercosur countries.
 
Economic nationalism is the best-shared ideology in the world, and the political opposition to globalization is expanding.
Former White House strategist and alt-right American ideologue Steve Bannon was well aware of this when he encouraged the Five Star Movement and the League to join forces, and later to challenge the Union by adopting a protectionist policy, be it on immigration or trade.

Europe can take advantage of the Trumpian chaos
 
First of all, the impact of the media must not be neglected. President Trump constantly asserts fake news. We must oppose them. We must repeat over and over again that while the European Union and the United States’ economies are largely open to international trade - which is not the case for large emerging economies like China, and even less so India - the EU is, on the margins, more open than the United States. Consider the following figures:

  • Imports of goods and services take 14.7% of US GDP, compared to 16.3% of EU GDP [3].
  • The trade-weighted average customs tariff rates is 1.6% for both the EU and the US, it is lower in Canada (0.9%) and higher in China (3.5%) [4].
  • The share of imports subject to non-tariff barriers is 44% for the United States, versus 19% for the Union [5].

Secondly, our strategy should be to respond firmly, yet proportionally and reversibly to the US measures, in line with the measures announced by Canada, Mexico and the European Union. We should also challenge US decisions before the WTO, as the defence argument of national security invoked by the United States does not hold water.
 
Furthermore, the Union should seek to take advantage of the chaotic situation created by the US policy through a selective alliance strategy - a sort of European version of the America first slogan. On the one hand, we should promote multilateralism with Canada, Japan, Australia and China, which all see it as in their interest, and with whom Europe should seek to conclude trade agreements, not only for goods and services, but also for capital movements. On the other hand, we should conclude a tactical alliance with the United States in order to obtain credible commitments from China on the protection of intellectual property, especially for European companies established or wishing to establish themselves in China. The expression “trade war” is misleading, because when it comes to international trade, there is no such thing as friends or foes: there are only partners.

Best for last: strengthening the competitiveness of the Eurozone
 
Finally, the Union must strengthen its competitiveness. The challenge posed by the rise of populist movements, based on the feeling of exclusion shared by a large share of the population, also requires that competitiveness be strengthened and that social inclusion be improved. This would allow productivity gains, which are the only sustainable source of prosperity, to no longer seem like they only benefit a minority. There is therefore no other option but to pursue reforms designed to make the supply side more competitive, including the banking system, to make labor markets more flexible and institutions more credible, more transparent and closer to citizens. The use of new technologies can help on this matter, as emphasized by many previous Institut Montaigne reports [6].
 
It is also essential that public resources target innovation, research and education, rather than questionable subsidies. In this respect, the European Research Council (ERC), now part of the Horizon 2020 program, is a good role model, as 70% of its funded research projects have achieved either a breakthrough or major scientific progress. The figure proposed by the Commission for after 2020, i.e. a budget of €100 billion for seven years, represents a big step forward. Yet it would remain three times lower than agricultural subsidies and would be well below what is necessary for the Union to keep up with the United States and China. The latter’s scientific ambitions never fail to surprise [7], and their research budget is increasing twice as fast as their GDP.
 
The Eurozone, where economic integration is most advanced, should be at the forefront of innovation, as it is the only long-term guarantor of resources able to make growth more inclusive. In addition to the public funding of research, the Eurozone must make progress on the single capital market, and in particular venture capital, so that the allocation of Europeans' abundant savings goes to innovative companies rather than to Member States debt securities.
 
We must not fool ourselves. Yet we can still hope that the European summit on 28 and 29 June will live up to the challenges of the chaotic world taking shape before our eyes.
 

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[1] According to the Department of Commerce, which produces statistics on the trade in goods and services, the United States have had a surplus of $ 2.8 billion with Canada in 2017. It seems that Trump restrained himself to the trade in goods. In fact, didn’t his advisor Navarro declare on Bloomberg, on 8 March: “My function, really, as an economist is to try to provide the underlying analytics that confirm his [the President] intuitions”?

[2] The table indicating FOMC committee members' median projections shows an increase of 0.5 percentage point for the remainder of this year, and 0.7 percentage point in 2019, a total of 5 increases of 0.25 percentage point, to the nearest rounding. Source: Federal Reserve Board and Federal Open Market Committee release economic projections from the June 12-13 FOMC meeting - Board of Governors, 13 June 2018.

[3] Data for the year 2016, the last year known for extra-EU trade in services. Sources: US national accounts (BEA, NIPA Tables), EU national accounts and balance of payments (Eurostat, BPM6).

[4] Source: World Bank, year 2017.

[5] Source: World Bank, years 1997 to 2001.

[6] See “Social Protection: A Vital Update” (March 2018), “Innovation in Healthcare: Let’s Heal Our Talents” (March 2018), “Justice: Get Digital” (November 2017).

[7] It is worth noting that while the United Kingdom is toughening its visa policy for foreign researchers, China is doing just the opposite, for instance authorizing foreign academics to lead research teams in China. 

 

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