The next chapter in the transatlantic trade war

European trade commissioner Phil Hogan has spent the last few days in the US, in an attempt to improve the transatlantic relationship. Or to put it more bluntly, in an attempt to prevent the US from hiking tariffs on European goods. Hogan and his US counterpart Lighthizer have not issued a joint statement, but in two separate speeches Phil Hogan yesterday reiterated the importance of the (trade) relationship between the EU and the US.

Hogan said that his visit had obviously not solved all outstanding issues between the two trading blocks, yet talks could be seen as a good starting point. The most concrete achievement seems to be Tuesday's joint statement by Japan, the US and the EU on reforming the WTO to address disrupting Chinese state support to domestic companies.

On trade, the issue of the French digital services tax has not been solved. The US is still of the opinion that the tax is discriminatory against US companies. French Economy Minister Bruno Le Maire and US Treasury Secretary Steven Mnuchin are supposed to work things out in the coming week by negotiating a compromise on the tax involving the OECD. If no compromise is reached the US has the intention to raise import tariffs on French goods. The dispute over European government subsidies to Airbus has also not been solved. The US argues that the EU is not doing enough to address US concerns. While the US could still raise retaliatory tariffs on a broad-based import package, Hogan said there is still basis for discussion.,

Regarding agriculture policy, Hogan emphasized that the EU has increased beef and soy beans imports from the US in the past year(s), in a bid to demonstrate the EU's willingness to work with the US on this front. Moreover, some regulatory changes in this field could be agreed upon. Yet he also underscored that lowering tariffs on agriculture products are a non-starter.

On the bright side, US officials with whom Hogan held talks, have not mentioned hiking car tariffs, so that threat has moved to the background. Yet only for now, we would argue.

All in all, Phil Hogan’s visit could be the starting point of improved cooperation, but as expected much work still needs to be done. Given the limited ability of the EU to act on US demands this will not be easy, to say the least. Behind the scenes the officials in Brussels will continue to work on a strategy to ease the frictions between the US and the EU, but in the short run tensions will very likely persist.

Hogan to the rescue

Phil Hogan’s trip to the US followed on multiple spats in the relationship between the EU and the US in the past months. The latest quarrel is about a digital services tax to be implemented in France, which the US deems to be discriminatory against US companies. Yet the issue is just one of many in past months and years. At the side of the EU there is irritation over US reluctance to appoint judges for the WTO appellate body, US tariffs to retaliate European subsidies to Airbus and US tariffs on steel and aluminum. At the same time, the Trump administration has problems with the large trade deficit the US is running with the EU (Figure 1) and the latter’s reluctance to include agriculture policy into trade negotiations. Moreover it wants the EU to spend more on defense and to side with the US on its China policy. Finally, points of view differ on how to deal with Iran and Russian gas. While the EU is unwilling to do the US’s bidding, it also realizes the importance of a good relationship with the US. After all, the US is the EU’s largest trading partner, absorbing 7.5% of its exports. In the end, all that matters was perfectly summarized in the slogan from the Clinton campaign: It’s the economy, stupid.

Now that the phase one deal between the US and China has been signed, it is especially important to calm trade tensions with the US, since the US will now shift its focus to the EU (see infographic). At this stage it is doing so by threatening to raise tariffs as a reaction to France’s digital services tax and pressuring the EU to exclude Chinese telecom providers from its networks. But in our view also the threat of higher car tariffs keeps lingering in the background as well. In any case, we believe that if (i) the phase one deal with China proves to be resilient and (ii) the EU appears to be unwilling or unable to adhere to US demands regarding trade policy, China policy or defense spending, the US could move forward to actually raise tariffs.

Import tariffs on cars would be especially damaging for economies with large car exports to the US and large car industries, such as Germany, Hungary and Italy (for a detailed analysis see Very dangerous European cars part II). Car production in these large car producing countries could shrink by as much as 5%, if the US would hike import tariffs on European cars to 25%.

The trade tactics of the EU have been rather consistent over the past years. When a trade issue pops up, we expect the EU to stick to the following three-step approach:

1. Send a senior official to the US to cool things down (such as Mr. Juncker for the steel tariffs or Mr. Hogan recently)
2. Threaten to retaliate if tariffs/measures are actually imposed (such as counter tariffs on Levi Jeans and Harley Davidson motors). If necessary, actually impose these measures
3. After retaliations are in place, renegotiate the tariffs and try to heal the relationship

In fact, the EU has already made clear that it would retaliate if the US were to move on tariffs related to the French digital services tax and hike tariffs on 35 billion euro worth of US imports if the US raised import tariffs on European cars. But an escalation of the conflict is not in Europe’s interest, given its large exports to the US. And the threat of car tariffs is especially rattling Germany given its very large car producing sector (and the vulnerable state of it at the moment). In fact car tariffs could provide the final push for the country to enter a recession. So we expect the EU will continue to try to smooth the relationship with the US.

That said, keeping in mind the limited willingness and ability of the EU to act on US demands and the relative calm the phase one deal with China provides, the US could decide to raise pressure by actually increasing tariffs on European imports. Such a move would clearly increase the risk of the transatlantic (trade) dispute spiraling out of control. As the EU would likely retaliate before it would be willing to talk, this, in turn, could lead to the US administration ramping up the pressure by a new set of measures. And so on.