Trump announced harsh tariffs that will hit the global economy and markets. This is a historic watershed where the present rules-based world order is threatening to crumble yield to one where the strong prey on the weak.
US President Donald Trump announced reciprocal tariffs that were higher than feared. The tariff package will increase tariffs on China, for example, to as much as 54 percent, including previous tariffs. EU tariffs will rise by 20 percentage points. The base case is 10 percent, which hints where negotiated tariff rates may finally settle. Just a few weeks ago, ten percent sounded draconian, now it sounds positively reasonable.
Round 2, retaliatory tariffs
Other countries will respond with their own tariffs. Counter-tariffs are limited by US threats of retaliation. The US has more bargaining power than other countries because of its large economy and geopolitical might.
Trump wants to leverage the power of the world’s greatest economy into bargaining power. Why play by the rules, if you are the alpha male. According to his niece, as a child Donald hid his little brother's favourite toy, which he was desperately searching for. Now we are all his younger sibling wondering what happened to the toys we played with all these years.
The toughest of the opponents is the European Union. The Union is gearing up for a trade war by having prepared a directive to tax American service. A significant proportion of the sales of American technology giants are service exports. However, it’s likely that most countries cannot retaliate. Especially the smaller economies.
A negotiation ploy or not?
Trump’s tariffs have been designed to facilitate bargaining. Negotiations will eventually lead to lower tariffs. But tariffs are not just a negotiating tool for the Trump administration. Tariffs are a universal panacea. Two key economic thinkers in the Trump administration, Peter Navarro and Stephen Miran, prescribe tariffs on disease after disease. Tariffs fix the trade deficit, bring industry back to America, protect strategic industries and create high-paying jobs and revenue for the government.
Torture chamber
Trump is constrained by fear of losing the support of his core supporters. That's why Trump wants to get the negotiations done at the start of the term, before the Republicans prepare for the mid-term elections and while Joe Biden can still be blamed for price rises. Tariffs will be high initially because it puts opponents under maximum pressure, which will speed up negotiations.
Economic impact
In economics, tariffs are poison to the economy. Professor Larry Summers compares tariffs to a natural disaster or an oil crisis. He also described Trump's mercantilism as particularly inept because tariffs apply to all products, including those that are essential to the US. According to economists, the tariff war exacerbated the Great Depression of the 1930s.
As a result of tariffs economic growth falls and prices rise. The US is a closed economy where foreign trade is a relatively small portion of GDP. The EU suffers more because it is a more open economy, and China because it is an investment-driven and trade-driven economy. The effects of tariffs can be divided into direct and indirect effects. The direct effect of tariffs, where consumer purchasing power and net exports fall, depends on the volume of trade. The indirect effect comes from uncertainty hitting industry and investment as well as financing becoming more expensive.
The fact that the US is waging a trade war against everyone could change the picture. US exports may suffer retaliatory tariffs in all directions, while exports from other countries face tariffs only on US exports. This is why Trump also emphasises retaliation as a result of retaliatory tariffs and possible alliances. More than likely, there will be no alliance of the tariff stricken against the US.
A watershed moment
Since 1945, US presidents have pushed for rules-based trade regardless of party affiliation because the country was perceived to benefit from this arrangement. America also realised that it was a mistake to retreat from the world after the First World War. After the Second World War, America did not repeat this mistake but committed itself to the world order it had created. Trump believes that the US does not benefit but suffers from the current arrangement. He understands a world where the strongest dictate terms on the weak. In this world the US is king.
Figure 1: Trump raises tariffs to historically high levels
Valtteri Ahti
