USA duties, an entirely avoidable European escalation

USA duties, an entirely avoidable European escalation

March 26, 2018

Claudio ColacurcioAlessandra Lanza

Trade war continues to remain a latent risk, given the temporary nature of the exemption for the EU

 

In the end the prisoner appears to have solved its dilemma and Europe will also be able to rely on a temporary exemption from an increase in duties on steel and aluminium as laid down in the Presidential Proclamation of 8 March. 

The scenario of the exchanges across both sides of the Atlantic had indeed seemed to bring about a “prisoner's dilemma” situation because of the relations that hold between Europe and the United States, whereby the lack of collaboration could result in the worst balance: a trade war between those that with an interchange equal to more than EUR 700 billion represent the chief bilateral flow in global exchanges. 

Trade war continues to remain a latent risk, given the temporary nature of the exemption and constitutes the actual focus for analysing the new American trade policy. With the steel and aluminium initiative, the US administration in fact identifies in global trade and its unbalance (in 2017, the import of both products amounted to EUR 43 billion, more than double the total exports) an authentic threat to national security both in political and strategic terms (both materials enter the defence industry significantly) as well as in economic terms (specifically, in the field of employment in the sectors concerned). This interpretation is undoubtedly somewhat emblematic of the convoluted season currently experienced by globalisation, when faced with a clear lack of competitiveness of one's team in a given sector (this is, after all, the message relayed by a negative trade balance), first the rules of the game in the broadest sense are called upon (a global trade system in force for well over 20 years) and then, not one, but all parties to the competition are concurrently and implicitly accused of unfairness (which is why trade defence tools such as anti-dumping are in place). 

 

The US market nowadays has a somewhat marginal role for Italian steel and aluminium exporters

It is the spirit behind these initiatives more than the imminent, and for the time being averted, economic repercussions that is keeping the tension still high. After all, the election campaign and the previous trade defence initiatives (in January the rise in rates concerned Korean washing machines and Chinese solar panels) had already emphasised an inclination towards unilateral actions taken by the US administration, putting at risk the system of rules and balances currently enshrined in the principles of the WTO. Had the protectionist action been limited to steel and aluminium alone, it appeared instantly obvious that the economic impact would have been somewhat limited. For instance, by glancing at Italy's flows, the 71 “product codes” for which the law modifies the rate profile are worth little more than EUR 500 million: that is to say, barely 1.2% of total exports from Italy to the United States.

Besides, for both products, the US market nowadays has a somewhat marginal role for Italian steel and aluminium exporters, tantamount respectively to 3.7% for the first (less than Algeria and in any case eighth market of destination) and 2.4%for the second (less than Slovenia and tenth country of destination). The rise in duties, while at such significant levels, would not entirely invalidate the American demand towards Italy, considering the specialisation in product niches, often not easily replaceable even after a sudden increase in costs. In the intermediate goods area, Prometeia estimates point towards a negative relation between export and rate level: a rise by one duty point coincides with a fall in exports by 1.6%. Having grasped the relative proportions, the loss for Italy would therefore be equivalent to almost EUR 200 million of minor exports (0.04% of exports from Italy worldwide in 2017) in the case of complete downstream transfer on prices; alternatively, exporting companies should sacrifice almost 115 million in margins, absorbing the duties on their price lists, so as to retain their competitive pricing; a plausible strategy, particularly if the rate initiative is viewed as limited in time.

 
Fig. 1 United States imports of aluminium and steel, key suppliers (market shares)
 
USA duties, an entirely avoidable European escalation
Prometeia processing on Eurostat and National Statistics Institutes Data
 
 

Penalised countries include China

Other suppliers would appear to have been more affected than Italy, some already exempted together with Europe (aside from Canada and Mexico, Korea, Brazil and Australia have been recently added), others for which a negotiation is still ongoing, but for which some form of safeguard is likely (Japan). Conversely, penalised countries include China, that in addition to the initiative dated 8 March has recently been threatened with sanctions in other much more strategic sectors. As regards steel, the impact will in any case be somewhat marginal: the Asian country already today is affected by ad hoc trade defence measures (mostly in the form of anti-dumping duties) and, with a share of almost 4% on American imports, would have very little to loose from a generalised tightening of rates.

 

Consequences on the actual US economy

Irrespective of how many will enter the final list of the bad and the good according to the US administration, another aspect for appraising the new trade policy pertains to the direct and indirect consequences on the actual US economy. Apart from the trade diversion (a change in suppliers not determined by competitive factors, but by discriminatory policies across importers), a measure of costs and benefits should, for instance, also consider the impact on enterprises using both products as well as the impact on consumers. 

An artificial closing of the market would indeed encourage end users to purchase from suppliers with higher prices, resulting in increased costs along the chain and in a compression of the generated added value. For instance, by comparing the average prices of European steel to US prices relative to the products affected by the measure, it is clear that in 48 cases out of 63, the price of EU manufacturers is lower and that therefore a potential replacement would necessarily lead to higher costs.

This increase would not only concern manufacturers burdened by the new duties, but would be extended to all. Glancing back to the historical precedent of 2002 (identical rise in steel rates by the Bush Administration), in the first year the average price of steel on the US market grew by more than 3 points as compared to a basket of metals not affected by increased rates. Given the weight of the raw materials affected in the productive processes, this variation would appear somewhat significant and able to largely undo any possible gains from the increase in domestic production. For instance, in the US metal, mechanical, automotive or packaging industries the weight of steel and aluminium amounts to between 30% and 5% of input costs. Hence, in absolute terms, by replicating a relative price dynamic identical to the historical precedent, the impact on the margins of the principal manufacturing sectors (or on the final process, in case of downstream transfer) would amount to over USD 10 billion alone, more than it is reasonable to estimate that domestic production may increase. Therefore, is is unsurprising that – as recently stated in the Economist – the ratio between the US companies against such measures and those in favour would be equal to 3,000 to 1.

However, even a positive net balance between the highest steel and aluminium made in the USA and the extra costs along the chain would fail to justify the US protectionist drift. Economic history teaches that any beggar-thy-neighbour policy indeed entails more risks than opportunities for all countries involved, including the actual United States. In particular, the last few weeks have brought into sharp focus how the new protectionist measures can easily trigger a true trade war between Washington and its partners, thus representing a threat to global economic growth. 


 

The risks of a possible escalation

The tit for tat with Europe over the past weeks is somewhat representative of the possible escalation [1]. Since the announcement of the measures on aluminium and steel, the European Union has in fact provided for a list of products made in USA similar in value to what has been jeopardised by the new American rates [2]. In accordance with the practices relating to trade disputes, the list covered the same sectors affected by the protectionist measures as well as other specific goods deemed particularly effective in placing the US administration under pressure (some highly symbolical of the US lifestyle or associated with specific lobbies and territories). 

The United States then responded by identifying in European cars a potential target in the event of countermeasures by the EU. It is not hard to imagine Brussels' reaction to this far more relevant closing of the market (equivalent to 27 billion from the EU, 3 billion from Italy for cars alone). In particular, it is possible to organise a similar response, by blocking both the import of cars from the United States as well as some areas of specialisation of the main swinging states (Florida, Pennsylvania, Ohio).

Fig. 2 Dimension of interchange involved in case of USA-EU trade war (value expressed in billions of Euros) 
USA duties, an entirely avoidable European escalation
Prometeia processing on Eurostat and National Statistics Institutes Data
1. same steel and aluminium codes + evocative products including jeans, bourbon, peanut butter, motorbikes, cosmetics, maize and wheat
2. USA cars + soya bean and other agricultural products + main Florida, Ohio and Pennsylvania specialisation products
 

As mentioned above, this is the typical prisoner's dilemma, an analysis scheme made famous by the game theory, whereby the absence of dialogue between the two subjects leads to a worse outcome than the one that would be attained via their cooperation.

Figure 3 elucidates the possible payoffs in economic terms of the repercussions of a possible trade war between Europe and the United States. The rules shared according to the MFN principle of the WTO (current situation with zero-duty quota or marginal duties) do not entail any change and have a neutral payoff equal to zero for both blocks.

 
Fig. 3 The trade relations between United States and European Union: possible payoffs (delta export and production expressed in billions of Euros)
USA duties, an entirely avoidable European escalation
Prometeia processing on Eurostat and National Statistics Institutes Data
N: does Not protect; P: protects
 

Instead, the second quadrant (in the top right-hand corner) and the third quadrant (in the bottom left-hand corner) describe the situation in which the United States and Europe unilaterally decide to raise trade barriers, without, however, being subject to any reactions from the counterparty. Specifically, the second quadrant delineates the payoffs relating to the implementation of the unilateral imposition of US duties. According to the estimates of an econometric model correlating the rate level to the quantities exported in the United States, the rise in US duties would result in a drop by 2.1 billion in exported steel and aluminium for Europe (approximately one third of the current levels) . At the same time, the United States would indicate an increase by 1.9 billion, especially thanks to higher domestic production. The two figures (the loss for the party facing discrimination and the profit for the party imposing the duty) differ since not all the competitive gap left by Europe would be covered by US manufacturers (Canada and Mexico, exempt from duties, would indeed occupy part of it). If, conversely, Europe were the first to impose duties unilaterally on the previously cited products, the United States would loose approximately 3.3 billion in export and Europe would gain 2.9 billion.

As well as stressing the negative sum game of protectionism (the profit of the offending party is in any case lower than the loss of the party facing discrimination), neither one of the two intermediate quadrants represents the most likely result. In the absence of cooperation, both the United States and Europe have in fact the incentive to impose duties by initiating an actual trade war and the extension of products burdened by duties (from steel to peanut butter, cars, and so on). This is the scenario explicated in the fourth quadrant, averted for the time being, in which mutual market closures result in a net loss for both participants. Trade war is, in short, the worst balance also for those US workers that the protectionist tightening issued on 8 March would have liked to safeguard. Viewed through the European lens, taking into account the loss of 4.4 billion and the gain of more than 20 billion in higher exports, had the TTIP (the free trade agreement between both sides of the Atlantic) been accomplished, the difference of how trade policy can contribute to development becomes apparent. Moreover, while beyond the scope of this article, it is crucial to remember that trade between countries is often not just a positive sum game in terms of respective growth. History shows that it has always been a prerequisite to guarantee, thanks to the sharing of common interests, stable relations and an open dialogue between countries, even if extremely diverse and distant. Thus, a generalised return to protectionism would undermine not only wealth, but dialogue and peace across countries worldwide. 

At the same time, Europe's exemption from the new duties has failed to make less urgent a reflection on the source of the existing unease and manipulation surrounding free trade. Every trade policy, even when aimed at the removal of barriers and at the creation of growth and well-being for the nations involved, is not, however, neutral, especially in the short-term. Not only are intra-state redistribution and, above all, lifelong learning systems crucial tools for free trade, but today they represent a cardinal requirement in order to enable free trade to fully spread its positive effects, without penalising those remaining on the sidelines of the globalisation paths and indeed, maximising and distributing the surplus of free trade. Protection without protectionism.

 
 
[1]  The threat of countermeasures has been a historical deterrent in the trade relations that hold between Europe and the United States and has contributed, for instance, to withdrawing the already mentioned  rise in rates in 2002.
[2] For a detailed outline, reference should be made to http://trade.ec.europa.eu/doclib/docs/2018/march/tradoc_156648.pdf 
[3] Imports are different due to the different level of import penetration across the countries and products concerned.
Read All