Walking away with Our Heads Held High

Rasa Gulbe, 3rd Year Graduate at SSE Riga, currently working on a Bachelor Thesis about Factors impacting investment behaviour and income inequality, has written the third article in a series "Rocky road".

The start of July is right around the corner, and with it one of the most notable celebrations for the U.S. and the American Chamber of Commerce - the US Independence day. Yet, this year another notable event takes place at the start of this month - EU tariffs on select US products come into force *(1). 

These tariffs on highly specific groups of imports from the US (mainly steel or steel related, but also bourbon, orange juice, cranberries, and even peanut butter) were imposed as a response to the tariffs imposed by the US on EU steel and aluminium at the beginning of June *(1, 2). When reading into this "exchange", the reader is met with a plateau of arguments supporting this move from the EU, but mainly, it is described as a necessary punishment, to ensure that such actions are not repeated nor even remotely tolerated, as they disrupt free trade *(1, 3). These tariffs are supposedly created in a way to cancel out the negative effects of the US tariffs, resulting in a zero-sum outcome, while still making a clear statement 2. This seems to be supported by the fact that many of the EU-imposed tariffs target goods produced in specific states, the regulatory bodies of which were either involved or supported the protectionist move from the US *(4).

However, as I see it, it is a worrisome step in the wrong direction, based on reasoning which is as old as our civilization, yet has never truly worked. "Tit-for-tat" is a great strategy, a stable one, sometimes even called the golden punishment, yet over the long run it is a destructive one. This strategy promotes continuous affenses (continuous creation of new tariffs, or increases in the size of the existing ones), resulting in expensive products for the consumer and the producer, while artificially harbouring inefficient industries, under the slogan of "protecting local producers".

Of course, action had to be taken regarding the US tariffs. Without punishment there would be nothing to keep other states and members loyal to principles of free and open trade, since in the short run the state that breaks such principles "to protect local markets" benefits. Most economists claim that because these tariffs affect only a few product groups the minor price increase might not have a strong or long lasting effect on the economies, but as I see it - it is the principle and idea that is the most worrisome in this case. Analysts from the leading banks of Scandinavia and northern Europe hold a similar view - side effects of this "exchange" of tariffs might be the most damaging *(4). What are these side effects? Firstly, Mr. Trump has threatened to follow up with even more trade restrictions, which might result in a trade war between the EU and US. Such war would increase prices of various goods in both regions, cause inflation increases, and overall might cause economic instability. On a more global scale - there might be some switching when it comes to the main importers and exporters of these specific goods, causing other regions to gain from this pointless battle. Yet, what worries me the most is something even more global and longer-term oriented - increasing trade restrictions causes stagnation. Without a free exchange of goods a lot of the innovation and economic growth that we have seen take place in the last decades would not have been possible *(5). Such global competition is necessary to foster efficient and competitive companies which thrive for innovation and development to gain their market share, instead of waiting for the government to step in whenever they feel threatened.

So, what does the future hold? Of course, there are many possible outcomes which depend on the parties involved and the power they have. Based on Trump's rhetoric, it appears that he might choose to defect for another period (a move expected in a "Tit-for-tat" strategy), and then the ball is in the EU's court. We might cooperate or defect once again. In case of the latter, if neither of the sides change their strategy, we will end up in a downward spiral leading to very restricted (if any) global trade. If we choose to cooperate, i.e., do not increase the number or size of trade restrictions, we will have made our point with the introduction of these tariffs, while showing our willingness to maintain free trade, which might cause a reconsideration in tactics on the side of the US. Hence, I maintain the view that it might be the best tactic to simply walk away with our heads held high from a pointless but harmful fight.

Written by Rasa Gulbe.
Graduate of the Stockholm School of Economics in Riga. Consultant at Agile & Co.

Further Reading

*1) The Financial Times. EU presses ahead with retaliation to US steel tariffs.
*2) Time. EU to Launch Retaliatory Tariffs on U.S. Imports in July.
*3) The Guardian. EU to impose tariffs on US imports from July.
*4) Diena. Ekonomisti: ES atbildes tarifiem ASV precēm būs neliela ietekme uz Latvijas patēriņa cenām (Economists: the EU Answer to the US Tariffs on Goods will have a Small Impact on the Consumer Price Level in Latvia)  https://www.diena.lv/raksts/viedokli/latvija/ekonomisti-es-atbildes-tarifiem-asv-precem-bus-neliela-ietekme-uz-latvijas-paterina-cenam-14200105 
*5) Scott L. Baier, Jeffrey H. Bergstrand. The growth of world trade: tariffs, transport costs, and income similarity

A fascinating read about how people act when the other party does not cooperate (warning: Game Theory & Statistics intensive): 

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