Since the election of Donald Trump, US trade policy is threatening to become more and more protectionist and this could be a wake-up call for Europe to strengthen its single market and stabilise the European Union, writes Thieß Petersen.
Thieß Petersen is a senior adviser for Bertelsmann Stiftung.
Since the election of Donald Trump, US trade policy is threatening to become more and more protectionist. Such a change in trade policy would reduce international trade and economic growth in all countries.
Although economic damages for European economies would be lower than for the US itself, losses in GDP are substantial. One way to offset these damages is a strengthening of the European internal market.
Protectionism: Why it does not work
The basic idea of a protectionist trade policy is the hope that imported products will be replaced by goods and services produced by domestic companies. Those in favour of a protectionist US trade policy, expect that there should be an increase in domestic production, employment and income in the United States.
As a matter of fact, this is a wrong assumption. A country which uses protectionist instruments reduces domestic GDP and employment.
Of course, some products can be produced by domestic companies if those companies gain in international competitiveness because they are protected against foreign suppliers.
However, the price for the American products would be higher than for the imported goods because, without higher trade barriers, US companies would not be competitive – otherwise there would be no demand for imports in the first place.
As a consequence, the entire price level in the US rises. Due to higher prices, international competitiveness of the US declines. Hence, exports will decrease. And lower exports result in lower production, lower employment and lower income.
Apart from this replacement of foreign goods and services by US products, the American economy still needs to import products from abroad. Due to higher tariff and non-tariff trade barriers, the prices for imported goods and services rise. The result is once again a higher inflation rate with a decline of exports, GDP, employment and income in the US.
Apart from the negative impact on American competitiveness, rising inflation has another growth-dampening effect: higher prices reduce the purchasing power of American consumers. Therefore, demand for goods and services America decreases. US companies have to reduce their output because they are not able to sell all their products. The result is an additional reduction of employment and income.
US companies have to reduce their output because they are not able to sell all their products. The result is an additional reduction of employment and income.
Last but not least, lower imports of the US economy imply lower exports for those countries which suffer from American protectionism. As mentioned before, a reduction of a country’s exports causes a decline in employment, GDP and income.
So if foreign countries are faced with lower incomes, their citizens can spend less money on goods and services. The lower demand for goods and services affects domestic products as well as US products. Hence, American exports decline.
In summary, economic isolation has negative economic consequences for the country which hopes to increase employment and income through tariff and non-tariff trade barriers.
US protectionism – who suffers most?
The size of economic damage depends on the extent of protectionism and on the reactions of those countries that are affected by higher customs duties and other barriers to trade.
In a recently published study, we analysed several scenarios of a protectionist trade policy. Here are Just a few results concerning the strongest economic isolation assumed in the simulation calculation.
In this scenario, we make the assumption that the US increases its import duties against all countries by 20% and its non-tariff barriers by 20%. In addition to that, these countries take the same measures against imports from America.
The result would be substantial losses in income and GDP for the US economy:
Income per capita is projected to be 2.3% lower in the long run due to the economic isolation. With regard to the actual economic situation, this percentage loss corresponds to $1,300 per capita or to a loss of GDP of $415 billion. Only Canada (minus 3.9%) and Mexico (minus 3.4%) are facing larger percentage drops in GDP per capita.
For European economies, economic losses are much lower (France: minus 0.25%, Germany and United Kingdom: minus 0.4%). Nevertheless, in GDP terms, the current annual loss would be $12 billion in the United Kingdom and $13 billion in Germany.
Especially in times of low economic growth, even small reductions of GDP are painful for workers, consumers and companies.
Economic alternatives for Europe
It is unclear whether the US government really wants to implement the announced protectionist measures. The withdrawal of the discussed “Border Adjustment Tax” is a first step in the right direction. It might be a sign that Washington is not willing to act against its own economic interests.
However, if the US should increase trade barriers against goods and services from Europe, European economies need new trading partners.
One way to stabilise trade and economic growth is strengthening the European internal market. Possible entry points are the markets for services. Hence the threatened economic isolation of the American economy could be a wake-up call for promoting the European single market and stabilising the European Union.