Trump delivers three big blows as trade war threat blows hot and cold

Talk of a trade war blows hot and cold, then hot again.  The Prussian military analyst Carl von Clausewitz pointed out that “three quarters of the factors on which action in war is based are wrapped in a fog of greater or lesser uncertainty”.  This is an apt description of the current state of the world trading system which seems to have been turned upside down by a barrage of unilateral action by the United States.  How did we get to this point and can we see anything through the fog?

A bit of history

The U.S. more than any other country was the driving force behind the creation in 1948 of the General Agreement on Tariffs and Trade (GATT), which provided a solid foundation for trade in goods for nearly 50 years, until it was superseded by the World Trade Organization in 1995.

The U.S. was also a prime mover in the creation of the WTO.  Compared with the GATT, the WTO had improved rules and expanded into the areas of trade in services and the trade-related aspects of intellectual property.  It also had a strengthened dispute settlement system (the previous weakness of which had been one of the main criticisms of the GATT).

The system relies ultimately on the willingness of the major trading nations to abide by the rules.  Only by setting this example can they expect others to follow suit.  In this respect they are the guardians of the system.

The problem now is that one of the main players – the United States – has reconsidered this guardianship role.  Not only that, but the U.S. has turned vehemently against the multilateral system that it created.  The trade policy of the Trump Administration is economic nationalism – “America First”.

“Three big blows” and more

With its characteristic knack for encapsulating a complicated situation in a simple catchphrase, China has labelled recent U.S. actions as “three big blows” against the global trading system.

  1. First, under section 232 of its Trade Expansion Act of 1962, the U.S. imposed import tariffs of 25 per cent on steel and 10 per cent on aluminium, citing national security grounds which most observers regard as specious. These additional tariffs apply even to close allies, notably Canada, Mexico and the EU.

With its huge overcapacity, China is usually considered as the largest supplier of low cost steel but in fact most Chinese exports to the U.S. are already covered by special restrictions such as anti-dumping or countervailing duties, and China only accounts for 3 per cent of all U.S. steel imports.

In the WTO, both China and the EU have launched challenges against the U.S. on these tariffs which they regard as traditional “safeguard” measures rather than being justified under the WTO’s national security exception.  Such safeguard actions raise the possibility, under WTO rules, of compensatory tariffs being imposed by affected exporters.  As these challenges are pursued, the WTO could ultimately be put in the invidious position of having to rule on whether U.S. national security interests are truly at stake – a potentially explosive issue.

On 1 June, EU Trade Commissioner Cecilia Malmström announced that the EU did indeed intend to retaliate against the U.S. tariffs as, it believes, it is entitled to do under the WTO’s Safeguards Agreement.

  1. Stung by international and domestic criticism of the steel and aluminium tariffs, the U.S. Administration accelerated the conclusion of an investigation under section 301 of its Trade Act of 1974 into China’s policies and practices related to technology transfer, intellectual property and innovation. The investigation concluded that China uses joint venture requirements, foreign investment restrictions and discriminatory licensing to force technology transfer and discriminate against U.S. companies.  It was estimated that this resulted in harm to the U.S. economy of at least $50 billion per year.

The U.S. then announced a list of 1,333 products imported from China that, it proposed, should be subject to 25 per cent additional tariffs, having an annual trade value commensurate with the estimated $50 billion of harm caused to the U.S. economy.

Although at one stage this aspect of the trade war was apparently put on hold, the U.S. has recently clarified that the tariffs will indeed be applied once the product list has been finalised (following a process of domestic consultation which has now ended).

Meanwhile, dispute settlement proceedings have been initiated in two opposing cases at the WTO.  In one, the U.S. challenges the legality of a number of Chinese laws and regulations which discriminate against U.S. intellectual property holders.  In the other, China challenges the legality of the proposed additional 25 per cent tariffs on a range of Chinese products.  These cases are at an early stage.

The EU has also just announced that it will pursue its own WTO case against China for breach of intellectual property rules, mirroring the U.S.

  1. The third “blow” is the S.’s apparent determination to render the WTO’s Appellate Body inoperative. The Appellate Body is supposed to comprise seven people, appointed for four years each (renewable once), three of whom must sit on any one case.  The U.S. has however for some time refused to appoint any new Appellate Body members, or to reappoint any of the existing members.  The Body is now reduced to four people, and the appointment of one of these expires at the end of September 2018.  At that point, there will only be the bare minimum of three serving members, which will greatly increase the time taken to deal with appeals.  Two other appointments expire in December 2019 by which time, assuming the U.S. continues to block new appointments, the Body will no longer be able to function.

This runs the serious risk that the WTO’s dispute settlement system, which has successfully resolved many trade disputes over the last 23 years, will be inoperable as a whole.  If a “losing “ party at the initial panel stage appeals the case, but there is no body to hear the appeal, cases could remain in permanent limbo.

The U.S. cites “judicial overreach” as its main objection to the Appellate Body.  In practice the U.S. has won a great many cases on appeal but it has been incensed by the Body’s repeated striking down of its longstanding practice of “zeroing” in anti-dumping cases.

 

The U.S. Department of Commerce alleged that foreign imports have “eroded” the U.S. auto industry

 

Almost all other countries regard the U.S. action (or inaction) in this context as a serious systemic threat to the WTO.  Some are considering the possibility of ad hoc procedures in individual cases where, by mutual agreement, the parties would agree to appeal procedure similar to the current arrangements.  But, for the time being, the situation remains at an impasse.

These are not the only signs that the U.S. Administration has turned its back on the rules-based international order.  TPP was consigned to the dustbin; renegotiation of NAFTA is proving to be a particularly tough exercise; there are simmering transatlantic trade tensions over trade balances, technology, data protection and pharmaceuticals; and, more broadly, some U.S. foreign policy initiatives are rolling back established conventions.

Most recently, the U.S. Department of Commerce alleged that foreign imports have “eroded” the U.S. auto industry.  It has initiated another probe under Section 232 of the Trade Expansion Act of 1962 to determine whether the decline “threatens to weaken the internal economy of the United States.”  This mirrors the “national security” justification for the steel tariffs and runs the same systemic risks.  The EU and Japan are particularly aggrieved.  A bad idea seems to be getting worse.

Teetering on the brink

The worst case scenario is a full blown trade war in which international rules are set aside and the trading system is fragmented, with very serious consequences for the global economy.

Much now depends on how the EU and China react, both bilaterally and in the WTO.  The classic Trump Administration tactic seems to be to exert maximum pressure through unilateral action, thereby (it hopes) forcing other parties to the negotiating table with concessions in their pockets.

Three big questions

Three questions may determine whether the fog thickens or begins to lift.

First, will the EU and China stand on principle, retaliate in kind and press forward with their challenges to the U.S. in the WTO?  Or will they bend somewhat and seek a deal?  Or will it be a mixture of the two? In the steel case, the EU seems to be inclined to take a harder line.  China will also stand on its principles: it is in no mood to tolerate “unequal treaties” as it did in the nineteenth century.  But, as long as it is accepted as an equal negotiating partner, it might be more flexible on the details.

Secondly, how much does President Trump need in order to declare victory?  We don’t know and, quite possibly, neither does he at this stage.  His Administration is simply pushing as hard as it can and will make a judgement at a certain stage.

Thirdly, what are the consequences for the multilateral trading system represented by the WTO?  Possibly the U.S. now wants to tear down the current edifice and recreate a new system in its own image.  Some developed countries are also dissatisfied with some aspects of the WTO and could be tempted to engage in a discussion to revamp the WTO.  But many emerging and developing countries would likely resist, again with the risk of fragmentation.  The spectre of two or more competing trading systems running in parallel would not appeal to the business community worldwide.

Weather forecast: murky

It would be foolhardy to predict any specific outcome.  Indeed any “outcome” as such seems unlikely in the short term.  We are going to experience a period of extended turbulence in trade policy, with events taking unexpected twists and turns, at least until the next Presidential election in the U.S.  The fog will not lift anytime soon.

Business, as a rule, strongly dislikes unpredictability and uncertainty.  And what is bad for business will also in due course adversely affect employment and growth.  The prospects for an international coalition of business interests coming together to speak truth to policy makers seem distant.  But if economies worldwide begin to suffer, and as the self-defeating nature of protectionism in an increasingly technologically-integrated world becomes apparent, the voice of international business may yet be crucial.