The possible re-election of Donald Trump as US president in November 2024 could entail a significant upheaval for the world trading order if he fulfills his announcements to raise tariffs (60 percent against Chinese goods, 10 percent against products from the rest of the world), mainly in order to reduce the US trade deficit. Such steps would not only harm the world economy during significant global strains but also blow further to the WTO, as the envisaged tariff increases would violate international trade rules. It is worth noting the tariffs President Biden added, including the 100 percent tariff on Chinese-made electric vehicles (EVs). Moreover, President Biden placed 50 percent tariffs on semiconductor imports ($1 billion a year) from China.
Donald Trump’s previous first term in office was primarily characterized by his refusal to sign up for a trade deal with Asian countries, the re-negotiation of NAFTA, the marginalization of the World Trade Organization (WTO), a trade war with China and deteriorating trade relations with the EU that led to the partial reform of the US free trade agreements with Korea (KORUS), Canada and Mexico (NAFTA, later USMCA) as well as the conclusion of a “mini-trade agreement” with Japan (USJTA).
Accordingly, the transatlantic relations with the EU are also likely to suffer. First, old trade disputes settled mainly with the Biden administration could flare up again, e.g., regarding steel and aluminum. Second, Trump could abolish cooperative measures by the Biden administration that mitigate the protectionist elements of the US Inflation Reduction Act for EU exporters. Third, the future of the EU-US Trade and Technology Council (TTC) might be jeopardized. Accordingly, we should expect the impact of two scenarios:
Scenario 1 entails an increase of US tariffs to 10 percent on all US imports and 60 percent on US imports from China in 2025. Donald Trump and his former trade advisers have publicly envisaged these threats.
In scenario 2, in reaction to scenario 1, China would retaliate with a tariff increase of 40 percentage points on imports from the US. The following results of the two scenarios with the Global Economic Model of Oxford Economics for the four years of a potential second Trump term from 2025 to 2028 stand out.
The US economy (US GDP level) would be negatively affected in the first years in the minus up to minus 1 to minus 1.4 percent in the two scenarios due to a simulated temporary confidence shock in the short term that has adverse effects on private investment and consumption. Moreover, private consumption decreases due to higher consumer prices and unemployment. A cumulated loss in the GDP over the 4-year horizon amounts to nearly 600 billion US dollars in the first scenario and nearly 1,000 billion US Dollars in the second scenario.
In scenario 1, however, the US GDP level would remain only marginally negative in 2028 mainly because of the temporary nature of the confidence shock and the improvements in the trade balance, the fiscal balance, and the terms of trade. However, in case of retaliation by China in scenario 2, the US would also suffer GDP losses in the medium term, in the range of about half a percentage point of GDP, with a slowly decreasing trend after 2028.
Regarding the US trade balance, in absolute terms, the trade balance would decline further because other trends like the rising US government deficit are more critical macroeconomic drivers of the trade balance than tariffs. Moreover, the US loses competitiveness due to an appreciation of the real effective exchange rate, which tends to raise imports and reduce exports.
The approach of Trump and his advisers to raise tariffs to reduce the US trade deficit is fundamentally flawed from an economic point of view if the US and particularly the government continue to be large net borrowers globally. The same was true for Donald Trump’s first term when generous tax reductions further increased the US government deficit. As a result, the US trade balance hardly changed between 2016 and 2019 (and remained at 2.7 percent of GDP) despite significantly higher tariffs against China.
The simulated tariff shocks would hit the world economy harder than the US. In scenario 2, world GDP would be more than 1 percent lower in 2028. Moreover, world trade would be negatively affected as well. This can be illustrated by looking at Germany as an example of a rather export-oriented economy. In scenario 2, the demand of Germany’s main export partners would decline by about 5.5 percent in 2028. This translates into a decline in German exports of 4.5 percent.
As a result, private investment declines considerably in Germany. In absolute values, it would be 27 billion euros lower in scenario 2 and would thus contribute more than half to the total GDP loss of about 50 billion euros in 2028. This is equivalent to a decline in the German GDP level of about 1.4 percent. However, in scenario 1, a GDP loss of 1.2 percent would result in 2028, a significantly more significant decline than for the US.
In absolute terms, the cumulated GDP losses over the 4-year time horizon amount to more than 120 billion euros for Germany in scenario 1 and nearly 150 billion euros in scenario 2. The main reasons for the difference between the two countries are that Germany is more export-oriented than the USA, and its trade balance will deteriorate while the US trade balance improves.
The EU would also be hit harder than the US. Given the negative effect of a potentially renewed protectionism under Donald Trump, the EU should proceed along two lanes: First, the EU should prepare for such a scenario now. Before all, the EU should use the remaining term of President Biden to put the trade relations with the US on a more solid footing. In the best case, this could be achieved by institutionalizing the TTC and by convincing the Republican Party in Congress that the TTC is a crucial forum to coordinate trade policies vis-à-vis China with the EU. Moreover, signing a critical minerals agreement and a Global Arrangement on Sustainable Steel and Aluminum would be essential steps to reduce the likelihood of a backlash from Donald Trump concerning transatlantic trade relations. A further step should be for the EU to foster its relations with other trading partners by signing more free trade agreements, such as with Australia, Indonesia, or India. Second, if Trump were elected and threatened to implement new trade barriers against the EU, the EU should be able to react. The EU should also be willing to threaten credible retaliation measures to counter such a threat. For such purposes, the Anti-Coercion Instrument was recently implemented and could provide the framework for possible retaliatory measures of the EU. While it is true that retaliation would aggravate the trade war and have detrimental economic effects, it appears necessary to have a counterstrategy founded on realpolitik.
