Ever since David Ricardo developed the principle of comparative advantage at the beginning of the 19th century, we have known that the international division of labour increases production and income in all countries that participate in cross-border trade. Despite this, President Donald Trump is relying on import tariffs. For the US economy as a whole, this is not a good idea. And the EU will suffer from escalating trade conflicts. To minimise the economic damage, rapid responses are required – and unconventional reactions might be an option.

What trade policy measures can be expected under Trump?

For years, the US has been importing more goods and services from the rest of the world than it exports. In foreign trade relations, the US spends more money than it earns. As a result, the US current account shows a deficit. By contrast, other countries, such as China and Germany, have current account surpluses.

chart: Global trade imbalances (2000 to 2024)

Participation in international trade has had more far-reaching consequences for the US during the past two to three decades:

  • On the positive side, low-priced imported goods mean American consumers have benefited from cheap Chinese products.
  • On the other hand, this mass production of goods requires many workers, and it has been outsourced to countries with low wages, especially China. This has led to widespread job losses in the US while simultaneously pushing down wages.
  • Nevertheless, the US economy has benefited overall from trade with China, just as David Ricardo predicted.

But in an attempt to stop negative developments in the labour market, Trump reacted with import tariffs on products from China and Europe during his first term of office. He now wants to apply this trade policy strategy again.

What are the consequences of import tariffs for the US?

Introducing tariffs means that imported products are sold at a higher price in the US, making the American market less attractive for foreign suppliers. American companies, on the other hand, may become competitive again with higher prices. If this is the case, US production and employment will increase.

But protecting individual US industries has considerable disadvantages for the US economy as a whole. For example, this happened in 2002, when the US government introduced tariffs on imported steel to protect domestic steel industry.

  • In the US, steel became more expensive because of the import tariff. As a result, production costs rose for all American companies manufacturing goods that require steel. Consequently, steel-containing goods became more expensive and demand for these products dropped.
  • Higher prices mean a loss of purchasing power for American consumers – they cannot buy as many products with their income. The result is a second decline in demand for goods.
  • US companies adapted to the lower demand and reduced their production. This was accompanied by job losses.
  • According to empirical estimates, steel price rises triggered by the import tariff led to a total loss of around 200,000 jobs in the US in 2002. There were only 187,500 jobs in the entire American steel industry at that time.

Trying to bolster selected US industries through a protectionist trade policy comes at the expense of overall economic development because production and employment are weakened. Additionally, price rises on goods cause inflation rates to rise.

Consequences for the EU

Even if the US government did not impose import tariffs and other trade restrictions on European products, the EU would still suffer from this policy. In particular, two aspects need to be considered.

Firstly, if a bilateral trade war shrinks production, employment and income in the US and China, consumers in both countries can afford fewer European products. As a result, exports by European companies to America and China decrease. This has the knock-on effect of declining production and employment for European exporting companies and their suppliers, weakening Europe’s economic development.

Secondly, US tariffs on Chinese products mean that China can sell fewer of its products in the US. This makes it very likely that Chinese companies will try to sell their goods elsewhere, including Europe. This leads to an increased overall supply of goods – and excess supply causes prices to fall. If European companies are unable to cover all production costs, they have to reduce or even cease their output. The result would be job losses. This is particularly likely if Chinese products are offered at state-subsidised prices.

Economic policy options for Europe

If trade disputes between the US and China or between the US and Europe escalate under a Trump administration, there are several trade policy response options for the EU.

Firstly, the EU could respond with tariffs. In fact, the international trade system allows the use of anti-dumping duties and anti-subsidy duties. If imports suddenly increase because of unforeseen developments, temporary safeguard measures are permitted, even if the increase per se is not caused by unfair trade practices.

But such tariffs have negative effects on the EU. Retaliatory tariffs protect European companies from foreign competitors that sell their products at dumping prices in the EU or receive state subsidies. However, tariffs increase the price of imported products, resulting in price level and inflation rates rising in Europe.

Alternatively, the EU could grant financial aid or tax breaks to domestic companies that are struggling to compete with subsidised products from abroad. If European companies can sell their products at lower prices, competitiveness increases – within the EU and in the rest of the world. The downside of such policies ties up public financial resources and factors of production, so these factors cannot be used in other sectors.

Products subsidised by the EU are available at a lower price abroad, so this only makes sense from a macroeconomic perspective in exceptional cases. For example, EU state aid can help protect emerging key industries from subsidised foreign competition. In most cases, it would be better for the domestic economy to import products tariff-free from abroad and use the freed-up factors of production in industries in which European companies have a price advantage.

A completely different reaction is conceivable too – the reduction of European trade barriers. The logic of this approach is as follows:

  • If the EU unilaterally reduces tariffs and non-tariff trade barriers, this will improve the export opportunities of all non-European economies, including the US. In the rest of the world, exporting companies can raise production because they can increase their sales in the EU. As a result, there is stronger export-driven economic growth outside the EU. This effect can be reinforced by facilitating investment. For example,this can be achieved through the new Sustainable Investment Facilitation Agreements. The EU concluded such an agreement with Angola in 2024.
  • European economies benefit from economic growth in foreign countries. Stronger economic growth outside the EU leads to an increase in income abroad, which increases the demand for goods. This affects products that non-European countries import, so European companies can sell more goods in the rest of the world. Consequently, production, employment and income increases in Europe.

However, the prerequisite for this approach is that non-European countries do not prevent EU exports through protectionist measures. If this is not the case, protectionist responses by the EU may become necessary – accompanies by all the undesirable side effects. Alternatively, the EU can conclude new trade agreements with other regions, but this takes time and is not a quick solution.

About the author

Thieß Petersen is Senior Advisor at the Bertelsmann Stiftung, specialising in macro-economic studies and economics. His focus lies on the causes and effects of financial and economic crises, as well as the chances and risks of globalisation. Most recently, he worked on the effects of carbon pricing and the benefits of a potential global climate club.

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