Here is what you need to know about the risks of a US trade war

President Donald Trump has signed an order for special tariffs of 25% on imports into the United States of foreign steel, and 10% on aluminium. He openly says that this could lead to a trade war, which he could easily win. But what exactly is a trade war?

There is no set definition. In the 17th century, England and Holland fought actual wars for domination of European and colonial trade. In the 1930s, responding to the world economic slump, major trading countries tried to protect industries and jobs from competition by imposing steep tariffs and other restrictions on imports. When we talk nowadays about trade wars, we mean aggressive tit-for-tat use of tariffs and other administrative actions affecting trade.

What are tariffs and why do they matter?

Import tariffs, also called customs duties, are a basic tool of trade policy. They are financial charges on imported goods levied by governments and collected by national customs authorities. Their purpose is to protect domestic producers from competition from cheaper imports; often at the same time they raise government revenue and prevent disruption from unfair trade practices. Usually the charge is a percentage of the consignment value, but sometimes it is a “specific” duty, ie a fixed sum per unit of quantity, weight or volume.

All trading countries base their tariffs on a so-called “harmonized system”, which has 99 chapters covering more than 5,000 individual product descriptions and many subdivisions. Item by item, governments apply their own chosen rates of tariff (or no tariff). Very rarely, a government may apply a tariff to exports of an item which is a valuable national resource, in order to deter exports and maintain domestic supply.

How do tariffs work in customs unions and free trade areas?

A customs union is a treaty-based grouping of countries which remove tariffs and other barriers to trade (such as quotas or differing trade procedures) between themselves. All apply the same tariffs and procedures to trade with non-members (the fullest current example is the European Union). In a free trade area the countries remove tariffs and other trade barriers among themselves, but each is free to apply its own independent regime to trade with non-members. World Trade Organisation (WTO) rules require in both cases that the participant countries remove “substantially all” trade restrictions between themselves, which in practice means 90% or more.

Can governments use special tariffs to protect domestic industry and trade?

Yes, within strict limits laid down by the WTO. Where a domestic industry complains of unfair and damaging competition from a foreign company selling a product into the market at artificially low prices or below cost (“dumping”), or from a foreign government unfairly subsidising exports, the government of the importing country may investigate the complaint. If it determines that dumping and/or subsidisation are taking place and causing or threatening injury to the complaining industry, then so-called “anti-dumping” or “countervailing” duties may be imposed on the imports up to a level sufficient to counteract the margin of dumping or subsidy. Often the threat of an investigation may be enough to remedy the abuse. Alternatively, instead of applying a duty the investigating government may accept an undertaking from the exporting company or government to increase prices of the items concerned.

There is another WTO provision which is sometimes used where a sudden surge of imports appears to be damaging a domestic industry. The importing government may investigate the complaint and if it is justified, may impose for a limited time a “safeguard” in the form of special import tariffs or quotas to counteract the surge.

But isn’t that just what President Trump is doing?

No, only in the recent case where Boeing complained that the Bombardier aircraft company was being unfairly subsidized by the Canadian and UK governments to sell small airliners into the US. The Administration found that subsidization was taking place and proposed 300% countervailing duties on the imports. However, they could not be implemented because the independent US International Trade Commission, which is responsible for determining whether or not injury is taking place or is threatened, ruled that Boeing was not injured, since it did not make the class of planes in question.

Back in January 2018, and in response to complaints by major US manufacturers, the US imposed anti-dumping duties on imports of solar panels and washing machines. The structure of these duties is complex, but they may in some cases be as high as 30% for solar panels, and for washing machines 50%.

On the new steel tariffs, the Administration carried out an investigation of steel imports under a quite different provision, namely the US Trade Expansion Act of 1962, which permits the Administration to act against imports of “any article” which appear to endanger US national security. WTO rules do permit member governments to take trade defensive action in the event of threats to national security.

In the steel case, the US invokes the national security defence on the ground that a viable indigenous steel industry is vital to the entire economy. But it is unlikely that this let-out can be stretched, as the US has done, to justify imposition of tariffs covering every class of a particular commodity, especially one as multifarious as steel. That issue can only be resolved, as it probably will be, by action under the WTO disputes settlement system.

In the case of aluminium, the US has carried out no formal investigation at all. The Administration has simply imposed a blanket 10% duty. This is not permissible under WTO rules, and the US Administration has offered no justification for its action apart from general references to national security.

So shouldn’t other countries affected by the US tariffs on steel and aluminium retaliate against US trade?

That would be a big step towards unleashing a “trade war”. The President of the European Commission initially spoke about retaliation, but the US’ trading partners, including China, are now being more circumspect. Retaliation, whether in the form of special duties or quotas, would in the absence of due process also be against WTO rules; and it would hurt industries, traders and consumers on both sides.

This happened back in the 1980s when the European Community first banned imports of US hormone-fed beef in a dispute that still drags on today. Then the US imposed retaliatory trade sanctions against imports of some important European products. The European Community got as far as discussing a list of US products for counter-retaliation, though that was never activated. The right way to deal with the current US action is through the established, and effective, WTO disputes system.

What is the United States up to on trade?

On present form, “America First” is a threat to the entire basis of the multilateral trading system. At the World Economic Forum in January, US Commerce Secretary Wilbur Ross was challenged about whether the US was risking the launch of a trade war. He said that US actions on trade were aimed to fix “incorrect policy decisions” which had been taken under a post-World War Two system (meaning the system of rules developed under the General Agreement on Tariffs and Trade and now the WTO) that was no longer appropriate. The US did not intend to abrogate its leadership role in world trade, but the basis must be “more fair and equitable”, and the US would no longer be “a sucker or a patsy” on trade. On a different interpretation however, America does seem to be stepping back from its history as a main driver of the open international trading system.

Who suffers from trade wars?

We all do. Manufacturers in producing countries lose output, profits and jobs. Ancillary traders and services like shippers, financiers, insurers and importers lose turnover. Consumers in importing countries face reduced availability of goods, and higher prices. Governments suffer loss of revenue because of reduced trade volumes. When in the 1930s major industrialised countries tried to protect their domestic industries through aggressive use of import tariffs or other trade restrictions, the result was a drop of around half in the volume of world trade, which contributed to mass unemployment and impoverishment.

In the modern world of globalised production and value chains there would be severe risk of disruption of component supply lines, with knock-on effects on manufacturing, output, costs and employment.

What’s likely to happen next?

It’s hard to say. The Trump Administration is determined to persist in rebalancing the international trading system more in the US’ favour. We don’t know what might be the next target for protectionism, following the attempted action on aircraft subsidies (though that failed), and the tariffs on solar panels, washing machines, steel and aluminium.

The steel case is important to producers all over the world who export to the US. If affected exporting countries prefer to maintain the moral high ground, their recourse will certainly be a challenge in the WTO, which could cover the aluminium tariffs too. But that could take a year or more to settle if the initial dispute panel findings were referred (as they certainly would be) to appeal. Meanwhile the US looks like getting away with protectionist actions, so long as its major trading partners, above all China and the EU, regard the risk of a full-on trade war as the greater and more damaging threat.