A pause is not a U-Turn

Trump has the trade world in a 'fork' manoeuvre, but high European consumption taxes, excessive regulation, and high energy costs have made the West uncompetitive regardless of US tariff rates.

When game fishing, you must first get the fish on the hook, but then it is important to give it some slack, every now and again, to allow it to tire itself out, before you reel it in and attempt to land it. Donald Trump did this with Canada and Mexico, and he has now done the same with the 75 countries that have requested a trade agreement. These countries have 90 days to agree to a deal.

Before coming to the negotiating table, several leaders protested that Trump's trade wars were dangerous, but they seemed to be oblivious to their own trade barriers. Some leaders proclaimed that they were strong believers in free trade, but none of them had thought to lower their trade barriers before Trump decided to raise US tariffs to similar levels. But if they believed in free trade so fervently, surely, they would have removed their own country’s trade barriers years ago without the need for US coercion.

Commentators with Trump Derangement Syndrome are claiming this pause is a Trump U-turn on tariffs. But is it? The US still has 25% tariffs on steel and aluminium, 25% tariffs on cars, and now a blanket 10% tariff on everything else from every country except China, which was always the main target of Trump’s tariffs.

Despite world leaders' and economics professors' proclamations about the benefits of free trade, there can be no free trade if China, the world's largest exporter, refuses to play by WTO rules. But landing China on to the Free Trade boat was always going to be difficult. Most countries rely on Chinese-made materials and parts for their manufacturing, and many companies have relocated their assembly plants to China. This has given China unwarranted confidence.

However, despite China's retaliation, Trump’s tariff threats have brought many of its satellite countries to the negotiating table. None of them can afford to lose access or market share to the world's apex consumer – the US. China believes it can take this risk, but I suspect it simply doesn’t purchase enough US exports for its retaliatory tariffs to have an impact. Not that the Chinese government needs to retaliate with tariffs – they could merely make it illegal for their citizens to buy US goods. However, should they do this, China will struggle to find an alternative market for its current exports to the US, valued at $450 billion in 2024.

The ‘Fork’ manoeuvre

To change metaphors, Trump is now in a winning position in a game of trade noughts and crosses, or chess if you prefer, where he has two possible winning lines, but his opponents can only block one of them. If countries agree to lower their non-tariff barriers, the US and the world will benefit, but if they refuse to reduce their trade barriers, the US will have found another large source of revenue – 10% tariffs. This revenue could be used to reduce US debt or cut US income taxes. The tariffs will have a similar effect on US consumption as a Goods and Services Tax (GST) or a Value Added Tax (VAT) does on other countries’ consumption, while also giving US firms some trade protection as they onshore their production.

The World’s Apex Consumer

The US is the world’s Apex consumer because it has very low consumption taxes as well as low tariffs. There is no federal Value Added Tax. Some States charge a sales tax, but several don’t, and even the highest state sales tax is only 7.5%.

If we believe the Pigouvian idea that governments should tax the things they want to reduce and remove taxes on the things they want to encourage, then the US has encouraged consumption of not just domestically produced goods but also imported goods, while European countries have discouraged it. The UK government, for example, adds 20% to the price of non-essential consumption and 5% to essential items such as energy.

Consequently, many people buy high-value items when they are travelling to countries with lower sales taxes or countries that allow them to reclaim their VAT when they take the goods out of the country. UK international Airports are like shopping malls, unlike airports in the US; with low tariffs and low or no sales taxes, there is less need for duty-free shops. However, if these new US tariffs on China persist, I predict that there will be an Apple Store in the Duty Free section of every international airport frequented by US tourists before the end of the month. Companies often find methods to circumvent tariffs.

European commentators and economists seem unaware that the US encourages consumption, unlike the EU, with VAT rates of up to 27%. No one complains that such an imposition will cause a global recession, yet these same commentators believe that Trump’s tariffs will. Perhaps they should reduce their own consumption taxes before calling the kettle black.

The very sad thing about the US introducing the equivalent of a 10% sales tax on non-Chinese imported goods is that many goods will still be cheaper in the US than in the UK or the EU.

This week’s equity market sell-off of US companies that produce their goods in China is justifiable as the new tariffs will make these goods less competitive in the US market. But iPhones and Air Max trainers are sold globally, and they won't become more expensive in other countries. Surely other markets would buy the excess products? But alas, no. Instead, European governments are concerned that their markets will be ‘flooded’ with ‘cheap’ products that are no longer competitive in the US.

Just think about that. European countries hate consumption so much that they are worried that goods will be cheaper in their countries. It sounds like Trump’s complaints about the EU are true. They really don’t want their populations to benefit from free trade, especially free trade in American goods.

Many European companies' share prices were also falling, reiterating that they, too, rely on exports to the US. Trump does seem to have a point. They all depend on selling to the US rather than to their domestic markets.

Regulation and energy costs are killing more industries than trade barriers.

Perversely, the UK has very high tariffs and other trade barriers on many things that it can’t produce efficiently because it has a vocal lobby group that pushes out bleeding-heart stories of individuals who will be left unemployed if the government doesn’t protect their uncompetitive employer with trade barriers. But often, competition from imports is not the primary problem.

In some cases, the UK doesn’t have adequate raw materials, or the company owners have taken dividends rather than investing in the latest plant and equipment to make the goods more efficiently. However, most often, the UK energy costs are too high for the industry to ever be efficient in the UK, even with abundant raw materials and new plant and equipment. No level of tariffs could ever make up for the cost of UK energy and other environmental regulations placed on companies by the UK government.

While the commentariat is complaining about Trump's tariffs, they seem to have overlooked the US EPA's 31 deregulations announced a few weeks ago. This will be as important for reindustrialising the US as any tariffs placed on China. Fewer regulations were one of the ways China was able to out-compete Western nations for dominance in many industries. Additional incentives will be needed if the US is to regain these industries. Several incentives are already in the pipeline, such as immediate tax deductions for new plant and equipment and borrowing costs, and a cut in corporate tax rates, as well as a review of employment laws. But at least in the US, States can compete to host on-shored manufacturing plants with more conducive wages, employment and environmental regulations and tax incentives. If the UK or the EU wants to also regain their industries from China, they will also need to reduce their energy costs, regulatory burdens and their high taxes, including their high consumption taxes.

Why do we trade?

With all the talk about tariffs and trade wars, people seem to have forgotten why countries trade. It is not about trade rules; it is about efficiency through specialisation or natural resources. Companies should be free to import goods that they can’t produce, can’t produce efficiently, can’t produce all year round, or can’t produce in large enough quantities to satisfy their demand. None of these categories of goods should ever have tariffs or non-tariff barriers on them.

The US established the GATT to help rebuild countries devastated by WWII, and it has been one of the few countries that tried to follow GATT and later WTO rules. The few high tariffs the US had before 2016 were mostly in retaliation for other countries blocking trade. The most famous example was the Johnson government’s 25% tariffs on trucks in retaliation for the EU’s non-tariff barriers preventing US broiler chicken imports in the 1960s. The consequence was that Japanese manufacturers, Honda, Toyota and Nissan, established manufacturing plants in North America, while Mercedes-Benz shipped truck parts to the US, where they were assembled to qualify as domestically manufactured goods. This changed car manufacturing forever. Now, all large car manufacturers use parts mass-produced in one factory and then shipped to other countries to be assembled. Specialisation and mass production of parts have lowered the price of most manufactured goods, not just trucks. It is also worth noting that the US truck tariffs are still in force, and truck manufacturers stayed in the US.

Very few countries are able to make everything efficiently all the time. The US was once in this position, and if Trump’s tariffs work as Johnson’s truck tariffs did, they may be again. But an alternative solution would be for everyone else to calm down and lower their own protections.