Will tariffs trigger a new era of trade wars?

Inflation seems to have slipped from the headlines. This is unsurprising because, since May, inflation in Britain has been hitting the Bank of England’s target of 2%. Yet this is largely because of a sharp reversal in goods and energy inflation. Meanwhile, services inflation and the cost of owning and maintaining property in Britain continue to rise. This suggests that we are still in a broadly inflationary period, with much of the pressure being taken off as the costs of goods and energy ease from previous highs. 

This is particularly important to understand because talk of tariffs and trade war is on everyone’s lips – and there is nothing like a trade war to raise prices for consumers. Earlier this month the EU increased tariffs on Chinese electric vehicles (EVs) from 17.4% to 37.6%, because it is concerned that Chinese EVs might outcompete domestic European models. Yet while the bureaucrats fret over a lack of competitiveness, the industry thinks that tariffs will make the situation worse by rendering European-made cars uncompetitive on the world market. Just before the tariffs were imposed, Germany’s auto association urged the EU to drop them.

Why tariff fever is doing the rounds

Tariff fever does not seem to be coming from industry leaders, but rather from “securocrats”: those concerned with issues of national security. Just after the recent Nato summit, Germany announced that it was imposing a ban on the use of critical components made by Chinese companies Huawei and ZTE in the country’s 5G infrastructure. Britain imposed a similar ban in 2020. BT says the ban has cost the company £500 million; Britain now does not make it into the top 15 countries in terms of 5G availability. 

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Germany’s pivot to prioritising security over economy signals that all manner of trade warfare may be becoming mainstream. Only a few months ago, in April, chancellor Olaf Scholz visited China stating that he wanted to maintain good trade relations. By midsummer, there were massive tariff increases in place on Chinese EVs and Chinese companies were denied access to German 5G infrastructure. It seems that even countries whose leadership is trying to shift toward more open economic relations are failing to deliver. 

Ground zero for tariff fever seems to be Washington DC. Since the election of Donald Trump in 2016, talk of protectionism and trade war has moved from the fringe to the mainstream. Many of the think tanks that would typically have pushed US policymakers towards free trade have reluctantly accepted that some degree of trade war is all but inevitable. A new mantra has arisen: free markets at home and protectionism abroad. 

Whether these developments are good or bad for America, it is by no means clear that they are a good fit for Europe. The World Bank’s data shows that in 2023 trade comprised 27% of American GDP. Compare this with the UK, where it makes up 66%, or the EU, where it is worth 97% of GDP. For all its talk of free trade, the US is quite a closed economy. This is obvious if you visit the country and notice how many of the goods – from cars to electronic products – are produced domestically. In contrast to, say, German cars and electronic products, you will typically not see these US goods being sold elsewhere in the world. All this highlights that the US is already quite a protectionist economy, and although these policies have protected American jobs, they have also rendered much of American industry uncompetitive on the world stage. 

The US has the advantage here of a huge domestic market – and one that has never really been exposed to the strong competitive winds associated with open trade. The idea that Europe, much less Britain, can copy the US in this regard seems fanciful. Despite these obvious facts, European leaders seem to be willing to go along with these transplanted American plans because they have no alternative on the table. Note that since the Russian invasion of Ukraine in 2022, the securocrats have been getting more seats at the policymaking table relative to the economists and business leaders.

Britain's stand on imposing tariffs

In a rather surprising move, the newly elected Labour government has signalled that it is not interested in imposing tariffs on Chinese EVs. The Labour government seems more willing to listen to business leaders than its European counterparts. This departure by the United Kingdom from European-wide policy is notable for several different reasons. 

First, the new Labour government is generally seen as being far more pro-EU than the outgoing Tories and so many expected it to follow the party line in the EU. Second, Labour has historically favoured domestic jobs over international competitiveness, and so it might have been expected to jump on the European tariff bandwagon with glee. Third, as we have already seen, it was Britain that pioneered the ban on Chinese 5G components in Europe. Getting out ahead of the rest of Europe on 5G infrastructure highlighted how Britain is far more tightly aligned with the national security apparatus in the US. But this time the Europeans seem more inclined to follow the Americans than the British. 

What does this divergent move by Labour signal? It is hard to tell. In April, then-shadow foreign secretary David Lammy published an essay in the journal Foreign Affairs entitled The Case for Progressive Realism. In it, Lammy made the case that Britain was a much less important player on the world stage than when Tony Blair took office in 1997. With the rise of China and India, the world had become “messy and multipolar”, Lammy argued, and this had “ended the era of US hegemony”. The now-foreign secretary argues that Britain must “adopt a strategy that simultaneously challenges, competes against, and cooperates with China as appropriate” and that the country must “recognise China’s importance to the British economy”. 

Perhaps what we are seeing with this British divergence from the EU on the question of tariffs is Labour and Lammy’s new strategy in action. In the immediate future it means that Britons will have access to cheap Chinese EVs and these cheap EVs will continue to hold down the headline consumer price index (CPI), even as the upward drift in the general cost of living continues apace. Whether a new strategic approach to Chinese cooperation can counterbalance some of Labour’s more inflationary policies (most notably, the public-sector pay increases it floated recently) remains to be seen. But the approach is certainly novel.

What will a Trump presidency mean for the UK?

Whether Britain’s strategy can weather changes on the international political stage, on the other hand, is a different question. Now that president Joe Biden has declared that he will be stepping aside in the race, it is left to vice president Kamala Harris to try to hold the White House for the Democrats. This does not look like an easy prospect for Harris. Observers of the American political scene largely agree that all the energy is behind Trump, especially since the attempt on his life. 

Trump has committed to radically different foreign policies and economic policies. On the foreign policy front, Trump has portrayed himself as a dealmaker. This would seem to imply that a Trump presidency might lower the temperature and calm things down on the global stage. While this may be true, we must also factor in Trump’s economic policies. The former president wants to marry his mission of global peace with a radical policy of economic protection. “I’m a tariff man,” he boldly tells journalists and supporters. 

So far Trump and his team have been light on details, but the general plan appears to be to lower taxes for Americans and raise tariffs. There is absolutely no doubt that this is an inflationary policy. Lowering the rate of tax for workers and consumers puts more money in people’s pockets. More money means more spending – and more spending, unless it is met by an increase in the supply of goods, means higher prices. 

Yet it is hard to see where an increased supply of goods might come from. If a Trump administration raises tariffs at the same time as lowering domestic taxes, then the supply of goods at affordable prices will shrink as there will be less capacity to pull in imports at reasonable prices. Perhaps the Trump team is gambling that this policy will force US firms to step into the breach and provide US consumers, now flush with money they would otherwise have paid in taxes, with access to domestically produced goods. 

This will take time, however. Some goods can be substituted with similar products, and if there is sufficient demand, US industry will be able to provide them. But some goods cannot easily be substituted, and will require very large amounts of fixed-capital investment to get the industry needed up and running. While a high-demand, high-tariff policy might benefit the US economy in the long run, it will almost certainly cause inflation in the short term. Add to this the fact that the Trump team has signalled that it wants to devalue the dollar and you have a recipe for high inflation moving forward. 

What does this mean for Britain? First and foremost, US tariffs will not affect British prices much unless they are copied. If the new government maintains its current course and refuses to copy US trade policy, there is no real channel for US tariffs to affect British prices. But if the US starts to see Trump’s tariffs as a component of Western foreign policy aimed at hobbling China, then it may apply pressure on Britain to follow suit. It is hard to imagine Starmer’s government spoiling its security relationship with the US to maintain an independent trade policy. 

The question of the dollar is more vexing, however. If the Trump policies led to higher inflation, this would mean that US interest rates would rise. If the Bank of England refused to match these interest rates, sterling would fall, generating inflationary pressure in Britain. If the Bank did replicate the higher interest rates, however, they would drastically slow the UK economy – potentially generating a recession. The upshot is that Britain might not even have to catch tariff fever for its economy to experience the turmoil of a second Trump presidency. The fact that the sterling-dollar rate and British-American national security are joined at the hip may be enough to guarantee the country a wild ride.

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