Contrary to Donald Trump’s famous statement, it is an old adage of economists that trade wars cannot be won, but that they only lead to endless rounds of retaliatory measures which lead to economic losses on both sides. However, important trade partners of the USA have reacted to Donald Trump’s aggressive trade policies quiet conciliatory: the NAFTA agreement was renegotiated and Mexico made significant concessions in favour of the US car industry; EU commission president Jean-Claude Junker promised to increase imports from US liquefied natural gas and soybeans to reduce the trade surplus of the EU; and the beginning trade talks between China and the USA mainly address Chinese concessions on the protection of intellectual property rights and on the reduction of its trade surplus. President Trump may indeed win the trade war – and the success of his protectionist policies will have devastating effects for the open economic order as we know it.
Rapid trade liberalisation implies social and political costs, but these costs are almost always excelled by the economic gains of international trade. As a result, countries find themselves in what game theorist call a prisoner’s dilemma situation, where they face incentives to exploit the cooperation of their counterparts. However, the steady repetition of the game allows them to play ‘tit-for-tat’ and to reciprocally reduce their trade barriers step by step. Consequently, protectionism should only be successful in the very short run, when it exploits the one-sided trade liberalisation of other countries. In the long run, other countries should retaliate against protectionism by re-establishing trade barriers themselves, and protectionist countries would forfeit the economic gains of international trade. In the end, destructive trade wars should motivate all players to return to trade liberalisation, and the open economic order would be stabilized.
However, countries with an interest in an open economic order should not retaliate against every single trade barrier. Sometimes they need to be generous, if they want to sustain the system of international cooperation. Many trade barriers are established for reasons beyond protecting uncompetitive industries. For example, European consumers regard non-tariff trade barriers against genetically modified foods and seeds as legitimate. And the USA justifies its current trade measures by referring to its national security interests – a motivation, which is allowed for by WTO law. If other countries reacted on all such trade barriers with strong countermeasures, the liberal trading order would have collapsed a long time ago. Thus, countries always need to balance between generosity and retaliation, but it is usually uncertain at the outset, which is the right strategy to stabilise international cooperation on trade.
Retaliatory trade measures are further impeded by asymmetries between the different economies within a trade war. Generally, smaller economies are much more dependent on international trade than larger economies, because they generate less comparative cost advantages and economies of scale on their own market. But even some larger economies are highly trade dependent. Economies with strong export industries – like that of China or Germany – gain much more from trade liberalisation than the USA, which suffers from deindustrialization and an increasing trade deficit. Export economies have much more to lose, if international trade breaks down, and so they may be willing to make concessions in order not to lose access to big and important export markets like that of the USA.
When the stakes are high and the situation is uncertain, instead of risking a full- blown trade war many countries may be tempted to stabilise trade cooperation by appeasing a protectionist culprit. In respect to trade cooperation with the USA, the stakes are always high, because the US represents the biggest export market in the world. And the situation is also rather uncertain, because the somewhat erratic behaviour of the US administration is difficult to assess. How far is Donald Trump willing to go? How long can he withstand, if the US economy is suffering from retaliatory measures? Because of the size of the US market and the unpredictability of President Trump’s strategy, appeasement seems to be the easier and cheaper option. The rationale of Donald Trump’s strategy is to exploit exactly these concessions, which result from the US market size and the prevailing uncertainty among America’s trade partners.
The problem with appeasement is that it makes protectionism a winning strategy for the USA in general and Donald Trump in particular. As long as other countries do not retaliate, their generosity and cooperation can be successfully exploited. This may have two negative consequences: The chances that Donald Trump changes his strategy or that he is voted out of office in 2020 are declining, if he is able to protect the jobs of American workers with little negative repercussions for the US export industries. And if protectionism turns out to be successful, the strategy may be copied by politicians in other countries. The Brazilian president Jair Bolsonaro gives an obvious example, how elections can be won by following the role model Donald Trump. As a result, protectionism may not be a short-living phenomenon, but we may witness the beginning of a protectionist era in the international system.
Policies of appeasement only embolden the bully. The EU and China can only fight the spectre of protectionism if they retaliate forcefully against trade barriers, and make protectionism a losing strategy. Retaliatory measures and the resulting trade disputes will harm the European and Chinese economies in the short term, but they are the only way to inflict costs on the US economy and to ensure that Donald Trump does not win from protectionist measures. Only when Donald Trump’s trade policies are unsuccessful will domestic opposition and pressure rise from his electorate to change these policies. And only when protectionism is unsuccessful will it lose its appeal for populist governments of other countries. Thus, even if trade wars are harmful in the short-run, they may be the only instrument we have to fight the rise of protectionism in the long-run.