Trade at the Heart of the EU’s Economic Security

The Russian invasion of Ukraine exposed the EU’s economic vulnerabilities: excessive energy dependence on an unreliable partner and an unbalanced reliance on exports instead of domestic consumption and investments. Economic security became the number one priority and revealed two urgent needs: for greater diversification and for greater reliance on own domestic economic production. This realisation led to discussions on critical raw materials, energy sourcing and types of energy with great emphasis on the transition away from fossil fuels to renewables, but also on domestic payment systems that have given an impetus to the digital euro (Demertzis & Lipsky, 2023).

However, almost three years later, the election of Donald Trump to a second term has put trade back in the middle of discussions. In his election campaign, President Trump was not shy about his intention to use tariffs to deal with unfair competition practices coming from China or the perceived trade advantage (persistent trade surpluses) coming from the EU. But this tendency complements a trend that has already been there for some time and accelerated at the start of the pandemic in 2020, as shown in Figure 1. Since 2020, measures introduced every year that could be characterised as protectionist and are harmful have doubled, even if liberalising measures have also increased globally.

Where does that leave global trade and what is the cost particularly in the EU? The EU has no alternative but to retaliate, even if this is just a race to the bottom (Demertzis, 2018). In his recent report on how to improve EU competitiveness, Draghi (2024) appreciated the lack of a level playing field globally due to protectionist measures in both trade and industrial policy. In his recommendations, Draghi strongly advocated that the EU must pursue similar policies, albeit cautiously and while judging the merits of each case.

And indeed, no sooner had the ink in the report dried than the EU imposed countervailing duties on Chinese electric vehicles (EVs). But what is at stake here now that the threat of more tariffs is almost certain to materialise? We evaluate two things in this paper. First, the merits of countervailing duties on Chinese EVs. We argue that this measure is more perfunctory than effective. Neither the consumer nor businesses will benefit from it and indeed when asked, businesses do not favour duties as a way levelling the playing field (Panitsas, 2024). Second, we summarise the results of two recent studies by Bouet et al. (2024) and McKibbin et al. (2024) on the possible winners and losers of a global trade war. The US and China face substantial losses in GDP terms. The effects on the EU are relatively contained. The simulations show that by imposing proportionate counter-tariffs, the EU reduces the impact on its GDP. This means that it has clear economic incentives to escalate tariffs as a response.

EU countervailing duties on Chinese electric vehicles

The European Union has agreed to impose tariffs on electric vehicles imported from China in response to what it sees as unfair state subsidies. The EU is a net exporter of electric vehicles, with €40 billion worth of exports and €30 billion worth of imports. The main destination for EU electric vehicles is the UK (€9 billion worth) and second is the US (€9 billion worth). But when it comes to imports, the EU imports €16 billion worth of EVs from China and €6 billion worth of EVs from Korea. Figure 2 presents the shares of electric vehicles for the EU imports and exports.

On 4 October 2024, the European Commission (EC) proposed the imposition of countervailing duties (CVDs) of up to 35.3% on EVs from China, over and above the 10% tariff on imported cars. In the process of deciding, five member states voted against, 12 abstained and the remaining 10 voted for the duties. The EC proceeded with setting out the CVDs regulation, which entered into force on 31 October 2024. It may be a little surprising to outsiders that the EC could proceed with imposing CVDs given the lack of agreement between countries. However, this is very well within its rights under the qualified majority rules applicable in antidumping/CVD cases (EC, n. d.).

Negotiations with China may continue even after these duties are imposed. The preliminary tariffs introduced in July 2024, and the anticipation of escalating measures in October have already put a dent in Chinese EVs sold in the EU (Palazzo, 2024).

The timing

European Parliamentary elections in June 2024 led to the reappointment of Ursula von der Leyen as the EC president. In her second mandate, she will be expected to deliver on the big economic issues: economic security, competitiveness and productivity. With the two commissioned reports out now, the first edited by Enrico Letta on advancing the Single Market and the second edited by Mario Draghi on promoting the EU’s competitiveness, the EC has a very clear list of the things to do to deliver on these challenges. There is now great pressure to pursue the proposals put forward and deliver on the big issues.

Given the EC’s remit on trade policy, tariffs on Chinese EVs are a quick way to give the impression that it is acting on one of the issues put forward by the Draghi report: the need to pursue differentiated trade policy. The EU has traditionally pursued a three-prong trade policy: protect multilateralism, retaliate proportionally if attacked and pursue bilateral treaties. However, one of the diagnostics in the Draghi report is that global trade policy has become a tool to protect one’s own domestic economy, which distorts the level playing field. The EU has no alternative but to follow suit, he argues, because as its economy depends the most on trade by comparison to other jurisdictions, the EU is also distinctively vulnerable to protectionist measures adopted by others. Draghi proposed therefore that the EU also use trade policies to “level the playing field”, albeit in a cautious and case-by-case manner.

The EU’s experience with solar panels has no doubt also played an important role in accelerating action on EVs. Keen to promote the energy and green transition, many EU member states provided incentives to both consumers and businesses for installing them. This made the EU the biggest consumer of solar panels globally. With a clear cost advantage, Chinese solar panels became the most in demand, which resulted in the displacement of European firms. The same issue was relevant for solar panels that is relevant now for EVs: is this cost advantage legitimate, in other words are they better products, or is it the result of unfair subsidies? This has led to investigations, provisional countervailing duties and eventually a settlement. But to this day, EU solar panel producers still lament unfair competition from China (Abnett, 2024) and how it has shrunk the sector. The EC is surely keen to accelerate any action when it comes to electric vehicles given their economic relevance to the sector and its impact on the green transition.

What is the aim?

An important distinction in the EU’s approach compared to the US is that it does not aim to impose prohibitive tariffs on Chinese EVs. It is therefore not the intention to prevent Chinese EVs from being sold in the EU. Rather, the tariffs aim to level the playing field to the extent that it is disrupted by unfair government subsidies for Chinese EVs.

The EU will continue to engage with China to find acceptable remedies when it comes to what are considered unfair practices (Bickenback et al., 2024), but while doing that, the argument goes, imposing tariffs will limit the damage to the EU industry. An important element in the EC’s decision is to remain WTO compatible not only because of the importance that EU member states give to multilateral institutions but also to prevent a bilateral trade war. The Chinese authorities have already started a discussion at the WTO level, which is helpful because the EU aims to promote greater transparency to be able to identify which subsidies distort trade and which do not.

What is at risk?

First of all, the lack of consensus demonstrates that it is not clear who benefits from these tariffs. While a yes/no vote reveals respective member state’s view on their effect, the fact that 12 member states abstained demonstrates great uncertainty of the benefits for the whole of the EU.

Second, it is not clear that these tariffs will achieve their objective (Spinak, 2024) of raising the prices of Chinese EVs and increasing the competitiveness of the domestic industry. The Chinese EV industry faces overcapacity, which puts it in a good place to absorb this cost increase without jeopardising market share. But beyond subsidies, which the EC is right to complain about, the EV sector in China is much more advanced than that in the EU, which simply makes it more competitive. Tariffs buy time but do not solve the deficiencies that the EU’s sector face, from an underdeveloped battery supply to slower innovation and lower investments. In a recent study of European CEOs of big companies, only 9% of the sample sees tariffs as the solution to unfair practices coming from China (Panitsas, 2024).

Third, any tariffs will automatically harm the EU consumer, who must now pay a much higher price.

Last and perhaps the most imminent risk is that it adds to the list of EU-China grievances and therefore to the degree of global fragmentation. It is not unreasonable for the EU to aim to protect its economy from unfair practices. But how it does this is crucial. Antagonistic measures will only reduce China’s willingness to cooperate on other issues, like advancing with climate objectives and, crucial to the EU’s safety, having China be part of the solution to the Russian invasion of Ukraine.

While the Draghi report advocated for differentiated trade policy, it also cautioned that as 50% of the EU’s GDP relies on trade, it has a lot to lose from bad trade policies. There are recommendations in both the Letta and Draghi reports that provide undisputable benefits and therefore have wide consensus among member states. Deepening and expanding the Single Market, simplifying and reducing the regulatory burden, and managing vulnerable economic dependencies are a few examples of what the EU can benefit from.

US tariffs and the threat of trade wars

During his first term, President Trump imposed steel and aluminium tariffs on the EU. Following the principle of proportional retaliation, the EU imposed rebalancing tariffs on selective US products such as Harley Davidson motorcycles and bourbon. These tariffs are temporarily suspended until 31 March 2025 while the EU waits to see how much of Trump’s election campaign promises on tariffs will be put into place. We describe below the costs of such tariffs and proportional retaliation.

Figure 3 shows that in 2023, trade between the EU and the US amounted to about €1.5 trillion, of which €500 billion are in goods. Germany and Italy are the largest EU exporters to the US. According to the Draghi report, 50% of the EU’s GDP comes from trade. So, there is a lot at stake for the European Union if President Trump imposes tariffs because it would escalate to retaliation and might lead to a full-scale global trade war.

Understanding the costs of a global trade war and what it means for the EU

There are several attempts in the literature to understand the effects of potential tariffs, through a set of simulations in which the US imposes tariffs on goods as described by President Trump during his campaign. We report on the results of three-model simulation studies and draw some common lessons to the extent these exercises allow it.¹

The first study is by Bouet et al. (2024). Their simulations consider a universal 10% tariff on all US imports and 60% tariffs on goods imports from China. They then consider a scenario in which the world retaliates proportionally.

The two scenarios explained:

Scenario 1: The US imposes tariffs. US increases import tariffs by 10 percentage points (pp) on all goods from all partners, except Mexico and Canada, but increases tariffs by 60 pp on goods from China. Results show change in GDP compared to baseline in 2030.

Scenario 2: The world retaliates. US increases import tariffs by 10 pp on all goods from all partners, except Mexico and Canada, but increases tariffs by 60 pp on goods from China. All US trading partners retaliate by raising tariffs on US goods by the same margin (10 pp or 60 pp in the case of China). Results show change in GDP compared to baseline in 2030.

Table 1 summarises the effects on GDP in the medium-term (2030) and describes the deviations from the baseline, in other words, deviations from where the economy would have been had these tariffs not been implemented.

We summarise the results as follows:

• China suffers the biggest losses. By far, the biggest effect by year 2030 is in China; it suffers a drop of 1.1% of GDP. A full global retaliation will increase these costs by 0.2% (from -1.1% to -1.3% of GDP).
• The US also suffers significant losses (-0.7% of GDP).
• Global proportional retaliation harms the US. If there is proportional global retaliation, the GDP losses for the US almost double (from -0.7% to -1.3%).
• The effects on the EU are relatively contained. The costs to GDP changes range between -0.1% (France) and -0.3% (Germany) and -0.2% for the rest of the EU. However, what is really interesting is that by retaliating proportionally, the effects on EU GDP are reduced (to -0.1%). This implies that there will be an immediate incentive for the EU to retaliate (and indeed it will). This is not the case for China, which appears to lose out through retaliation (albeit in small numbers).

Table 2 reports the drop in exports and imports (as well as GDP). By far, it is the US that faces the biggest drop in both exports and imports, followed by China.

The immediate (in one year) impact on the US economy by just imposing 60% tariffs on China is a drop of 1.1% in GDP, an increase by 0.8% on inflation and an increase by 0.3% on unemployment (see Table 3).

The Bouet et al. (2024) study also shows that part of the reason why the costs to China are not bigger is because there is trade diversion due to the prohibitive 60% tariffs imposed. Table 4 shows that while Chinese exports to the US drop by 80.5%, exports to many other countries increase. Canada and Mexico alone see an increase in their imports from China by 19.4% and 41.1% respectively. The rest of the countries see a relatively small drop in their exports to China. Similarly, US exports to China drop by 58% but increase to Canada and Mexico by 4.0% and 16.8%, respectively. It is worth noting that there is talk of the possibility of 30% tariffs on imports from Mexico, but this is not implemented in this study. It is therefore likely that these gains in US exports to Mexico may not materialise. On top of that, Chinese exports to Mexico may increase more than shown in the table.

The second study by (McKibbin et al., 2024) also has a few simulations on the economic impact of these tariffs both for the US and globally.² They perform the 10% and 60% shocks separately (with and without retaliation). So, the results are not directly comparable to those of the Bouet et al. (2024) exercise that combine the two tariffs but offer a few interesting results. Table 5 summarises the economic impact on GDP for a few countries, for four alternative scenarios.

A few key messages that emerge from both studies. If the new Trump Administration imposes the tariffs that were discussed in the campaign, then we consider the effect following proportional retaliation globally.

• The studies presented here indicate that the US and China suffer the most by a full-blown trade war. In the first study, following US tariffs on its exports, China appears to increase its trade with other countries (including in the EU). In other words, there is trade diversification.
• China clearly suffers from a 60% tariff imposed by the US. Its GDP will drop by 1.0%, and if China retaliates, this will increase its losses further.
• The effects on the EU are contained by comparison. France even benefits slightly from these tariffs. The impact on Germany is marginally negative and tends to go away. Both studies above show that the EU has an economic incentive to retaliate, in other words, the GDP effects of these tariffs are either more positive or less negative by reacting proportionally.

Conclusions

The EU’s economic security will be at the top of the agendas of both national as well European supra-national institutions. Next to trade instruments, like counter-tariffs, anti-coercion instruments and of course reaching out to the WTO appellate body, the EU is also building other instruments (McCaffrey & Poitiers, 2024). In this arsenal, the EU will be looking to improve the screening of foreign investment within its borders but also evaluate risk from outbound investments particularly in critical technologies. It will be looking to increase coordination between member states when it comes to export controls. Additionally, economic security will require greater diversification for critical raw materials and energy and an acceleration of investments in critical technologies necessary for the green and digital transitions.

But all these will be done in the context of more aggressive trade policies, which are now put to the fore of economic policy. A second Trump administration comes with a promise of tariffs that will distort global trade. For the moment, this is just a threat, not a policy. The economic analysis tells us that from a US perspective this threat is not credible because it causes economic harm to the domestic economy. However, as Autor et al. (2024) have argued, tariffs have been a useful political instrument in that they helped gain support for the Republican party. In this case, the EU will have to consider whether and how to negotiate. The EU will continue to rely on the US for military support, and the need to completely decouple from Russia leaves room for increasing LNG imports from the US. These will all feature in an EU attempt to ensure its security and help prevent global trade wars.

• 1 IMF (2024) also has a set of simulations but they include combinations of shocks rather than one-off tariffs only..
• 2 See online tool here https://camadashboards.shinyapps.io/TrumpPolicies/#section-macroeconomic-projections.
  

References

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