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Last week, the US announced it would levy tariffs on all steel and aluminium imports. While US imports of steel and aluminium represent a small share of global trade, around 2% of global goods trade, the move threatens to embroil the world into a retaliatory trade war. The European Union (EU) swiftly responded with its own draft of potential tariffs on US steel, clothing and other industrial goods but these tariffs target just under 1% of total EU goods imports from the US. China, arguably the most important trading economy in the world, has so far shown restraint. The early consensus is that US tariffs and the EU response, if implemented, will not be a major dent in the global economy. But any material escalation in trade barriers would, and there is a palpable fear that such an outcome is likely.

The US tariffs hardly come as a surprise. Anti-trade rhetoric has long been a key feature of President Trump’s platform and the administration has taken gradual steps in advance of this particular move. In April 2017, the US Commerce Secretary initiated a study of the steel and aluminium trade and released the results of the study last month, recommending tariffs be applied. There was also a precedent for this decision. In 2002, President George W. Bush implemented a 30% tariff on steel imports but with exemptions for some US steel importers as well as countries such as Canada and Mexico. That policy lasted only one year before it was repealed on retaliation fears. In addition, the administration is positioning itself to increase its protectionist policies. In August 2017, the government commissioned a study on China’s intellectual property practices which could also result in recommendations for future tariffs when its findings are released later this year.

All of this points to a firming resolve on the part of the US government to implement its anti-trade agenda. This creates potential downside risks for the global economy because global trade is significantly more important to both the US and the rest of the global economy than it was two decades ago. Goods’ imports accounts for around 23% of global GDP compared to 17% in the early 2000s and global trade has been one of the main drivers of global growth, exceeding global growth 15 of the past 20 years.



That being said, the current steel and aluminium measures are small in scope. They are likely to reduce US imports by around 1%, all else equal, and will have a negligible impact on global growth. But if protectionist policies are ratcheted up, a material deterioration in trade flows could have a larger impact. We estimate that a 5% decline in US import demand would directly reduce global growth by 0.2 percentage points (pps). The indirect impact through lower expected profits, depressed consumer spending and investment intentions in the rest of the world could reduce growth by an estimated 0.2-0.3 pps. In total, global growth could decline by 0.4 to 0.5 pps from a 5% drop in real US imports. It is important to note that this assumes no retaliation from other major economies. If that were to occur, these negative growth impacts would be substantially higher.

In addition to slower growth, trade barriers would push up domestic inflation through higher import prices, lower profitability would slow capital flows and governments would likely need to step in to prop up growth, increasing fiscal deficits and public debt levels. These effects could also be amplified if tariffs quickly spread to other related products. For instance, imported products made of cheaper foreign steel will be more competitive than domestically produced products. Corrective tariffs would be needed to address the imbalance and the original intent of the trade measures.

Although the impact of the current proposed tariffs is relatively small, if retaliatory measures are ramped up by the EU and China the impact on the global economy could be much more severe. In short, a global trade war would be a race to the bottom with no winners. Facing this potential outcome, the rest of the world might be wise to adopt a policy of coordinated restraint in the face of US protectionism to prevent further escalation. That would undoubtedly be challenging for policymakers but the economics would be worth it.

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