Re: Strategy Proposals to react to #TariffEscalation - To: Open Market Governments

How should governments react on the recent US tariff announcements? Retaliate with similar tariffs - like China? Propose negotiations to drill some small holes in the tariff wall - many governments have announced this, and the president is ready to negotiate "if countries offer something phenomenal". Tit-for-tat, like for dental floss, chewing gum and motorcycles? Start a broader consultation - like the EU with their strategic talks to different sectors? Wait, because the US government might just reverse their decision? Or just better prepare for a world with more insecurity?

Government Advisors are usually useless, because smart people do not need them while others do not listen. But there is an exception: A sudden crisis. As the US government only finalized its strategy in the last few hours before "liberation day", no other government had a ready response, all just knew they had to do something. This is the time to turn to advisors and ask for a detailed suggestion, due in the few hours preceding the evening news. Suggestions are difficult, because the situation may have changed before the written suggestions are finalized. Still, here is a proposal.

Basics first:

No one likes theory, but you should be knowledgeable about economic basics. Let us start with Adam Smith and his invisible hand. He describes in his "Wealth of Nations" "that governments do not normally need to force international traders to invest in their own home country." Later, Paul Samuelson, popularized the use of the term “invisible hand” to "refer to a more general and abstract conclusion that truly free markets are self-regulating systems that always tend to create economically optimal outcomes, which in turn cannot be improved upon by government intervention". In other words, the market always wins. If you do not believe, take a look at prohibition when the US banned alcohol during 1920 - 1933. Far from converting citizens to teetotalers, it created a secondary, illegal, market for alcoholic beverages to the benefit of the Mafia. The same was true before 1989 in Comecon countries when not everyone could get consumer goods according neither to their needs nor to their regular salary, as opposed to those with access to foreign convertible cash who could afford everything at the detriment of the 'regular' economy.

The second person to remember is David Ricardo who came up with the theory of "comparative advantage". In modern times, he would have argued that it does not make sense for the US to make sneakers that can be imported when this limits the chances to sell medical electronics to Vietnam.

The third person worth mentioning is George C. Marshall. He got the peace Nobel prize not for his military successes, but for his ideas that started the "Marshall plan" and the conviction that "the division of labor is the basis of modern civilization", and that if the US wants to sell something abroad, it needs to give the buyer a chance to earn his money, by buying from him as well. And that, without this, "there can be no political stability and no assured peace".

The last thought, that trade will ensure peace, has been challenged in the last years, specifically with the war of Russia against Ukraine. It should be added that Russia is able to wage this war because it can trade with other partners like China or Iran.

To this set of three theories that have been validated for quite some time, should be added the knowledge of the base accounting scheme for a country. There is trade, services and financial flows and the

• Trade balance: import and export of goods; raw materials and energy make important factors

• Service balance: services bought and sold, this includes tourism

• Financial transfers: remittances from citizens from or to their families abroad, foreign investment in- and outflows, credit in-and outflows, international assistance

Only these three together mold the balance of payments. Which may or may not go against a reserve if a country has piled up some cash, like Russia or Norway from former oil sales. If a country has a negative balance of payments, it has a problem - like Venezuela or Argentina. Balancing the (Trade + Service) volume is sound economic policy, all while watching the financial balance as well. But watching the trade balance alone is nonsense. This is easier to understand for tourist destinations like the Seychelles that will never intend to produce their own buses, but a little bit more difficult for industrial nations with a mercantilist past where the service import was mostly represented by slaves who got traded against some glass pearls.

The last hypothesis here is not standard knowledge, yet based on reasonable grounds: Economic growth does not correlate with democracy. We currently have countries with impressive economic growth like China, but no democracy so to speak. We have democratic countries which levy a huge toll on their economy for defense reasons like Israel. But we can link economic growth to values like stability or rule of law. Even the most autocratic leaders tried to establish a secure system to ensure the safe back and forth transit of merchandise and its counter value. In a way, it can be argued that countries like Yugoslavia were better at achieving economic growth through rule of law than many of their successor countries with more corrupt judges and public purchasing organizations.

Second: the current situation

Before jumping to conclusions, like simply copying the recipes from 1947, countries need to consider some current issues like

• Digitalisation:

Value may be created outside the country borders, e.g. when tourists booking via Airbnb send 1/3 of the revenue off shore and outside the country taxation. Add the advertising revenue by Facebook & Co. or the trade profits of online dealers like Amazon. Add licensing, e.g. for the right to use the name Starbucks, that adds tax revenues in tax havens at the detriment of the countries that produce or serve the coffee.

Any economic policy needs to integrate these effects. The fact that most of the big digital companies are based in the US makes the required policy more complex, with a higher need for innovation and risk-taking. The US has already acknowledged this, as demonstrates the line-up of the big digital players behind the current president.

• Structural balance of payment issues.

A Lack of strategic input factors like raw materials or energy, or raw earths for industrial countries, create a need for compensation revenues. While each country is responsible for its own balance and will thus have to find an individual solution, large imbalances are not sustainable. In economic limbo, Terms of Trade, the amount you pay for imported goods in relation to the price of your export goods, do play a role. But even if we assume fair terms because of international competition, a country cannot just let go of a (trade + service) deficit for a long time.

Yugoslavia made this experience after 1989 when no one was ready to lend money on favorable terms for global strategic reasons; the breakup was one of the consequences as the relatively richer Slovenes and Croats did not want to continue to pay for their poorer fellow states. The Euro zone mastered the Greek crisis in 2009+ but clearly showed that there are limits if there is no economic incentive for those lending funds.

As Europe has much less energy available compared to the US - selling their LNG and maybe oil is high on the wish list of the current US government - the energy strategy needs to be integrated, especially if Russia or the Middle East are not good political alternatives.

Another factor is that the US has a very export-oriented agriculture while Europe tries to keep some autarky, another area of conflict yet also opportunity: last time, a deal "soy beans against champagne" could be struck even though the then and current president prefers McDonald's food & drinks.

Any US government should realize that in case of a balance of payments (trade + services) deficit, the shortfall has to be covered by foreign money, either through investments or by obtaining loans.

And this is true not only to finance the federal deficit. Also consider that the US borrows money from other countries for their industry and private households. As Ursula von der Leyen recalled at the World Economic Forum, "European household savings reach almost € 1.4 trillion, compared to just over € 800 billion in the United States. € 300 billion of them are invested abroad every year." Without the savings and trust of Europe, but also Japan and China, the US could not lead the economic policy that it currently does. The tariff increase is supposed to solve this, assuming that it works. In other words, assuming that the US treasury gets more money from import tariffs than it loses from reduced purchasing power and linked economic effects through the induced price increase.

US policy background and options

The US tariff policy does not come down from heaven, and is not an AI suggestion generated last week. And the US has some more options that the president may implement.

• Increasing tariffs has been a long-term goal - for some

Analysts hint that tariffs are the one constant policy of the current president, a policy opinion rendered public in 1987 when he was running ads in the largest newspapers (The Atlantic). Changes or deals are possible on other issues but this is a tough one. Not sure for his potential successor, though, if the policy shows no results by the 2026 mid-term elections.

• Possible US$ devaluation

A devaluation of the US$ may help US exports but will make imports more costly. Money lenders will lose interest in the US$ while loans become more costly for the US treasury. This will raise interest rates, which is bad for the US economy. Again, the tariff increase will have to bring in lots of money to compensate these effects. Devaluating the US$ on purpose - as thought by some - is a possibility but with risks, a catch-22.

• US Tariff vs. tax trade-off

Can the US compensate the price effect of tariffs by lowering taxes on companies and citizens? The current president is confident and points out a situation when 120 years ago not only the US, but also countries like Germany were financed by tariffs, not income taxes. This question is not easy to answer: Some countries still finance their governments that way, like Russia, the Gulf countries or some tax havens like Panama. Russia and the Golf countries perceive their income from energy exports, related royalties and export tariffs, not by import tariffs. Micro-countries like Andorra do not really serve as good examples for larger states. What can be said: if there is a large import volume as compared to the citizen base, it may work - e.g. for a Caribbean island. But if the majority of the GDP is created by the internal market, like in the EU, taxing only imports will not suffice. It could work for Alaska if very few inhabitants benefit from royalties on energy exports, become rich from attracting Silicon Valley businesses so that they can afford the tariffs on their imports. With a larger population and a rising state share, be it for education, health or social transfers, this does not seem an option.

Now, the current US tendency is to increase tariff revenue and reduce taxes and the share of the state in the GDP. How far this can go remains to be assessed. As a consequence, if tariffs rise, the US market for international exporters will become smaller.

• US share in international trade

The shrinking importance of the US in international trade is not only a prediction. According to the Economist, it is already a fact: from 20 % in 2000 it shrank to under 15 % in 2023. EU + "open market allies" like Canada, Australia and others have 1/3rd of the global trade, more than double the US. If this trend continues, the US will become - on a global level - "economically irrelevant". Like today's Russia after they started the war.

These are strong words, and of course apply differently whether you sell sport utilities or snails. But it gives a clear view on the options: focus on growth sectors, and reduce your engagement in shrinking sectors.

• Negotiation tactics

Keep in mind that long before even considering presidency, the current holder of this office wrote a book that became a no. 1 national bestseller entitled “The Art of the Deal”. The front page announces “He makes one believe in the American Dream Again”. The back page cites him as “the personification of hustle”. Many of his moves could just be part of a deal strategy, like making an announcement that crashes the stock market, buying cheap, withdrawing the announcement and benefiting from the stock market gains.

Governments can take advice from him directly, click to see the "Elements of the Deal".

These tactics are not common knowledge, yet not new. Adolf Hitler and Vladimir Putin with his sidekick Sergey Lavrov act just alike. People with less speculative minds know how to integrate a more long-term view. Would you use 1/3rd of your salary to rent an apartment in a Trump Tower if you do not know whether the rent doubles next week? You may see it differently if you get a three night bargain at hotel Trump, but not if you are trying to house your family for the next five years. So the “good news” of the reduction of a 33 % tariff down to 10 % should not let you forget that the next “Foreign Pollution Free Act” with a 37 to 100 % additional tax is already in the Congress.

• Acting individuals on the US side

A short look at the bio of four key players in the current administration besides the “PotUS” can also be helpful (click for a short bio and opinions of four key players):

Recommendations to any government

Negotiation

The first reaction of many governments is their hope to negotiate a better deal than the current tariffs. Many may be misled into believing all they need is a better deal than their competitors. The UK is reported to have such thoughts, as in fact expected since after Brexit. Even small countries like North Macedonia adopt this strategy, based on the fact that they import mainly defense equipment and sell a small number of items. Several US advisors are indeed open to such deals, Elon Musk on top of the list.

Negotiation will also occur, from the national importers’ side - especially those with good relations to the current government - as well as from the foreign side. Everyone will exert their influence on the negotiations.

There are some "buts" to this strategy.

The first, is that the US has raised a 10 % tariff even on countries where the US has a trade surplus; that the US has raised even higher tariffs on countries where the (trade + services) balance is zero or the US has a surplus; and that the US has raised tariffs on nearly all countries except Russia, including an only-penguin-inhabited island. Obviously, there are other intentions behind the tariffs than to punish 'enemies'. Israel got hit with 17 %, Ethiopia with 10 % - not really the same picture as for the political cooperation. Remember, tariffs are part of the current strategy since at least 1987, have some historic examples in the 1930s, and their goal is to move manufacturing to the US.

Second, whoever comes will have to wait in line. Large countries, powerful friends or large contributors to election campaigns will have more chances than poorer or less ruffian countries. In the words of the current president, the reduction of the reciprocal tariffs is possible for countries if they make a “phenomenal” offer. Phenomenal? like maybe forcing the sale of Tik-Tok to American investors. But not every country has such assets on hand. And once this offer has been realized, e.g. the company sold, what will stop the US from asking for more to improve the negotiated status? The last deal with the EU, agreed in 2018, is now gone, as is the US-Mexico-Canada agreement negotiated by the current president that started in 2020.

Third, let us imagine a country gets a deal, which will certainly include better US market access. The US complains about non-tariff barriers more than about tariffs - countries like Switzerland and Israel have recently abolished tariffs completely for US products and still received higher tariff rates as the EU. Non-tariff barriers are mostly norms, from metric vs. imperial measurements to health standards like for food colors that make US Skittles illegal in Europe as Kinder eggs in the US.

In February, the president wrote “we're not going to be the 'Stupid Country' any longer. MAKE YOUR PRODUCT IN THE USA AND THERE ARE NO TARIFFS! .. THIS WILL BE THE GOLDEN AGE OF AMERICA! WILL THERE BE SOME PAIN? YES, MAYBE (AND MAYBE NOT!). BUT WE WILL MAKE AMERICA GREAT AGAIN, AND IT WILL ALL BE WORTH THE PRICE THAT MUST BE PAID.” (Capitals as in the original). And here it gets complicated. A country / the EU may offer to lower a standard, e.g. allowing some banned food colors for sweets – Americans survived after all… But no country can force its industry to invest in the US. And why should they negotiate then? No country has any advantage in its industry moving overseas.

Other non-tariff barriers are even harder to come by. Let us take vehicles. The US produces quite a lot of vehicles for Europe: take Jeep, BMW and Mercedes that manufacture their SUVs in the US. It makes sense because those vehicles fit both markets, a Jeep Wrangler is a world product. US-company Ford sells, but also produces most of their vehicles in Europe: Because no one in the US would buy a Ford Kuga or Puma, and Europeans are not so fond of the F-150, namely the relevant best-sellers in the relevant markets.

Fourth, abolishing tariffs for US products contradicts WTO agreements and "most favored nation"-status: a benefit given to one WTO member should be given to all other WTO members (exceptions are possible for developing countries, free trade areas and custom unions).

With the differentiated tariffs by country, the US abandons this principle. It has blocked WTO already since 2019 and now stopped funding, and was never a big fan of the organization anyway.

But if some countries allow market access to US products that other countries do not, those countries may retaliate if this becomes a significant loop hole for US products.

Anyway, this is not a strategy for single EU countries because trade issues are EU affairs. But this consequently means that there also are limits for EEA, CEFTA or other countries that have EU agreements if they want to keep their access. Think about Northern Ireland which has an open border with EU member Ireland, 20 % US tariff, but is part of UK, 10 % US tariff. Have fun determining which rate to apply to Viagra, with Non-EU raw materials, pilled and licensed in Ireland and maybe packed and shipped from Northern Ireland. And the same will be true the other way around, if products can reach the UK that can travel to Ireland, and farther if profitable.

• Negotiation strategy

Different countries have different strategies regarding negotiations. China has acted without negotiation, added tariffs themselves and sold US treasure bonds in higher amounts. The US has reacted with increasing the tariffs even further. Some argue that there will be no deal between China and the US at all.

The UK and Japan have been first in line, the US president admitted that the line is so long that they have difficulties handling so many talks at once. Others, like the EU, have started with consultations, e.g. with their own industries, before coming up with offers that may not be acceptable to voters, like to allow the chlorine cleaning of food.

Governments may be well advised to wait a little bit and use the time to consult with stakeholders before negotiating. The EU is doing this, having strategic talks to industries before facing the US again. Their trade envoy Maroš Šefčovič just found out that talking to US Secretary of Commerce Howard Lutnick or US Trade representative Jamieson Greer was not helpful to avoid any tariff escalation since the one pushing the president for higher tariffs is the presidential advisor for trade and manufacturing Peter Navarro whom he did not meet while in Washington.

In a few weeks, the US administration may feel the first effects, e.g. of increasing the tariffs of Chinese-built iPhones to 124 %. Unless some make concessions and get a deal. Once this possibility demonstrated, others would have no choice but to in turn possibly offer, e.g. accepting US food or US car safety standards or reducing tariffs for US industrial goods to zero.

Focus on other markets

With the shrinking share of the US in world trade, focus on other regions became a strategy even before the last tariff announcements. A strategy that some countries are already implementing, e.g. Austria. In the end, it does not matter who drinks your wine as long as you earn money with it.

New opportunities loom. Africa is a growing market, and a growing middle class in countries like Kenya or Angola are potential buyers, from luxury goods to trucks. Latin America has strong cultural ties to Europe which facilitates trade. And the Asian "lions" are always in for good business. New agreements like Mercosur may offer opportunities. Canada could join the EEA. An agreement similar to the CPTPP Comprehensive and Progressive Agreement for Trans-Pacific Partnership could be concluded to give more access to the Pacific region, currently available to the UK only as the sole European member.

• Strong international Commerce organizations

Switching the trade (and service) export focus requires a strong international commerce organization, strong chambers of commerce, good collaboration between different industries (e.g. food export and incoming tourism have strong synergies) and a professional management. This comes neither easy nor free of charge. A fact that the UK discovered after Brexit and had to spend a lot of money just to explain trade barriers that did not exist before to small businesses.

Practical hint:

It does not make a lot of sense for 27 European countries to establish 14 different trade missions in a small country like North Macedonia. Having three different regional promotion agencies like Belgium or different pillars for companies (AHK), information (GTAI), commercial policy (embassy) and more (IPD, ..) like Germany neither. Not to forget tourism promotion. A common European commercial office with backup links in all member states would be a better solution.  The Austrian way to combine most of the functions in one organization seems to be a better base for success. Other possibilities are CEBAC, an association of all associations, or the AEB Association of European businesses in Russia.

Increasing trade with other regions can also be done by establishing common standards. The US just experiences an egg crisis, and this is largely due to different egg standards between the US and potential alternative suppliers who cannot just jump in in short-term.

Strengthening of the home market

Here is a line of reasoning for the tariff increase that deserves some thought. It is buried deep in the Executive order in para 11:

"Moreover, non-tariff barriers include the domestic economic policies and practices of our trading partners, including currency practices and value-added taxes, and their associated market distortions, that suppress domestic consumption and boost exports to the United States.  This lack of reciprocity is apparent in the fact that the share of consumption to Gross Domestic Product (GDP) in the United States is about 68 percent, but it is much lower in others like Ireland (27 percent), Singapore (31 percent), China (39 percent), South Korea (49 percent), and Germany (50 percent)."

In essence, the US is saying

Your policies do take away to much money from the consumers, so we cannot sell enough to them.

And there is some truth to that. Just compare the US growth rates since the financial crisis to the growth rates of the EU. The chart shows the development per capita and adjusted for purchasing power.

It shows that a US inhabitant becomes much richer compared to all others, while the growth in China or India has not really benefited the citizens on a per head basis.

There has been a lot of discussion about the impact of VAT. While every knowledgeable person agrees that VAT is not discriminatory to imports: a 30 000 € car carries the same VAT whether it is imported or locally produced, just like it carries the same GST sales tax in the US. But the rates and therefore the total amounts are different. A Dodge Hornet costs 30 854 € in the US, the essentially identical Alfa Romeo Tonale amounts to 34 959 € in France. Because the 6 % sales tax in Michigan takes 1 750 € out of your pocket, the 20 % VAT 5 821 €. In other words, a French citizen can only afford a Peugeot 308 where a lower-taxed American gets an Alfa Romeo/Dodge.

The lower growth and consumption are a likely consequence of a higher stake of the state in the GDP, increasing labor cost and taking away purchasing power through taxes. It makes sense to increase efficiency through digitization and cutting red tape. A target that the EU has already set for their commissioners, e.g. to reduce reporting obligations by 25 %, and 35 % for SMEs.

The S3 Smart Specialization Strategy gives recommendations on how to achieve higher economic growth, and the EU has made S3 mandatory for all European regions. Government administrations, academia and companies are supposed to work together to focus on the economic development, regulations and research in promising sectors only.

Education comes as another focal point. Again, the European system leaves graduates with much less debt (and supposedly more fair chances) than the US system. But it turns out that the US system delivers better results, from Nobel prizes to salaries. Smart Specialization may step in. The “number of anthroposophy graduates that the Czech Republic needs” (to cite the Czech president) is much lower than the number of English-speaking accounting graduates, some 'economic steering' and interlocking with the job market, e.g. via mandatory traineeships, can thus help.

Its strong defense sector benefits the US both in its political weight and technological spinoff. Israel shows a similar result. Remember that the Internet was developed as a defense initiative. Investments in this sector will pay off, if done in a smart way - again Smart Specialization may show a good process of how to achieve results in the triangle between military, academia and businesses.

One of the reasons for the strong US economy is demography. The US attracts the brightest minds from the entire world while aging is the major tone in most of the European demography songs. Creating an attractive environment for families to raise children and immigrants to come will help the economy, as do policies that help older citizens to keep some activity in the economy. Abolishing the mandatory retirement age did help, not harm, e.g. the Canadian economy.

Other sectors promising growth are the rising housing prices. Encouraging citizens to settle in less densely populated areas with lower prices, using the advantages of digitalization, can increase wealth by decreasing costs and speculation profits. There is no reason to let people stack in social housing towers around Paris or Berlin when convenient space is available within a 90 min drive.

This goes together with investments in infrastructure. Our Third Millenary requires appropriate infrastructures. A high-speed rail makes sense between Paris and Brussels, but not necessarily between Annecy and Val d'Isère. An optimized economic model between clean-fuel planes, clean rail, clean buses and clean cars - all of them semi- or fully autonomous - plus skates, bikes and pedestrian options needs to be found.

Health costs become an issue, even though Europe here has an advantage: the US spends 16,6 % of its GDP for health while Europe does not spend more than 12,7 % in Germany, with large countries like Italy spending 9 %, and other countries like Poland only 6,7 %. New approaches like in Denmark focus on not exceeding 10 %, spending half of it on prevention. In this context, elderly and juvenile care can also benefit from attention. Is it really necessary to develop in every elderly home or hospital a different care strategy or can AI help? Everyone complains about the lack of staff while they explain that they spend half their time on paperwork. In our time of digitalization, "time on person" target should be 90 % and logging the potty results of grandma and grandson alike should be left to technology that is just as able, possibly better and certainly faster, to do the job.

Likewise, relevant to health is the pharma sector. Europe depends very much on India and others for base materials. On the other hand, many countries in Africa and else depend on European pharma products. A sector that needs international attention, just to avoid that billions go into research for Viagra and nothing into research for Alzheimer - you may forget what the blue pill was for…

That energy and climate preservation need attention is no news, at least not outside the US. The energy cost advantage of the US has already driven many companies west across the big pond (e.g. for Ammonia production, Europe now imports the finished product). A competitive European industry needs to have a competitive energy supply, or be again at the mercy: of the Middle East as in 1973, of Russia as in 2022 or of someone else, like China for photovoltaic panels and wind turbines.

Conclusion

To sum up, negotiation, alternative markets via strong commerce organizations and strengthening the home market are the three options. While the first two can deliver short term results, the third one seems to be the most sustainable and promising in the long run. Our governments need to focus on what the US government is claiming to be doing: Make the citizens rich again. We may not like the way things are done on the other side of the Atlantic, but we should not turn a blind eye to what the voters wanted there - and may one day claim elsewhere. Such claims in the 1920s in Italy and 1930s in Germany have set up regimes that nearly destroyed the world.

We still have time to suggest a democratic, fair and rule-based way, but we should not ignore the target.

Other Sources:

• Richard Baldwin, Trump Tariffs and the World Trade System

• Simon Evenett, Marc-Andreas Muendler: Evidence from Tariff Laffer Curves – Tariffs cannot fund the government

• Simon Evenett: Briefing on US Tariff Pause

• Tommaso Giardini, Svenja Bosard: Geopolitical Tensions in Digital Policy

• Shuting Pomerleau, The New US Carbon Tariff Proposal: A Brief Overview