The Decisive | Season 3 Ep.15 - Trade Tensions: How the EU Could Respond to U.S. Tariffs

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Kristen Hallam  

Welcome to The Decisive podcast brought to you by S&P Global Market Intelligence. I'm your host, Kristen Hallam. In this episode, we're exploring how global trade tensions could impact the European economy and how the European Union might respond to tariffs and other measures. Joining us for this discussion are my Market Intelligence colleagues, Shuchita Shukla, Senior Economist, Europe; and Dijedon Imeri, Principal Analyst for Europe CIS Country Risk. Welcome, Shu and Dijedon. It's great to have you both on The Decisive.

Dijedon Imeri  

Thank you for having us.

Kristen Hallam  

So for our listeners at home, we're recording this episode on April 8, which is 6 days after the big announcement on tariffs last week from the U.S. government. Could you walk us through what has been announced for the EU and what that means for our growth forecast?

Shuchita Shukla  

Yes, of course. So in his announcements on April 2, U.S. President Donald Trump imposed a minimum 10% additional tariff on U.S. imports from all trade partners beginning April 5. He also announced individualized higher reciprocal tariffs that will replace the baseline 10% rate for 60 or so worst trade offenders, that is countries with which the U.S. runs the largest trade deficits, and this list includes the European Union. So from April 9, which is tomorrow for us, most U.S. imports from the EU will be subject to an additional 20% tariff. I say most because there are some products that are exempt from these reciprocal tariffs, namely, automotives and parts and steel and aluminum, which are subject to the 25% Section 232 duties instead, and copper, pharmaceuticals, semiconductors, lumber, bullions and energy and minerals that are not available in the United States. Now I appreciate that that's a lot of information to take in and a lot of dates. So here is the bottom line to remember. Under the current schedule and according to our calculations, from April 9, the effective tariff rate on total U.S. imports from the EU will be about 18.5%, up from just 1.6% in 2022. That's a big jump, and that obviously means bad things for our growth forecasts. So our baseline, which was based on a staggered 10% tariff imposition was already incorporating about 0.2 to 0.3 percentage point of drag on Eurozone and EU growth over 2025 and 2026. And the reciprocal tariffs that were announced last week are likely to shave off another 0.2 to 0.3 percentage points from that baseline as the tariff shock is much bigger and non-staggered in its application.

Kristen Hallam  

Thanks so much for walking us through that, Shu. Definitely some big numbers there. Dijedon, what does the European Commission have to say about these higher reciprocal tariffs?

Dijedon Imeri  

Thank you, Kristen. The European Commission has at least 2 things to say. Firstly, it continues to make overtures to Washington, D.C., signaling that its preference is still to negotiate some sort of deal that would avert further escalation. Yesterday, the European Commission President Ursula von der Leyen released a press statement where she offered a 0 for 0 tariff scheme to the U.S., which basically would entail the elimination of all tariffs on industrial goods, including things like cars, pharmaceutical and chemical products, machineries and so on and so forth. Now I read reports already this morning that President Donald Trump had outright rejected this. But even if we can't verify that for now, there is the important caveat that the EU and the U.S. already attempted this back when they were negotiating the transatlantic trade and investment partnership. That deal was ultimately scuppered by none other than President Donald Trump during his first term. And I haven't seen any indications that he has had a change of heart since then. So it's doubtful to say at least that this will be enough to persuade the U.S. government. If the European Commission's attempts to reach some sort of deal fail, this will force it to retaliate in some capacity. In the immediate term, it will respond in 2 stages. There are imminent countervailing duties that it is planning to introduce in mid-April in response to U.S. global tariffs on steel and aluminum, which were introduced last month. These countervailing duties are up for a vote tomorrow at the Council of European Union. And once they're ratified, they would be implemented, as I mentioned, by the middle of this month. When it comes to the other, the so-called reciprocal tariffs that cover most European exports to the U.S. and car exports as well, the commission has given itself a 4-week window to respond. Now this is probably for 3 reasons. The first and obvious reason is to buy more time to negotiate with the U.S. government. The second and related reason is to ensure that there is cohesion within the bloc because without the full weight of the European Union, this would weaken the hand of the European Commission in ongoing negotiations with the U.S. And the third, I think it is also to allow domestic political pressure to build up in the United States. We've seen market turmoil in the wake of Liberation Day. And if this continues to unfold, that could build momentum and political pressure on the Trump administration to potentially renege on some of these tariffs or at least be more open to negotiations and concessions.

Kristen Hallam  

And just to remind our listeners, this is a very fluid situation as Dijedon described. So more twists and turns to come. But before we dive into what's ahead, I'd like to look in the past a little bit because, as you mentioned, this is President Trump's second term in office and his administration did impose tariffs in his first term as well. Dijedon, could you remind us of the tariff announcements in his first term?

Dijedon Imeri  

Yes, sure. I mean this is not their first rodeo, although what's happening now is, of course, on a much grander scale. But the steel and aluminum tariffs, for example, were originally introduced back in 2018, and so were a bunch of the countervailing duties that the commission has proposed. And back then, the first Trump administration and the European Commission, which was headed by Jean-Claude Juncker, managed to avert an escalation after the commission promised to buy more American energy products, particularly LNG, and also agricultural products, mainly soybeans. Now this was a curious thing because in many ways, this wasn't something that was up to the European Commission to promise. The commission can't really dictate who buys what energy products. That's mainly done by commercial entities. And in any event, the Americans were knocking on an open door because the market trends underway at the time were already going in that direction of Europeans buying more LNG and buying more soybeans. But it allowed the 2 sides to claim a symbolic victory, which managed to not so much resolve the trade dispute at the time, but at least freeze the tariffs for several years.

Kristen Hallam  

And what were the factors that contributed to that particular outcome?

Dijedon Imeri  

There were several factors on both sides. On the EU side, the EU was in a stronger position at the time to push back in many ways. This was before COVID. Russia had not invaded Ukraine at the time. And some of the key member states and strongest economies within the block, notably Germany and France, were politically and economically much more stable at the time. At the same time, the flip side of this is, of course, and this is something we can discuss later as well, the European Commission has since then actually amassed a lot more regulatory instruments and tools, which you can bring to bear against the United States if it comes to that. So in some ways, it is more prepared. But in other ways, it was actually in a stronger negotiating position at the time back then. On the U.S. side, of course, there were several factors as well, not least the composition of the first Trump cabinet, which was more skeptical of imposing tariffs on the European Union compared to the current cabinet. There was also the fact that Trump was facing a reelection. And then towards the end of his term as well, he was overtaken by events in the form of the coronavirus pandemic, which basically paused any sort of push or moves towards introducing further tariffs. Most, if not all of these guardrails are not there anymore. So to the extent that Trump is serious about these tariffs, which he seems to be, there are far fewer obstacles in his way to push in this direction.

Kristen Hallam  

Shu, was the drag on the EU's economy less severe back then than what we're expecting now?

Shuchita Shukla  

Yes, it was indeed. And for the reasons that we've just discussed, right? So the 2018 tariffs were imposed on a much smaller portion of EU's exports to the U.S., about EUR 6.5 billion at the time compared with almost EUR 26 billion now that are impacted by the Section 232 duties on steel and aluminum. And we didn't really see the full impact of those 2018 tariffs because they were later suspended under certain import quotas in 2020. But for the steel and aluminum industry, in particular, the drag was quite notable as between 2018 and 2020, EU exports of these goods to the U.S. declined by over 50%. So there was pain back then as well, but it was just not as widespread as we are expecting it to be now.

Kristen Hallam  

Dijedon, let's come back to you. Could you tell us a bit more about the EU's decision-making process and how it's different from the way we've seen, say, Canada, Mexico and Mainland China respond to tariffs more recently?

Dijedon Imeri  

Yes. Obviously, a key difference between the European Union and the countries that you mentioned is the fact that the EU is a political and economic union comprising 27 member states and supernational institutions like the European Commission. This means that the decision-making process is more complicated on some issues like treaty change or the imposition of sanctions. You need unanimity. So you need all member states on board, which give all of them veto right. Now when it comes to this particular subject matter, the question of trade and tariffs, a lot of that falls under the responsibility of the European Commission. But ultimately, the Council of the European Union comprising the 27 different member states also needs to sign off on this. So it needs to ratify countervailing duties and countermeasures. So to take the case of the imminent countervailing duties that are a response to U.S. steel and aluminum tariffs, the vote will be held tomorrow under the so-called comitology rules. And this means that the proposal, the short list of imports from the United States that will be subject to EU duties, that list will be accepted unless there is a qualified majority of member states against that list. What does this mean? It means that at least 55% of member states representing 65% of the EU’s population need to oppose that shortlist in order for it to be blocked. Otherwise, it is approved. Of course, the short list, it's not something that the European Commission decides unilaterally. It's done in consultation with the EU member states. That's what the extraordinary meeting yesterday between EU trade ministers was all about or at least that was one of the key focal points, to iron out some of the differences on what exactly to include in that list. And that's probably also why the initial response was delayed from the 1st of April until mid-April because there were some differences. Ostensibly was to buy more time to negotiate with the Americans, but I think this was also a key reason. And it underscores how in the case of the EU, because of how it's constituted, the decision-making process opens up the possibility for more horse trading and dilution of countermeasures as well as their delay.

Kristen Hallam  

And another reminder that this is a very dynamic and fluid situation. And also a good reminder that even though we tend to think of the EU as one entity, and it is the world's third largest economy when viewed as one entity, which is one reason why we're talking about it today, it is, in fact, a union of 27 distinct nations and economies. And with that in mind, Shu, how are we tracking these different economic implications of higher tariffs for each member state?

Shuchita Shukla  

So, when we think about the transatlantic trade surplus that the Trump administration aims to correct, what it essentially means is that overall, the European Union and its industries are importing U.S. demand and exporting their manufactured output. And higher U.S. tariffs are going to diminish this demand. So central to our economic impact analysis is the question of how do we define the vulnerability of a member state or an industry to this incoming drop in U.S. demand. And the way we answer this question is by estimating how much production each industry in each member state is exporting to the U.S. We can then add up these shares across all industries to get the country's overall vulnerability, and we can add across countries for each industrial sector to get the vulnerability at the EU level. And we are able to do this by building a very granular view of the EU by leveraging our 2 incredible databases from the Global Trade Atlas Service and from the Comparative Industry Service. And to help visualize this better, we like to present our results as a vector where each column is a member state and each row is an industry. So then each cell of this vector tells you the share of total output that will be lost in the corresponding geography and the corresponding industrial sector if the U.S. stopped importing from the EU entirely. Now of course, even under higher tariffs, we do expect or at least hope for some trade to still happen between the EU and the U.S. So, this vector is not calculating what the actual export or production loss will be. But instead, it is depicting where these losses will likely concentrate and where it will hurt the most in the EU.

Kristen Hallam  

I do you love a good spreadsheet or a good dashboard. So just thinking about that visual image that you've given us there and the description of how you track this, which industries or countries are flashing the reddest in your vector at the moment?

Shuchita Shukla  

Yes. So, for the EU overall, we estimate that about USD 1.2 trillion worth of aggregate supply or industrial supply is directly attributable to serving U.S. demand. That's about 7% of EU's GDP and the most engaged industries include pharmaceuticals, machinery and equipment, electronics and electricals, automotive, chemicals and beverages. So, the tariff exemption on pharmaceutical products, for instance, is a big deal for the EU. Now our vector shows that these most engaged industries are concentrated in a few member states, for instance, France, Italy and Ireland for beverages – think wine and whiskey – Ireland for chemicals and pharmaceuticals and Germany, Italy, Austria, Slovakia and Sweden for motor vehicles. Our vector is also very good at highlighting cases where an industry may not look very exposed for the EU overall, but it is going to be a notable source of export losses in some countries, like paper and pulp in Finland, and cases where a country's entire exposure to the U.S. is basically down to just one industry like automotive for Slovakia. So when we add up these industry-level engagements for each member state, we can see that Ireland is by far the most exposed in the EU, followed by the trade-heavy Northern European member states like Germany and the Nordics and tailed by the more service-oriented Southern European member states like Spain, Portugal and Greece. The smaller Central and Eastern European member states like Czechia, Hungary, Poland and Romania are more indirectly involved in serving U.S. demand via their role in supplying inputs and intermediate production for final German exports to the U.S. So, they may not flash the reddest in our vector, but there is this indirect exposure that is quite high even in the emerging periphery of the EU.

Kristen Hallam  

Lot of information there, very interesting about pharmaceuticals. I'd love to dig into some of these industries more, but we have limited time. So maybe we'll save that for a future podcast episode. Dijedon, keeping these differences in mind, will we see a united response from the bloc? Or will we see cracks?

Dijedon Imeri  

Well, that's the million-dollar question, right? And we are seeing some signs of differences within the block on how to respond. So, you have member states like France and Germany, for example, which won nothing off the table in terms of the instruments and tools that the European Union and specifically the commission can deploy against the United States. Meanwhile, you have member states like Italy, in particular, which is, as far as I know, within the EU, I think the third largest exporter to the U.S. They have basically questioned whether the EU should retaliate at all against the U.S. tariffs. And then you have some countries that occupy a more intermediate position where they want some form of retaliation, but they're still calling for a cautious approach. And this is very much informed by the fact that you have very different growth models and varying degrees of exposure to the U.S. tariffs, as Shu just outlined. And we've seen this materialize in a very concrete example of the imminent countervailing duties that the Council of the European Union is going to vote on tomorrow, namely the question what to include in that list. And a sticking point has been whether to include a 50% tariff on American whiskey and bourbon. The Trump administration has threatened to retaliate against the EU, if that happens with a 200% tariff on European wine and champagne. And this has spooked the big wine producers within the bloc, especially Italy and France, and they have been lobbying for the removal of these items from that list. And that's, again, one of the reasons why that initial automatic reintroduction of rebalancing measures was postponed until mid-April. And that's a concrete example of how you might see depending on what type of goods we're talking about, you might have different interests and different member states advocating for different degrees of countermeasures. In this case, France, which otherwise has been quite hawkish, is, in fact, lobbying for the removal of some items because it would hurt its wine industry. So it's a very good case study of what might happen. But at the same time, these U.S. tariffs have are of such a magnitude that there is no precedent for it, and it might very well force the European member states to unite. The only time will tell.

Kristen Hallam  

Yes. I think this may be the first podcast episode that we've done where we've mentioned wine, whiskey, bourbon, all in the same podcast. So...

Shuchita Shukla  

All good things.

Kristen Hallam  

And champagne.

Kristen Hallam  

All good things, yes. Yes. And sobering to think about how those things might be restricted in the future. Pun intended. So apart from tariffs, Dijedon, what else is in the EU's arsenal of regulatory tools that they can bring to bear?

Dijedon Imeri  

Yes. As I mentioned, over the last few years, the European Commission has amassed quite a few regulatory instruments. These include the enforcement regulation, the vertical block exemption regulation, the Digital Services Act and the Digital Markets Act. These, if they're activated, they can allow the commission to impose limited but targeted measures on U.S. services and U.S. service providers. This would include things like the position of fines, taxes, localization criteria to limit market access. But the big gun to use another cliche is the anticorrosion instrument. This one was actually designed with Mainland China in mind but can just as well be deployed against the United States. And if activated, this one would give the European Commission very broad powers and would allow it a high degree of creativity to do countermeasures against the U.S., everything from tariffs and quotas, but also restrictions on trade and services and trade-related aspects of intellectual property rights. It can restrict access to foreign direct investment for U.S. firms as well as bar them from participating in public procurement. It can also target natural or legal persons. But this is, in many ways, the regulatory tool of last resort. To activate it would require a qualified majority. And it's not clear whether there is the appetite to do that just yet within the European Union, but it's certainly something that the EU can threaten U.S. digital and financial service providers with.

Kristen Hallam  

Interesting. Very interesting. And Shu, aside from the direct hit to EU exports, are there any other economic influences to keep in mind?

Shuchita Shukla  

Before I answer that, Kristen, I think it is important to highlight that the negative trade impact for the EU is not going to be limited to just declining exports to the U.S. Increasing tariff barriers are going to weaken external demand for European goods even outside the U.S. and European exports will also be more expensive around the world because of the notable appreciation of the euro following reciprocal tariff announcements last week. But coming back to your question, aside from trade, higher global uncertainty and falling equity prices are likely to dampen investment spending and a negative turn in economic sentiment could also lead to lower employment growth, which may make households more reluctant to spend. Now under our assumptions of limited EU response that we've just talked about, we think that the overcapacity created by these tariffs will largely be disinflationary for the Eurozone and will allow the European Central Bank to cut rates faster by 25 basis points each in the April and the June meeting, taking the policy rate to our estimate of the terminal 2%. We also think that the mounting growth concerns increase the likelihood that the ECB could cut below this neutral level. But over the medium term, we think that the negative export drag will at least be partially offset by additional German spending on infrastructure and defense, which will be a positive activity in both for the whole bloc.

Kristen Hallam  

All right. Well, we could, I'm sure keep talking about all of these topics. It's been a really rich discussion today, but it's time to wrap up. Any final thoughts? Shu, since you just had the floor, let's start with you.

Shuchita Shukla  

So, it perhaps is a bit obvious to say that the macroeconomic landscape right now is incredibly volatile and uncertain with both cyclical and structural implications for the European economy. There will certainly be a lot more to chew on over the coming days and weeks and months and possibly even years. So watch this space for our continued analysis of EU's economic transformation, that is in motion.

Kristen Hallam  

All right. And what about you, Dijedon? Any final thoughts?

Dijedon Imeri  

Yes. I mean, sort of on the same topic, we've talked a lot about the EU's outward reaction and EU-U.S. dynamics, but what's happening now also has ramifications for the European project itself. There is a long-standing debate about to what extent crises are a driver behind closer European integration. And it's true that the EU has shown itself to be much more resilient than a lot of experts expected in the wake of the financial and sovereign debt crisis and the COVID pandemic. But at the same time, a lot of the old problems and challenges that were identified at least 15 years ago, if not longer, remain in place, things like the Capital Markets Union, which remains incomplete, for example. And the question is whether this particular moment will be different. And I'm not going to attempt to forecast this. I will just draw the audience's attention to 2 factors which differentiate this particular moment from previous challenges. One is at the European and global level is the fact that this is not a single crisis, but rather multiple or a poly crisis. We obviously have the U.S. tariffs, but then there is also the prospect of trade diversions of cheap imports inundating the European market as exporters from other countries try to cut their losses as a result of the U.S. tariffs being imposed on them. Then there is a fact that the war between Russia and Ukraine continues to be waged at the EU doorstep. And this is completely rewriting the post-war security paradigm in Europe, especially since the reelection of Donald Trump. And then you also have the challenges of the green transition, which we mustn't forget hasn't gone away just because of these recent developments with trade and tariffs. And then the second factor is at the member state level. A lot of the key member states that have a lot of economic clout and which have traditionally been skeptical of closer European integration, things like fiscal union, for example, or closer security cooperation, they face a very different and much more difficult situation right now. A key example is Germany. Germany's entire growth model, which centers on exports is facing an existential challenge because it faces a prospective loss of key export markets. And that creates a situation where the German government might be more susceptible to ideas around closer European integration. Again, it might not happen, but certainly, the factors that might lead in that direction are present in such a way at this moment, which wasn't the case previously. And I think that is what could make this a truly historical moment.

Kristen Hallam  

All right. And on that note, thank you so much, Shu and Dijedon for taking the time to share your insights with us. That wraps up this episode of The Decisive podcast. Check out the links in the description of this episode for deeper dives into the topics we've covered. Until next time.