A tariff-fying start

Over the last few days, President Trump has turned his campaign promises into reality, announcing major tariff hikes. But if the spotlight shifts to the UK, we should be cautious about retaliating.

A tariff-fying start 

On 1 February, Trump announced steep new tariffs on the US’s three biggest trade partners: 25 per cent on Canada and Mexico, and a further 10 per cent on China. These three countries are the top exporters to the US. All three run trade surpluses with the US, but the similarities between the countries end there: Canada and Mexico are deeply integrated with the US, sending 68 per cent and 74 per cent of their goods exports to the US, with a North American free trade agreement in place since the 1990s. In contrast, only 12 per cent of China’s goods exports go to the US.

With tariffs on Mexico and Canada delayed by a month (after an arsenal of retaliatory measures were announced by Canada), tariff-increases on China going ahead, and Trump now eyeing the EU, this is likely just the opening salvo. But the fallout is expected to be negative for all those involved. The impacts of the 2018 US-China trade war had concentrated but ultimately small effects, but the new measures are potentially much broader and will hit hardest those countries which are more integrated with the US. 

The importance of imports

Trump’s fixation on reducing imports is misguided. Trade’s success is often measured by exports, but imports deserve more credit when it comes to improving living standards. When Britain exports goods and services – whether whisky or legal expertise – we earn the means to afford imports in return. The point of exports is to pay for imports. 

Imports bring cheaper goods and greater variety. Since 2002, prices for UK goods with high import intensity have risen by less than those with low import intensity, while also offering consumers greater choice. 

And imports are important for industries that are embedded in international supply chains. In the UK, two-thirds of all the goods we use – whether as inputs into domestic industry or consumed by government or households – are foreign-made. Businesses using intermediate inputs – shipped back and forth over a border – rely on low tariffs to enable them to source the best inputs. 

How should the UK respond?

Since the UK now has full control over its trade policy (exciting!), it can decide unilaterally how to respond to the new tariffs. So what should the Government do? 

Once you set aside justifications like protecting infant or vital industries, putting tariffs on imports can make sense for two broad reasons. First, by discouraging imports, tariffs can push down on their pre-tariff price (i.e. force those exporting to the UK to charge less for them). But this only works for big countries (like the US) importing differentiated products over which they have some market power. The UK is too small, and the biggest of its imports from the US (oil and gas) too commoditised, for this channel to work for us. Tariffs would just drive-up costs for UK consumers and industry, albeit raising a bit of revenue for the Treasury in the process. 

The second reason is that, by retaliating, you signal that you are not to be messed with and, relatedly, have something (tariff cuts) to offer in a future negotiation. Of course, it’s an open question how effective this will be with the current administration. Mexico and Canada both threatened retaliation and saw their tariffs delayed by a month – but whether correlation = causation is yet to be seen. 

So, if President Trump’s crosshairs alight on the UK, we should be cautious about retaliating. For the sake of UK consumers, it may be best to kill the yanks with kindness, roll out the Royal Family if need be, or at least to turn the other cheek. 

Fog in channel; continent cut off

Although Britain is in the driving seat, there will be considerable pressure for the UK to track what is happening to trade policy in the continent next door. As a medium-sized country dependent on a nearby giant market for trading goods, there are limits to the scope for the UK to act independently. 

But the bigger risk for Britain is that an escalating series of tariffs and retaliatory measures trigger a full-blown trade war, weakening global demand for UK exports. Meanwhile, with gilt yields closely tracking US Treasuries, US interest rates rising in response to inflationary pressure could in turn make UK government debt more expensive. Either way, the UK should tread carefully before raising prices on consumers and businesses, something that would likely delay Bank rate cuts that the Chancellor may be depending on to help the fiscal position.