Sleepwalking into another trade war

The world is embroiled in a mega-crisis comprising the Covid-19 pandemic, Russia’s war in Ukraine, high inflation, recession fears and rising debt distress across emerging markets and developing countries. The last thing we need is an additional source of economic harm. But that’s what we may get, in the form of another destructive trade war.

Trade wars are immensely damaging because countries tend to retaliate by erecting ever-higher trade barriers. This vicious cycle was blamed for greatly prolonging the Great Depression in the 1930s, which is why the United States led the effort to develop a new world trading system after 1945. For 70 years, global commerce was underpinned by the rule of law, with an international organisation — the General Agreement on Tariffs and Trade, which was succeeded by the World Trade Organization — ensuring impartial adjudication of disputes.

But in 2017, Donald Trump’s administration effectively withdrew US support for the WTO and started a trade war with China.

Unfortunately, President Joe Biden’s administration has neither rescinded Mr Trump’s trade measures nor restored important WTO functions such as the dispute-settlement mechanism. And if that wasn’t bad enough, this year’s US Inflation Reduction Act (IRA) and CHIPS and Science Act will inflict so much damage on trading partners and allies that they will almost certainly have to retaliate. The US will then find itself in a trade war not only with China but also with its allies.

For example, the IRA provides a US$7,500 (about 250,000 baht) subsidy to US purchasers of electric vehicles, provided that they are both made in America and composed predominantly of American parts (and these components must include batteries, which constitute 40% of EVs’ cost. Similarly, the CHIPS Act allocates $52 billion to finance investment in chip-making factories built by private companies in the US.

It is doubtful that the EV subsidy, which strongly discriminates against foreign-made cars from the EU, the United Kingdom, Japan and South Korea, is warranted. Nor is it likely to fulfil its intended purpose of “creating good jobs” and accelerating the shift away from internal combustion engines.

The CHIPS Act is even less likely to achieve its backers’ desired results. There is already a looming semiconductor supply glut, and that has led some leading producers (both American and foreign) to declare that they will follow through on plans to build new production facilities only if they receive subsidies.

From the perspective of foreign political leaders, the auto industry is too economically important for them to stand by and do nothing in the face of unfair US practices. As French President Emmanuel Macron made clear to Mr Biden during his recent state visit to the White House, America’s unilateral protectionism risks triggering a broader trade war. Equally, other governments are under mounting political pressure to subsidise chip production in response to the recent US moves, and several foreign manufacturers are announcing plans to build factories in the US to avoid the unfair competition.

Had the IRA and CHIPS Act gone into effect on Jan 1, as planned, America’s allies would have almost certainly retaliated, which in turn will invite US countermoves. This tit-for-tat escalation could affect more and more export categories. Mr Macron has already indicated that Europe should start discriminating in favour of its industries.

The world’s major trading powers must act quickly to prevent the eruption of a full-blown trade war. The chips issue should be taken to the WTO, and the US should abide by a likely ruling that the subsidies are illegal. Chip producers could jointly agree on a pact specifying export rules for machinery and chips and an enforcement mechanism. The US could substitute much-needed additional investment in education and training, which would enable domestic producers to hire well-trained workers more readily, for some of the physical investment now contemplated.

For EVs and batteries, too, foreign and domestic producers must compete on a level playing field. Car-exporting countries could subsidise all purchasers of new EVs by the same amount as the Americans; the Biden administration could seek an amendment to the law to provide subsidies to purchases of all EVs, including imports. In addition, the American domestic content requirements for batteries would also need to be adjusted.

As with chips, any of these measures would enable a far superior outcome for the global economy. Protectionism sets the bar low. ©2023 Project Syndicate