What if Trump is re-elected?

Such steps would not only have a negative effect on the world economy – and this at a time of significant global strains. They would also deal a further blow to the WTO, as the envisaged tariff increases would clearly violate international trade rules. Transatlantic relations with the EU are also likely to suffer. First, old trade disputes that were largely settled with the Biden administration could flare up again, e.g. regarding steel and aluminum. Second, Trump could abolish co-operative measures by the Biden administration that mitigate the protectionist elements of the US Inflation Reduction Act for EU exporters. Third, the future of the EU-US Trade and Technology Council (TTC) might be jeopardised.

This report simulates the impact of two scenarios. Scenario 1 entails an increase of US tariffs to 10 per cent on all US imports and to 60 per cent on US imports from China in 2025. These threats have been publicly envisaged by Donald Trump and his former trade advisers. In scenario 2, in reaction to scenario 1, China would retaliate with a tariff increase of 40 percentage points on imports from the US. The following results of a simulation of the two scenarios with the Global Economic Model of Oxford Economics for the four years of a potential second Trump term from 2025 to 2028 stand out:

The US economy, i.e. the real US GDP level, would be negatively affected in the first years in the range up to minus 1 to minus 1.4 per cent in the two scenarios compared to the baseline scenario. This is in part due to a simulated temporary confidence shock in the short term that has adverse effects on private investment and consumption. Moreover, private consumption decreases also as a result of higher consumer prices and higher unemployment. Cumulated GDP losses (in constant prices) over the 4-year horizon amount to nearly 600 billion US dollars in scenario 1 and nearly 1,000 billion US dollars in scenario 2. In scenario 1, however, the US GDP level would remain only marginally negative compared to the baseline in 2028. This is mainly because of the temporary nature of the confidence shock and the improvements of the trade balance, the fiscal balance and the terms of trade relative to the baseline scenario. However, in case of a retaliation by China in scenario 2, the US would suffer GDP losses also in the medium term, in the range of about half a percentage point of GDP with a slowly decreasing trend after 2028.

Regarding the US trade balance, it is striking that the tariff shocks would improve it only relative to the baseline scenario; in absolute terms the trade balance would decline further. This is because other trends like the high US government deficit are more important macroeconomic drivers of the trade balance than tariffs. Moreover, the US loses competitiveness due to an appreciation of the real effective exchange rate which tends to raise imports and reduce exports. This shows that the approach of Trump and his advisers, to raise tariffs in order to reduce the US trade deficit, is fundamentally flawed from an economic point of view, particularly if the US and particularly the government continue to be large net borrowers in a global context. The same was basically true for Donald Trump’s first term when generous tax reductions contributed to further increasing the US government deficit. As a result, the US trade balance hardly changed between 2016 and 2019 (and remained at 2.7 per cent of GDP) despite significantly higher tariffs against China.

The world economy would be hit harder than the US by the simulated tariff shocks. In scenario 2, the level of world GDP would be more than 1 per cent lower than in the baseline scenario in 2028. Moreover, world trade would be negatively affected as well. This can be illustrated by looking at Germany as an example of a rather export-oriented economy. In scenario 2, the demand of Germany’s main export partners would decline by about 5.5 per cent relative to the baseline scenario in 2028. This translates into a decline of German exports of 4.5 per cent. As a result, private investment declines considerably in Germany. In absolute values, it would be 27 billion euros lower in scenario 2 and would thus contribute more than half to the total GDP loss of about 50 billion euros in 2028 (in constant prices). This is equivalent to a decline in the German GDP level of about 1.4 per cent relative to the baseline scenario. However, also in scenario 1 a GDP loss of 1.2 per cent would result in 2028, a significantly larger decline than for the US. In absolute terms, the cumulated GDP losses (in constant prices) over the 4-year time horizon amount to more than 120 billion euros for Germany in scenario 1 and to nearly 150 billion euros in scenario 2. The main reasons for the difference to the US lie in the fact that Germany is more export-oriented and that its trade balance would deteriorate while the US trade balance improves. The EU would also be hit harder than the US.

Given the negative effect of a potentially renewed protectionism under Donald Trump, the EU should proceed along two lanes: First, the EU should prepare for such a scenario now. Before all, the EU should use the remaining term of President Biden to put the trade relations with the US on a more solid footing. In the best case, this could be achieved by institutionalising the TTC (Benson, 2024) and by convincing the Republican party in Congress that the TTC is a key forum to coordinate trade policies vis-à-vis China with the EU. Moreover, signing a critical minerals agreement and a Global Arrangement on Sustainable Steel and Aluminum would be important steps to reduce the likelihood of a backlash of Donald Trump with regard to transatlantic trade relations. A further step should be for the EU to foster its relations with other trading partners by signing more free trade agreements, such as with Australia, the Mercosur, Indonesia, or India. Second, if Trump was elected and would threaten to implement new trade barriers against the EU, the EU should be able to react. To counter such a threat, the EU should be willing to also threaten credible retaliation measures. For such purposes, the Anti Coercion Instrument was recently implemented and could provide the framework for possible retaliatory measures of the EU. While it is true that retaliation would aggravate the trade war and also the detrimental economic effects, it appears necessary to have a counterstrategy founded in Realpolitik.