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July 03, 2018

Some realism about tariffs

We hear it every day from economists that tariffs don't work, and that Donald Trump is somewhat learning-impaired in his trade policies. There is no doubt that - from a global perspective - a trade war would bring large welfare losses, but Trump is pursuing a much narrower goal, one that looks like succeeding.

When the EU imposed punitive tariffs on Harley-Davidson, the company decided to move part of its production outside the US. That was viewed as victory for the EU - which it was in one sense. But it also demonstrates that Trump's logic is working. The country that benefits the most from a trade war is the one with the largest excess supply of consumption over production - the US in this case. 

The FT has a very good insight story into how the car industry will react to tariffs - and found that the response will be exactly the same as that of Harley Davidson. VW, a company with 122 factories across the world, said it will move production to the US if faced with tariffs. The paper quoted a senior executive of the company as saying, essentially, that this is a no-brainer. 

So if your narrow goal is to produce as many cars in your country as you consume, then the trade tariffs are working. This is clearly not a good policy goal, but it is Trump's goal. Around half the cars bought in the US are produced outside - so there is a huge potential to shift production back home. Here is the assessment of a car analyst at Evercore ISI, as reported in the FT:

"The sad truth is that if you impose tariffs, production will move around. If nationalist trends continue, the inevitable outcome will be more production where you sell the car because that’s the only way to avoid larger tariffs."

Trump is dangerous, especially for countries like Germany and Japan. But Trump is not stupid.

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July 03, 2018

How the Brexit carousel has come full circle

Our Brexit coverage has become a little less prominent as we focused on the political crises on the continent. But fortunately this does not matter much since the discussion about the future relationship still hasn't progressed much from two years ago. The UK debate is still mostly delusional. Then, as now, the EU can only accept two Brexit trade options in principle: 

  • a customs union plus extensive compliance with single market rules - similar to that of the EEA;
  • a Canada-type trade deal (though it is not clear how that could ever solve the Northern Irish question).

It was always thus. In the first case, the UK would have to respect freedom of movement - in full. The EU may compromise on the extent to which services would have to be integrated into a customs union. But they will never compromise on free movement. They'd rather have no deal. If the UK's goal is to have an independent immigration policy, the only option available is a Canada deal. It was always thus.

This is why this whole business about max-fac and other silly schemes would be a waste of time to discuss. This Friday, Theresa May holds a cabinet meeting that may either come up with a third solution to be duly rejected by the EU, or it may come to the only compromise that would work - a time-sequenced combination of the two options above: a temporary customs union/EEA deal for as long as it takes to implement a Canada agreement.

The combination of the EU's inflexibility and the UK's continued delusions is why we believe the chances of a no-deal Brexit have risen. We agree largely with the analysis by Peter Foster in the Daily Telegraph this morning, who takes a detailed look at why the EU is so inflexible even on the customs union. This is because services constitute an embedded component in the production of many goods. Not being subject to the competition rules in this area could give UK companies an undue competitive advantage in a customs union. The EU and its precursors in the 1950s started life as a producers' cartel. That's how they still look at this. For the same reason, we would expect the EU's position to soften somewhat after the US imposes tariffs on EU cars. A no-deal Brexit would mean that car imports into the UK, the largest export market of German car makers for example, could also be subject to tariffs. We therefore see some room for compromise. But the whole deal could still blow up once the UK realises fully the sheer extent of the EU's inflexibility on the four freedoms. 

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