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Europe Must Be Braced for a Trio of Shocks

https://www.ft.com/content/2f88a688-c270-11e9-a8e9-296ca66511c9

US President Donald Trump has been lampooned, with good reason, for his claim that “trade wars are good, and easy to win”. But in one sense he is right. The American economy is huge and relatively closed. That combination means trade turmoil involving the US can inflict much greater damage on others than its own economy has to absorb.

Despite a contraction of US industry and higher prices for American consumers, overall growth remains adequate. It remains to be seen how the latest market gyrations affect the economy, but so far, the brunt of the macroeconomic damage has fallen not just on Mr Trump’s main target — China — but on Europe, which has been caught in the crossfire.

Unlike the US, the EU economy is as trade intensive as China’s, and accounts for the largest share of world trade of the three. While China is experiencing a slowdown partly due to US actions against it, Europe is suffering just as much in collateral damage.

Europe’s growth rate has slowed to a trickle and has been markedly lower than the US’s for the past two years. Trade is not the only cause, but it is the most important one. The OECD has highlighted that European countries’ trade growth stalled last winter, both among themselves and with the outside world. Germany, the continent’s trade-oriented economic core, has been one of its worst performers over the past year. It saw gross domestic product shrink in the last quarter, its car production continues to plummet and industrial weakness has spread to other EU economies.

Worse may yet be to come. As Shahin Vallée of the German Council on Foreign Relations warns, the US-China stand-off may intensify from trade war to currency war, with competitive devaluations adding to Europe’s export woes. The big question now is whether the crisis in trade-dependent manufacturing will weigh on domestic confidence and reduce demand for the much larger services sector. There are signs this is already happening.

All this is bad enough, but it is only one of three possible trade-related shocks about to hit the EU. In addition to being a collateral casualty, Europe is at risk of becoming the next direct target of American trade aggression. The OECD’s chief economist, Laurence Boone, said in July that the trade war will move to the EU “probably at the end of the summer”. Mr Trump has been rattling his sabre in that direction for both French wine and German cars — the bloc’s single biggest agricultural and industrial export items. Trade flows between the two economies amount to more than $1tn a year.

The third risk is a no-deal Brexit on Halloween, which would throw up big trade barriers overnight. Britain and Ireland would be the most hurt by this, but that does not mean the shock to other members of the bloc would be negligible.

If this trifecta of trade shocks materialises, the German car industry, which has big markets in both the US and the UK, will again be at the centre of the trouble. Given its importance in the German economy and its interconnections with the rest of Europe, the sector can act as a superconductor of shocks to other industries and countries. That is the lesson of the first of the three shocks; there is all the more reason to fear similar effects from the other two.

What should the EU do? It cannot insulate itself from the trade disruptions themselves. That would mean shifting the German economic model, and the European supply chains linked to it, away from relying on manufacturing exports. Such a step would take time, require extraordinary political leadership, and may be unwarranted if the trade troubles prove shortlived. For economic as well as strategic reasons, the EU may simply have to live with trade disruptions.