The Next War: Trade war between EU and US?

Cold steel

Nov 11th 2003
From The Economist Global Agenda


After a World Trade Organisation ruling in its favour, the European Union is set to retaliate against America's illegal steel tariffs. The transatlantic dispute over export subsidies is also coming to a head

FLAT-ROLLED, hot-rolled or cold-finished: steel, in all its forms, costs Americans more as a result of President George Bush's decision in March 2002 to impose steep import tariffs on the metal. His decision stirred up transatlantic trade politics, which comes in only one form: hard-boiled. On Monday November 10th, the appeals court of the World Trade Organisation (WTO) upheld the European Union's case against the American steel tariffs. Within a month, the EU is threatening to retaliate with up to $2.2 billion of tariffs of its own. The hit list includes Harley Davidson motorcycles and Carolinian textiles. It also includes orange juice and other citrus products from Florida, where Mr Bush's brother, Jeb, is governor. According to Joe Klein, a journalist, the list prompted Mr Bush to approach Romano Prodi, president of the European Commission, at a summit and ask: "Why are you attacking my family?"

The EU does well over $380 billion of trade with the United States. Less than 5% of that trade is contested. But with world trade talks stalled, trade disputes are coming to the fore. Steel is one, beef hormones and modified genes two more. But the biggest and longest dispute of them all rages over more than $4 billion of tax breaks for American exporters.


Broadly speaking, America taxes its citizens and businesses wherever they may roam. EU countries, by contrast, only tax what is earned and sold in their territories. As such, they do not impose value-added tax (VAT) on goods sold abroad. This helps their exporters no end and puts America at a disadvantage. The United States tries to compensate by sparing from taxation some of the profits its companies earn overseas. For over 30 years it has been looking for a way to do so without falling foul of global trade rules, which outlaw export subsidies.

America's Domestic International Sales Corporations, introduced in 1971 and deemed illegal in 1976, were replaced by Foreign Sales Corporations, declared illegal in 1999; these were in turn replaced by Extra-Territorial Income (ETI). That regime was itself confirmed as a breach of WTO rules in January 2002. The dispute is, says Gary Clyde Hufbauer of the Institute for International Economics, like a Russian novel that never seems to end.

Europe's trade commissioner, Pascal Lamy, was in Washington last week to call time on both disputes. Retaliation against the steel tariffs was, he said, a "racing certainty" by mid-December. Likewise, if the ETI is not repealed by March next year, the EU will slap a 5% duty on a range of goods (including sugar, leather, cosmetics and even parts for nuclear reactors), rising each month to a ceiling of 17% by March 2005. In total, the WTO has authorised the Europeans to hit America with over $4 billion of punitive measures in the export-subsidies case, and the EU has authorised itself to impose a further $2.2 billion in the steel case (with Japan and six other plaintiffs waiting in the wings).

What will Mr Bush do about it? Congress is already in the midst of repealing the ETI, with the Senate and the House each discussing separate bills. But they envisage phasing out the tax breaks over three or more years rather than eliminating them all at once, as Mr Lamy demands. Even then, a repeal bill is not certain to pass, and is quite unlikely to pass before the end of the current session.

As for America's steel tariffs, they currently stand at 24% on the most significant imports (such as flat-rolled steel), down from 30% in 2002, and they will fall further next year. But they are not due to expire until March 2005. The stated rationale for the tariffs was to give the industry breathing space in which to restructure. In trying to square the tariffs with his professed commitment to free trade, Mr Bush offered not the familiar "infant industry" argument, but a "mature industry" argument: the steel industry is buckling under the "legacy costs" of paying the pensions and health care of retired workers. It is also suffering from overcapacity: too many firms, operating on too small a scale.

Steel lobbyists point out that the industry has consolidated in the past year. But they fail to explain how tariffs helped this process. Indeed, by raising the profitability of ailing firms, the tariffs may have raised the price the stronger firms had to pay to acquire them. Mr Lamy points out that steel mills were shuttered and merged across the EU with some state aid, but without the help of tariffs. Having borne the pain of its own restructuring, why should Europe bear the pain of America's as well?

Nor are the tariffs painless for America. Even the United States International Trade Commission, which recommended the tariffs, reckoned they would cost American firms and workers $680m. Higher prices benefit steel producers, but they hurt steel users, many of them manufacturing companies also struggling against foreign competition. Some, such as Caterpillar, were allowed to bypass the tariffs in buying their steel inputs. Others were not so lucky. Mr Hufbauer estimates that steel-using industries might have lost 26,000 to 43,000 jobs to the tariffs in their first year alone.

This economic discomfort may impress Mr Bush less than the political goodwill he has bought from steel-producing states, such as West Virginia, Pennsylvania and Ohio. That goodwill was crucial to his bid to win "trade promotion authority", which lets him strike trade deals that Congress can vote on, but cannot amend. If he removes the tariffs, he may lose support for the Central American Free Trade Agreement that he hopes to bring to Congress next year.

More important than votes in Congress, however, are votes in the 2004 election. The EU may not be after Mr Bush's family, but its proposed sanctions do look like a fairly naked attempt to shift his electoral calculus, jeopardising jobs and votes in swing states, such as North Carolina, Wisconsin and Florida. Some congressmen resent such threats: if the EU acts, they want Mr Bush to tighten, not remove, the tariffs against European steel.

Some also think the EU is getting ahead of itself. Now that the steel tariffs have been ruled illegal, they say, the Europeans must wait for WTO arbitration and grant America a reasonable period of time to put its house in order. They may be right: the WTO has never proceeded this far with such a case and is sailing into uncharted waters. But it could take months of deliberations to chart those waters?-and the EU will not wait that long. If Washington does not move quickly to dismantle its steel safeguards, Brussels is ready, right now, to flash some steel of its own.

Walter,

A2K is not representative of American opinion....