The emergence of an open multilateral trade system that separated trade from geopolitics played a crucial role in the post-World War II economy. But today, as geopolitical considerations increasingly influence trade policies, a new paradigm is becoming visible.
This trend began with the customs tariffs imposed by former US President Donald Trump on Chinese imports in 2018, which were maintained by President Joe Biden’s administration, causing China to impose its own tariffs on US imports. Then, in 2022, following the invasion of Ukraine by Russian President Vladimir Putin, the G7 countries and the European Union imposed broad economic sanctions on Russia, effectively banning imports and exports to and from this country.
Instead of causing a decrease in global trade, these trade barriers and restrictions merely made it more cumbersome, resulting in its slowdown (“slowbalization”). Notably, despite the war in Ukraine and disruptions to the supply chain in recent years, trade as a percentage of GDP reached a record high in 2022, highlighting the resilience of the international trade system. In fact, the increases in shipping prices since that year can be attributed to an unexpected rise in the volume of products shipped worldwide.
While it may be tempting to argue that geopolitically motivated measures have had a negligible economic effect, the resilience perceived in global trade can be deceiving. Although recent trade barriers generated higher trade volumes, many of them have significant costs.
At first glance, the notion that a tariff could boost trade may seem paradoxical. However, almost all of the tariffs and trade restrictions imposed by the US since 2018 have been specifically targeted at China, leaving imports from other countries untouched. Consequently, there was a sharp decline in Chinese imports, and imports from countries like Vietnam have increased. Many consumer products are shipped to the US after being assembled in Vietnam and other Southeast Asian countries.
But these imports still depend on intermediate inputs from China. Therefore, trade volumes have grown because, while US imports of consumer goods from Asia have remained constant, China’s exports of intermediate inputs to its Asian neighbors have increased. Similarly, while Mexico has surpassed China as the leading exporter of products to the United States, its own imports from China have risen by nearly 40% since 2018.
The electric vehicle (EV) market illustrates how discriminatory practices can promote trade. Tariffs on Chinese EVs are approaching 30%, and US regulations disqualify EVs that contain components produced or assembled in “entities of interest” for receiving tax credits, effectively preventing Chinese manufacturers from entering the US market. In contrast, European EVs are subject to a significantly lower tariff of 2.5% and qualify for a $7,500 rental subsidy under the Inflation Reduction Act. Consequently, Chinese EV exports have shifted to Europe, while European automakers have thrived in the United States.
Meanwhile, the EU is undergoing a similar process. Following Western sanctions on Russia, European exports to Turkey and Central Asian countries such as Kazakhstan and Kyrgyzstan have skyrocketed. At the same time, trade volumes between these countries and Russia have surged.
Such methods of evading sanctions or discriminatory tariffs result in higher production and logistics costs, as products must now be transported to intermediary countries before being shipped to the US. Therefore, discriminatory sanctions and tariffs can both boost trade and reduce prosperity.
These detrimental effects underscore the importance of the “most favored nation” principle that has long been the cornerstone of the global trade system. Concerted efforts to liberalize trade, first through the General Agreement on Tariffs and Trade, and later with the World Trade Organization, have increased trade volumes and overall prosperity through this non-discriminatory approach. In contrast, current trade barriers and discriminatory tariffs for geopolitical reasons explicitly target specific countries seen as hostile or potential threats.
Who pays the price? Economic theory (and common sense) provide a clear answer: the countries imposing discriminatory trade restrictions end up paying the costs while the rest of the world benefits. Consequently, while the US and China suffer the negative effects of their trade war, Vietnam and Mexico emerge as winners as intermediaries. Similarly, Turkey and Central Asian countries benefit from sanctions against Russia, while the EU foots the bill.
This distribution of costs and benefits helps explain the limited international opposition to Trump’s tariffs against China. After all, the EU, Mexico, or Vietnam have little incentive to object to a US policy that benefits their own industries. Therefore, it is unlikely that international pressure will deter powers of the caliber of the US or China from prioritizing geopolitical considerations over trade liberalization. To counteract this trend, it is crucial for political leaders to realize the adverse effects of trade barriers.
As the most open and geopolitically least ambitious of the world’s major economic powers, the EU is likely to be the first to recognize this. The United States, in particular, is the power that stands to lose the most if it continues its trade war with China. To avoid this outcome, it must change course and return to the non-discriminatory principles that have long underpinned global trade policies.
