How robust is trade between the US and the EU?

Donald Trump's latest threat of imposing import tariffs of 25 per cent on goods from the EU has once again fuelled fears of a trade war between the US and Europe. However, a study co-authored by the University of St. Gallen argues that in addition to current trade conditions, historical exchange relationships also play an important role in the future development of trade volumes. Although the study was not conducted with the current global conflicts in mind, it could nevertheless provide insights into how to assess their impact.

The Iron Curtain still has an effect

‘The starting point for our study was actually that, even after the fall of the Iron Curtain, the countries of Western and Eastern Europe trade much less together than one would expect given the short distance and the size of the economies,’ says Prof. Dr. Reto Föllmi from the Swiss Institute for International Economics and Applied Economic Research at the University of St. Gallen (HSG). The researchers suspected that the historical separation of the two blocs has negative long-term effects on trade relations. And, conversely, that trade relations that have been established over a longer period of time are less sensitive to disruptions such as the imposition of tariffs. To investigate this, they compared trade data from different countries. The trade relationships compared included those that had a long history, such as that between Eastern and Western Europe. But there were also relationships that had been more intensive over a longer period of time, such as those between former colonies and their colonial powers. It was found that even after the end of colonial dependency, the latter still traded more with the former colonial power than with other countries.

Path dependencies due to high market entry costs

The study also analyses the impact of the ‘Venezuela shock’ of 2009 on trade between Colombia and Venezuela. At the time, former Venezuelan President Hugo Chavez had frozen diplomatic relations with neighbouring Colombia and announced his intention to drastically reduce trade relations. As a result, Colombian exports to Venezuela fell by 50 per cent. However, not all exporting companies were equally affected, as the authors of the study write. Companies that had already established trade relations in Venezuela for some time before the Venezuela shock were less susceptible to the diplomatic and trade policy upheavals. According to the study, this is likely to be due to path dependencies in the form of expenses already incurred for market access: ‘If a company has been exporting to a country over a long period of time, it has already invested a lot of money in this trade relationship. For example, it has already built up a good personnel network or invested a lot of resources in getting to know local market conditions and regulations,’ explains Reto Föllmi. However, these long-term investments also reduce the current market access costs for these companies compared to competitors that have not yet established such long-term trade relations with the same country. The latter are therefore more easily deterred by trade barriers such as tariffs.

Can trade between the EU and the US survive Trump?

The authors of the study, which included researchers from ETH Zurich, the University of Pavia and UC San Diego, were able to show that in the analysed data, up to 25 per cent of trade decisions are based on such long-term effects. Reto Föllmi is unable to say how strongly this also applies to the current trade conflict between the USA and the EU and what proportion of trade will remain unaffected by higher tariffs. ‘However, our study shows that trade between partners with historically good trade relations, such as the EU and the US, is more resilient to disruptions than is often assumed.’ But this resilience also has limits, as Reto Föllmi emphasises, if a disruption lasts too long. The study does not provide an answer to the question of how many companies have the stamina for four years of Donald Trump.