Europe's Surrender

Thoughts on a spectacularly one-sided trade deal between the EU and US

Following on from yesterday’s newsletter which discussed Trump’s apparent trade war success (So Many Losers), here is an update with a few thoughts on the hopelessly one-sided EU-US trade deal that was announced yesterday evening between Donald Trump and Ursula von der Leyen at an awkward meeting in Scotland:

1. Clearly this deal is a humiliation for the European Union. Brussels has accepted a 15 percent across the board tariff, which would have been unthinkable even three weeks ago when it thought it had reached an agreement for a 10 percent baseline tariff only for Donald Trump to pull the rug at the last minute. Even 10 percent would have been a significant climbdown, given that the EU had initially responded to Trump’s “Liberation Day” 20 percent reciprocal tariff threat by proposing a “zero-for-zero” tariff deal and threatening retaliation if it didn’t get it. For a bloc that prides itself on being a trade powerhouse to have folded so easily and accepted such a one-sided deal is a blow to its standing and hands a huge win to Trump.

2. Why did Brussels put up such a weak fight? Largely due to divisions among EU member states. The European Commission drew up an initial list of targets for €26 billion worth of retaliatory tariffs, but member states whittled down to €21 billion. Had every member state got their way, this would have been reduced to €9 billion, reports the FT. A subsequent package of €72 billion of retaliatory measures came much later in the day. But member states could not even agree to deploy this weapon, leading Brussels to back down - or “chicken out” - even as higher tariffs kicked in. That partly reflected fears that the EU could not win a trade war. But it also reflected fears that a trade rift could lead to Trump withdrawing security guarantees for Europe.

3. The best that can be said for the deal from a European perspective is that it could have been worse. The 15 percent tariff will apply to almost all goods, which means that the EU will escape most of Trump’s sectoral tariffs: most importantly the 25 percent tariff on cars but not, it seems, the 50 percent tariff on steel and aluminium exports. And 15 percent is, of course, a lot less than 30 percent, which is what Trump was threatening to impose on the EU if no deal was reached by August 1. That is why stock markets have risen in response to the deal, unlike on April 2 when the “Liberation Day” announcement of “reciprocal” tariffs led to a market turmoil.

4. Under the deal, the EU has also agreed to buy $750 billion of energy over the next three years and to invest $600 billion in the US economy. This sounds like a further humiliation, and is presented by Trump as the price the EU must pay for access to the US market, but details are thin and much of this may be money the EU would have spent anyway. As the Wall Street Journal notes, “Europe is already the largest foreign investor in the U.S., with European direct investment increasing by roughly $200 billion from 2023 to 2024. Three times that over an undefined period is hardly a great coup.” European defence spending is also about to ramp up massively, with much of this inevitably destined to be spent in the US.

5. How the energy part of the deal will work is a particular mystery. Last year, the total imports of energy by the EU stood at EUR375bn so for the EU to buy USD250bn of US energy products per year for the next three years would require a massive re-allocation of European imports, notes Gilles Moec, chief economist of Axa Group. While the US is the biggest supplier of oil to the EU, it only has a 15% share. The US does supply more than 50% of EU imports of Liquefied Natural Gas, but LNG accounts for only 17% of total EU imports of energy products. That raises some questions as to how much of this will actually happen - like China’s pledges to buy more US goods during Trump’s first term - or whether it was eyewash to get a deal over the line.

6. The real win from the EU’s perspective is that it has successfully fended off Trump’s demands that it rewrite its regulatory rulebook to benefit US companies. In particular, Trump had been demanding changes to EU digital services rules, agricultural rules and pharmaceutical pricing. The irony is that this is the one thing that US companies would have most wanted out of any trade deal. Instead, they have been hit with a massive hike in tariffs on imports, which as discussed yesterday, they are currently having to absorb through lower profits, without any increase in EU market access. Had Trump chosen to pursue a genuinely reciprocal free trade deal, these are issues on which a negotiation might have been possible. As things stand, the EU can legitimately claim to have preserved its regulatory autonomy.

7. That Trump decided to fold on his regulatory demands and to exempt the EU (and Japan) from sectoral tariffs speaks volumes about his underlying motivation. When he began his tariff onslaught, there was a lot of debate about what he was really trying to achieve: to eliminate trade deficits, reshore manufacturing jobs, isolate China, boost federal revenues etc. It is now clear that what he cares about most is boosting federal revenues to help pay for the tax cuts in his “Big Beautiful Budget Bill” since, as discussed yesterday, aspects of the deals he is striking are likely to increase the trade deficit and favour foreign importers. Once the tariff revenues start rolling in - and they already increased fourfold in May - they will be hard to kick. Biden never reversed Trump’s first term tariffs and the safest assumption that these new US tariffs will be here to stay for the foreseeable future.

8. Clearly there will be a hit to the European economy as a result of this deal, since the higher tariffs are likely to lead to lower exports to the US. Gilles Moec, chief economist of Axa Group, reckons that European GDP could be half a percentage point lower. Ironically, the hit to US GDP could be even greater at 0.7 percentage points. But ultimately how this pain is shared will depend on a host of other factors, including how much of the extra tax is absorbed by exporters versus US importing companies, how much is passed on to consumers and what happens to the dollar.

9. Besides, US tariffs will be just one factor among many that will determine the outlook for the European and global economy. One reason why the markets have become relaxed about Trump’s tariffs is that they are currently more focused on the opportunities of the AI revolution. Lower energy prices are helping to mute the inflationary impact of higher tariffs. Large fiscal stimuluses in China and Europe, partly in response to the Trump shock but also to fund European rearmament, are helping boost short-term growth.

10. Meanwhile the flurry of new trade deals being negotiated around the world should boost growth and productivity everywhere except America, as discussed yesterday. Indeed, the best response to US tariffs would be for the EU to eliminate its own internal barriers to trade, which the IMF calculates to be the equivalent of a 46 percent tariff on goods and and 110 percent tariff on services. Ultimately, the Trump shock is just that - a shock. If it jolts Europe into doing what it should be doing anyway, it may even be an opportunity, not least to put itself in a position not to be humiliated again.