Starmer's Brexit Reset plus other European dilemmas

Thoughts on Trump's quest for reciprocal trade, the return of Brexit cakeism, five options to save broken Brussels, and is Tesla paying the price for Elon Musk's political activism

Photo by Christian Lue on Unsplash

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In this newsletter:

• Trump’s Painful Delusion: Europe braces for reciprocal trade

• Starmer’s Brexit Reset: The return of cakeism?

• Broken Brussels: Five options to save Europe

• Tesla’s Sagging Shares: Putting a price on political connections

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1. Trump’s Painful Delusion

So it looks as if Donald Trump’s trade wars will be coming to Europe next week. "I'll be announcing that, next week, reciprocal trade, so that we're treated evenly with other countries," the president said on Friday. "We don't want any more, any less."Although he didn’t specify which countries would be hit, it is widely assumed that the European Union, among others, is in his sights.

How worried should Europeans be? After all, his “opening salvo” against Mexico and Canada lasted less than 24 hours. That was how long it took him to agree to pause for a month threatened tariffs of 25 percent in return for some relatively minor, and possibly re-announced, concessions. An extra 10 percent tariff on China imposed last week remains, though this is far short of the 60 percent tariff that he had threatened during his election campaign.

Nonetheless, one reason to believe that Trump means business is his use of the word “reciprocal”. Whereas the tariffs on Canada and Mexico were levied as negotiating tactics in pursuit of non-trade related aims - to restrict illegal immigration and the cross-border supply of fentanyl - the next round of tariffs look designed to serve a core Trump obsession.

As Bob Davies explains in an essay for Foreign Policy:

Trump seeks to remake global trade based on what he calls “reciprocity”—treating other countries, supposedly, in the same fashion as they treat the United States… He has his sights set on any country with which the U.S. has a large, persistent trade deficit, which in his mind means it is treating the U.S. “terribly.” Success would mean sharply reducing the trade deficit, no matter which country he hits or what other geopolitical goals it impedes.

Trump’s fixation with reciprocity is long-standing. In his first term, he proposed the United States Reciprocal Trade Act, which would have given him authority to raise tariffs to competitors’ levels and used his State of the Union to promote the bill. But the bill never made it out of committee in the House or Senate. Meanwhile, Peter Navarro, Trump’s White House senior trade advisor, mapped out a roadmap for a term reciprocal trade strategy in an essay in Project 2025, the 887-page compilation of recommendations for Trump 2.0.

Navarro ranked trade targets according to the size of their bilateral trade deficit with the US and the difference in average tariff levels. India and China top the list, followed by the European Union, Thailand, Taiwan, and Vietnam, and then Malaysia and Japan. Under Navarro’s plan, any new tariffs could then be reduced if the target country agreed to reduce theirs to US levels.

At one level, Trump has a point. US exporters do face much higher tariffs in many countries than those America imposes on importers. For example, he has long complained about the EU's 10% tariffs on auto imports being much higher than the U.S. car rate of 2.5%. Meanwhile Chinese average tariffs are as high as 10 percent compared to U.S. tariffs of 3.4 percent, and Indian average tariffs as much as 50.8 percent or Indonesia’s 37.1 percent.

Nonetheless, there are a couple of problems with Trump’s reciprocal approach. The first is that it is unlikely to do much to reduce America’s giant trade deficit. That is because, as Bank of America notes, the deficit is a structural problem:

The current account deficit is a macroeconomic imbalance. It is the difference between the national savings and investment of a country. Targeting bilateral trade deficits will not fix the current account deficit.

On the one hand, the US savings rate is low due to a combination of strong private consumption and record high fiscal deficits. On the other hand, the US economy offers very attractive investment opportunities, with relatively high risk-adjusted expected returns.

Those capital inflows are the reason the dollar appreciates over time, driving therefore a current account deficit, with the trade deficit being obviously the major component. Unless you meaningfully change the savings-investment imbalance, the current account deficit will persist. If the US administration is seriously thinking about reducing the trade deficit, a good starting point would be to put the fiscal accounts in order. However, this is not what we expect.

The second problem is that Trump’s reciprocal approach comes with significant costs. Micheal Froman, President Barrack Obama’s US trade representative and now president of the Council for Foreign Relations, says that there are three categories of costs that protectionist measures carry:

• The cost of implementation: tariffs put up the price of imports which businesses are likely to pass on to consumers, leading to higher inflation

• The cost of retaliation: China has already retaliated against last week’s tariffs with higher tariffs of its own on a range of goods as well as restrictions on exports of critical minerals and an anti-monopoly investigation into Google. The EU can be expected to retaliate too.

• The cost of imitation: When the architect of the rules-based economic order begins to pick and choose which rules to follow, other countries will have greater cause to follow suit, imposing their own selective tariffs.

The real issue is therefore how much of these costs Trump thinks America is willing to bear. Last week, in the brief interlude between announcing tariffs on Canada and Mexico and suspending them, Trump admitted for the first time that his tariffs plans would indeed entail some costs: “WILL THERE BE SOME PAIN?” he asked on Truth Social. “YES, MAYBE (AND MAYBE NOT!)”

In the case of Canada and Mexico, the threatened tariffs were so economically damaging, as evidenced by the brief market panic on Monday, that Trump appears to have concluded that the pain would be too much and promptly capitulated. Bank of America reckons that by the same token, tariffs on the EU could be watered down, if rationality prevails and Trump prioritises growth.

But if Trump really is determined to eliminate the trade deficit via tariffs, or concludes that he needs tariff revenues to help pay for his tax cuts, then this trade war could escalate far beyond what the markets currently expect.

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2. Starmer’s Brexit Reset

Given the risks to the European and global economy from Trump’s trade policies, it is clearly even more vital that European governments pull whatever levers they can to boost growth in their own economies. Nowhere is that more necessary than in Britain, where the government received further bad news last week in the form of a Bank of England forecast that downgraded expectations of growth this year to just 0.75 percent and raised its inflation forecast to 3.7 percent. And what lever could be more powerful than to try to undo some of the damage of Brexit?

A terrific piece by Jeremy Clarkson in the Sunday Times today highlights just how damaging Brexit has been for British businesses trying to trade in the EU. The TV presenter says that when he comes across people who still think that Brexit is a good idea “I get so cross that my hair catches fire and teeth start to itch”. He then goes on to explain the bureaucratic and logistical nightmare he faced trying to cross the Channel to film on the continent. It is easier, he says, to cross from Turkey into Iraq than from post-Brexit Britain into France.

Meanwhile a new report commissioned by Best for Britain, the pro-European campaigning organisation, calculates that a new UK-EU trade deal based on deep regulatory alignment in goods and services could boost UK real GDP by up to 2.2 percent over the long-term without breaking any of Labour’s “red lines” of no return to the EU customs union, single market or free movement. That would reverse more than half the 4 percent long-run hit to GDP that the Office for Budget Responsibility estimates was caused by the original Brexit deal.

How realistic is it that such a deal could be reached as part of the government’s “reset” of relations with the EU? Having spent part of last week in Brussels, where I was participating in the EU-UK Forum, I have my doubts.

There’s no question there has been a welcome change of tone in UK-EU relations, as was clear from the warm reception given to Sir Keir Starmer when he became the first British prime minister since Brexit to attend an informal dinner of EU leaders. A date has now been set for a first UK-EU summit which will be held in London on May 19 to officially launch the reset.

It is also true that there is some frustration on both sides of the Channel at the relative modesty of what the government is seeking in terms of its reset: this is currently limited to a defence pact, whose contents are uncertain, a veterinary deal to reduce border checks, an energy deal to link the two sides’s emissions trading systems, access to EU police databases, easier touring rights for British musicians and mutual recognition of professional qualifications.

These would all be valuable improvements on the existing deal if delivered, though they would be unlikely to move the economic needle to any meaningfult extent. Indeed, there is some scepticism in Brussels about how much of a deeper relationship with the EU London really wants. Some detect a return to “cherry-picking” and “cakeism”, the attempt to gain access to parts of the single market without having to abide by its obligations and while offering little in return.

There is particular irritation at Labour’s high-handed dismissal of the EU’s desire for a youth mobility pact. This is seen as not just highly desirable but a test of the UK’s faith and commitment. After all, what could be more fundamental to the development of a deep relationship between Britain and the EU than a project to build cultural, academic and professional links between the younger generations?

Optimists on the UK side hope that Starmer’s modest demands can pave the way for a deeper relationship in the future. That’s because any deal on veterinary standards, energy, and access to EU databases will almost certainly require the UK to agree to dynamically align to EU rules, updating its own laws in response to changes in EU law, and agreeing to abide by judgments of the European Court of Justice on disputes relating to the application of EU law. That would create a precedent - for both sides - that could be extended to other sectors over time.

Indeed, some go further and advocate setting up a permanent institutional arrangement with its own secretariat to explore future ways to deepen the relationship. This could be modelled on the US-EU Trade & Technology Council that Brussels established with the Biden administration which Trump looks certain to abandon. That would provide a forum to establish joint approaches to regulation and open the door to a Swiss-style UK-EU relationship based upon multiple sectoral deals enhanced access to the EU market.

But some in Brussels are wary of such ideas. The EU has always hated the Swiss arrangements which it sees as the ultimate exercise in cherry-picking and have been adamant that they are not on offer to Britain. Many believe that the Trade and Cooperation Agreement - the UK-EU trade deal - serves the EU well. Indeed, suspicion of UK motives is heightened by the fact that it is seeking to diverge from EU rules in crucial areas for the future such as regulation of AI.

Besides, the Trade & Technology Council ended up achieving very little. What’s more, the EU’s complicated politics means that every negotiation risks becoming hijacked by national interests, as Starmer has discovered as his hopes for a defence pact at a time when there is a war on the continent have become hostage to French demands for a deal on access to UK fisheries. Underlying all such discussions is a simple question: why not just rejoin?

What seems clear is that the kind of deeper relationship that many pro-Europeans in Britain want will require a significant change of mindset - on both sides.

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3. Broken Brussels

What struck me most in Brussels last week was the degree of pessimism about the EU itself compared to my last visit in the autumn. I found some of those who I had long considered to be the most staunchly integrationist pro-Europeans in despair at the ability of the EU institutions any longer to deal effectively with common problems, including urgent security challenges arising from the war in Ukraine and the return of Trump to the White House.

The publication of the Commission’s new Competitiveness Compass, its strategy for tackling the bloc’s deep economic challenges which I wrote about last week, had only deepened the disillusionment. It largely consisted of reheated initiatives that only served to highlight how little progress the EU has made in in deepening its single market. It is hard to feel confident that projects that have eluded the EU for a decade or more will be delivered amid today’s fragmented politics.

This rather bleak paper by Jean-Claude Piris, the former head of the EU Council’s legal service, for the European Policy Centre, says the problem is structural:

The EU decision-making is in a deadlock, as it requires unanimity (among 27 and potentially 30+ members in the future) for major issues. It is easy to adopt bold general objectives, but difficult to decide on precise implementing legislative and budgetary acts. Moreover, the rules adopted by the EU have increasingly been circumvented in recent years, including on core EU issues, such as the Single Market, the Eurozone and Schengen. With no changes, the EU is thus in danger of slowly unravelling.

So what’s the answer? Piris reckons there are five options, but only two are realistic - and even these carry substantial risks to EU cohesion.

• change the Lisbon Treaty to allow more qualified majority voting. But this “appears to be politically impossible, even in the long term”.

• activate existing clauses in the Lisbon Treaty to allow more majority voting. But this would require unanimity and so is likewise very unlikely.

• adopt a new treaty to create a closer political community among some member states. But this would likely require revisions to national constitutions and referenda creating huge political and legal problems

• use enhanced cooperation under the existing treaties to pursue projects such as common defence

• establish new intergovernmental agreements among some member states outside the EU Treaties, though perhaps with a role for EU institutions, forming coalitions of the willing for common projects such as defence

The last of these is most intriguing, not least because it could open the door to the involvement of non-EU members such as the UK and Norway. That could include the launch of an urgently-needed common defence fund.

Amid the EU’s dysfunction and in response to extraordinary geopolitical pressures, it may be that Britain’s best chance of deepening its relationship with its neighbours lies in exploring new forms of cooperation.

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4. Tesla’s Sagging Shares

Alongside Donald Trump, no one has dominated the news headlines over the last few months so much as Elon Musk. The Tesla boss has emerged as one of the most polarising people on the planet as his Department for Government Efficiency wreaks havoc on the US government while Musk himself has embraced Germany’s far right AfD party and picked fights with the British prime minister. But could his political activities be having an impact on Tesla?

Tesla Inc. shares tumbled about 11% this week, weighed down by shockingly bad sales reports from around the world. In Germany, sales plunged last month to the lowest since 2021, and they tumbled in France and the UK as well. The news from China, one of Tesla’s biggest markets, is also bleak. Deliveries fell 11.5% year over year — while the shares of Chinese competitor BYD Co. notched their best week since 2020 as investors cheered an update to its smart-driving technology.

Tesla shares are now down 25 percent from their December high, having nearly doubled after the US election as investors bet that Musk’s political connections would reap dividends for the carmaker. Yet even after this recent fall, Tesla shares are still extraordinarily highly valued compared to the rest of the Magnificent 7 tech stocks. The chart below from Reutersbreakingviews showing Tesla’s share price as a multiple of next year’s forecast earnings compared to that of AI chipmaker Nvidia tells its own story:

As Jonathan Guilford notes, everything may yet work out:

Tesla’s energy storage unit doubled sales. The end of subsidies could fatally weaken competitors. Political favoritism also has its perks, and the company’s self-driving system – if it works – really should be more flexible than what rivals can deliver. AI breakthroughs also herald improved economics for the vehicle technology.

Meanwhile, it is worth noting that Musk’s political connections don’t seem to be harming his other businesses. Last week, Morgan Stanley was able to sell a large chunk of the outstanding debt that it had taken on when it helped finance Musk’s acquisition of Twitter, now renamed X, at a price that all but guaranteed no losses for the bank from the largest portion of X’s borrowings.

Nonetheless, with Tesla shares trading at 120 times next year’s forecast earnings, its a brave investor that bets that Musk’s political connections will outweigh the damage that his political antics are surely doing to the brand.