American Roulette Trump Tricks Trade Partners into Dangerous Game

Donald Trump has issued a new ultimatum in his tariffs dispute with the European Union. Although his strategy may appear erratic, it has its own logic. Things could get dangerous if the EU decides to play his game.

Donald Trump is extremely familiar with gambling. Before becoming the president of the United States, Trump was a real estate magnate with casino properties in gambling cities like Atlantic City, Las Vegas and elsewhere. And he's never dropped the gaming mentality. Indeed, playing his foes against each other is what got him into the White House in the first place.

In the dispute over steel and aluminum tariffs, Trump proved again this week that he sees politics in much the same way as he does casinos: as a big game in which he wants to write the rules and be the croupier at the same time.

Trump already abandoned the playing field of the World Trade Organization (WTO), with its clear provisions for tariffs and procedures for resolving disputes, back at the end of March. At the time, he threatened the European Union and other trading partners with high tariffs on steel and aluminum if they didn't voluntarily reduce their exports to the U.S. He issued an ultimatum, which he extended by a month this week.

Trump is also using the carrot-and-stick approach in his relations with China. He ultimately threatened billions in tariffs against the country, but then dispatched a delegation this week to negotiate with Beijing. The president has disparaged the WTO, but his administration has also lodged its own complaints with the WTO's dispute settlement court as part of his trade tiff with adversaries.

As erratic as all that may seem, it would be inaccurate to view Trump's activities as irrational. Economists often use game theory to explain why countries sign trade deals and establish rules -- and why they then break them. It can also be used to explain Trump's behavior. "Trump's economic premises may be wrong, but going by his own logic, he is playing the game skillfully," says Christian Rieck, a game theory expert at the Frankfurt University of Applied Sciences.

The president's declared goal is that of reducing the U.S. current account deficit from its 2017 level of more than $466 billion. In particular, the U.S. imports more goods from places like China, Japan, Germany and the EU than it exports in return.

Sowing Discord

The sources of the trade deficit are varied and complex, but Trump is intent on addressing the problem primarily via trade policy. He wants to force his partners to lower import tariffs for products from the U.S. or to limit their exports to America through quotas. To achieve that, Trump is sowing discord among trading partners and he is attempting to negotiate bilaterally, thus undermining the WTO.

From his perspective, Trump has already scored some preliminary victories. South Korea and Argentina have announced they will limit their steel exports to the U.S. while Australia and Brazil could soon follow suit. For its part, the EU is divided over how it should proceed with Trump -- with Germany and France, in particular, proving difficult. Chancellor Angela Merkel and President Emmanuel Macron represent different interests, something that even German members of the European Parliament find irksome.

"We need less Merkel and Macron when it comes to trade issues and more Malmström," says Daniel Caspary, a trade expert with the conservative Christian Democrats in the European Parliament. Cecilia Malmström is the European commissioner for trade and she is prone to remain tough in her position toward Trump. She is also eager to remain within the framework of the WTO, whose authority the U.S. president has directly questioned.

This development isn't without irony. It was largely the United States that initiated the General Agreement on Tariffs and Trade (GATT) after World War II and later the WTO. It enabled the U.S. and other countries to escape a dilemma they were facing. "It's the prisoner dilemma that explains the existence of the WTO," says Gabriel Felbermayr, director of the ifo Center for International Economics in Munich.

Under this game theory model, two prisoners who have been accused of a crime committed jointly are interrogated separately. If neither says anything, then they are both convicted and sentenced to shorter jail sentences for smaller, provable offenses. If only one confesses, then that prisoner is freed and the other receives the stiffest sentence. If both confess, then both get stiff sentences, but not the stiffest. The dilemma for the prisoners is that they are unable to coordinate their responses. That's why the rational decision is for both to confess to avoid the maximum penalty. But the two would be in a better position if they had been able to cooperate with each other.

It may also be just as rational for two countries to protect their own economies through tariffs, but if both of those countries make the same decision, then both will fare worse economically than they would have if they had cooperated in ways that could have benefited both.

"The economic dominance of the U.S. in the postwar era can explain why it made sense for the U.S. and most trading partners to support the rules-based GATT system and later the creation of the WTO," says Robert Staiger, an economist at Dartmouth College in New Hampshire.

Researchers have shown that smaller countries can often improve their position in relation to larger trading partners by imposing unilateral import tariffs rather than negotiating an agreement with the larger partner. But if all potential trading partners do the same, then it damages the major trading power just as it does the smaller countries. So, the Americans agreed to a multilateral agreement with rules that place both weaker and stronger countries on equal footing in terms of trade policy.

A Changed Playing Field

But both the playing field and the participants have changed since the founding of the WTO in 1995. Europe has gained economic power, and China's ascent to become a global power accelerated after its became a WTO member in 2001. "At the moment when America lost its hegemonic position, support for the WTO began to erode," Staiger explains.

Trump is now openly attacking the organization. He's trying to convince himself and voters that WTO rules are the reason for the high trade deficit the U.S. has with the rest of the world.

At the same time, political policy can only exert limited influence on this phenomenon. Generally, surpluses and deficits are the product of decisions freely made by consumers and investors. Nobody is forcing Americans to buy cars from Mercedes, Audi or BMW rather than those made by General Motors.

One contributing factor to Germany's export surplus is the German propensity to save their money. Those savings are often invested in the U.S. and act like loans that are then used by the Americans to finance their demand for German products.

Trump himself is also partly responsible for causing the U.S. trade deficit to grow again recently. After providing American tax payers with a multi-billion-dollar, debt-financed tax rebate, he shouldn't be surprised that imports swell as American demand for foreign products increases.

Trump's Game of Chicken

But Trump believes he can lower the deficit by instigating a trade war . So, he's building up pressure against the trade partners he feels are fleecing him, says Rieck, the game theory expert. He says the back and forth on the steel ultimatum has all the hallmarks of a game of chicken. If neither side relents, then it is possible that both cars will be totaled. "In the steel tariffs dispute, to some extent Trump stepped on the gas, but with the extension of the ultimatum, he is applying the brakes -- at least for now," says Rieck. This, he says, has made Trump's threat less credible and it has weakened his negotiating position.

Meanwhile, the other player in this game of chicken is divided over whether it should hit the brakes and yield to Trump or not.

Even if Europeans make an honest effort to demonstrate unity against Trump, the cracks in the façade are visible, especially the differences between France and Germany. The German government has signaled a willingness to accommodate the U.S. by expressing a readiness to talk about the level of the import tariffs on American cars that Trump is lamenting, but the French are not. The reason for the difference is that the automobile industry, and particularly the U.S. automobile market, is of significantly less importance to France than it is for Germany.

The French government also fears a comprehensive restructuring of the trade relationship between the EU and the U.S. Germany, on the other hand, supports reintroducing a stripped-down version of the Trans-Atlantic Trade and Investment Partnership (TTIP), the failed free-trade agreement between the EU and the U.S.

Why? Because whereas Germany has a trade surplus with the U.S. of 50 billion euros, American trade with France is more balanced. In addition, a review of rules affecting the agricultural sector would also be part of a new trade deal between the U.S. and the EU. In the last deal, the French succeeded in closing off their agricultural sector from strong competition.

Finally, France wouldn't be much affected by the steel tariffs threatened by the U.S. because in contrast to Germany, there are very few steel plants left in France.

Brussels Prepares for Trade War

Ultimately, though, neither Merkel nor Macron is sitting in the driver's seat on this issue. EU Commissioner Malmström is responsible for trade in the European single market. And despite the new deadline, she is preparing for a trade war with the Americans. The unadorned room in the European Parliament where the Monitoring Group USA of the International Trade Committee meets has become a kind of "war room." Here, members of parliament hunch over the fine print of lists of possible countermeasures that could be taken by the EU if Trump really does act. The EU's weapons are already known: They range from tariffs on bourbon and go all the way up to Harley-Davidson.

There wasn't any palpable relief on Wednesday when parliamentarians discussed the latest reprieve from Washington with Malmström's staff. Instead, there was broad consensus for standing up to Trump's blackmail attempt. "For the very reason that it is aimed at undermining WTO rules alone, we cannot yield to Trump's pressure," says Bernd Lange, the chair of the International Trade Committee in the European Parliament. On Wednesday, European Commission President Jean-Claude Juncker said virtually the same thing.

Trade expert Felbermayr, however, believes it is still possible that the Europeans might ultimately agree to Trump's logic of bilateral negotiations and, if necessary, also interpret the WTO rules more loosely. For one, they fear the higher costs associated with a trade war in the short run. For another, the costs of an undermined WTO would only become visible down the road. "And thirdly, the WTO and its courts would not work anyway without the support of the U.S.," he says.

The fact that the Europeans may not be able to protect their interests by relying on WTO arbitration could influence the course they choose to take. Trump is currently blocking the appointment of judges to the WTO's crucial appellate body. Three of seven seats are already unfilled and two further judges will depart by the end of 2019. At that point, the body would become incapable of doing its job.

Furthermore, U.S. government is justifying the new tariffs as being crucial to national security interests, thus circumventing WTO rules. It's uncertain whether the EU or China could have any legal leverage over that argument.

A New Trade Regime?

It's possible that the three major economic blocks are cautiously approaching a new trade system that would not be based first and foremost on a global treaty like the WTO, but on bi- and trilateral deals.

One could see it as a game in which players punish another player's violation of the rules by also deviating from the rules in the next round. New tariffs would be answered with countertariffs. "It's a game that could lead to many new balanced situations, also to one in which all the partners realize the best possible situation, meaning cooperative equilibrium," Felbermayr explains. Such a thing is possible, he says, even without a coordinating forum like the WTO.

But the tit-for-tat game that the trade powers may now be playing could also go awry. If, for example, one player doesn't care if it gets punished in the distant future. "The 'good' equilibrium will not be achieved with populists who adhere to a 'Devil may care' philosophy," says Felbermayr.

From the sounds of things, though, such a game can't end well with a gambler like Trump.

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