The tit-for-tat tariff escalations between the United States and China would push the world’s two largest economies into a de facto “mutual embargo,” a situation that can only be resolved through face-to-face negotiations, according to Pascal Lamy, a former director-general of the World Trade Organization.
In adapting to the impact of the tariff war, China still needs to boost domestic demand and rebalance its growth model toward increased consumption — something it has not yet succeeded in doing, Lamy told Caixin in a recent interview. He warned that many countries feared Chinese exports will be redirected from the U.S. toward them because of China’s overcapacity.
His remarks came as the U.S. and China locked horns in ongoing trade conflicts, with Washington imposing a 145% punitive tariff on all Chinese imports and Beijing retaliating with a 125% levy on U.S. goods. Despite President Trump’s optimism about striking a trade deal with Beijing within four weeks, both economies are grappling with the fallout.
Lamy predicted that, at some point, the leaders of the two countries will sit down and negotiate a range of issues, including trade, technology and Ukraine, and come to an agreement.
A mutual embargo
Taking into account the current tariff rates, Lamy described the situation as tantamount to a mutual embargo. China’s domestic market cannot absorb the exports originally destined for the U.S., which underscores the need to promote internal circulation rather than rely on export growth.
Asked whether China might divert these exports to Europe, Lamy was doubtful. The European Union wants different goods from those China exports to the U.S.’ “This is normal,” he explained. “International trade is about buying what you need from someone who is better placed to produce it, and China and the U.S. don’t export the same range of goods and services, so there is no real substitution.”
Trump’s desire to solve the U.S. trade deficit with tariffs won't work, he went on, it will only create inflation in the U.S. Erecting a tariff barrier around the U.S. will slow U.S. growth. “The bond market has realized that this is a big problem, so the U.S. Treasury market is down, and Treasury yields are up” ― which drove Trump to temporarily suspend high “reciprocal tariffs” for most countries, except China.
90-day pause
Lamy noted that Trump’s trade war has divided the world into two camps: small countries that have no ability to retaliate, and large economies, such as the EU, China and India, which have the capability to counterattack and negotiate fairly.
The EU has already expressed a willingness to enter negotiations — but only on a win-win basis. “Not a negotiation where one side wins and one side loses — that’s just Trump’s idea of negotiation,” he interpreted.
If a win-win deal is not possible, “then we will retaliate, possibly with tariffs on goods and possibly with higher tariffs on U.S. services, an area in which the U.S. has a huge trade surplus with the EU.”
The purpose of retaliating in this way is to put added pressure on U.S. consumers and investors so they realize they will pay a higher price because of the tariffs imposed on the U.S. economy, he explained.
“This is self-inflicted injury. It’s like taking a gun and shooting yourself in the foot. As long as the U.S. domestic economy is in the spotlight, the purpose of retaliation by other countries is to increase the damage that comes from America’s self-inflicted injury.” Lamy said.
The U.S. has surrounded itself with trade barriers three times in its history: the McKinley Tariff Act in the late 19th century, the Smoot-Hawley Tariff Act in the 1930s and now the Trump tariffs.
The U.S. has a tradition of adopting an isolationist approach, Lamy observed. “It has a long history of psychological, historical and cultural factors when it comes to tariffs ... I don't think it makes sense to try to isolate a large country from the rest of the world. But clearly, that's what Trump is trying to do.”
The WTO without the U.S.
Lamy argued that the WTO must learn to survive without the United States, which is why the EU is establishing an interstate dispute settlement mechanism with other countries.
Since December 2019, the WTO’s Appellate Body has been paralyzed after the U.S. blocked any new appointments, leaving it unable to deliver binding resolutions on trade disputes. The EU has tried to resolve the situation by establishing a multi-party interim appeal arbitration arrangement open to other members.
“We already have two WTOs, one with the U.S. that is not working and one without the U.S. which is,” Lamy said.
Lamy also called for broader reforms for the WTO including stricter discipline on subsidies, the promotion of digital trade, greater powers for the WTO director general to reform the organization.
The U.S. accounts for 13% of the world’s imports,” Lamy noted. “The remaining 87% should join hands and stick to their obligations to the WTO. The U.S. may want to go its own way, but the rest of us must not be contaminated by this.”
Contact reporter Lu Zhenhua (zhenhualu@caixin.com)
