Import tariffs and competition

Paul de Bijl, Chief Economist at the Netherlands Authority for Consumers and Markets (ACM)

The recent U.S. tariffs mark a turning point in global trade. Leaving the impact on economic growth and inflation aside for now, I will discuss how these tariffs affect competitive dynamics. What could be a smart strategy for Europe from a competition and innovation perspective?

Impact on competition and innovation

The fewer barriers there are, the greater the potential market is on which businesses compete with one another. That is good for what economists call 'competition on the merits': businesses gain market share by outperforming competitors – in terms of quality, costs, or service, not as a result of artificial protection.

Businesses need to perform, just like athletes. They are constantly training, improving their tactics, and upgrading their equipment. Businesses that also compete internationally know this all too well. Joseph Schumpeter called it 'creative destruction': a process of constant renewal since competitors are forced to make room for more innovative newcomers. That dynamic stimulates investments to create new ideas. Consumers subsequently benefit from new products and services, quality improvements, and price reductions. In addition, a larger playing field offers a greater earning potential for successful innovations.

The U.S. tariffs disrupt that process. They are tearing apart a trans-Atlantic trade area. That reduces competition on U.S. markets. Businesses gain protection against foreign competitors, not because they are better, but thanks to an unlevel playing field that hinders foreign competitors.

The protection against foreign competition has an upward effect on prices in the U.S., and reduces pressure on U.S. companies to innovate. The rationale for the tariffs seems to be that businesses that export to the U.S. should move production to the U.S. However, that will take time and it will be costly, due to, for example, duplicating production capacity as well as reducing economies of scale. European companies for which the U.S. is a key market need to come up with a makeshift solution on the double. In some cases, that will indeed amount to setting up a production line in the U.S., but also searching for other markets or reorganizing the value chain.

Strengthening competitiveness

The tariffs will destroy a lot of things, but not in a Schumpeterian sense. Instead of freeing up resources for more-productive uses, trade barriers impede competition and innovation.

The question of whether or not the EU should give the U.S. a taste of its own medicine reduces these complex dynamics to a binary narrative: who blinks first? Who makes the most concessions? A counter-response of imposing similar tariffs on U.S. imports will raise prices in Europe as well, without necessarily increasing our innovativeness – on the contrary. We cannot let ourselves be pushed around, but having both sides impose retaliatory tariffs will leave us worse off as well.

What would a smart strategy be like from a competition and innovation perspective? A different way of responding is diverting your opponent’s force rather than confronting it directly, and, in that process, strengthening your own position. Like in aikido and judo. In real-world terms: by implementing the recommendations made in the Draghi report (2024) on European competitiveness. This implementation can follow a dual-track approach.

First, by fully committing ourselves to the development of innovative ecosystems within the EU, with dynamic cross-pollination within value chains, and, of course, based on robust European coordination and guidance. Since the EU has, rightly so, worked on regulation of the digital economy (including the DMA and the DSA), it is high time we lay the groundwork for European counterparts to the big tech firms. Think of the EuroStack-pitch for a European digital value chain rooted in our own infrastructure, for example in cloud computing.

Second, by removing existing trade barriers within Europe. Having a common European playing field will partially compensate for the fragmentation outside that playing field. According to the IMF, our internal barriers are comparable to a tariff of approximately 44 percent on goods and 110 percent on services – compared with an effective tariff of approximately 3 percent on imports from outside the EU. Removing these internal barriers will clear the way for innovative, cross-border industrial clusters, as well as for scaling in the case of success.

Strategic autonomy

Tariffs fragment the playing field at the cost of Schumpeter’s process of creative destruction, that is, at the cost of innovation. It is tempting to retaliate, ultimately hoping to end up somewhere in the middle. As logical as that may seem, it may be smarter to improve Europe’s innovativeness and smoothen out the remaining barriers on our own playing field. That would be beneficial for us while it also boosts our strategic autonomy. Thus, we reduce our dependency on major tech firms outside of Europe at the same time. It also creates more stability in an era of uncertainty, rather than fueling it even further.

We have to face the reality of U.S. tariffs. In any case, it is uncertain whether concessions or retaliations will change much to the U.S. policy. Moreover, their tariffs are particularly expensive for them, and even more so if Europe fully commits itself to strengthening its own competitiveness and innovativeness. While the implementation of the Draghi report does not seem to be moving fast, let the U.S. tariffs be the trigger for going full steam ahead.

A modified version of this blog was published on fd.nl (in Dutch).