For decades, the rest of the world, especially China and European countries, have produced far beyond their consumption, selling goods to the United States in exchange for a growing dollar. This happens because the U.S. consumes far more than it produces, swallowing up the differences in the form of persistent trade deficits and using debt to fund these deficits that Chinese and European investors are happy to buy.
President Trump is reluctant to accept this situation. His administration accelerated what my colleagues and I said in investment management firm Bridgewater Associates, a shift in modern mercantilism: a threat to national wealth and strength from the trade deficit.
Mr. Trump and many of his supporters believe that the ongoing trade deficit has put the United States in dangerous dependence on other economies, put national security at risk and undermine stable middle-class work. This is the main reason why he imposes tariffs and adopts other policies for today’s headlines.
Although modern mercantilist policies aim to deal with all American competitors, they pose a particularly serious threat to Europe's economic engine. If the United States is reluctant to continue experiencing a huge trade deficit, it means that everyone else can produce more “pie” than they consume.
However, this challenge may ultimately drive the urgent need for change and economic revitalization in the region. After Mr. Trump’s recent actions and comments on Ukraine, Europe suddenly realized that it could no longer rely on the United States for security. The region also needs to admit that it cannot rely on the United States to achieve economic stability.
In this trade conflict, the United States has the upper hand in the trade conflict because it currently encounters a huge trade deficit. It imports more to tariffs than exports, and if U.S. companies increase domestic investment and bring supply chains home, there will be more gains.
This is contrary to the positioning during the Great Depression trade war, which began in 1930's Smoot-Hawley Tariff Act. The United States was the United States that operated a trade surplus at the time and was therefore more vulnerable to tariffs and trade protectionist measures.
As tariffs intensify, every country that makes a surplus with the United States will find it more difficult to sell its products in the United States, but European products will suffer the greatest pain because their most important industry is the one in which China has established its greatest advantage.
China has maintained a modern mercantilist belief for decades and has used government tools to subsidize the industry for many years, which is strategically important and has suffered huge losses along the way. Sometimes, it supports production much higher than the market demand level.
After decades of government-backed technological advancements, China is a strong competitor: automobiles, advanced industrial machinery, electrical equipment and equipment; not to mention areas that Chinese policymakers reward, such as artificial intelligence. As a result, Chinese companies are in good shape and can capture the largest available trade surplus.
Europe, on the other hand, will find itself increasingly squeezed, the United States is unwilling to absorb the products it produces, and any still open exports that China competes with in Europe and in smaller countries.
The European automotive industry is already feeling this pressure. Foreign electric car manufacturers have disrupted the market, especially Tesla and Chinese companies like Baid, both of which are backed by different levels of government industrial policies until they are profitable. However, European governments have been reluctant to follow the same path and send money to private enterprises; if China takes trade protectionist measures, its desire to protect its automakers from China's competition, and its fear of losing its desire to enter the Chinese market.
A threat to the European automotive industry exists. Investors are so pessimistic about these companies that they suggest they may lose their struggle to survive. If stock prices continue at this downward trajectory, the economic pain of eliminating such an important industry will expand to the rest of the economy, intensifying pressure on European leaders to adopt protectionist and competitive industrial policies.
While the pressure to protect these legacy industries will be enormous, it would be a huge mistake if Europe cannot address what makes its economy so vulnerable in the first place: slow growth in productivity and weak innovation. China has built a competitive power through technological disruption (partially supported by government support), while the United States has outperformed Europe in terms of technological innovation and productivity growth over the past decade. California, for example, has produced a quarter of the global “unicorns” – young companies are worth more than $1 billion, while Germany’s economy is roughly the same, producing only 2%.
Europe lags behind the United States because of its fragile and repetitive regulatory regime, especially in the technology sector, and the strict labor market, making it difficult for companies to hire and fire workers.
These problems are well known. In 2024, the EU was undercriticized in a sober report on its competitiveness led by former Italian Prime Minister Mario Draghi, but it was strong in its recommendations for change.
Some of its proposals, such as nearly $900 billion in public investment in areas such as technology and defense, may be transformative and could address the most serious obstacles to European productivity and innovation. So far, despite the urgent need for action, European policy makers have been unable to implement the recommendations of the Draghi report.
The security crisis in the mainland may eventually take publicity actions. Germany has taken an important step and has forgotten its self-restriction on fiscal policy to make meaningful defense investments. The question is whether Europe will take this opportunity to change its economy more broadly, and whether its leaders will realize they have no other good choices.
