What happens when the world’s strongest trade relationship is suddenly thrown into uncertainty? A prevalent topic within recent media that greatly affects the world economy has been Tariffs, specifically those implemented under the Trump administration. An important tariff for students at the Erasmus University Rotterdam has been the 50% tariff on EU exports to the US that was planned to take place. At the end of May, a US trade court ruled that President Trump did not have the authority to impose the sweeping import taxes. A day later however, an appeals court allowed the tariffs to stay in place while the case was litigated. While negotiations are continuing, the tariffs are scheduled to take effect on July 9, 2025. This measure, which targets sectors such as automobiles and industrial machinery, threatens to affect the largest trade relationship globally, a transatlantic trade relationship worth over €1.6 trillion in 2023. As a reference point, that is about 1.5 times the total GDP of the Netherlands, indicating significant economic impact. Beyond its immediate political implications, this development creates large demand for econometricians, needed to model trade elasticity, retaliatory dynamics, and general equilibrium effects that may be needed if the sweeping important tariffs come into effect.
But how do tariffs work? Tariffs are a form of tax that is charged on goods imported from other countries, typically as a certain percentage of the goods value. These tariffs are paid by the companies that bring the foreign goods in and go to the government. For example, in the US, import tariffs would be paid by the American companies importing products from Europe, to the US government. These additional costs incurred by US companies tend to be passed on to consumers. The question is why such a policy, which largely raises prices for American consumers, would even be considered. President Trump states that tariffs will encourage US consumers to buy more American-made goods (as foreign goods become more expensive), increase the amount of tax raised and lead to huge levels of investment. Furthermore, he supposedly aims to reduce the gap between the value of goods the US buys from other countries and those it sells to them. Whether these arguments outweigh the strong effects of staggering prices for consumers is a political question on its own, but this article focuses on the effects of these tariffs on Europe.
In general, a tariff placed on European goods tends to cause US importers to reduce the amount of products they import from Europe, which lowers the revenue earned by European exporters. The specific macroeconomic consequences of Tariffs on Europe depend strongly on the price elasticity of demand for the affected products. For instance, if European automobiles face a price elasticity of -1.5 in the U.S. market, a plausible estimate given empirical literature, a 50% tariff would reduce quantity demanded by approximately 75%. Such a contraction could directly lower annual GDP growth in export dependent economies like Germany.
The question arises whether more complex models can be used to estimate the impact of tariffs. The gravity model of trade provides a potential, robust framework for estimating the broader impact of tariffs. This model, which states that bilateral trade flows are proportional to the economic mass of trading partners and inversely related to trade barriers, was first proposed by Jan Tinbergen, famously the pioneer of Econometrics, Nobel Laureate, and one of the founders of the Econometrics Institute at Erasmus University Rotterdam. Essentially, the model argues that larger economies tend to trade more with each other, and that this trade is negatively influenced by distance (which also represents trade costs like tariffs). Hence, this model argues that increased trade costs, such as tariffs, negatively impacts trade volumes between trade partners. To precisely estimate these effects, careful estimation using panel data techniques, incorporating fixed effects for country pairs and sectoral heterogeneity have to be considered. However, this model provides an econometric framework that can be used to estimate the potential effects of tariffs on the European export industry.
Finally, history suggests that tariffs rarely go unanswered. The European Union has already drafted several retaliatory measures targeting U.S. agricultural and technology exports, which may lead to a trade war. Partial equilibrium models, which are often used in economics to measure the impact of tariffs, fail to capture such consequences. Here, computable general equilibrium (CGE) models which take into account global interactions and interconnectedness may be recommended. Econometric analysis, especially on such a large scale, informs policy trade-offs. With the help of statistical methods, researchers are able to quantify the costs of potential trade wars relative to cooperative trade regimes. Hence, while econometrics cannot resolve political disputes, it can significantly aid in policy making through more accurate cost estimates.
As July approaches, the necessity of data backed policies grows stronger, increasing the need for Econometric models. In a world with growing geopolitical tensions, the use of econometrics on a larger scale is becoming increasingly evident. The 50% tariffs that the Trump administration aims to place on European imports into the US has the potential to have detrimental effects on both the economies of the EU and that of the US. Whether the EU should retaliate, and whether president Trump's intentions end up outweighing their own costs associated with these sweeping tariffs, is a question that only an econometrician can estimate.