How Europe can avoid a trade war in a 2nd Trump term

• Europe's economy could be negatively impacted by Trump's proposed tariffs, economists say.
• They say the EU will need to employ some retaliatory measures but has to be careful not to escalate.

The US stock market has cheered the pro-business agenda that Donald Trump has promised in a second term, but policymakers in Europe are bracing for potentially tough four years ahead as the President-elect looks poised to potentially set off a new trade war.

Trump has championed tariffs as a key protectionist policy to boost his "America first" agenda, proposing sweeping tariffs of 10%-20% on all countries and 60% on goods from China.

Europe appears particularly at risk from the impact of tariffs amid an already fragile economy, experts said.

Germany's central bank president Joachim Nagel says the tariffs could cost the country 1% of its GDP, causing it to possibly slip into negative growth next year, while both French President Emmanuel Macron and former Italian Prime Minister Mario Draghi have warned the US and Europe are barreling toward a trade war.

Goldman Sachs said recently the tariffs could cost the whole euro area a 0.5% hit to real GDP, with the bulk of the downturn likely to be felt next year.

Economists and analysts said that in order to avoid a trade war, policymakers in Europe need to employ a specific playbook to mitigate the economic drag while keeping trade tensions in check.

Retaliatory tariffs, but at a smaller scale

According to Andrew Kenningham, chief European economist at Capital Economics, the European Union will likely need to retaliate, though not in exactly the same way as the US.

Kenningham says the EU will likely hit the US with targeted tariffs on certain industries, rather than an across-the-board action.

"It would probably impose targeted tariffs on products of symbolic or political importance rather than an across-the-board tariff and probably on a fairly modest scale," he wrote in a recent note.

It wouldn't be the first time the EU has employed such measures. Kenningham points to the EU's use of item-specific duties on US imports, like Harley Davidsons and bourbon whiskey, after Trump employed tariffs on steel and aluminum from the EU during his first term in 2018.

Those retaliatory tariffs were worth less than half those imposed by the US at the time, but worked to soften the blow without instigating further tensions between the US and Europe, he said.

This time around, any retaliation will have to strike a similarly smaller blow than the actions from the US, Kenningham said.

"They want to de-escalate, rather than escalate any trade conflict," he told Business Insider.

Trade deals to avoid tariffs

Kenningham said EU policymakers could also negotiate a deal to avoid US tariffs. The European Commission could pledge to purchase certain commodities from the US in greater quantities in exchange for an exemption from tariffs, similar to how the commission negotiated over purchases of liquefied natural gas and soybeans in Trump's first term.

Kenningham says the commission doesn't have total control over actually implementing these trade deals, though, so it's unlikely Trump would opt to go that route again.

Alternatively, the bloc could strike a deal to purchase more defense equipment from the US to continue supporting Ukraine as the US appears likely to scale back, Kenningham added.

Match the US's lean away from China

Another option would be for the EU to try and side with the US in its trade war with China, Kenningham says, referring to Trump's proposals for 60% tariffs on good from China.

That could mean further barriers to imports of Chinese electric vehicles, as well as more curbs on investment from Chinese firms in Europe, he says.

That plan could face pushback from Germany, though, since China is a big market for its stumbling auto industry.

"The automotive sector is frontline. German car producers are extremely exposed to the Chinese market," the Brookings Institution's Carlo Bastasin said, adding, "The automotive sector is undoubtedly vulnerable. It's already going very, very badly."

But the EU may not have a choice, Kenningham said.

"Admittedly, the EU will not want to drastically cut ties with China," he wrote. "But policymakers may be forced to move more rapidly if faced with strong US pressure."

In reality, some version of all of those potential actions will likely come into play, Kenningham added.

For now, trade experts say it's still unclear when—and how much—Trump will raise tariffs on the EU.

Bastasin doesn't expect tariffs as high as Trump has threatened, and thinks they will fall closer to 5%, which isn't a sizable increase from the 3% tariff average reached under his first presidency.

Still, he warned that any drastic actions from the US could pose long-term risks to the relationship between the two powers.

"There is a possibility that if the strategy toward Europe is very aggressive, Europeans may change attitudes toward the Transatlantic Alliance. I don't mean NATO, but on traditional friendship and cooperation," Bastasin said.