US tariffs: does the EU have a viable alternative?

Brussels – Regardless of the TACO issue (Trump always chickens out), i.e., irrespective of whether or not the US president sticks to his proclamation to apply 30% tariffs on imports of goods from the European Union as of August 1, 2025, it should be noted that the US has a trade deficit of more than $200 billion with the EU. While the current account balance tilts sharply in favor of the European bloc, the balance of payments component, an overall metric that aggregates cross-border transactions in and out of each country, in favor of the US relates to the exchange of services, i.e., intangible asset flows that include consulting, financial, credit and banking intermediation services, as well as professional services such as legal advice and software development. 

Until proven otherwise, the ambitious goal underlying Trump’s protectionist strategy is to make the domestic production fabric more competitive and to steer American consumption towards goods produced by US companies, hoping to increase their competitiveness by shielding them from much of the competition with foreign companies through tariff measures on imported goods. A project that, if ever realized, would transform the world’s leading economy and, until now, a bastion of neo-liberalism, into an island of protectionism in the industrialized world, self-sufficient and oriented towards a development sustained by domestic consumption that could feed the profits (markup) of domestic companies. 

Precisely because closing a hundreds of billions of dollars trade balance gap is an ambitious goal that can only be pursued in the medium to long term – which implies that the Old Continent is likely to continue to realize trade surpluses vis-à-vis its largest trading partner for a long time yet, even with the possible application of tariffs – the most effective tool available in the ‘toolbox’ of the EU budgetary authorities, i.e., the European Commission and the governments of the member states, is not counter-tariffs, such as reciprocal ones with the US or more targeted ones on steel and aluminium that the EU would is preparing to adopt if it fails to sign a trade agreement with the US on acceptable terms through negotiations – but instead controls on capital flows. 

In fact, according to the definition given by the World Bank in its excellent dataset, the net financial account is the inverse of the sum of the balances recorded on the current account and the capital account. This implies that a country that runs trade deficits with other partner countries must necessarily finance them – to rebalance its balance of payments with the rest of the world – through surpluses on the financial transaction account. This means investing in assets such as foreign stocks and bonds or by taking advantage of favorable tax regimes, such as Ireland, Cyprus, and Luxembourg in the EU context, by establishing branches and subsidiaries of domestic companies that generate profits in countries that apply low corporate income taxes, or no net wealth tax on the net assets of companies following the adoption of the Global Minimum Tax of 15%, and then transferring this capital back to the parent company. According to data from the International Monetary Fund, the EU-US bilateral financial balance, as measured by foreign direct investment, is nearly balanced. In contrast, the EU had a surplus in the financial investment account of $70 billion in 2023, which is relatively small compared to the proportions of its trade gap with the US. It is therefore a narrow and easily bridged gap, to the extent that in the previous year (2022), the US was in surplus on financial transactions, claiming a preponderance of assets over liabilities owed to overseas countries, with a surplus of approximately $49 billion.

Indeed, the EU’s attitude must continue to be constructive and open to dialogue in this trade cold war scenario, to secure the most cost-effective deal possible. However, negotiators should be motivated by the realization that two factors are potentially the most credible deterrents capable of dissuading Trump: 1) renewed turbulence in the financial markets – namely, the risk of a global recession – with the stock market volatility having returned, a few months ago, to levels comparable to the years to which the last global shocks date (2008 and 2020), especially following Liberation Day, on April 2, 2025, the day on which the tycoon announced his protectionist strategy based on the implementation of tariffs. Market reaction to the latest announcement of 30% tariffs on EU exports to the US as of August 1 was more muted probably in the light of market skepticism on the actual implementation, at least in these proportions, of the announced tariffs, a perplexity certainly fueled by the numerous announcements and as many postponements and reversals of course by the US President on tariff policies; 2) the EU and the US are each other’s largest trading partners and the total volume of their bilateral balance of payments, i.e., the total value of their trade in goods and services, amounts to almost €2 trillion according to Official Council Data and the European Commission, accounting for as much as 30 percent of world trade in goods and services.

This second factor is crucial, as it implies that the European bloc can stem the new US protectionist drift by opting for the right instruments, even without coalescing with other economies. While counter-measures would be measures of limited effectiveness, as the balance of payments, especially the current account (trade) balance, hangs sharply on the EU side, it is on services, investment, and capital flows that the balance is much more balanced. It is on that component of the balance of payments that the EU could really hit its trading partner. Given the size of the current account imbalance primarily in favor of the Old Continent, the EU is likely to continue running trade surpluses against the US for a long time to come, so the latter will necessarily have to continue financing them. Responding with controls on capital movements, whether in the form of actual limits on flows or preventive measures such as the introduction of wealth taxes and higher taxes on corporate profits, could significantly tighten the conditions of external debt financing for the US government.

If protectionist measures were to be implemented, they should be met with retaliatory protectionist responses, rather than symmetrical ones, such as countervailing tariffs. However, according to the interpretation underlying this article, such responses should be strategic and targeted, rather than symmetrical, such as capital controls. The EU should also adapt its economy to face the challenges arising from the new global trade order by concluding new trade agreements with other partners and striving to equip itself with a more competitive economic structure, thereby also enhancing its competitiveness in exports. It would be possible to achieve this by loosening the budget constraints the euro area imposes on itself for investments, especially public investments with high multipliers, including those in terms of productivity. This would mean excluding capital expenditure from the calculation of the budget deficit within the framework of the Stability Pact. Such expenditure, not current spending, includes funds allocated to education, research and development, and economic incentives to companies to unlock private investments in physical and human capital (innovation, modernization of production factors, and training of workers). A productive economy is less vulnerable and can also cope much more effectively with tariffs.