U.S.-EU Trade Tensions: Causes, Consequences, and Possible Cures

CRS Report for Congress
U.S.-EU Trade Tensions: Causes,
Consequences, and Possible Cures
Raymond J. Ahearn
Specialist in International Trade and Finance
Foreign Affairs, Defense, and Trade Division
The United States and the European Union (EU) share a large and mutually
beneficial trade and investment relationship. Given a huge volume of commercial
interactions, trade tensions and disputes are not unexpected. In the past, periodic
episodes of rising trade tensions and even threats of a trade war have been followed by
successful efforts at dispute settlement. This ebb and flow of trade tensions has
occurred again this year with highly publicized disputes involving steel and tax breaks
for U.S. exporters. Both disputes have been characterized by mutual feelings that the
other side has taken actions that are unreasonable and inconsistent with the rules of the
World Trade Organization (WTO). Moreover, both Washington and Brussels have
played hardball in crafting retaliation lists aimed at influencing each other’s domestic
political process. While fears of an all-out trade war usually are exaggerated, the trade
disputes may impede U.S.-EU cooperation in other areas. A number of ways have been
suggested to diffuse current trade tensions including greater reliance on compensation
as opposed to retaliation and greater emphasis on diplomatic as opposed to legalistic
solutions to disputes. While potentially helpful, the fact that some of these high-profile
disputes have been unresolved for decades suggests the difficulty of finding permanent
solutions. Congress has a strong interest in these disputes and plays a significant
legislative role, particularly on the export subsidy issue. This report will be updated as
events warrant.
The United States and European Union (EU) are parties to the largest two-way trade
and investment relationship in the world. Annual two-way flows of goods, services, and
investments now exceed $1 trillion. While only a tiny fraction of these interactions lead
to disputes, the dominant role that both economic powers play in the world economy1

makes settlement of the disputes particularly important.
1 For background, see CRS Report RL30608, EU-U.S. Economic Ties: Framework, Scope, and
Magnitude, by William H. Cooper, and CRS Issue Brief IB10087, U.S.-European Union Trade
Relations: Issues and Policy Challenges, by Raymond J. Ahearn.
Congressional Research Service ˜ The Library of Congress

U.S.-EU trade tensions have ebbed and flowed in recent years. During the summer
of 2000, the two sides bickered over the EU’s discriminatory policies affecting imports
of bananas and beef treated with hormones. The United States imposed 100% tariffs on
about $300 million of mainly luxury items such as Danish ham, truffles, Roquefort
cheese, and Italian handbags. The EU countered by successfully challenging in the WTO
a U.S. tax benefit for export sales known as the Foreign Sales Corporation (FSC) – now
known as the extraterritorial income exclusion or ETI.
With the onset of the Bush Administration in 2001, cooperation began to supercede
confrontation. Pascal Lamy, the EU Commissioner for Trade, and Robert Zoellick, the
U.S. Trade Representative, reached agreement on the banana dispute and U.S. retaliatory
tariffs associated with bananas were lifted in April. The two sides agreed to disagree on
the hormone dispute, and the EU consented to provide the United States more time to
bring its tax law in conformity with its WTO obligations. Moreover, Lamy and Zoellick
collaborated to launch a new round of WTO negotiations last November in Doha, Qatar.
Last year’s lull in trade threats was broken on March 5, 2002 when President Bush
announced his decision under Section 201 of the Trade Act of 1974 to impose fairly
steep, albeit temporary, tariffs of up to 30% on approximately $8 billion in steel imports.
Canada, Mexico, Israel, and Jordan – countries that have a free trade agreement with the2
U.S. - were exempted from all tariffs.
The President’s decision to rely on a trade remedy and to impose the tariffs in a
selective fashion raised cries of indignation and protectionism from European leaders, and
prompted a quick response. On March 27, 2002, citing a threat of diversion of foreign
steel from the U.S. market to Europe, the EU announced provisional tariffs of 15% to
26% on 15 different steel products. The EU also immediately moved to challenge the
U.S. action under the general WTO dispute settlement rules and, more provocatively,
under a never tested provision of the WTO Safeguards agreement. Under the latter
provision, the EU claimed that it may impose retaliatory sanctions on the U.S.
immediately (rather than wait up to three years for a WTO dispute settlement ruling) if
the U.S. does not agree to compensation.
To date Brussels has delayed implementing its threat of early retaliation because the
Bush Administration has moved to exempt much of European steel shipments to the U.S.
But if the EU decides on swift retaliation rather than waiting for the WTO to rule on
whether the U.S. steel tariffs are a violation of world trade rules, U.S. trade officials will
be under great pressure to retaliate against the retaliation. This situation is further
complicated by the August 30, 2002 WTO ruling that the EU is entitled to retaliate
against $4 billion in U.S. exports in the ETI tax break case. While the EU is preparing a
retaliation list for U.S. exports that could be subject to punitive duties, EU officials have
stated they are still willing to give the United States more time to change the tax laws that
are at the heart of the dispute.

2 For background, see CRS Report RL31107, Steel Industry and Trade Issues, by Stephen

Escalation of U.S.-EU trade tensions in the first half of 2002 was spurred by three
inter-related factors. First, each side viewed actions the other had taken as unreasonable
and motivated by narrow political considerations. Second, each side saw the other
skirting WTO rules and shirking WTO obligations. Third, each side believed that the
other was playing political hardball in crafting retaliation lists that clearly attempted to
influence internal political deliberations.
Narrow political actions. Balancing divergent domestic and foreign goals – a
strong domestic economy, responsiveness to domestic political interests, promotion of
an open world trading system, and fostering strong relationships with key allies – is part
of trade policy decision-making. When decisions are skewed toward achieving one of
these objectives, controversy often ensues. In this context, the Bush Administration’s
steel decision was viewed as unreasonable by many Europeans who saw it as driven
primarily by narrow domestic political calculations, not broader domestic economic or
foreign policy interests. Whether valid or not, many Europeans believed that the decision
was motivated by electoral considerations. Moreover, many Europeans were incensed
by the discriminatory manner in which the tariffs were implemented, targeting the EU
hardest and excluding countries that have a free trade agreement with the United States.
On the contrary, Washington was irked by EU actions that appeared to have narrow
political motivations of another kind. The EU’s decision to challenge a provision of the
FSC-ETI export tax benefit is a case in point. While the FSC was enacted in 1984, the
EU did not challenge the provision until November 1997. Many on the U.S. side suspect
that the challenge had much to do with an attempt by the European Commission to gain
negotiating leverage over the United States, as well as with getting even for U.S.
pressures over beef and bananas. The fact that few European companies were
complaining about the tax break as disadvantaging them commercially further suggests
a calculated political motive for launching the case.
Skirting WTO rules. The aggressive EU reaction on steel was related, in part, to
its belief that the U.S. action violates numerous WTO rules. An essential element of the
EU’s complaint is that its steel exports to the United States declined by 33 percent
between 1998 and 2001, and that the WTO Agreement on Safeguards permits temporary
restrictions on imports only when imports are increasing. EU officials also questioned
whether the U.S. decision adequately links the remedy to the actual level of injury caused
by imports as opposed to other causes. In addition, they were skeptical that the U.S.
decision to exclude its free trade partners from the tariffs was permitted under the most-
favored nation principle of the WTO.
U.S. officials argued that EU concerns about whether its steel action complies with
its WTO obligations should be determined by a formal WTO dispute settlement panel–
a process that normally takes up to three years. But the EU maintained that the WTO
safeguards agreement allows it to adopt countermeasures immediately because the
United States did not show an absolute increase in imports over the most recent three year
period. Accordingly, the EU argued that it is entitled to retaliate on about $320 million
worth of U.S. exports. U.S. trade officials responded that any immediate unilateral
retaliation against the United States would be unprecedented in the history of the WTO
and would “strike at the heart of the multilateral trading system.”

Retaliation and domestic politics. The WTO permits retaliation (imposition
of very high tariffs on a trading partner’s exports) when recalcitrant governments fail to
comply with dispute panel rulings against them. While used sparingly, both the United
States and EU have imposed or threatened retaliation in ways that have sparked a raw
nerve on both sides of the Atlantic.
When the Clinton Administration levied retaliatory tariffs on European exports over
the banana and beef hormone disputes in 2000, the hope was that the Danish, German,
Italian, and French exporters affected by higher prices would lobby their respective
governments to change the EU policies that were in violation of WTO rules. While some
of the “targeted producers” did lobby to change the policies, the retaliation may have
stiffened the resolve of other Europeans not to give in to U.S. pressures. This is because
many Europeans view retaliation as a frontal assault on European unity – an effort to set3
one Member State off against another in an attempt to influence EU decision-making.
Despite its condemnation of retaliation as a trade weapon, the EU in the aftermath
of the Bush steel decision emulated previous U.S. efforts and devised retaliation lists
(one to be used under the Safeguards provision and one to be used under the Dispute
Settlement provision) with domestic political considerations in mind. The EU lists include
products from regions such as citrus from Florida, steel from the mid-west, and textiles
from North Carolina that are considered politically important to President Bush. Leaving
no mistake about intent when he released the list, EU Trade Commissioner Pascal Lamy
expressed hope that the threatened countermeasures would help persuade the U.S.
Administration to lower its steel barriers.
On the one hand, the good news is that U.S.-EU trade disputes are unlikely to get
out of hand. Some disputes may even facilitate greater trade liberalization,
competitiveness, and industrial restructuring over time. On the other hand, the bad news
is that the current tensions and mutual recriminations may make U.S.-EU cooperation in
other areas more difficult, and they clearly threaten the viability of the WTO trading
Good News. An all-out trade war between the two sides appears remote due to
domestic political opposition and the high level of economic integration that now exists.
As retaliation hurts consumers, retailers, and companies dependent on “targeted” products
for inputs into their production processes, these groups lobby Brussels and Washington
intensively to keep specific products off any retaliation list that may be drawn up.
Moreover, given the huge stake each side has in the other’s market through direct
investments and merger and acquisition activity, both European and American
multinational companies (MNCs) serve as powerful lobbies that caution restraint. Any
imposition of across-the-board and high trade barriers could create massive disruptions
in the worldwide production arrangement of MNCs and also deflate economic activity on
both sides of the Atlantic. An estimated 60% of U.S.- EU trade is accounted for by intra-
corporate transactions. These factors, in turn, limit the scope and flexibility that U.S. and

3 For background, see CRS Report RS21185, Trade Policymaking in the European Union, by
Raymond J. Ahearn.

EU trade officials have in devising a politically acceptable retaliation list or in imposing
across-the-board and high trade barriers.
Selective trade disputes may have consequences that some view as positive. For
example, President Bush’s decision to raise steel tariffs reportedly was motivated in part
to enlist the support of legislators from steel producing states for passage of Trade
Promotion Authority (TPA) legislation. USTR Zoellick argued that the President’s
willingness to raise tariffs was a short term necessary step for obtaining the leverage TPA
may provide for negotiating new sweeping trade liberalization agreements later on. In
addition, the Bush Administration argued that higher U.S. tariffs would help spur
international negotiations to facilitate the restructuring of the steel industry worldwide.
Regarding the export subsidy case, the WTO challenge may serve as a prod for
consideration by the Administration and Congress of a fundamental restructuring of the
corporate tax structure.
Bad News. Escalating trade tensions, however, are not cost-free. Polls indicate
that trade disputes likely have some effect on public attitudes, contributing to a perception
of each other as inward-looking, egotistical, and hypocritical free traders. Trade tensions
and mutual recriminations may also make cooperation in other areas more difficult. This
includes efforts to settle other trade disputes if media and public pressures intensify for
linking disputes. Most assuredly it also includes efforts to make quick progress in the
recently launched Doha Round of multilateral trade negotiations. Transatlantic trade
tensions over agriculture, for example, stalled progress on the Uruguay Round of trade
negotiations for several years in the early 1990s.
What impact trade tensions may have on cooperation on broader foreign policy
issues, such as the war on terrorism, remains uncertain. But high profile trade disputes
are likely to raise sharper and more critical questions concerning the benefits of such
cooperation. If trade tensions work to undermine the notion that the United States and
Europe share common values or lead to a view that a weaker America or a weaker Europe
is in the other’s interest, then the consequences could be more significant.
The most serious consequence of escalating trade tensions may be the strain placed
on the WTO system itself. As the EU and U.S. are the WTO’s two biggest parties and
most important leaders, their relationship and example are critical to the smooth
functioning of the multilateral trading system. When either party does not comply with
WTO obligations, acts unilaterally, or uses the dispute resolution system to score political
points, the WTO-centered world trading system arguably suffers.
Possible Cures
Several cures or recommendations to ameliorate current trade tensions have been put
forth. These include greater reliance on compensation (as opposed to retaliation), and
greater emphasis on diplomatic as opposed to legal solutions to disputes. While helpful,
the fact that some of these high-profile trade disputes have been on-going in one form
or another for several decades suggests how difficult dispute resolution can be.
Compensation Instead of Retaliation. When a country refuses to comply with
a final dispute resolution ruling, the primary enforcement mechanism is WTO authorized
retaliation. Many observers maintain that the system should place more stress on trade

compensation in order to limit the negative consequences of retaliation. Trade
compensation would require the defending country to open other markets in
compensation for the markets it restricts. Instead of restricting trade, compensation
would bias dispute resolution towards lowering trade barriers - the essential goal of the
The hurdles to greater reliance on compensation are both political and legal. In the
steel safeguards case, for example, if the United States were to reduce tariffs on textile
imports as compensation for raising tariffs on steel, one industry would be asked to “pay”
for another industry’s protection. Moreover, payment of compensation before the WTO
rules whether the U.S. steel safeguard action was imposed consistent with WTO rules
could be viewed as admission of wrongdoing.
Greater Emphasis on Diplomatic Solutions. The U.S. and EU are the
heaviest users of the WTO dispute resolution system. Some of the disputes between the
two sides have been submitted to a WTO panel for resolution without strenuous efforts
at resolving the dispute beforehand. Some disputes arguably have been initiated out of
a desire to score political points by winning cases that show the other side in technical
violation of WTO provisions. Once the dispute panel is formed, neither side is inclined
to seek a negotiated solution out of fear of compromising important principles and
obtaining a ruling on who is “right” or “ wrong.” In the process, numerous disputes have
become acrimonious and have hurt the credibility of the WTO as an institution.
To deal with problems accompanying a confrontational approach, many observers
have emphasized the desirability of greater reliance on a diplomatic approach that stresses
conciliation and problem-solving over legal precision. In a sense, this is the route U.S.
trade policymakers may be taking in the steel dispute by offering selective EU member
states favorable consideration of their exporters’ requests that specific products be
exempted from U.S. steel tariffs. As of mid-August 2002, the Bush Administration had
exempted around $600 million out of $2.3 billion of steel from European producers
affected by the tariffs. Exemption from U.S. tariffs, in turn, has helped shore up
opposition in member states such as Germany, Sweden, and Great Britain to precipitous
EU retaliation. While the EU in July 2002 agreed to postpone until September 30, 2002
a decision on the threatened retaliation, most observers feel that the high level of
exemptions granted European producers to date undercuts the support for early retaliation
Another form of diplomacy may be helping resolve the export tax subsidy dispute
– a dispute where the EU has repeatedly emphasized that it does not want to retaliate
against the United States, but rather wants the United States to comply with the WTO
panel ruling. To show good faith that it is moving in that direction, Chairman William
Thomas of the House Ways and Means Committee on July 11 introduced H.R. 5095, a
bill that reportedly would bring U.S. tax benefits for exports into conformity with WTO
rules. While the legislation has been opposed by some of the largest beneficiaries of the
tax benefit, the WTO ruling authorizing retaliation will strengthen the pressures for
finding a consensus approach. Yet, because a number of Senate leaders are calling for
the formation of a “study group” to reach a consensus, a legislated tax reform “fix” is
unlikely to pass Congress this year. In the process, EU patience may be tested although
the threat of retaliation may limit U.S. trade pressures on other disputes.