How did the world come to the brink of a trade war?

A key theme of Donald Trump’s election campaign in 2016 was that American jobs were being lost as a result of unfair global trade. Most commentators thought it was bluster when Trump threatened to impose swingeing tariffs on Chinese goods and to pull the US out of trade deals.

But the US president has kept his campaign pledges. First, he withdrew the US from the Trans-Pacific Partnership, a trade agreement signed by Barack Obama. Then he launched an investigation into China’s alleged theft of American intellectual property rights. In March, he said the US would impose tariffs on imported steel and aluminium. Further action against China has also been announced.

So how big a deal is this?

Potentially massive. The world is currently closer to a full-scale trade war than at any time since the 1930s, when the American Smoot-Hawley tariff prompted a domino effect among other industrialised nations. Many protectionist measures have been introduced since the global financial crisis of a decade ago but, for the most part, they have been small scale. The current tension is far more serious: it involves the world’s three biggest economies – the US, China and the EU – and it is too big to ignore.

The assumption is that Trump is using tariffs to squeeze better trade terms out of China and the EU, and to put the pressure on Canada and Mexico to reform the North American Free Trade Agreement (Nafta). But nobody knows for sure, and the fear is that the US action will damage business confidence at a time when growth is slowing.

There are hopes the fallout could be contained. According to the Dutch bank ING, exports of steel and aluminium to the US make up just 0.3% of worldwide goods exports from the EU and represent a tiny 0.05% of the bloc’s GDP.

But should the situation escalate, the consequences could be dire. Should the US and EU ramp up various tariffs, including on cars, the impact could knock 0.4% from US growth and 0.3% from the EU.

The US has a trade in goods deficit with the EU of about $38bn, with about $78bn exported to Europe from the US, and $116bn going the other way. Should the tariffs be raised by 10% above proposed levels, the OECD has estimated it would reduce global trade by about 6%.

What happens now?

The EU has said it will retaliate by slapping tariffs on a range of high-profile American goods and will start a case against the US at the World Trade Organisation, which polices global trade. If Trump responds to Europe’s countermeasures with fresh action of his own, the conflict could escalate quickly.

What is the impact on consumers?

Consumers are often the ultimate losers from trade wars. Decades of globalisation mean retailers sell goods from all over the world, so higher tariffs on imports could push up the cost of high street goods. Manufacturers would raise their prices to deal with the higher cost of raw materials.

Protecting the US steel industry might help its workers in the short-term, but if the US is unable to make steel as cheaply as foreign rivals have been able to, then American manufacturers would also face higher costs.

The motorcycle manufacturer Harley-Davidson has warned tariffs will probably push up costs for all of its products, regardless of where it gets its steel from, and that retaliation from the EU would have a “significant impact on our sales, our dealers, their suppliers and our customers”.

Alongside motorcycles, the EU has said it could slap additional tariffs on orange juice, whisky and Levi’s jeans, which would hit US exporters and push up the cost of imports for European shoppers.

Should the tit-for-tat escalate further, Trump might choose to impose tariffs on the European car industry – which would hit Germany hardest. Cars worth about $32bn were exported to the US from the EU in 2017 – about five times as large as steel and aluminium exports combined.