Goods Tariff vs Digital Services Tax: Transatlantic Financial Market Reactions.

• Author: Bin, Leo

1. Introduction

   Across the US Trump presidency period (years 2017-2020) the world sees a new and dramatic series of global business conflicts, including unilateral punitive tariffs, industry-specific taxes and the associated retaliations from counterparts, broke out as a chain of actions and reactions between the US and many counties/regions in the rest of the world. This event-study research work examines the abnormal return patterns in both equity and currency markets, surrounding a variety of key events associated with the business disputes between two of the largest economies in the world, the European Union (EU) and the United States (US), which jointly accounted for nearly half of the global GDP by the year of 2018 (European Commission, 2018). The transatlantic business relationship has not been easy even before the Trump administration. For example, the Transatlantic Trade and Investment Partnership (TTIP) went on for more than three years and fifteen rounds of negotiations yet ending with no deals when the Obama administration expired in year 2016.

   President Trump has been long claiming his international political plan of "America First" and "Buy American, Hire American." He formally fired his first shot on March 8, 2018, when he proclaimed, under the name of protecting US national security, his presidential executive order of a 25% and a 10% tariff on steel and aluminium imports, respectively. After pairwise negotiating and granting tariff exemptions on steel and aluminium imported from countries such as Australia, Argentina, Brazil and South Korea, the US Commerce Secretary Wilbur Ross announced on May 31, 2018, that such exemptions would no longer be granted to her largest trade partners such as Canada, Mexico or the EU (the no. 1 steel import source to the US), with the proclaimed tariff starting to apply right on the following day June 1, 2018. As retaliations, the EU Commission pronounced a new regulation on June 20, 2018, imposing levies on the worth of [euro]2.8 billion American goods including peanut butters, jeans, whisky and Harley-Davidson locomotives, soon effective on June 22, 2018.

   The initial fight seemed to reach an armistice when EU Commission President Jean-Claude Juncker visited the White House about one month later. On July 27, 2018, both US and EU top leaders jointly announced their agreements upon the key principles to negotiate freer, fairer, and more reciprocal trade, including transatlantic trade cooperation toward the goals of "zero tariffs, zero non-tariff barriers, and zero subsidies" (except for the automobile trade, in which the EU have been earning considerable surplus from the US), increasing US energy exports to Europe, reforming the WTO, etc. Such a sign of compromise and progress provided both the US and the EU with welcoming relief (European Commission, 2018). To carry on the reconciliation momentum, on August 30, 2018, Cecilia Malmstrom, the European commissioner for trade, suggested that Brussels would also accept the dropping of automobile tariffs to zero if Washington agrees to act likewise.

   However, the truce turned out to be short-lived. Not only both US steel and aluminium tariffs and EU retaliatory tariffs remained effective, but also on October 17, 2018 in Brussels, US Commerce Secretary Ross openly expressed the Trump Administration's impatience in the transatlantic trade negotiation: "We really need tangible progress; our president's patience is not unlimited" (European Commission, 2018).

   The EU-US trade dispute in WTO regarding their respective commercial aircraft business can be dated back to year 2004. But on April 9, 2019, President Trump tweeted and then US trade representative Robert Lighthizer announced the plan to impose tariffs on another $11 billion worth of EU goods, based on the WTO ruling against EU's governmental subsidy practice to boost Airbus' commercial aircraft business. The US list of punishment covers European products ranging from aircraft to sweet biscuits, from cheese to wines. Tit-for-tat, on the 17th of the same month Brussels announced her own list of tariffs on $20 billion US goods, also based on the WTO ruling against US's governmental subsidy to Boeing. EU's countermeasures targeted US products from aircraft to chemicals, from citrus fruit to ketchup. Starting October 18, 2019, per WTO authorization the US implemented tariffs on EU goods of $7.50 billion per year; and on October 13, 2020, the WTO also authorized the EU to do the same on US goods of $3.99 billion per year, which officially became operative since November 10, 2020.

   During his re-election year, President Trump also repeatedly attempted to open a new battlefront in EU automobile tariffs. On January 22, 2020, he threatened to impose tariffs as high as 25% on European cars if a transatlantic trade deal in his favour cannot be made soon. On June 8 of the same year, he made the same threat again, with the EU warning about fighting back. Eventually, President Trump has postponed imposing the automobile tariffs up to this day. Yet on December 30, 2020, the Trump administration announced new tariffs on wines and aircraft parts imported from France and Germany.

   The US, especially during years 2017-2020 under President Trump's administration, have largely been gone on the offensive in forms of "tariff wars." On the other hand, EU members (including the UK up to December 31, 2020) have been active in implementing their DST economic war plans, in attempts to protect their domestic digital economies against US tech titans (e.g., Alphabet, Amazon, and Facebook), preserve their cultural independence, while increasing their governmental revenues.

   Some key events associated with EU DST developments include:

   1) On October 29, 2018, the British Chancellor of the Exchequer Philip Hammond proposed to levy a 2% DST on local revenues from those large and profitable digital services firms. Even with US pressures, the UK DST was enacted on July 22, 2020, and became retroactively effective from April 1, 2020.

   2) On November 6, 2018, Sweden, Denmark and Ireland objected the proposal of DST across the whole EU, thus thwarting EU efforts from members such as France and Germany. Such an EU-wide taxation policy required the approvals of all EU members.

   3) On July 4, July 11, and July 24 of 2019, the 3% DST was enacted by the French National Assembly, the French Senate, and the French President, respectively. But on December 2 of the same year, the Trump administration threatened to impose retaliatory tariffs on $2.4 billion of French products. Under such pressures, on January 21, 2020, France agreed to delay the implementation of DST and started a new round of trade negotiation.

   4) On June 2, 2020, US Trade Representative Robert Lighthizer announced to start investigations, under Section 301 of the 1974 Trade Act, into DST measures adopted or considered by various foreign countries, most of them are European. On June 17, 2020, US Treasury Secretary Steven Mnuchin announced to withdraw from the EU-US DST negotiations. Such actions infuriated many EU members.

   5) On December 15, 2020, the European Commission proposed both the Digital Services Act and the Digital Markets Act, which aim to provide new regulation rule sets applicable across the whole EU, even though the DST provision was not explicitly specified in those two legislative initiatives.

   During the past several years, the US uses punitive tariff as the major trade weapon, while the EU employs the DST as another implicit form of tariff. In order to examine the possible wealth effects on both American trade tariff and European industry taxation, this research work applies the event-study methodologies to measure the abnormal return patterns in transatlantic equity indices and currency markets, surrounding those key announcement days summarized as above.

2. Literature Review

   So far, there have been no known publications which jointly conduct such an event study on both markets of equities and currency for trade war events, let alone for such events in the most recent years up to year 2020. The relatively few existing event studies with regard to trade wars mainly focus on US and/or Chinese securities market reactions to Sino-US trade dispute escalations (e.g., Crowley et al., 2018; Li et al., 2018; Ozdagli, 2019; Burggraf et al., 2020; Wang et. al., 2020), covering neither EU nor trade partners' currency market responses. Huynh et al. (2020) investigate the spill-over effects in returns and volatilities across multiple currency exchange rates for international trade uncertainties, focusing on US-China trade war but without covering US-EU disputes over either tariff or DST. The most recent empirical research that studies both the currency and stock market performance can be dated back to Patro et al. (2014), concerning the association between currency devaluation events and corresponding equity market reactions but without exploring the role of international trade uncertainties in the valuation process of currency or equity markets.

   A national economy's financial wealth has been found to be materially influenced by domestic political tensions (e.g., Heilmann, 2016; Hillier and Loncan, 2019), military hostilities (e.g., Burch et al., 2016), dangerous infectious diseases (e.g., Donadelli et al., 2017; Donadelli et al., 2020; Pandey and Kumari, 2021), aviation disasters (e.g., Kaplanski and Levy, 2010), and trade disputes (e.g., He et al., 2017). Such distresses are perceived by the investing public as value-destroying because they jeopardize global supply links and consumer market demands, therefore depressing expected cashflows while also increasing uncertainty-driven cost of capital financing (DeBondt and Thaler, 1987; Larson and Madura, 2001; Hertzel et al., 2008; Houston et al., 2016; Caldara et al., 2020). Such prior studies have found significant valuation effects of distressful events on securities market, currency...