A NEW TRADE war has erupted between the United States and the European Union, but this is one dispute that will not go out of control. The E.U.'s decision to impose punitive tariffs on 1,700 products exported by the U.S. is bound to be a short-lived affair as the world's two most important trading powers are both aware of what needs to be done to settle the underlying dispute over U.S. export subsidies that the World Trade Organisation has decreed as illegal. Since Washington has stated that it will comply with the ruling, the question is how quickly it will bring its laws into conformity with WTO regulations. The Europeans have been speaking a language of restraint and the sanctions they have announced will be imposed in a phased manner. The action is altogether in the nature of signalling to the Bush administration and the U.S. Congress that the subsidy issue needs to be removed as soon as possible from the list of trans-Atlantic disputes.

The friction over the Foreign Sales Corporation (FSC) rules in the U.S. tax code, which for years have provided substantial export subsidies to domestic companies, goes back to the 1980s. Yet it was only after the formation of the WTO in 1995 that the issue went to a trade disputes panel. Although the U.S. lost the case in 2002, it has been dragging its feet about the abolition of the offending tax shelters. Since the amount involved is $4 billion a year and some of the biggest U.S. companies such as Boeing and Microsoft have been beneficiaries of the subsidy, it has always been known to both sides that an acceptable settlement would involve replacing the WTO-incompatible subsidies with WTO-compatible tax cuts. However, with Congress unable to legislate the necessary changes soon enough, the E.U. has finally decided to retaliate with sanctions authorised by the Geneva-based multilateral trade body nearly a year ago. The authorisation is for cross-retaliation worth up to $4 billion a year. Yet the E.U. has chosen to impose additional customs duties that, to begin with, will cost U.S. exporters no more than $16 million a month. A wide range of products from toys to jewellery has been targeted, but the punitive value will increase very slowly and reach $666 million at the end of 2005. The intention clearly is to prod the U.S. into coming up with an acceptable solution and not to provoke an angry reaction.

The search for a compromise between competing legislative packages that are in Congress will now be catalysed and this particular dispute will then be out of the way. But this will not be the end of the story. The U.S. has been at the receiving end in one high-profile WTO case after another. Before the FSC dispute there was the steel tariff issue in which Washington had to roll back countervailing duties that had been imposed to protect domestic industry. The country has also recently lost two important cases on anti-dumping duties. The string of adverse rulings has fuelled resentment in Congress about the multilateral trading system. This has made it much more difficult for the Bush administration to build legislative support for a give-and-take package that the U.S. must eventually agree to if it wants to salvage the Doha round of trade talks. The irony about the WTO's dispute settlement process is that a system designed to make the smaller economies fall in line does affect, even if only occasionally, the most powerful of economies.