What happens when political expediency and rhetoric begin to inform the international trade policies of the world’s largest economy, rather than informed policy and economic research? All it took was one man, marching forward with the clarion call of making ‘America Great Again,’ to be elected President of the United States of America, and the above question turned into a grim reality for the globe.
David Ricardo, in his 1817 treatise ‘On the Principles of Political Economy and Taxation’, laid the foundations of the world of free trade. Departing from the old traditional view of mercantilism, which was based on the idea of maximising exports and minimising imports, the world moved towards the idea of specialisation and comparative advantage. The idea that countries should manufacture whole or even parts of a good according to their manufacturing advantage in the commodity and trade in a free and open market overturned mercantilist ideas and quickly gained momentum.
The final and definitive turn in favour of free trade occurred with the General Agreement on Tariffs and Trade (GATT) and the eventual establishment of the World Trade Organisation (WTO), which established a regime of global free and fair trade with mutual disputes to be settled by arbitration. The Most Favoured Nation Clause (MFN) was agreed on to prevent trade wars and geopolitical retaliation through trade and economics. Under the GATT and WTO regimes, world trade volumes grew to roughly 43 times the 1950 levels, growing at a CAGR of 4% annually.
The US has since 2019, crippled the WTO appellate mechanism by non appointment of its quota of members to the system. The appellate mechanism hears appeals against WTO dispute panel decisions as a final measure. Crippling of the mechanism means that appeals are stuck forever and no arbitration or enforcement in cases of trade disputes may be conducted at the WTO. This in effect renders the WTO a purely cosmetic body with no enforcement powers. Trump’s antics turned this spark into a raging fire with open trade wars plaguing the global economy.
The Economic Case Against Tariffs
Restrictive trade measures have been regularly cautioned against by trade economists. Paul Krugman refers to tariffs as ‘regressive taxation’ due to their potential impact on domestic manufacturing and inflationary pressures passed on as taxes to the domestic economy. Classic economic theories, prominently ‘comparative advantage’ of Ricardo states that optimal economic growth is achieved under free trade. Tariffs artificially inflate the rates of goods across nations and lead to suboptimal resource allocation both domestically and across the globe and create ‘deadweight losses’.
Academic literature has some interesting evidence against tariffs and trade wars:-
- Studies show that the United States experienced substantial increases in the prices of goods and the complete pass-through of the tariffs into domestic prices of imported goods and estimates showed a reduction in aggregate US real income of $1.4 billion per month by the end of 2018 in the first Trump administration.
- An analysis of panel data of 151 countries by economists from the IMF, showed that tariff increases lead, in the medium term, to statistically significant declines in domestic output and productivity, more unemployment, higher inequality, and real exchange rate appreciation.
- Supply chain disruptions arising from tariffs lead to changes in product-level exposures and lead to decline in exports of import-tariffed products equivalent to an export tariff by 2-4%.
- Another argument against tariffs is the one by Stopler and Samuelson, who show that imposing tariffs on low skill imports (similar to the moves by the Trump administration) would lead to decline in high-skill wages and production thus hampering technological progress and innovation in the nation.
Thus, economic literature indicates that tariffs are not optimal coercive or retaliatory measures.
A Flawed Policy
US trade deficits in electronics and pharmaceuticals run at 414 Billion dollars, which is 45% of its trade deficit in 2024. These critical sectors are irreplaceable in the short run and are exempt under present US tariffs. Coupled with a further 13% share of the textile-footwear segment, a majority of these tariffs impact sectors that are unlikely to be replaced with domestic manufacturing and hence would lead to inflationary pressures in the US.
For the same reasons, the additional government would be additional taxation on the US citizens themselves and the trade deficit is likely to be minimally affected. For domestic manufacturing, the ‘infantile industry’ argument does not hold water in the US and as Annie Kreuger, the former Chief Economist of World Bank describes, would lead to ‘rent-seeking’ and the decline of manufacturing instead. Moreover, the US trade deficit under Trump tariffs in his first tenure, increased by 119 Billion USD, showing a counter to the exercise.
Political instability further plagues Trump’s antics as the increased prices and inflationary pressures pass on directly to the home consumer. Significant backlash is expected especially as the voter base of the Trump administration remains low income groups. Further, if the tariffs hit the industrial base, the Republicans may see significant funding challenges during election cycles. These two factors have already seen many core republicans targeting Trump led policies and advising restraint. 203 days into Trump’s inauguration, the approval ratings have already hit rock bottom at 56% disapproval as per the Economist.
The US is dependent for critical elements such as rare earths on the very nations Trump wants to wage a war with. Of the 42 minerals studied that enable emerging technologies, the U.S. is import-reliant on 13 minerals. Of these 13, China was the leading source of U.S. imports for 9. It comes as no surprise that the Trump administration backed off easily after a show of muscle flexing and is now in no mood to engage in confrontations with China.
What do US Tariffs Mean for India
The US is India’s largest trading partner with nearly 17.9% of India’s merchandise exports landing up in the nation. This fact, combined with a potential tariff rate of 50% and erratic tariff policy of the Trump administration seen in the light of the short-lived tariff war with China has emerged as a source of worry and caution among sections of policy-makers.
Exports to the United States, while accounting for nearly 1/5th of global trade volumes of India, provide for only 2% of Indian GDP, largely driven by the fact that the Indian economy is still dominated by domestic growth and consumption. Combining this with the exempt sectors, only 1% of the national GDP are impacted by the evolving tariff situation. The impact on India’s economic growth is expected to be further minimal, projected in the range of 0.2% to 0.4%. While this risks the economic growth to fall below projected figures of 6% YoY, the impact is not unremediable in the long run.
India’s larger challenges would stem from indirect spillages of the new tariff policy of the US. Reduced competitiveness could neutralise the comparative advantages offered by India through its policy focus on reducing compliance and taxation costs through SEZs and financial incentives through PLI schemes for firms with a substantial consumer base in the United States.
In an interconnected global economy with the US being the largest economic player at roughly 20% of the global income generation and considering the global hegemony of the national currency (USD), global economic growth could see substantial hits with potential impacts spilling over to India. Trade policy uncertainties could push institutional and individual investments away from economic productivity into locked assets, resulting in reduced economic growth. Investments into Asia could also take a hit especially with the Trump administration specifically targeting the same.
Uncertainties and erratic tariff policies could also reduce the effectiveness of fiscal and monetary policy tools in the coffers of federal banks including RBI. Standard tools of varying repo rates in the hopes of inducing investment and pushing up the economy may be overshadowed by lack of investor confidence. Monetary tools targeting corporate taxation and duties may also lose their sheen, overpowered by tariff rates and a hostile US administration.
India has yet to realise its full domestic growth potential. In the medium term, focus on domestic economic growth can potentially lead to decoupling India’s economic growth from tariff challenges. This can be delivered through targeted efforts of reaping demographic dividend and improving women’s LFPR, leading to a virtuous cycle of improved household incomes, production and domestic demand led growth. India is yet to tap into global markets fully. India’s target of 2 Trillion Dollar exports by 2030 if met against the unfavourable backdrop of the present tariff scenario would lead to a share of 7% in global exports and potentially improve growth projections.
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