A no-win game

Apparently, there is a growing concern among nations over the ‘reciprocal trade and tariffs’ memorandum issued on February 13 by the White House. In brief, it outlines a customised approach by the US toward its trading partners in areas such as tariffs, unfair and discriminatory taxes on US products, disguised trade barriers affecting businesses and consumers in the US, and manipulation of exchange rates. The announcement by President Trump is evidently triggered by a whopping US trade deficit of USD 1 trillion, of which China alone contributes 30.2 per cent, followed by Mexico at 19 per cent and Canada at 14 per cent. The US decision is perceived as a heads-up for a full-blown tariff war in the near future, pushing countries to brace for the impact on their respective economies. Canada has already retaliated by imposing a 25 per cent tariff on US goods worth USD 155 billion, while Mexico has indicated that it will soon follow suit.

Markets are buzzing with speculation over possible retaliatory escalations destabilising global trade. Businesses may diversify supply chains away from the targeted countries, affecting companies and jobs dependent on them. Turbulence in the stock markets of Europe and Asia, rising production costs, and spillover effects on the prices of goods could be natural consequences. What should be the best course of action for nations during such turmoil in international trade is certainly a matter of serious concern, if not outright panic.

Though India contributes only 3.2 per cent to the US trade deficit, the situation equally concerns India, as the US remains its top export destination, accounting for 17.7 per cent of total exports as of now. A recent SBI report shows that India's tariffs on US goods have risen substantially from 11.59 per cent in 2018 to 15.30 per cent in 2022, while, conversely, the rise in US tariffs on Indian goods was barely 1.19 per cent during the same period. ‘Reciprocal tariffs can have a cascading effect on various sectors of the Indian economy as well. Experts believe that the most vulnerable products could include electrical goods, industrial machinery, gems and jewellery, pharmaceuticals, fuels, textiles, iron and steel, automobiles, and chemicals. Most importantly, 54 per cent of India’s software exports are to the US as of 2024 (RBI), an area not yet targeted by President Trump—a blessing for now.

Trade wars and protectionist policies are not new. They involve measures such as raising tariffs, fixing import quotas, providing domestic subsidies, and lowering exchange rates (currency devaluation). In the short run, they help reduce trade deficits, increase domestic demand, and may also create jobs. However, in the long run, as history shows, they result in slow growth, pushing economies to the edge. High costs combined with low consumption, poor innovation, and stagnant technology make a country less competitive in international trade.

Economists Breuss, F (WTO Dispute Settlement: An Economic Analysis of Four EU–US Mini Trade Wars—A Survey) and Chad Bown (The Review of Economics and Statistics, 2004, vol. 86, issue 3, 811-823) argue that while tariffs may benefit certain individual industries, they are not only harmful to trading partners but also constitute an act of self-harm. A 2019 study by the World Economic Forum states that a trade war can have two major effects: weaker global growth, which adversely impacts international trade, and tighter financial conditions for nations. The ultimate impact depends on how vulnerable a country’s economy is to global financial conditions and its exposure to trade with each of the core economies.

Thiemo Fetzer and Carlo Schwarz from the University of Warwick say (https://www.weforum.org/) that when major powers like China and the US are involved in a trade war, it is certain that neither will win, while bystanders begin to ‘fish in troubled waters’ as trade veers away from the conflict zone, benefiting a few countries that capture the diverted exports. Tariff hikes not only penalise the manufacturing company but also the assembler of the product and its suppliers along the chain. A permanent tariff war can be disastrous for global investment flows, employment, and growth in both developed and developing countries.

A pertinent question is: Why do trade wars occur when the WTO exists as the leading forum for international trade cooperation? The answer is that the role of the WTO is apparently eroding due to the increasing number of regional trade agreements. The WTO has played a commendable role in preserving trade cooperation and preventing trade wars, even during difficult times such as the global financial meltdown of 2008. For example, the WTO ruled against the EU in 2012, leading to adjustments in its banana import regime following a dispute between the US and Europe over discriminatory practices. Likewise, in 2002, when the US imposed safeguard tariffs on steel imports from Europe, the WTO ruled against the US and prevented a trade war. When China restricted exports of rare earth materials to the US, the EU, and Japan, the WTO ruled against China and facilitated the lifting of export restrictions in 2014. Similarly, disputes between Canada and Brazil, as well as between the US and Europe over illegal subsidies to their respective aircraft manufacturers and airline companies, were resolved through WTO intervention.

The WTO’s Dispute Settlement Mechanism (DSM) emphasises a rule-based system, a de-escalation platform, and the preservation of multilateralism, which help prevent disagreements from escalating into trade wars. According to Ralph Ossa (‘Trade Wars and Trade Talks with Data’, American Economic Review, December 2014), the WTO’s success in preventing trade wars outweighs its failure to promote trade talks; nevertheless, institutional reform is long overdue. The WTO should act proactively to resolve trade disputes between the US and its trading partners. China is reportedly approaching the WTO, challenging the present actions of the US as violations of international trade rules. Nations look up to the US as a world power to cooperate with the DSM and set an example.

To withstand the immediate impact of trade wars, a country’s economic fundamentals need to be strong and its macroeconomic indicators stable. India has both strengths and weaknesses. High tariffs imposed by the US on China may result in Chinese goods flooding the Indian market at a time when India is already serving as a dumping ground. However, the flip side is that it presents an opportunity for India to reduce its trade deficit with China while ‘comfortably’ increasing trade with the US. A study by FIEO suggests that India can secure additional exports worth USD 25 billion in sectors such as electronics and electricals, automotive parts and components, organic chemicals, apparel, and textiles, thanks to the tariff war between the US and China. Unlike export-dependent countries such as China, Canada, and Mexico, India benefits from huge domestic demand, which can help its manufacturing sector withstand the headwinds of global trade wars. However, fluctuations in global growth can indirectly impact India’s economy, especially in the face of a soaring dollar and a sinking rupee.

Dr. Arvind Panagariya states that tariff hikes will not significantly affect India’s 6.5 per cent growth rate, but further reform is necessary in the ‘exemption Raj’ of the tax regime. Negotiations must continue to strike a mutually beneficial bargain for both India and the US. According to the Minister for Commerce and Industry, even as India forges new trade partnerships with the developed world, it will push for lower tariffs on labour-intensive goods while allowing increased imports of oil, gas, and defence equipment from the US.

The writer is a former Addl. Chief Secretary of Chhattisgarh. Views expressed are personal