Opinion
India must not let Trump’s tariffs and trade disruption weaken its export thrust
Summary
- Negotiating a way ahead with the US may be difficult and globalization clearly faces uncertainty, but we should keep our import duties low and strike a series of trade deals to make all the gains we can.
Game theorist Thomas Schelling once wrote that coercion depends more on “the threat of what is yet to come than on damage already done." He added that countries in conflict situations would want “an impressive unspent capacity for damage be kept in reserve." Schelling wrote his classic works on strategy in the context of the Cold War between the United States and the erstwhile Soviet Union, two superpowers with massive stockpiles of nuclear weapons.
His words should resonate again as US President Donald Trump opens his second innings at the White House with threats of tariffs against countries that he believes are harming the economic interests of his country. The way Trump suspended broader tariff hikes on imports from Canada and Mexico makes many believe that this will be his game plan—threaten a country but not carry out his threat.
Also Read: Dani Rodrik: America’s trade partners should resist magnifying the irrationality on display
The problem is that soon others will begin to see his words as a series of hollow threats which will not be carried out. He will, at some point, have to impose punitive tariffs on some major country or economic bloc so that his statements are seen as credible by the rest of the world. A street bully has to occasionally beat someone up for others to fear him.
We could be headed into a situation in which the US will work through a series of bilateral deals with individual trading partners rather than be the bedrock of the multilateral trading system that has served the world well since 1945. And the rolling negotiations—the threat of what is yet to come as well as unspent capacity for damage that Schelling wrote about—will likely keep the world on edge till a new equilibrium is established.
Jagdish Bhagwati had argued that multiple preferential trade agreements between countries would end up like a tangled spaghetti bowl of deals that would hamper global trade. The problem could become even more acute now.
Also Read: Trump’s reciprocal tariffs: Time for India to rethink its trade policy
Economic logic will not come in the way of Trump. One of the core tenets of the theory of international trade is the gravity model. Just as the attraction between two celestial bodies is based on their size and distance between them, so too is trade between countries deeply influenced by their economic size as well as how close or far apart their borders are. It is thus no surprise that the US trades more with Canada and Mexico than with Japan and China.
As Trump continues to upend the international trade system, there are three possible outcomes worth considering.
First, a spiral of retaliatory tariff hikes raises barriers between countries to an extent that it could end globalization.
Second, Trump manages the threats so deftly that countries gradually bring down their average tariffs to US levels, and thus actually increase global trade.
Third, the other major economies in the world respond to American trade uncertainty by signing between themselves a series of regional agreements.
The third possible outcome would mean not the end of globalization, but a new version built around more regional trade, as alternate supply chains are slowly built. The net impact of this new system of global welfare will depend on whether it leads to trade creation or trade diversion, a distinction famously made in 1950 by Canadian trade economist Jacob Viner.
Trade creation broadly entails a move from more expensive to less expensive producers. Trade diversion leads to a move from less expensive to more expensive producers.
Trump has threatened India on two issues. India has higher average tariffs on American imports than the other way round. And it hopes to move some of its international trade to currencies other than the US dollar.
Also Read: Ajit Ranade: Trump’s policies offer India a pretext to reset import tariffs
The question is whether India should respond by deepening its trade ties with the US by bringing down tariffs on American goods or by striking a more comprehensive trade deal with that country, or enter a pan-Asian trade deal such as the Regional Comprehensive Economic Partnership (RCEP) that includes China, or move ahead with a blend of these various options.
India’s complicated choices will involve both strategic as well as empirical calculations. As far as the latter is concerned, a lot depends on the extent to which trade between India and the US is complementary rather than competitive, in which sectors comparative advantages lie for the two countries, and the intensity of trade between them in the years to come. There could be trade turbulence ahead, and it will be a challenge to negotiate it so that the Indian economy is not harmed.
India has been a beneficiary of the wave of globalization that began at the end of the previous century. It should remain a trading nation rather than withdraw behind protectionist walls. Keeping tariffs low as well as closing trade deals should remain on the agenda even as the international situation changes, or even worsens, as Trump’s threats play out.
The author is executive director at Artha India Research Advisors.
