One of the significant global trends these days is the rise of protectionism. Prime Minister Narendra Modi identified this as one of three major global challenges in his speech at Davos earlier this year. The rise of protectionism is closely identified with the trade policies being articulated and implemented by US President Donald Trump. His government's move to impose high import duties on aluminium and steel is but the latest in a series of protectionist measures, and more may follow. These recent duties are squarely targeted against Chinese exports to the US worth $50 billion. The Chinese embassy in Washington DC instantly reacted by warning that Beijing would not hesitate to defend its legitimate interests and would not recoil from a trade war. The usage of "war" is purely metaphorical but does convey the potential impact.
While restricting cheap aluminium and steel from entering the US from China (most other ally countries are exempted), President Trump aims to protect American jobs. It takes months to restart closed smelters and steel mills, and new jobs created may be in the hundreds or a few thousands at best. But it will increase the cost of these materials for downstream industries like automotive, beverage cans, electronics and construction. The rise in the downstream costs and consequent loss of competitiveness can only mean higher imports of those products. Hence, trying to plug imports from China could lead to a surge of imports from other countries.
Does America intend to follow through with higher protective import duties for cars and cans as well? American consumers will surely lose. But more importantly, if China retaliates, by switching their demand for aircraft from Boeing to the European Airbus, it could hurt the US aerospace business. It could make life difficult for the many large US companies that operate in China, such as Microsoft, Apple or GE. Once this "war" escalates, there's no saying where it will head or how it will end. As if in apprehension of such developments, the Dow Jones stock market index fell by 1,100 points in just two days. This might have a domino effect on other stock markets around the world as the fear and nervousness spreads.
Most economists, business associations and industry bodies are against protectionism, but Trump is merely delivering on promises made during his election campaign. There is a part of his core electorate that thinks that raising tariffs and "punishing" China is the right thing to do. The Wall Street Journal even ran a piece saying it was China and not the US which started the trade war. It alleged that China had arm-twisted US companies who were investing in China to form joint ventures and share intellectual property, which was then openly stolen. China also unfairly undervalued its currency for decades, boosting its exports to the US. So, the current tariff hike is "payback" for the $375 billion trade deficit America has with China.
Such talk is politically seductive, but economically wrong. If China ran an undervalued currency for long, it would hurt its domestic workers because of depressed wages. If the US has a large and persistent trade deficit with China, it implies a higher standard of living for Americans. Most of China's surplus dollars are anyway invested in American government bonds, so there is that co-dependency. Also, a trade deficit with one country is offset with a trade surplus with another country, since global trade is always in zero balance, by definition. If US companies have concerns with China, there are ways other than wholesale tariff wars, like quiet back-channel economic diplomacy to resolve trade and intellectual property disputes.
The global trade in goods and services is today an intricate interconnected web. In goods trade, the manufacturing is organised along global value chains that straddle several countries. This is most obvious in the textile chain (fibre, yarn, fabric, garments, branded apparel, high fashion) or in electronics (chips, motherboards, devices, embedded software and branded products).
The classic case is that of the iPhone, which is manufactured and assembled in Asia (including China), but whose major value is captured by Apple, because of the high price of intellectual property of design and operating system software. Thus, out of a $1,000 phone, barely $10-20 may be retained in China. In a world of global value chains that require frictionless movement across trade borders, a "trade war" can be especially harmful to producers and consumers.
Tight spot
India will not remain an unaffected bystander in this trade war. It needs to pay dollars or other foreign currency for critical inputs like crude oil (close to $100 billion of imports), edible oil, high-end capital goods and machinery, electronic goods like mobile phones and defence equipment. None of these are currently manufactured in India, and hence have to be imported. Add to this the import of uncut diamonds and gold. All these imports can be paid for only by dollars earned from exports (not from foreign loans or stock market inflows).
Thus, India's exports need to flourish and enter world markets across various countries. As such, our exports have suffered due to demonetisation, whose effect lingers, delayed GST refunds and a strong rupee. This year, our current account deficit will be closer to 2.5% of GDP, more than three times what it was last year. We really need our exports to grow substantially this year. This includes earnings from tourism and software.
Confronted with this challenge, the prospect of a trade war between the two largest economies of the world is bad news. The falling stock and bond market sentiment can cause reversal of dollar flows, and increased trade barriers can cause collateral damage to us. Let's hope that wiser counsel prevails and cooler heads can de-escalate this situation through economic diplomacy.
(The writer is an economist and Senior Fellow, Takshashila Institution)
(The Billion Press)
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