Tariff shock must spur reform in India

It is not the time to teach basic international macroeconomics to the President of the United States of America. Renowned economist Jeffrey Sachs put it very well in a public speech. He said that high trade deficits, which are bothering President Donald Trump, are not the result of trade policies like low tariffs. They simply mean that Americans like to buy beyond their productive or earning capacity. It is like a consumer on a buying binge with a credit card. America’s production, earning, investing, saving, and buying activity is captured by a basic equation, called an identity, in the macroeconomics textbook. The equation says that the trade deficit is equal to the savings investment imbalance. In other words, the excess of imports over export earnings of America is just the mirror image of the excess of investment over domestic savings. This basic equation identity is unaltered by changes in import tariff rates, sanctions imposed on Russia or China, or any military spending or aid given to Israel or Ukraine. It reflects consumer behaviour and investor preferences. It is not an expression of business sentiment such as that expressed by the stock market. We may observe that America’s stock market remains at historic highs, despite the tariff mayhem.

The above equation identity means that any dollar shortfall needed to pay for the trade deficit is supplied by foreign investment inflow, which is the savings investment imbalance. But that inflow comes at a cost. If it is a debt capital inflow, it increases the country’s indebtedness. No wonder the aggregate debt of the US sovereign alone is $37 trillion, representing 125% of its GDP. The cost of this debt, i.e. the long-term interest rate, is close to 5%, even though inflation is quite low. The difficulty of continuing to attract foreign inflow of capital means interest rates will remain stubbornly high.

The bottom line is that harsh tariff policies against trading partners of the US will not drastically reduce the size of the deficit, but will hurt domestic imports because of higher costs, and will hurt exporters from foreign countries, as their net earnings and volumes may go down. Production, volume of imports and exports (to some extent), and incomes will go down, hurting GDP in the medium term. The tariffs are not a tax on foreigners but are paid by importer companies in the US, who pass along the cost to their customers via higher prices. Exporters may face lower profits or volumes, but one estimate is that exporters bear only one-fifth of the rising costs from tariffs, while Americans will bear most of the brunt. But President Trump’s policies change so frequently that it is impossible to make a firm prediction based only on current policy action.

Despite showing early willingness to negotiate a mutually beneficial trade deal and despite cultivating friendship and goodwill with Trump and his team, the outcome has been very bad for India. The 25% tariff on all merchandise exports to America, plus unspecified penalties, makes India’s position worse than peers like Vietnam, Indonesia, or Mexico. It will bring down GDP growth by 0.2% to 0.3%, and badly affect the exporting sectors of textiles and garments, gems and jewellery, electronics, mobile phones, auto components and metals, steel, and aluminium.

Points of contention

India drew the line on three things. First, no liberal access to the agriculture and dairy market in the country. This is especially for maize, corn, soybean, and dairy produced from cattle fed on animal protein. Second, no access for genetically modified crops or agricultural products. Third, no import of ethanol for fuel. An additional fourth point, proving to be sticky, is India’s insistence on its freedom to import crude oil from Russia. This seems to have irritated Trump the most, since he sees it as a direct affront to sanctions against Russia.

India must now ponder its response to Trump’s harsh actions. It is a testament to Trump’s peculiar strategy that he puts the other side always in reactive mode. Most of the trading partners end up either giving too much for too little (like the UK, the EU, or Indonesia) or use the leverage to counter-strike (like China with the rare earths export ban). India was tilting towards giving in too much, given the critical importance of the US market, and it being the only large economy with which India enjoys a substantial trade surplus.

This mini-crisis must be used to accelerate the progress on various economic, administrative, and other reforms. This is certainly not a 1991 moment of crisis when India had to beg for short-term foreign credit to fill its forex coffers. There is size, resilience, diversification, and will that can withstand this shock.

But let us not lose sight of worrying economic signs. Near-zero net foreign direct investment, stagnant private sector investment spending, 30% unemployment among college graduates who scramble for UPSC jobs, low productivity across agriculture crops, water stress, the increasing burden of doles to beneficiaries, the large mismatch between skills demanded (in age of AI and automation) and output of educational institutions, and most importantly, the continued shackling of the farmer, at the mercy of procurement policies, fickle bans, prohibition on forward trading, and illiquid land markets.

The farm laws need a consensus and consultative approach. The labour laws passed in parliament need to be applied and implemented via the four codes in all states. And the education sector needs massive reforms, whose spirit is embedded in the National Education Policy, but which awaits full implementation, to make the education-to-employment pathways effective. India needs to use this Trump Tariff alibi to push all these reforms, to make the economy chug faster and inclusive for all sections.

(The writer is an economist; Syndicate: The Billion Press)

Disclaimer: The views expressed above are the author's own. They do not necessarily reflect the views of DH.