THE CONTEXT: On April 2, the US announced sweeping “reciprocal tariffs” targeting countries with which it runs a trade deficit. This decision sharply increases import duties on goods entering the US and has global economic ramifications reminiscent of protectionist policies of the past (e.g., Smoot-Hawley Tariff Act during the Great Depression). The US trade deficit stands at around $1.2 trillion, indicating it imports goods worth $1.2 trillion more than it exports.
THE BACKGROUND:
1. Pre-Trump Tariff Regimes:
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- Before the Trump 2.0 era, average US tariffs hovered around 2.5%.
- Protectionism has been a recurring feature in US trade policy, but not at this large scale since the 1930s.
2. Smoot-Hawley Act and Historical Parallels:
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- The 1930s Smoot-Hawley Tariff Act imposed significantly higher tariffs to protect domestic producers but exacerbated the Great Depression.
- Drawing parallels, the newly imposed tariffs could spark trade wars and slow global economic growth.
3. Trade Wars and Their Consequences:
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- Global trade has fueled much of post–World War II economic growth.
- Sudden hikes in tariffs can trigger retaliations and disrupt global supply chains, leading to inflation and potential stagnation (stagflation).
THE THEORETICAL FRAMEWORK:
1. Comparative Advantage:
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- Countries specialize in producing goods where they have a lower opportunity cost.
- High tariffs distort this comparative advantage by artificially protecting domestic industries and discouraging imports.
2. Infant Industry Argument:
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- Protection is sometimes justified if it helps nascent industries develop.
- Conversely, the US imposing higher tariffs might be seen as protecting its domestic producers, but it can lead to inefficiency and retaliation.
3. Balance of Payments and Exchange Rates:
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- A trade deficit can also be adjusted through currency fluctuations.
- If tariffs do not lead to currency devaluation in exporting countries, import prices in the US will rise, generating inflation.
4. Retaliation and Game Theory
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- Other countries may retaliate by imposing their own tariffs on US goods, leading to a ‘tit-for-tat’ escalation.
- Trade wars often leave both sides worse off, a scenario illustrated by the ‘Prisoner’s Dilemma.’
THE CURRENT SCENARIO:
1. Tariff Structure
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- Base Tariff of 10% for all countries starting April 5.
- Country-Specific Tariffs start from April 9, determined by halving the estimated tariffs that these countries impose on the US.
- Examples: India faces 26%, China 34%, Vietnam 46%, EU 20%, UK 10%, etc.
2. Implications for the US Economy
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- Slower Growth: By hampering imports, the overall US economic growth could slow down due to disrupted global supply chains and costlier intermediate goods.
- Higher Inflation: Goods imported into the US will be costlier unless the dollar appreciates sharply, which could trigger a wage-price spiral.
- Stagflation Risk: If output stagnates while inflation surges, the US could witness stagflation—a combination of low growth and high prices.
3. Implications for Other Economies
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- Export-Dependent Countries: Nations like Vietnam, Bangladesh, and China, which depend significantly on the US market, are hit hardest.
- Currency Depreciation: Some countries might let their currency depreciate to keep their export prices competitive, leading to inflationary pressures at home.
- Global Slowdown: Tariffs disrupt the global flow of goods and can dampen business sentiment, affecting international investment decisions.
THE INDIAN CONTEXT:
1. India’s Tariff: Set at 26% total (10% + 16% additional).
2. US Criticisms of India (from US Trade Department report):
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- High Bound Tariff Rates at WTO: Averages of 113.1% on agricultural goods, with scope to raise applied rates arbitrarily.
- Frequent Changes in Tariffs without due notice or consultation, creating uncertainty.
- Protectionist Measures across multiple sectors (telecommunications, agriculture, retail, banking, insurance).
- IP Enforcement: Alleged inadequacy in protecting intellectual property rights.
- Digital Economy Constraints: Localized internet shutdowns hamper digital trade.
- Lack of Transparency in law-making and public procurement.
3. Silver Linings / Opportunities
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- Comparative Advantage vs. Competitors: India’s tariffs (26%) are still lower than Vietnam’s (46%), Bangladesh’s (37%), or China’s (34%), potentially giving India an edge in certain export segments.
- Negotiation Prospects: US officials hinted they could reduce tariffs if countries address US trade concerns. India is already negotiating a bilateral deal and could leverage this situation to reduce its own tariff barriers in return for concessions.
- Rationalizing Tariffs: External pressure might incentivize India to streamline its tariff structure for increased competitiveness.
THE GLOBAL PERSPECTIVE:
1. EU’s Role
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- The EU (20% tariff from the US) commands 38% of global trade—far more than the US at 13%.
- If the EU aligns with Asia or pursues deeper trade pacts, it can reduce dependence on the US.
- Potential new blocs or strengthened existing agreements (e.g., RCEP—though India has opted out) could reshape global trade routes.
2. Retaliatory Tariffs
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- Countries like China, the EU, and others may strike back, intensifying global trade tensions.
- A large-scale trade war could disrupt multilateral bodies like the WTO
THE CHALLENGES:
1. Global Economic Slowdown: Curtailing imports through tariffs can curb global trade volumes.
2. Risk of Stagflation: Combined effect of rising prices and stagnant growth in the US could spill over worldwide.
3. Threat to Rules-Based Order: These unilateral tariffs undermine the WTO framework, weakening the spirit of multilateralism.
4. Impact on Developing Economies: Smaller countries with weaker negotiating capacity (e.g., Cambodia, Bangladesh) bear disproportionate brunt.
5. Supply Chain Disruptions: Firms that rely on cross-border supply chains for inputs face unpredictability, leading to delayed investments.
SIGNIFICANCE AND IMPLICATIONS FOR GOVERNANCE
1. Shift in Trade Policy: Reflects a renewed emphasis on nationalistic and protectionist policies, changing global economic alliances.
2. Domestic Political Fallout: High inflation can erode popular support for incumbents; similarly, domestic producers might benefit in the short run but face retaliation abroad.
3. Diplomatic Leverage: Countries like the US use tariffs to force policy changes in trading partners, affecting sovereignty and domestic political processes.
THE WAY FORWARD:
1. For India
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- Streamline Tariffs: Prune excessively high applied rates, especially on non-agricultural products to attract foreign investment and boost competitiveness.
- Improve Ease of Doing Business: Enhance regulatory transparency, reduce arbitrary policy changes, and strengthen IP laws where needed.
- Bilateral Negotiations: Use the possibility of lowered US tariffs as leverage to open up certain sectors while safeguarding key domestic interests.
2. For the Global Community
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- Strengthen the WTO: Revisit and reinforce multilateral rules; seek dispute resolution rather than unilateral tariffs.
- Diversify Trade Partnerships: Nations can reduce reliance on the US market by increasing intra-Asian and EU-Asia trade ties.
- Monitor Inflation and Growth: Central banks should be prepared to tackle inflationary pressures arising from sudden tariff impositions.
3. Long-Term Solutions
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- Reforms in Domestic Policies: Countries singled out for protectionism or subsidies (like India) need broad reforms in agriculture, manufacturing, and financial sectors to meet global norms.
- Diplomatic Engagement: High-level dialogues to prevent a cycle of retaliatory tariffs; potentially chart out targeted mini-deals or sectoral pacts.
THE CONCLUSION:
A combination of targeted domestic reforms, robust multilateral dialogue, and inclusive trade frameworks can safeguard growth while upholding moral imperatives of equity and sustainability. By harmonizing national interests with global responsibilities, nations can collectively navigate current headwinds and foster long-term shared prosperity.
UPSC PAST YEAR QUESTION:
Q.1 How would the recent phenomena of protectionism and currency manipulations in world trade affect macroeconomic stability of India? 2018
Q.2 What are the key areas of reform if the WTO has to survive in the present context of ‘Trade War’, especially keeping in mind the interest of India? 2018
MAINS PRACTICE QUESTION:
Q.1 The recent announcement of reciprocal tariffs by the United States signals a renewed wave of global protectionism, with far-reaching implications for advanced and emerging economies. Evaluate how these tariffs could reshape global trade dynamics, particularly for developing countries like India.
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