A trade arrangement that leaves out the US could trump Trump’s tariffs

He lays down his cards with outrageous announcements and then back-tracks, especially in bilateral negotiations. It is a pattern repeated in his domestic interventions in different fields as well as his dealings with US neighbours like Canada and Mexico, allies like the UK, EU, Japan and Korea, rivals like China and Russia, and other countries like India. 

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But how much he will backtrack in a particular case, if he backtracks at all, remains uncertain. Indeed, uncertainty is the leitmotif of Trump’s exercise of raw power. Given this, specifically in the context of trade and tariffs, I asked Professor C. Veeramani, one of India’s leading trade economists, what the outcome would be if other members of the World Trade Organization (WTO) continued to trade in compliance with WTO rules but without the US. 

It is as if the other WTO members—or most of them—were to forge a massive free trade agreement (FTA) without the US.

This is a most unlikely scenario. Other countries, especially allies of the US, are too tied up with the US through security and other linkages for them to decouple from the US in the field of trade. However, economists follow this method of abstracting from the real-world to first address a question in a very simplified context, constructed through simplifying assumptions—which is sometimes called a model. 

The question is then revisited as the context is gradually enriched by incorporating stylized facts from ground reality to verify whether the original conclusion survives successive approximations back to the real world. Hence, my hypothetical question for Veeramani. His answer is quite interesting.

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Veeramani said that the US accounts for a small fraction of global trade. Current data indicates that its share is down to 10% and declining. Meanwhile, the share of China, the EU and emerging market economies has been rising. In other words, 90% of global trade occurs without any direct US participation. 

An FTA among major non-US economies, including the EU, Asean, China, Japan, India, Korea, Australia, New Zealand, Latin America, etc, would deepen supply chain integration among these countries by reducing tariff and non-tariff barriers. Assume, conservatively, that this non-US trade bloc initially accounts for 60% of global trade. 

Assume further that deeper integration among them raises intra-bloc trade by 5-10 percentage points over the medium term. A part of this would be attributable to trade diversion from the US, with consequent adverse effects on the US economy. But the rest would be additional trade creation. Overall global trade could increase by 3-6 percentage points, by Veeramani’s estimate. 

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Depending on the relevant response elasticities and complementary policy reforms in these countries, global GDP could also go up by 0.5-1 percentage point. But the impact on the US economy would be negative. Its share of world trade and GDP would decline, while that of European economies and the emerging economies of Asia, Africa and Latin America would rise. 

The scenario described above is unlikely. The rest of the world is unlikely to decouple from the US because of their security and other linkages cited earlier.  Nevertheless, this boundary scenario yields an important qualitative conclusion: namely, that the path Trump has chosen is likely to hurt America, while other countries are likely to be better off. 

This only captures the impact on the global economy via the trade channel; this is indeed one of the main channels through which US policies will impact the world economy. But there are two other economic channels that also need to be considered: finance and technology.

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As for the financial channel, a large number of countries in the Asean region and West Asia are already reported to be participating in a payment system promoted by the central bank of China, presumably supported by US-sanctioned countries like Russia and Iran, as a more efficient alternative to Swift. The more the US attempts to isolate its geopolitical rivals, the more it will accelerate a worldwide shift away from the present US-dominated global financial architecture. The market mechanism can bite in both directions.

The battle for access to technology—and it is indeed a battle—is mainly being fought on the artificial intelligence (AI) front. When the US government tried to block China’s access to recent advances in large language models with Generative AI capability developed in US companies, China shocked the world with its own Generative AI products, made available for free—or a fraction of the prices charged by US companies. As with the financial architecture, so also here: the more the US attempts to  isolate its rivals, the faster it will drive them to develop their own competing technologies. 

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This column has been limited to the economic domain and not gone into security relationships. In this domain, the lesson is very clear: the more that Trump pursues a pugnacious approach to subdue US neighbours, allies and rivals, the more he is likely to hurt America and help its rivals. In this context, the wisdom of India’s approach of  ‘strategic autonomy’ should be evident to all. 

These are the author’s personal views.

The author is chairman, Centre for Development Studies.