Opinion
Reciprocal tariffs: Should India respond to Trump’s move at all?
Summary
- India’s best advice would be to not react. We should keep calm and carry on our US trade talks with the US. Remember, America isn’t a dominant importer of merchandise imports anymore. Its tariff formula, though, may not be as irrational as some critics contend.
On Thursday, the Office of the United States Trade Representative (USTR) published the formula by which US reciprocal tariffs are to be calculated. The New York Times also published what calculation resulted in country-wise tariffs from 9 April onwards that range in a wide band. Reciprocal levies are set at 34% for China (which already had 20%), 27% for India, 20% for the EU and so on. According to Trump, these rates are only half of what they should be and therefore display US “magnanimity."
From all indications, the motive behind the US reciprocal tariff regime is to push its trade partners to balance their bilateral trade with it. Israel has already responded by unilaterally eliminating all tariffs on US imports. On the other hand, it is not clear how countries faced with much higher tariffs should respond.
Should one retaliate? Should one do nothing? How should India respond? These are some of the questions I will take up here.
Also Read: Mint Snapview: Many countries will retaliate against Trump's tariffs. India must not.
But first, some other issues should be clear. Keep in mind that the proposed tariffs are on merchandise trade. As I have argued before (see Mint, 20 January), the US no longer has the impact on trade it had even 20 years ago.
In simple terms, US import demand today constitutes only about 13% of world demand for goods. Even if one adds the fact that some exporters like China and the EU have routed exports to the US via Mexico and these got logged as Mexican demand, America’s total—direct and indirect—share of world imports would not go above 15%.
This is a far cry from the 20% direct US share in world imports back in 1990. And an even farther cry from the 60% odd US share in 1950.
Historically two things have happened. One, rising wage costs have led to a decline in the developed world’s production of manufactured goods (as trade theory rightly predicts), with supplies coming increasingly from factories in low-wage countries.
The resulting decline in import prices has raised standards of living in these rich countries, particularly in those that kept their import duties low, like the US. This is precisely why America has the highest standard of living today among OECD countries: it has had very low import barriers. US consumers have been beneficiaries of an open market. So has the US economy.
Also Read: Indira Rajaraman: US Liberation Day tariffs target the WTO’s playing field
High trade volumes between China and the US have been part of that story. China assembled products at low wage costs with inputs from East and Southeast Asia for shipment to the US and other OECD countries. This ‘assembly pattern’ of world production has been highly beneficial to the US.
Second, the structure of production in the developed world has shifted to services in response to rising wages. Today, the services sector uses far less labour than manufacturing. The digital technological revolution since around 2000 has meant that unskilled labour (Trump’s political constituency) can be substituted by technical increases in productivity. This has also been an economic response to declining fertility rates across all developed countries, resulting in a shrunk rich-world workforce.
So here is the conundrum. First, the US just doesn’t have the economic clout to enforce submission by other countries, at least not the manner it once did. This aspect, I have discussed in detail too (see Mint, 18 April).
Second, US tariffs would result in persistently higher inflation there. Note that the economic factors that led to changes in global patterns of production and trade were not brought about by protectionism, but by long-term structural trends. An attempt to reverse these patterns, so that manufacturing returns to the US, will push up the cost of living in the country.
Also, since Japan, China, the EU and other countries that have been slapped with additional tariffs are likely to retaliate, the harm done to US consumers and companies may well be irreversible.
Also Read: Andy Mukherjee: Trump’s tariffs should push India to double down on reforms
What about the USTR formula? As indicated in the NYT, the US reciprocal tariff calculation is simple. A country’s rate is half its trade deficit with the US expressed as a percentage of imports from that country.
This sounds extremely simplistic, since it makes no reference to how US imports will respond to tariff-raised prices—or varying elasticities of import demand. A closer look at the derivation of the reciprocal formula reveals the truth: if one assumes the right values, the elasticities balance each other out and become irrelevant. So a simple division of a deficit by import value—turned into a percentage—gives you the proposed tariff.
So what can we conclude? Global retaliation will certainly lead to some trade disruption, as in the 1930s, but the consequences will be nowhere as severe today, given the emergence of new trading blocs and the diminished US clout in world merchandise trade.
Also Read: Trade war: Trump’s shock-and-awe tariffs only have a faint silver lining for India
What should India do? The first suggestion is to do nothing. The USTR formula suggests a 26% extra tariff, though 27% was later announced. It would seem that is a blanket rate, but the White House has left itself considerable space for adjustments based on talks. An India-US bilateral trade agreement could get into category wise details, allowing New Delhi to figure out how best to give the US more market access while still protecting some politically sensitive domestic interests.
In the final analysis, this is one war only the US can lose.
The author is visiting professor, Shiv Nadar University.
