Indian virtue in the US-China trade war

Business Standard, 13 October 2025

The game of chicken

The global rules-based order is being systematically subverted by China. Its state-led economic model relies on practices that contravene the principles of the World Trade Organisation, including extensive industrial subsidies that create global overcapacity, pervasive non-tariff barriers, state-sponsored intellectual property theft, and forced technology transfer. In the security domain, Beijing openly disregards international law, exemplified by its rejection of the 2016 Permanent Court of Arbitration's ruling on the South China Sea. It undermines regional stability with military coercion against Taiwan and provides a crucial economic lifeline to Russia helping in the invasion of Ukraine. In response, the new US administration under Donald Trump has initiated a policy of imposing high, broad-based tariffs, aiming to force fundamental changes in China's behaviour [EiE Ep96 Is globalisation doomed?].

This confrontation is a geopolitical game of chicken. The game theory model is simple: two drivers accelerate towards each other on a single-lane road. The first to swerve is denigrated as the "chicken"; if neither swerves, the result is a catastrophic collision. The high-stakes standoff between Washington and Beijing is of this nature. Each side is projecting strength, but a closer look reveals significant internal weaknesses that pressure both to find an off-ramp.

Chinese weakness

On the Chinese side, the economy is afflicted by severe structural weaknesses. The collapse of the over-leveraged property sector is the epicentre of the crisis. This has triggered a solvency crisis for developers and for local governments that depend on land sales for a significant portion of their revenue. The contagion has, in turn, placed the banking system under severe stress, given its exposure to both property developers and local government financing vehicles. The government has ratcheted up economic nationalism, crushing private sector confidence and fuelling record-high youth unemployment.

Decades of state-directed industrial policy have created chronic overcapacity in one industry after another, from steel to solar panels to electric vehicles. China has not graduated to a market economy, shaped by the price system, with normal incentives of firms to do investment and a bankruptcy process. These sectors now depend on exporting their surplus production to remain financially viable, making them acutely vulnerable to tariffs and trade barriers.

The combination of central planning failures, a collapsing property bubble, and demographic decline invites a historical parallel with the USSR of the mid-1980s: a seemingly mighty, centrally planned economy quietly crumbling from within. Beijing's dilemma is acute. In 2023, China's goods exports to a broad bloc of advanced economies totalled approximately $1.85 trillion of which the US was at $427 billion. The Chinese government is torn between nationalist pride vs. the pragmatic necessity of ending the trade war to stabilise its economy.

American weakness

On the American side, for all the rhetoric about protectionism, the economic reality is also challenging. Imposing high, broad-based tariffs is a self-defeating policy that inflicts significant harm on the domestic economy. The tariffs disrupt supply chains, raise input costs for American manufacturers, and ultimately act as a tax on consumers. Apart from a capital investment boom in Artificial Intelligence, underlying US economic growth has stalled. The tariffs are feeding inflationary pressures. Reflecting a global retreat from American assets amid policy uncertainty, the US dollar has weakened significantly; the USD/Euro exchange rate has dropped by approximately 11% in 2025 alone.

It's efficient for them to make a deal

Both protagonists are engaged in high-stakes game of chicken from positions of surprising vulnerability. There is tremendous pressure on both sides to step back from the brink. Each leader wants to project strength and extract concessions, but each is captaining a ship that is listing badly. Both would prefer to end the trade war and tend to their domestic problems. This suggests that while the rhetoric will remain heated, the most extreme protectionist measures may prove temporary.

The optimal path for Indians

For Indian policymakers and firms, this volatile environment creates a strategic opportunity [EiE Ep114 What should India do?]. The optimal path is a strategy of deep and pragmatic global integration.

  1. India must prioritise concluding a comprehensive trade and investment agreement with the United States. Such a deal would stabilise a critical foreign policy relationship and unlock economic complementarities in technology, finance, and services. Progress remains stalled by tariff and non-tariff barriers on both sides, from complex rules of origin to restrictions on services, capital flows, and government procurement. Frictions over visas, tax complexities, and data localisation rules have also impeded progress. Systematically dismantling these obstacles would deepen India's integration with the world's largest market and reinforce our participation in strategic frameworks like the QUAD and iCET.
  2. This alignment reinforces India's positioning as the natural “China +1” alternative. Seizing this opportunity demands a renewed commitment to domestic structural reforms. This requires a fundamental overhaul of regulation and the functioning of regulators [EiE Ep99 Where Indian regulation went wrong]. It requires deepening indirect tax reforms and an orthodox GST. It means tackling foundational problems like slow judicial enforcement, and restrictive labour and land laws. The goal is to create an environment where foreign and domestic firms can operate with confidence, unlocking the private investment needed for sustained growth.
  3. India should accelerate its integration with other advanced economies through deep and comprehensive Free Trade Agreements (FTAs) with high-trust partners like the European Union, the United Kingdom, Japan, and Taiwan. These FTAs are more than just trade documents; they are vehicles for institutional spillovers that can elevate the quality of domestic governance. This outward orientation fundamentally alters firm-level incentives. As economists Jagdish Bhagwati and Anne Krueger observed decades ago, firms that compete globally tend to rent-seek less and innovate more.

The wise strategy for Indian firms is unambiguous: globalise. The imperative is to learn at the global frontier. As multinationals bring advanced technical and managerial know-how into India [EiE Ep111 The wonders of FDI], domestic firms must engage deeply with foreign capital, technology, and skilled personnel. A firm's degree of internationalisation serves as a powerful indicator of its quality [EiE Ep48 Graduating to globalisation]. Competing in global markets de-risks firms from domestic business cycles and regulatory vagaries. Production sites all over the world give resilience against the vagaries of governments that impose trade barriers. The approach of becoming a global firm forces a reliance on genuine competitiveness over state patronage. In this new era, firms must be deliberate in choosing partners, favouring jurisdictions with low geopolitical and regulatory risk: the high-trust liberal democracies.

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