Implications of US tariffs
Business Standard, 31 March 2025
The US accounts for about a quarter of world GDP, and used to play a leadership role in the globalised liberal order. All eyes are now on 2 April, termed `liberation day', where the US promises new tariffs.
What we in LDCs know
We in India have an intuitive understanding of underdevelopment. This gives us an edge in understanding the new US. Good policy making involves research, consultation and negotiation. None of these have been done in the period leading up to 2 April.
With EM levels of policy capability, the announcements of 2 April are fully unknown today. They will be littered with mistakes and unintended consequences. Populist regimes [EiE Ep42 The populist playbook] suffer from low capability and from pride: they find it hard to accept mistakes and reverse course. The Global Economic Policy Uncertainty index is at its all time high. After 2 April there is plenty of uncertainty yet to go.
It sometimes rhymes
In 1930, the US introduced the Smoot-Hawley Tariff Act, a significant milestone in the economic and political catastrophes that led up to World War 2. There is room for optimism that things will work out better this time. This is because the other advanced economies are less likely to repeat the mistakes of that period, in terms of retaliatory tariffs and retreats from floating exchange rates.
- Retaliatory tariffs?
- It is easy to think of trade as a process of deal making: I cut my tariffs because you cut your tariffs. Economists know better: Unilateral tariff reductions in India are a good thing for our self-interest, regardless of what others do. When you drink poison because someone else drank poison, it is mere machismo.
- Competitive devaluations?
- The power of global financial markets and international capital mobility has reduced the possibility of governments interfering in floating exchange rates with competitive devaluations.
There is a recognisable strand of thought that connects Smoot, Hawley and Hoover, to the philosophy of today's US government. But the rest of the advanced economies remain at first world capabilities in politics and the state. Some countries will carefully introduce tariffs that harm Trump voters in marginal constituencies, in order to negotiate with the US in ways that its political leadership understands. In the main, it is unlikely that the rest of the global trading system will collapse.
The uncertainty shock
The tariff story will not end on 2 April, and looking beyond this, liberation day is not the only problem in the air. From 20 January on, there has been an uncertainty shock to the world economy. Tariffs in the US will induce inflation, which could kick off rate hikes in the Fed through the 2% inflation target. Sectors like tourism and higher education are in retreat. Tariffs will harm exports by the US. The decline in US asset prices and the US dollar are likely to feed into reduced US consumption.
High uncertainty is adversely affecting the world economy. Managers look at the fog and prefer going slow, gathering more information before actions are undertaken. Firms worldwide have gone slow on decisions of strategic import. This demand shock has been coursing through the world economy from 20 January, and is now percolating into data releases. There is little possibility of uncertainty going down in April and May.
The Indian perspective
Indian interests are critically tied to a successful world economy. The most important successful industry that has come about in India is services exports, with a run rate of doubling every eight years. Difficulties in the world economy are bad for India. It is in India's interests to be a status quo power.
Indian firms tend to be highly connected into the US economy through elite human networks formed through traditional US strengths in higher education and openness to immigration. The firms need to factor greater uncertainty and reduced economic performance in the US, into their planning. It would be efficient to prioritise advanced economies other than the US as touchpoints for cross-border activity.
Difficulties in America create incentives for American companies to do more in India. For American firms, policy uncertainty in the US, and tariffs in particular, encourage an America+China+1 policy. More work will be sent to other production destinations including India. If difficulties in the US economy hinder revenue and profit growth, boards can readily double activity in India through the beachheads of contracts and FDI that are already in place.
In some products, there could be relative gains for India if tariffs against Indian exports into the US prove to be lower than those seen with other countries. When many numbers are up in the air, and new announcements come out fast and furious, there will be some such situations. Indian firms need to seize these situations, recognising that in a few days, the nice configuration of tariffs could be gone.
Responses by the Indian state
India has bubbled up into the prioritisation of the Trump team as the Indian government has the highest trade barrier of any large country in the world. According to newspaper reports, the Indian government has responded to this situation by offering to pull back on Indian economic nationalism and protectionism. Indian trade barriers are too high, and there are high levels of effective protection because of the dispersion of rates. A single rate like 0 or 1%, alongside special mechanisms crafted for special situations, is the right framework for us.
A sharp phase of pro-globalisation policies -- even if done under threat of the Trump regime -- would be a strong positive for the Indian economy. In that vein, we should applaud the decision to remove the `equalisation levy', which was (in any case) an error in Indian tax policy.
This moment could be catalysed for comprehensive economic agreements with the US, the UK and the EU. These should not be the old style Indian agreements, with hundreds of special clauses that preserve the existing structure of protectionism: they should be simple agreements that remove all barriers to cross-border activity. Such a group of agreements, which do genuine globalisation as opposed to the traditional approaches of suspicion and protectionism, would be transformative for India's economic future.
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