The Fallout of US Tariffs

CC by James N. Mattis

Tariffs and other protectionist measures from the US have injected bitterness into its relationship with many countries and India is no exception to this.

Back in 1930, 1028 prominent economists wrote a letter to Congress urging them to reject the Smoot-Hawley tariff act, which proposed to raise the tariffs on more than 20,000 imported goods. Congress did not heed their words and went ahead with the tariffs, which precipitated a trade war. Other countries naturally followed suit and retaliated against the US protectionist measures.

The disastrous effects of that trade war are well studied and often quoted as a warning. Both US imports and exports decreased and so did global trade. Gross National Product fell from $103 billion in 1929 to $56 billion in 1933. The tariffs, which were meant to protect American jobs, failed on that account as well. Unemployment increased from 8% in 1930 to 25% in 1932. Not all of these effects can be attributed solely to the protectionist measures, given that the economy was in a depression already, but it did have a significant negative effect.

In a case of history repeating itself, in May of 2018, more than 1100 economists, including Nobel Prize winners sent a letter to Mr. Trump against the new set of tariffs. Apart from expounding on the host of potential negative consequences, they mention an important aspect of international relations:

Finally, we would urge our Government to consider the bitterness which a policy of higher tariffs would inevitably inject into our international relations. A tariff war does not furnish good soil for the growth of world peace.

Tariffs and other protectionist measures from the US have already injected bitterness into its relationship with many countries and India is no exception to this. In India, the strongest support for India-US relationship comes from the southern states – Karnataka, Tamil Nadu, Kerala, Andhra Pradesh and Telangana – as they have had closer trade, investment and people-to-people ties with the US than the rest of the country. One blow to this has already come in the shape of tighter H1-B regulations, though it is too early to comment on its consequences. From the Indian national interest viewpoint, while reduced migration might hurt foreign exchange inflows via remittances, it might help in talent retention.

However, if the current trend of protectionism in the US extends to other goods such as pharmaceuticals, or to services such as software, the US faces the prospect of losing this support base. Further, if the US were to lose the support from the south, India-US relationship will again be seen largely from the prism of the Pakistan factor and the economic partnership will have to take a backseat.

There is also an unexplored potential for India and the US to have a mutually beneficial strategic relationship in the healthcare sector. Given the high healthcare cost in the US, it would benefit from lower-cost pharmaceutical products from India and India would gain to benefit from jobs created and from higher export revenues.

The India—US defense partnership will also be weakened if trade barriers hinder the relationship between the two countries. Purchasing defense equipment is a strategic decision, not a transactional one for India. The risk of being overly dependent on foreign powers can be mitigated if we procure military equipment from countries with which we have extensive economic ties. However, if general trade between the US and India suffers due to increasing tariffs, defense procurement from the US would no longer serve a strategic purpose and India will lose the strategic leverage that comes from being able to favour a country which can give us something more than just military equipment.

Finally, tariffs will also affect business and investment decisions. Given the particular state of global finance, with increasing inflation in the US (partially caused by increased import costs) and higher interest rates as a result, the flow of portfolio and direct investment from the US to India will reduce. With India’s banking sector facing a severe crunch due to high amount of non-performing assets, the need for private sources of funding for Indian companies will be acute. Simultaneously, China is continuously looking for opportunities to invest abroad, as witnessed by its aggressive buying of assets in other countries. The void that will be left by the US will be readily filled by China, and that is an outcome that neither the US nor India will be too keen to witness.

There are many points of convergence in India-US relationship, but to take full advantage of it, there needs to be a “good soil” for international relations and not be strained by tariffs, which will cause harm on both sides. On India’s part, it has done well by delaying the levy of retaliatory tariffs by 45 days for negotiations to play out. The US should acknowledge this and attempt to halt the rapidly deteriorating trade relationship with India.

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About the author

Anupam Manur

Anupam Manur is a Research Fellow at the Takshashila Institution. He was previously working as a Research Associate at the Indian Institute of Management – Bangalore. His policy research areas are at the intersection of economics, technology, and public policy. He is currently working on digital payments, blockchain and bitcoins, urban transport, and unaccounted income in India.