Trump 2.0 tariffs will worsen global economic climate, but India’s main problem is domestic trade policy

President-elect Trump strongly believes in tariffs as a response to many of America’s problems.

By Devashish Mitra

A possible solution to India’s jobs problem is the expansion of its exports, especially of labour-intensive manufactures. However, India’s export performance has been much worse than not only many of its competitor nations, but also many other countries at lower stages of development. While there are many domestic constraints on India’s export expansion, the size of external markets producers in India have access to also can potentially matter. In this regard, the international economic policies of countries which are potential buyers or users of Indian products are important.

One of the biggest potential external markets for Indian products is the US, where Donald Trump will be taking office next week as President for a second non-consecutive term. With every new administration, come new policies, including trade policy. But, with this change in administration, the changes in trade policy in particular deserve special attention. President-elect Trump strongly believes in tariffs as a response to many of America’s problems, whether it is lack of good jobs or trade deficit or the rise of China as a global power or a shortfall in government revenue.

There isn’t much uncertainty regarding whether we will have high US tariffs on Chinese manufactures. There is bipartisan agreement in the US on the need for it, as a response to national security concerns related to imports from China.  But, US tariffs are not expected to be restricted to just China.

Trump 2.0 tariffs is likely to disrupt economic climate

During his recent presidential campaign, Trump promised across-the-board tariffs: up to 60 percent on China and up to 20 percent on others. Going by the experience of his previous term, tariffs could also be on US’s allies, who will now face extreme uncertainty regarding Trump’s trade policies. Trump has also threatened a 100 percent tariff on countries trying to move away from the dollar as their global currency of choice.

According to economists Maurice Obstfeld and Kimberly Clausing at the Peterson Institute for International Economics, Trump’s new tariffs will “apply to more than eight times more imports than his last round” which is roughly around $3.1 trillion. Martin Wolf of the Financial Times predicts that Trump’s second-term tariffs will be such that his first term trade policy would, in comparison, look like “relatively modest starter protectionism.”

During the last Trump administration, the trade war with China was highly disruptive for the world economic climate. This time there is the possibility of a bigger trade war with China, as bigger tariffs generate bigger responses. Also, cooperation with allies on supply chains is going to be difficult, as those slapped with high tariffs are unlikely to cooperate.

Tariffs hikes lead to price spikes, which is an inbuilt check

Regarding barriers on service imports, visa restrictions, including on H1B and other work visas, will restrict service imports by the US. There are currently strong disagreements between the Elon Musk segment of Trump’s supporters and his base as to whether the H1B program should be expanded or restricted. Which way this internal disagreement will get resolved is anyone’s guess. While one way to restrict international movement of workers is through changes in official policy, there is also the possibility for the government to target implementation, in the form of understaffing consulates and embassies, as was done in Trump’s previous term. This will quite certainly adversely affect India’s service exports.

While the policies described above are clearly not good news for India, things might not be that bad in the end. A totally isolationist policy, including a very aggressive tariff policy, as promised by Trump during his recent campaign, might not be feasible. An important consequence of increasing tariffs is price rise, which, we know from election results all over the world, can have very adverse political consequences for the incumbent government. That is why, if price rises go out of control for the new administration after their tariff hikes, they might be forced to temper or even fully reverse their tariff increases. Destruction of global supply chains will create severe shortages, and, consequently, rise in prices.  There will be forces then moving in the direction of global supply chains with friendly countries. The push to move supply chains out of China will provide India with opportunities.

India’s real binding constraint is domestic policy choice

Moreover, what happens to US trade policy in the end might not finally matter so much for India’s exports. India’s own policies and institutions might be the real binding constraints. India’s own tariffs have been rising. As per estimates by economist Rajeshwari Sengupta, average tariffs on non-agricultural goods rose from 10 percent in 2015 to 15 percent in 2021. Also, Arvind Panagariya has found that while 11.9 percent of India’s tariff lines had tariff rates above 15 percent in 2010/11, the proportion had risen to 25.4 percent in 2020/21. This is a problem, as basic trade theory, in particular the Lerner Symmetry Theorem, shows that a mercantilist policy (one trying to promote higher exports and lower imports) is not feasible, and that taxing imports is equivalent to taxing exports.  Additionally, India’s protectionist policy also works against India’s labour-intensive input processing and assembly.

In this context, it needs to be pointed out that India’s Phased Manufacturing Program, promoting indigenous value chains in place of global value chains, is extremely misguided. Evidence provided by economists Choorikkad Veeramani and Garima Dhir shows that specializing in a few labour intensive tasks in global value chains can, through a volume effect, create greater total value added than in value chains that are kept fully indigenous. There is also a tariff inversion problem (which is one of higher tariffs on imported inputs than on imported output), which hurts India’s manufacturing firms.

In addition, barring recent FTAs negotiated with the UAE and Australia, India’s progress in negotiating FTAs has been slow overall. Progress has also been extremely slow with reforms in factor-market regulations, such as labour laws and land acquisition regulations. With these domestic constraints present and highly binding, what happens with US trade policy and its associated uncertainty might in the end be moot for India.

(Devashish Mitra is Professor & Chair of Economics and Cramer Professor of Global Affairs at the Maxwell School of Citizenship and Public Affairs, Syracuse University, NY, USA)

Views are personal and do not represent the stand of this publication.