India has responded to Trump tariffs. Tariffs on aluminium and steel imposed last year and the Donald Trump government’s ultimatum to India to cease import of crude oil from Iran have the potential of hurting India’s economic interests.
After keeping negotiations open for almost a year, it is the US’ withdrawal of duty-free access to Indian exporters under the Generalised System of Preferences (GSP) that has acted as the proverbial straw that broke the camel’s back.
When a big bully throws a punch at you, what do you do? Do nothing, or stand your ground and resist? By imposing tariffs on 28 items originating from the US, India has resisted Washington’s unilateral escalation of trade impediments. From a purely political standpoint, it makes sense. But what about the economic implications of a potential tariff war for a relatively smaller economy like India?
One of the key drivers of trade is the concept of comparative advantage — the home country (India) would import products relatively easier (and cost-effective) to produce in a foreign country (US), and export those items relatively easier to produce domestically. The reverse is true for the foreign country.
In his seminal 1953 paper, ‘Optimum Tariffs and Retaliation’, Harry G Johnson concluded that a country will win a tariff war if its relative monopoly power in world trade is sufficiently large — that is, the odds are greatly in favour of the bigger economy.
Using a different economic framework, in 2002, Constantinos Syropoulos concluded that if the bigger economy exceeds a certain relative threshold size, then it would prefer a world with tariff war than a world with free trade, to the detriment of the smaller economy. However, these results of Johnson and Syropoulos hold only in a static environment — when at least one government is impatient, cares only about short-run gains and doesn’t plan for longer horizons.
In a 2010 paper, Marcus M Opp studies tariffs and retaliation in both static and dynamic settings. His conclusions in the short-run setting are very similar to Syropoulos’, but his framework also yields an interesting result. As the degree of comparative advantage of the smaller economy (India) increases, across goods, the relative threshold size beyond which the bigger economy (the US) would prefer tariff war also increases.
This means, with continued economic growth, if India undergoes structural and economic reforms that will allow its industries to produce more efficiently, then the US will have to be a lot bigger than what it is to want to engage in a tariff war.
This is easier said than done and will require some years to achieve. However, such long-term planning on India’s part will make it immune to unilateral hikes in tariffs on its products by foreign countries in the future.
But what would the imposition of tariffs by India on these 28 US items achieve? In the short run, not much really beyond being a political gesture. It shows the world, especially Washington, that India is no pushover.
However, economically, the harmful side effects of India’s tariffs on US items (through a drop in US exports) will be more or less offset by US’ better relative production capacity, and the short-term gains it will reap by restricting India’s exports.
International trade is not a zerosum game and there is always complex dynamics at play. However, these tariffs could possibly achieve one important thing: bring Washington back to the negotiating table.
Senator Dianne Feinstein has expressed concern over the tariffs’ impact on California almond growers. It is unlikely that a Democrat like Feinstein will have any persuasive power over the current federal government.
However, if tariffs are imposed selectively such that Republican constituencies are adversely affected, then that might rally enough Republican senators to persuade Washington to adopt a more far-sighted approach and sort out differences at the negotiating table.
Perhaps this is a far-fetched thought, but an option that could be explored. In a dynamic setting, with governments that plan for longer-time horizons, the long-run benefit of cooperation exceeds the short-run gains from a tariff war.
The writer is assistant professor, economics, Ashoka University, Sonepat, Haryana
Source: The Economic Times