In the 1930s, the global economy was struggling with recession. Every national economy was suffering from lack of demand and was thus desperate to find markets. So, many countries decided to protect their economies from imports while trying to push up exports.
Everybody raised customs tariffs, or banned imports. This mercantilist approach is often referred to as the “beggar thy neighbour policy”. It would have worked perhaps if only one nation had done it. That country may have gained export volumes and exploited its domestic market into the bargain. (Japan got away with using this policy in the 1950s, when it was given a free pass as it recovered from the devastation caused by the Second World War.)
But as any game theorist would tell you, when a nation puts up trade barriers, it triggers retaliation from others. Then, every nation ends up poorer. Global trade more or less collapsed in the 1930s. Many countries ended up as closed economic systems, or autarkies, which neither exported nor imported.
The problem with autarkies is that no nation can exploit the comparative advantages it may possess. There is an opportunity cost to producing anything and countries need to leverage their ability to do something or the other more efficiently. To take a simplified example, resources employed in making bread are not deployed in producing steel. Say, nation A can produce 10 kg bread or 1 kg steel while nation B can produce 8 kg bread or 2 kg steel. Nation A should import steel from B and export bread in return because of their respective comparative advantages. That way, the combined output is optimised. If both A and B produce bread as well as steel, then the output of both goods drops.
The theory of comparative advantage explains why free trade works better for everyone. Game Theory also comes into play: nation A raises tariffs, B retaliates in kind. Matters inevitably escalate.
Between 1990 and 2016, global trade barriers progressively declined. India liberalised; China became an export powerhouse; the Soviet Union turned into 13 capitalist countries; the Warsaw Pact nations went capitalist; the European Union got bigger. The North Atlantic Free Trade Agreement happened; the Association of Southeast Asian Nations came into being; Mercosur happened. Trade blocs such as Nafta, Asean and Mercosur may not be ideal, but they do help increase trade between the members. And boosting growth has helped pull hundreds of millions of people out of poverty.
Over the years, negotiations between blocs and nations led to further, incremental liberalisation. But the trend changed when Donald Trump became the president of the United States in January 2017. Trump seems determined to revert to the policies that triggered a global recession in the 1930s. The US is now engaged in trade wars against China, the EU, Canada and India. It is also demanding sanctions against Iran (and Trump seems to want sanctions against Harley Davidson as well!).
US versus the rest
So, it is the US versus the rest of the world in this global trade war. The US has raised tariffs on all sorts of goods and tightened work visa norms. China has retaliated with tariff hikes; India has retaliated with tariff hikes; the EU has retaliated. And Trump still has two years to serve as the president (assuming he is not impeached). He has turned trade negotiations into some sort of a personality-driven reality show, replete with social media commentary. So it is possible, even likely, that we will see more rounds of this tit-for-tat game, leading to more goods facing higher tariffs.
This could trigger a reduction in global trade. The EU, India, China and other nations will not raise tariff barriers against each other. But if China sells less to the US, it will buy less from the EU, and the EU will buy less from India, which in turn will buy less from China.
Even after Trump is voted out (assuming he is, or he does not stand for re-election), or even if he reverses policy direction, the trade war will not end automatically. Trade agreements take years of negotiation, with faceless bureaucrats working out the endless necessary, boring details. It will take years to pull the world back to the status quo prior to Trump.
If the trade war carries on and escalates, India could be pretty badly affected over time. Trade makes an enormous contribution to India’s gross domestic product – over 40% in 2016, according to the World Bank.
India has to import energy, including crude oil, gas and solar equipment. (China enjoys a monopoly on rare earth metals which are essential for solar and wind power systems). India also has a negligible manufacturing base in electronic components, which means it has to import most of the parts that go into cellphones and computers even if they are assembled in Indian facilities. Stuff like specialised construction equipment and industrial robots are also imported.
India also exports a lot of things, including services. About 16% of Indian goods exports go to the US and 57% of information technology revenues come from the US. The IT industry contributes around 45% of India’s services exports of about $160 billion. Goods exports are hovering just below $300 billion and have actually declined in the last five or six years.
India’s service exports are not just about IT workers and doctors, though. There are the nurses, truck drivers, restaurant workers and oilmen who send back massive remittances, amounting to $69 billion last year. If global trade reduces, there will be layoffs in those industries as well.
The direct impact of a trade war with the US will be painful. The indirect impact of a reduction in global trade could be worse. What can policymakers do about this? Nothing really, unless they can persuade Trump that it is stupid to spark a trade war.
This now looks like a mega train wreck, happening in slow motion.