US-China trade war will have no winners

One of the significant global trends these days is the rise of protectionism. Prime Minister Narendra Modi had identified this as one of three major global challenges in his speech at Davos earlier this year. The rise of protectionism is closely identified with the trade policies articulated, and now implemented, by President Donald Trump. His government’s latest move to impose high import duties on aluminum and steel is but the latest in a series of protectionist measures, and more may follow. These recent duties are squarely targeted against Chinese exports to the USA amounting to 50 billion dollars. The Chinese embassy in Washington DC instantly reacted by warning that China would not hesitate to defend its legitimate interests, and would not recoil from a trade war. The usage of “war” is purely metaphorical, but does convey the potential impact.

While restricting cheap aluminum and steel from entering the USA from China (most other ally countries are exempted), President Trump aims to protect American jobs. It takes months to restart closed smelters and steel mills, and new jobs creation may be in the hundreds or a few thousands at best. But it will increase the cost of these materials for downstream industries like automotive, beverage cans, electronics and construction. The rise in the downstream costs, and consequent loss of competitiveness can only mean higher imports of those products. Hence trying to plug imports from China could lead to a surge of imports from other countries.

Does America intend to follow through with higher protective import duties for cars and cans as well? American consumers will surely lose.  But more importantly, if China retaliates, by switching their demand for aircrafts from Boeing to the European Airbus, it could hurt the aerospace business. It could make life difficult to the many large US companies that operate in China, such as Microsoft, Apple or GE. Once this “war” escalates, there’s no saying where it will head or how it will end. As in apprehension of such developments the Dow Jones stock market index fell by 1100 points in just two days. This might have a domino effect on other stock markets around the world as the fear and nervousness spreads.

Most economists and business associations and industry bodies are against protectionism, but on President Trump’s part, he is merely delivering on promises made during his election campaign. There is a part of his core electorate, which thinks that raising tariffs and “punishing” China is the right thing to do. The Wall Street Journal even ran a piece saying it was China and not the USA which started the trade war. It alleged that the China had arm twisted US companies who were investing into China to form joint ventures and share intellectual property, which was then openly stolen. China also unfairly  undervalued its currency for decades boosting its exports to the USA. So, the current tariff hike is a “payback” for the 375 billion dollar trade deficit that America has with China.

Such talk is politically seductive, but economically wrong. If China ran an undervalued currency for long, it would hurt its domestic workers because of depressed wages for long. If the USA has a large and persistent trade deficit with China, it implies a higher standard of living for Americans. Most of China’s surplus dollars are anyway invested in American government bonds, so there is that co-dependency. Also a trade deficit with one country is offset with a trade surplus with another country, since the global trade is always in zero balance, by definition. If US companies have concerns with China there are other ways apart from wholesale tariff wars, like quiet back channel economic diplomacy to resolve trade and intellectual property disputes. But the sabre rattling is currently increasing in pitch, and alas, no amount of counsel or economic theory lessons can reduce it for the time being.

The global trade in goods and services is today an intricate interconnected web. In goods trade, the manufacturing is organised along global value chains which straddle several countries. This is most obvious in the textile chain (fibre, yarn, fabric, garments, branded apparel, high fashion) or in electronics (chips, motherboards, devices, embedded software and branded products). The classic case is that of the iPhone, which is manufactured and assembled in Asia (including China), but whose major value is captured by Apple, because of the high price of intellectual property of design and operating system software. Thus, out of a thousand dollar phone, barely ten or twenty dollars may be retained in China. In a world of global value chains which require frictionless movement across trade borders, a “trade war” can be especially harmful to producers and consumers.

India will not remain an unaffected bystander in this trade war.  It needs to pay dollars or foreign currency for critical inputs like crude oil (close to a hundred billion dollars of imports), edible oil, high end capital goods and machinery, electronic goods like mobile phones and defence equipment. None of these are currently manufactured in India, and hence have to be imported. Add to this the import of uncut diamonds and gold. All these imports can be paid only by dollars earned from exports (not from foreign loans or stock market inflows).

Thus, India’s exports need to flourish and enter world markets across various countries. As such our exports have suffered owing to demonetisation (last year, whose effect lingers), delayed GST refunds and a strong rupee. This year, our current account deficit will be closer to 2.5 percent of the GDP, more than three times of last year. We really need our exports to grow substantially this year. This also includes earnings from tourism and software.

Into such a challenge (to grow our exports), the prospect of a trade war between the two largest economies of the world is bad news. The falling stock and bond market sentiment can cause reversal of dollar flows, and increased trade barriers can cause collateral damage to us. Let’s hope that wiser counsel prevails and cooler heads can de-escalate this situation through economic diplomacy.

Ajit Ranade is an economist and senior fellow, Takshashila Institution.

(Syndicate: The Billion Press)

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