In the past, protectionism led to the Great Depression. According to Nobel Laureate Paul Krugman, trade wars have always led to fall in world trade and a fall in world real income.
By Jayshree Sengupta
United States President Donald Trump has imposed higher tariffs on Canadian, European and Chinese goods. He has particularly targeted $200 billion of Chinese goods with 10 per cent duties. The Chinese have retaliated and both have imposed $34 billion worth tariffs on each other.
Trump’s protectionist policies, which are being applied since July 2018, are now beginning to hurt the American consumers, because most corporations affected by the tariffs on important inputs have no other alternative but to raise the prices of goods produced by them. Thus the impact of higher tariffs on steel and aluminum are being passed on to the consumers. This will ultimately reduce demand and real output of the American economy.
But by all accounts, the US economy under President Trump is doing well and unemployment is at its lowest in July 2018 — at 3.9 per cent. His policies have created many jobs across America about which he boasts often. Inflation has been kept down for years. The US economy is predicted to grow at a record of 3 per cent in 2018.
However, already inflation is creeping up from the annual core inflation rate of 1.9 per cent and is likely to reach the target limit of 2 per cent soon.
The reason inflation is picking up is due to companies making anything from cars to tractors, dishwashers to canned soft drink (Coca Cola) facing weaker profits on account of high input costs, comprising aluminum and steel that are subject to higher duties. Lower profit prospects may lead to their stocks going down. They are increasingly passing the higher costs and input prices to consumers by charging more for their products — like the famed washing machine makers Whirlpool.
Tariff related cost increases that fan up inflation will prompt the US Federal Reserve to raise interest rates more often than scheduled. Tariffs are raising company expenses at a time when they are already paying more for other materials, especially labour. The nascent recovery which Trump has been flaunting could be clipped short if interest rates rise and the cost of borrowing rises for firms.
Some companies, however, are not able to pass on higher costs through price increase because they fear shrinkage of demand — like in the case of General Motors. Companies like GM have also benefited from Trump’s tax cuts in the past and have been able to shore up profit and are not going for price increase. They are being helped by consumers who seem to be anticipating price rise and are stepping up buying big ticket items. This has been good for such companies so far, but it may not be sustainable because higher borrowing costs for consumers due to higher interest rates will soon shrink their demand.
Rising interest rates in the US will have a worldwide repercussion on the FIIs which will try to head back towards the US, abandoning the Emerging Markets. Already FIIs have been exiting Indian stock market in hordes ($7 billion since the beginning of 2018) creating a problem in foreign investment inflows and creating volatility in the stock market. This will make the supply of investible funds shrink in the Indian stock market, constraining corporations to make new investments. Volatility in the capital market will be very dangerous when India is trying hard to grow at a higher rate in the election year. It may lead to further FII outflow. If the Federal Reserve keeps raising interest rates over and above the two expected hikes this year, the rupee may depreciate further aggravating the problem of financing the high oil import bill and widening of the current account deficit.
Although Trump’s imposition of high tariffs will force China to seek imports from other countries, India may not be a big beneficiary because China will focus on countries that fulfill its specific needs. Its imports from the US consisted mainly of agricultural products and India can supply soybeans but since China has reduced duties on 8549 types of goods from India under the Asia Pacific Trade Agreement, India may already be a beneficiary. These items include chemicals, clothing, steel, aluminum and medicinal products.
In recent weeks, China’s economy seems to be slowing down. China’s trade surplus has shrunk considerably in recent months and the Yuan has slid by 6 per cent to a six-month low in a falling stock market. The Turkish lira has sunk to a new low after new sanctions on Turkish exports of aluminum and steel.
In the past, protectionism led to the Great Depression. According to Nobel Laureate Paul Krugman, trade wars have always led to fall in world trade and a fall in world real income. China is clearly losing out in the trade war because it is much more dependent on US demand and is getting hurt by taking a hardline stance. The US trade deficit with China was $375 billion in 2017. It imports $505 billion worth of goods from China. The fall in exports is hurting China. It’s try to ally with the European Union has also not worked and the Europeans are tightening scrutiny over Chinese investments in the name of national security. They have been worried by the influx of huge Chinese investments in recent years.
Higher oil prices will also contribute to the onset of a worldwide depression. The US is one of India’s main trade partners and hence it is important that its trade balance which runs into a surplus does not attract fresh tariffs. Both the US and India seem to be keen to resolve trade issues and prevent the implementation of India’s retaliatory tariffs worth $235 million on 29 American products that were supposed to come into effect in August 2018 in response to higher tariffs on steel and Aluminum. The US is already critical of India’s export subsidies and the RBI’s ruling on data localisation to ensure that firms operating in India move their servers to India.
As long as the US economy is buoyant, President Trump will seem to be a clear winner but any slowdown of the economy, caused by a hike in inflation leading to higher interest rates, may have disastrous consequences on the rest of the world because of the importance of the dollar and the Federal Reserve’s policies on world financial flows.