Recently, US President Donald Trump has approved multiple protective international trade measures and caused a global uproar. These measures are, though, not completely unexpected; and they have equally expectedly irked the global leaders. Many have already started suspecting that it is the beginning of an ugly trade war.
Are we really moving towards another trade war? How is this whole episode going to end up? Is it going to cause any havoc in Indian and global economy? No doubt, these are all trillion dollar questions; if not more than that. Whatever be the final outcome, it is definitely going to have serious implication in the world economy and politics; there is not even an iota of doubt about that. In case you are not convinced stay with us till the end of this article.
A primer on international trade
As we all know international trade is the exchange of goods, services and capital across the international borders. This is no new phenomena; similar trades are in practices since the ancient time between great civilizations; from Indus to European.
As per the basic concept of international trade, between two countries A and B, if country A is at an advantage of producing a particular good X at lower cost, then country B should buy or import X from country A instead of itself producing X at higher cost. Similarly, country A should produce and export more of good X and import other goods, for which it does not enjoy the advantage in production. The objective is to maximize profits for both the countries by utilizing resources available in each country at the best possible efficiency. There are other complexities in international trade theories; but let’s not get into those.
Generally, in ancient time an importing country traded in exchange of goods, which it could export or against the payment of a common currency like, gold. In case a country imported too much and exported less then there was a net out flow of gold from the country causing depletion in gold reserve of the economy. And gold being precious metal, depletion in its reserve was not considered prosperous for the economy. Later, gold was replaced by commonly recognized international currencies, like, US Dollar. The difference in export and import of any economy is commonly termed as balance of trade or net export. A country which imports more than it can export suffers from trade deficit.
Trade deficit: is it bad or good?
In economics, there is hardly any agreement on any issue. The same is true for the question we just raised! Trade deficit is good or bad depends on lot of things, including how a country is financing that deficit. After all, continuous depletion in foreign exchange reserve is not sustainable for a long term unless the country has a reliable way to replenish that. However, the whole discourse changes when we bring in the concern of a country like, US, which itself is a global political and economic powerhouse. US Dollar is the recognized currency of exchange in any international trade.
It is a fact that the United States of America owns the largest trade deficit in the world. In last few decades, it had accumulated a total trade deficit of $7.3 trillion. In 2016 only, it had a deficit of $734 billion in international trade. And USA is sustaining such a huge and increasing trade deficit by attracting foreign debts and investments, which have been possible only because of its political and economic power.
Possible implication of trade deficit in US economy
There are 4 popular arguments against the rising trade deficits in US and its implications.
- Threat to domestic industries – excessive dependency on imports is making domestic manufacturers out of business in sectors like iron & steel, aluminium, automobile, apparel, electrical equipment and machineries creating severe unemployment among common Americans middle class.
- Dependency on foreign debt – to plug the trade gap US economy is becoming too much dependent of foreign debts and investments. It is true that US economy is strong and growing; and foreign investors are bullish on its prospects. However, many in US suspect that excessive dependencies on foreign investors can potentially jeopardies America’s national security; make the domestic bond market susceptible to global chaos. As an example, China holds, by comparison, the largest share of total foreign holding of US debt. In case, Chinese central bank decides to offload a large chunk of that in favour of some other currency portfolio, it can cause steep depreciation in dollar valuation, at least in short term, and, at the same time, disturb monetary stability in US.
- Import dependency for items important to national security – this argument has been raised by the Trump government for imposing tariff on steel and primary aluminium. Primary aluminium is mostly used in defence and aeronautics. Import dependence for such goods can make serious dent on national security.
- Illegal trade practice – being the largest contributor to US trade deficit, China is allegedly involved in stealing of American IP rights. This has also raised concerns regarding validity of maintaining deficit with such trade partners.
List of top 10 US trading partners in terms of contribution to trade deficit in 2016 (million US$)
Source: https://en.wikipedia.org/wiki/List_of_the_largest_trading_partners_of_the_United_States
What is situation at present?
On March 1st 2018, US Government passed an order for special tariffs of 25% on imports of steel and 10% on import of aluminium into the country. Also, on 3rd April, 2018, US government declared punitive tariff of 25% on 1333 Chinese imports. This is going to cover roughly $50 billion worth of Chinese export to US. China has also reciprocated by imposing tariff on 106 US made products, including, soybean, aircraft and cars.
Though US started this trade protectionism with tariff on steel and aluminium; but it had temporarily exempted two major steel and aluminium exporting countries to US, Canada and Mexico, due to North American Free Trade Agreement (NAFTA). European Union has warned retaliatory actions in case US go further ahead with trade protectionism. However, unlike China, EU has refrained from taking any concrete action at this moment.
Export & import of steel and aluminium in US
Being a developed and growing country, demand for metals like steel and aluminium is ever-growing in US. In 2017, US imported around 35 million metric tons of Steel; a 15% increase from the year preceding. Majority of the import was done from select 10 source countries in 2017. The steel products primarily imported into US include stainless steel, semi-finished steel, long and flat products and also steel pipes & tubes. Growing demand in domestic market was mostly met with imported steel while crude steel production decreased in US since 2014. Several large steel mills closed their operations. Steel export also went down simultaneously.
Source: https://en.wikipedia.org/wiki/Iron_and_steel_industry_in_the_United_States#International_trade
Similarly, domestic production of primary aluminium in US slipped to 47% in 2016 which was the lowest level since 1951. At the same time imports of primary aluminium increased rapidly. There was time, as recent as early 2000, US was the biggest producer of primary aluminium. Today around 90 % of primary aluminium is imported to the country and utilized in manufacturing products like fighter jets, beverage can etc. Imported aluminium into US also includes aluminium sheet & plate, extruded items, foils, ACSR, bare cable etc.
Impact of protectionist trade policy in USA
On USA
Though, it might look trade barriers are prudent and effective ways to fight against excessive import and save the US economy from rising trade deficits, reality might differ for the economy as a whole.
- The immediate impact will be on American consumers; prices of consumer durables like electrical, electronic goods will increase.
- In absence of imported cheaper raw materials like, steel and aluminium; domestic producers will need to use expensive domestically sourced raw materials. This will increase prices of US made end products.
- Exports contribute a considerable share in US GDP; due to tariff on raw materials, production will be hampered affecting US exports.
- Increase in price will cause domestic demand to slow down; along with that fall in exports will hit domestic manufacturing hard. As a result, employment will ultimately go down further.
On World Economy
Top importing countries to US, like, Mexico, Canada, European Union, Vietnam, will feel the heat for the time being. They can reciprocate with tariff on US exports to their countries. Probable items will be farm products and aviation products. Simultaneously, they can also lodge complaint with World Trade Organization (WTO) for mediating in the situation.
On China
Though, China contributes the largest share in US trade deficit, it does not rank among the top exporters of steel and aluminium to US. However, cheap Chinese steel and aluminium have already played havoc in international market impacting US as well as other exporting countries. Due to growing economic and political power, China is being considered as biggest threat by US. The major reason behind the punitive tariff on Chinese products is to avoid Chinese products in US domestic market.
China has already reciprocated with a set of tariff on agricultural products like, soybean, sorghum, and aviation products, which are the biggest exports of USA to the country and kept the option open for expanding the scope of tariff to other US exports to China if US continues with protective trade policy with China.
On India
India stands among the top few manufacturers in steel and aluminium; but does not export much of steel and aluminium to US. In fact, India exports even less than 10% of total domestic production of steel and aluminium. Recent tariff on steel and aluminium will not have any serious consequence on India. In 2016, US had a trade deficit of $30.8 billion with India. In case, US continues with protectionist policy and raise tariff on India’s exports to US then surely India’s prospects will be hampered. However, situation has not yet reached that level.