History shows us tariff wars are unlikely to lead to economic growth or create jobs

On the day Donald Trump was elected US president, all global markets witnessed a steep fall. The fear was, if he actually decided to fulfil the promises he had made in his election campaign it would start a trade war and that would bring in disruption to the fragile global economic recovery. Now, 16 months since then, the US president has finally started what global markets had feared. The import duty on steel would soon be raised by 25 per cent and on aluminium by 10 per cent. This increase is being done with an underlying assumption that it will help American companies in creating more jobs and would force other countries to lower both tariff and non-tariff barriers for goods made in America.

If one looks at history, the probability of tariff wars leading to economic growth or creating jobs in a country that has initiated it is very low. In 1930, when global recession had started, the US had enacted the Smoot-Hawley Tariff legislation which started with levying taxes on agro products but later the list was expanded to include other products and industries. Over the next two years, US imports fell sharply but the protectionist policies also added to the pain of recession in the US economy as many countries reacted by putting more tariff on US goods leading to a decline of US exports to some regions.

There is every possibility that the tariff wars have just started following the US action. Now, other countries are likely to initiate counter measures by increasing tariff on goods which they import from the US. The European Union has already indicated that it will have to re-look at duties on US goods like jeans and bourbon.

While China is supposed to be the primary target of these tariff hikes, the fact is that trade wars are not as simple as they might appear as there would be collateral damage. Even though Indian steel companies would not be impacted much because the US does not have large steel imports from India, there is likely to be another impact. An increased steel tariff would impact the automobile industry in the US whose large requirement is met by plants from Europe and Asia. As a result, costs would increase. As the US auto industry is a big buyer of auto ancillary parts from India, auto ancillary companies could feel the pinch.

The demand to rejig tariff would not only be done by the government, a big amount of pressure is going to come from the corporate sector as they would try to protect their margins. In fact, some companies have already started to ask the government to have a re-look at the import tariff levied in recent budget. So, a new headache is going to emerge for our policy makers and that is what they should be ready to deal with. The fact is that India is not a major economic power and would need to use some simple calculation to figure out how to react to a more aggressive US president. If it does not hurt industry, there is no need for India to react to what the president is tweeting.

Even if the US were to impose duty on bike imports from India as president Trump had been claiming that India has put a 75 per cent duty on Harley-Davidson bikes, it would not have any impact on the Indian auto industry. The export of bikes from India to the US is just a couple of thousand units. For Indian auto companies, the Latin American markets are the ones that are important for them. However, tariff wars are fraught with pitfalls. If India were to lower import duty on Harley Davidson bikes, it will not only lead to loss of revenue but domestic players would feel the heat in a segment where they are trying to make space for themselves.

However, in case of pharmaceuticals and IT services, there is a need to be more careful as they are the ones where not only is the US in a position to put tariff barriers but create other problems. A hyperactive USFDA, which has already been issuing notices to Indian companies, could further harden its stand. It is here that the diplomatic skills of this government would be put to the test. Meanwhile, policy makers should not forget that trade wars have a history of ultimately impacting the value of currency. For that, policymakers should keep the RBI in the loop and look ahead rather than in the rear mirror.