By Siddharth Gokhale
Abstract
President Donald Trump’s recent executive orders and comments on tariffs and the status quo of global trade have sparked speculation over the future of U.S. trade policy and whether there exists a looming threat of a trade war in the forthcoming months. They do not, however, come as a surprise. During his first stint at the White House, the industrialist had indulged in a cut-throat trade war with its infamous rival across the Pacific and had decried several free trade agreements, calling the North American Free Trade Agreement “the worst trade deal maybe ever signed anywhere”, while also withdrawing from the Trans-Pacific Partnership. However, the recent imposition of tariffs and the threats that preceded them during the Republican campaign shed light on the overarching trade policy that the U.S. might wish to pursue in the next four years, and how it risks changing the fabric of trade for the U.S. and perhaps for the rest of the world too. It may well create a new economic order, one that is no longer controlled by or favourable to the U.S.
The Threat
In the last few months, starting from his campaign in August last year, the U.S. President has made innumerable threats of tariff-imposition, most amid deafening chants of “Make America Great Again” and “America First”. What initially seemed to be an endeavour to protect American goods and allow development of local American industry while decreasing the U.S.’ trade deficit has, of late, proved to have a volatile form and an erratic agenda. Most aspects of Trump’s proposal, which includes reciprocal and coercive imposition of tariffs, have yet to crystallize. However, with the latest slew of tariffs imposed on steel and aluminium announced, economists worry about the foundation on which the U.S.’ new tariff regime is proposed to the American public as protectionary, and that it could potentially have a counterproductive effect.
Tariffs: What They Are and How They Work
Since Ancient Greece, governments have levied charges or fees on goods and merchandise at ports and other points of entry into a market. Such a charge or fee is considered to be a trade barrier. Tariffs are merely the modern equivalent of this exercise, exacting a sum in the name of the State for allowing a good to be introduced and made available for sale in a particular market – essentially, a fee to access a particular market. However, more often than not, tariffs are wielded in a manner that reveals their darker side –that of a protectionist measure, allowing domestic industry to flourish and protecting it from foreign competitors by imposing a charge on the entry of competing foreign goods.
Per economic theory, the burden of this increase in the price of imported goods is distributed between the exporter shipping goods into the economy and the importer purchasing them; which of them bears a higher burden depends on several economic factors such as the price elasticity of goods’ demand and supply, substitutability of goods, market power and trade dependency. Where, as a result of these factors, an exporter to an economy faces a higher burden than he did before, he will find his exporting activities to be no longer as profitable as before. He will consequently be deterred from exporting to such an economy, thereby lowering the trade deficit of that economy. This, Trump argues, helps not only by protecting pre-existing American goods from competition posed by cheaper imports but also by encouraging domestic production. Further, Trump claims that the current tariff policy has emptied the U.S. Treasury’s coffers, and increasing tariffs boosts GDP, generating revenue which will help resolve the U.S.’ worsening debt crisis.
The Devil Lies in the Details
It is on the basis of this MAGA promise that the U.S. moves towards adopting the Trump tariffs. However, in doing so, it seems to remain blissfully unaware of major risks that may surface as it tightens the screws on import, the most obvious being that the revenue generated by the tariff-hike is unlikely to be sufficient to fund Trump’s plans for the U.S. economy. Further, if Ricardo’s law of comparative advantages, which forms the foundational premise of international trade, were followed, in an economy where tariffs are imposed in phases, imports will continue so long as it is economically viable and profitable to continue them, and the cost of importing remains less than sourcing from within the domestic economy. This will cause an increased trade deficit and consequently, a weakening currency, since more domestic currency will be required to be exchanged for foreign currency to pay for these imports. However, this currency weakening is merely a minor impact.
With such consistent high levels of costly imports arises the question of who will bear the burden of these higher costs. In the exceptional situation that the importer holds market and pricing power in the domestic economy, the importer may pass the cost on to consumers, in which case, consumers will end up paying higher prices for imported goods, but still lower than what they would be had the goods been sourced domestically. Alternatively, the higher costs may be borne by the importer himself, who will absorb the cost, causing a decline in profit margins and, by extension, reducing investment and employment. In either case, the effect on the domestic economy is highly detrimental, and these potential outcomes ought to be considered with even more seriousness in an economy that has yet to successfully survive the severe bout of inflation sparked by high post-pandemic budget deficits.
Where the cost of imports is tariffed to a point higher than domestic sourcing, logically then, demand will be compelled to pivot towards domestic production, and this would be a completely normal consequence of a protectionist measure. However, an import-reliant economy, whose shares in global value-added production and manufacturing, though significant, are incomparable to those of its sole competitor’s is unlikely to have economic infrastructure capable of supporting this new wave of domestic demand. Indeed, with this lack of supporting infrastructure, a move towards domestic sourcing may cause supply-chain disruptions for American industry and its global outposts at a scale potentially larger than those during the pandemic. Lack of industry-specific raw materials and resources within the domestic economy will likely worsen this problem for the American economy. Even if the U.S. were to go through with this line of approach, the skyrocketing costs of domestic sourcing will have the same impact as outlined before – either American business will absorb the costs and failing businesses will be pushed out of the economy, with shrinking investment and employment, or costs will be passed on to American consumers, which may cause hardly subdued inflationary pressure in the American economy to flare up again. For example, consider the potential impact of the tariffs on Canada and Mexico, U.S.’s largest trade partners. The U.S. is heavily dependent on Canada for its oil, cars, machinery, wood products exports and on Mexico for its supply of manufactured goods, including cars and agricultural products. Tariffs on these goods will definitely encourage development of domestic industry in the U.S. but could also disrupt supply chains and increase costs for American consumers. It is to no one’s surprise, then, that Trump has gone back on his campaign claim that the tariffs will affect American consumers.
Disrupting International Trade
Beside the fact that these tariffs have theoretical foundations that are shaky at best, they have no clear agenda yet are set to disrupt the status quo in international trade. It is clear from the threats of the U.S. President that he purports to employ tariffs not to achieve specific economic outcomes but to use them as a threat to bend nations to the will of the U.S. The most notable example of such mala fide use is the threat of tariffs made to act as a deterrent for countries that lie at the root of U.S.’s two major public concerns: illegal migration and drug trafficking. The imposition of tariffs has no direct consequence on these two concerns, but the U.S. has made out these threats to multiple countries in the hope that the economies to whom these threats have been made will act suo motu for fear of losing market access. It is no longer a mystery that Trump wishes to employ tariffs as a weapon of coercion on issues that may well be unrelated to trade.
However, coercive tariffs pose a significant risk to the smooth continuance of international trade. Firstly, reciprocal tariffs imposed by the U.S. may be met with retaliatory tariffs on U.S. by affected countries. This outcome is not unlikely, considering India had followed a similar modus in response to the round of tariffs raised by Trump in his previous term. However, such a tit-for-strategy could easily escalate into a trade war, causing global trade to descend into chaos, undermining the complex multilateral trading system that has been carefully developed over time, destabilizing international trade relations and a breakdown in global economic cooperation. Most importantly, due to the possibility of retaliatory tariffs, the tariffs could be counterproductive, with the U.S. losing access to foreign markets for its own exports, especially those conveniently available at its disposal till now.
This also highlights the last major consequence that the tariffs may have on global trade – the reshaping of the international economic order. While the U.S. is a highly consumerist economy with significant market power, reduced access to its market due to tariffs could lead to a stagnation or reduction in global manufacturing. Exporting countries may seek alternative markets, reducing their reliance on the U.S. and diminishing its influence in global trade. A prime example of this shift is the Trans-Pacific Partnership (TPP), which has moved forward without the U.S. after its withdrawal. The remaining member countries have forged ahead, creating new trade agreements and economic alliances that exclude the U.S., signalling a potential decline in its market power in the long term.
Conclusion
The wielding of tariffs by the U.S. as a protectionist weapon is likely to have dire economic consequences for its economy as well as global trade. As a trade-reliant economy, the U.S. risks facing supply-chain disruptions, inflation and the stagnation of its domestic economy. Using the economic tool to enable coercion on non-economic frontiers undermines multilateralism in international trade and by providing a reason for retaliatory tariff imposition, poses a threat to the stability of the global system and opens the floodgates for a full-scale trade war. In fact, such a use of tariffs may completely alienate the U.S. from global trade, sidelining it in a newly forged global economic order that is no longer directed by it. Ultimately, while the tariffs may have some short-term benefits, these are far outweighed by its potentially chaotic repercussions, including long-term instability both domestically and internationally. The U.S. ought to take this into consideration in shaping the future of its trade policy.
About the Author: Siddharth Gokhale is a fourth-year law student from Jindal Global Law School and leads the Economics and Finance Cluster of Nickeled & Dimed. He is an avid reader of economics and is passionate about exploring the realm of international trade and investment law. He also has a keen interest in corporate restructuring, insolvency, and bankruptcy.
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