December , 2018
Trade war: an act of irrational exuberance
13:15 pm

Kishore Kumar Biswas

Last September the Donald Trump government imposed import tariffs by a huge amount, $200 billion, mainly on Chinese goods to curb Chinese imports into the United States. Trump reportedly announced, “If China takes retaliatory action against our farmers or other industries, we will immediately pursue phase three, which is tariffs on approximately $267 billion of additional imports.” But in retaliation, China also imposed import tariffs on a number of US goods amounting to $60 billion. The ongoing imposition and counter imposition of import tariffs by the US, China and also by some other countries to an extent, has been the origin of trade war in the present world. Even a decade ago, the US had been the foremost flag bearer of globalisation and an open economic system. Then what can be the main reason behind the volte-face of the US administration, has been a subject of discussion around the world. It is also important because a fear of global economic slowdown, as a result of this trade war, has been pervasive not only in the developed and developing countries but also in the minds of the biggest industrial giants of the countries directly involved in the trade war.

The reason behind restricting imports from China

The first sign of protectionism started last March when the US imposed tariffs on import of steel and aluminum from all countries except its immediate neighbours namely Mexico and Canada. The US imposed additional tariffs of 25% on $50 billion of Chinese goods on grounds of American intellectual property rights and forced transfer of technology from US companies by China, which hampered the American innovation process and technological development. Even in the election campaign, Trump and his party spokespersons raised the issue of falling employment opportunity in the US due to ever rising import orientation. According to them, unfair trade practices of China are mostly responsible for this. The total foreign trade deficit of the US was close to $800 billion in the last financial year. Out of that, about 40% gap remained with China alone. Therefore, China should be targeted as the main culprit behind fall of employment opportunities in the US economy by artificially keeping Chinese goods cheaper, was Trump's argument. The imposition of tariff on Chinese goods in the US is an antidote to this.

Is trade protectionism a solution to US job opportunity problem?

Theoretically speaking, import cannot be lowered by imposing tariff on one country’s exports. Ambar Ghosh, Professor, Department of Economics, Jadavpur University, said, “The international trade theory suggests that an economy cannot improve its trade imbalance by imposing tariff on imports of a country’s products. A particular country may face export problem after tariff imposition. But that import will be continued from other countries. This will be true if the exchange rate is flexible and if there is no bar in trade, that is, the economy is open to international trade. If price of domestic goods in foreign countries increases after imposition of tariff, the export will increase and excess earning of foreign exchange will happen. The exchange rate will fall in consequence and prices will be higher in terms of foreign currency and the export level will come down to the earlier level. The opposite will happen if the price of imported goods increases due to imposition of tariff.” The exchange rate will increase and the price of foreign goods increases and the trade level will reach the previous level. This is the theoretical argument of increase in tariff and hence there is no impact of imposition of tariff. Actually import and export will be equal. If Chinese imports decreases after the recently implemented US policy, imports will be made from other countries.

Secondly, the US trade deficit is not a recent phenomenon. Professor Biswajit Dhar of Jawaharlal Nehru University, New Delhi, shows (EPW, September 15, 2018) that from the late 1980s (with some exception) the US current account deficit (CAD) has been negative. This was mainly responsible for negative goods trade imbalance. The service sector trade was mostly positive.

But the total deficit began to increase from the mid-1990s. Then China became a member of WTO. Dhar points out that the US government tried to show that China took advantage of ‘permanent normal trade relation’ to increase its penetration into the US market.

The trade deficit of the US with China started after the mid-1980s. From 2001 the deficit began to increase by leaps and bounds. In 2002 it was $100 billion. It was more than double by 2003.  In 2012, it reached $315 billion and US trade deficit reached $337 in 2017. Dhar also points out that after China's entry in WTO, China’s export to the US grew from $12 billion to $505 billion while import increased from $19 billion to $ 130 billion. In spite of all, it is to be noted that the total trade deficit of US with China was close to 40% of the US total deficit of $775 billion.

Why is US facing a persistent negative trade balance?

Dhar shows that the US trade deficit or a surplus of imports over exports through the national income identity model Dhar shows that trade deficit of an economy is equal to the savings-investment gap. That means the higher the trade deficit, the larger is the savings-investment gap. The latter gap emerges due to low savings ratio of the economy. It is known that the US economy has been a consumption led economy for many years. This is why the savings rate in the economy is very low. Dhar mentions that the US savings rate never touched even 24% of GDP since 1950. In the more recent period, it has always been below 17%. Then how has the US economy managed to maintain extravagance? 

This was done through borrowing in the international capital market. Dhar says as long as the market borrowing had been smooth for the US economy; there had been no problem for the economy as a whole. The problem started during the global financial crisis of 2008. It is said that in the earlier days, the impact of ongoing low savings was discussed in the US among policy makers and economists but no effective measure was taken.

After the global financial crisis set in, Barack Obama, the then President of the US dealt with the situation with different policy measurements including quantitative easing. The interest rate was close to zero for a long period. Then the government injected a huge amount of money by buying bonds and by other means but the economy was not improving. Tax relaxation by the Trump administration later was another way to increase demand in the economy. Actually, this made the US economy a more consuming economy rather than rectifying it. As a result, the trade gap peaked in Trump’s tenure to $800 billion. This led the US government to impose of import tariff in the US economy.

Inflow of capital is the main determinant

How does a country import more than what it exports? Ghosh said that it depended on the inflow of capital in the economy. There had been a huge inflow of foreign capital in the US economy. The exchange rate fell and foreign goods became cheaper. Therefore the import of foreign goods remained larger than exports. Ghosh also said that the US policy of imposing tariff against China in setting up bigger industrial base and create more employment opportunity in the economy was logically invalid and self-defeating.

Can India take advantage of this trade war?

China has comparative advantages on manufactured goods. The special industrial organisation in that country is the reason behind it. Some of the major items of Chinese exports are mechanical and electrical products, high-tech products, clothing, textiles, footwear, furniture, plastic products, ceramic, motors and generators and integrated circuits. In these sectors India has no comparative advantage over many other countries. On the contrary, some of the small economies like Malaysia, Bangladesh and Vietnam enjoy it. Saikat Sinha Roy, trade specialist and Professor, Jadavpur University, said that it was doubtful, at least in the short to medium term that India could take advantage of the ongoing trade war. At the same time Sinha said that it was yet to be decided whether the Chinese economy had started slowing down after the trade war. On the other hand, India may face problems as the result of the ongoing trade war. There are a lot of inputs of foreign origin used in the Indian production system. If prices of these inputs are increased, India will lose its competitiveness. So, as of now, India cannot get any advantage out of the trade war.

From the study it appears that the economic reason behind the inception of the US-China the trade war is based on invalid logic. It might be politically motivated to satisfy the unemployed or semi-employed youth about the government’s intention to create job opportunities in the country.


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