If US President Donald Trump’s proposal for tariff setting with each country and over items, separately, is actually pushed then its implications are far-reaching. One hopes that these “Trump Reciprocal” tariffs are only bargaining ploys that the US is adopting so that it can seek better deals with its trading partners with which it has systematic and steady trade deficits.
There are two elements here. One is bilateral negotiations, and the other is chapter by chapter “equal tariffs”. If the chapters are defined too narrowly such as “cars” for “cars”, “nuts” for “nuts” or “spirits for spirits”, then the outcomes will result in welfare losses for both parties. This is because it is comparative advantage (conditional on unchanging value of money among the trading partners) that results in the static gains from trade.
The working of comparative advantage would be curtailed unless the outcome of the negotiations is to reach the lower of the tariffs. If both countries raise tariffs in reaching “Trump Tariffs” then there would be trade reduction. However, if the chapters are more broadly defined, then the effects are not too large. Since the US apparently has lower tariffs than its trading partners – the EU included – with a broader notion of the chapter, there would hopefully be net tariff reductions which fundamentally should be trade creating.
With MFN not on agenda, Trump initiatives would be in violation of WTO
The bilateral basis for negotiations is not incompatible with the World Trade Organisation (WTO), provided the tariffs reached by the negotiators are extended to other countries as well. This is the idea of “Most Favoured Nation” or MFN. If MFN is not on the agenda, the Trump initiatives, if pushed as stated, would be grossly in violation of multilateralism and the WTO.
In any case, Trump in his first tenure thrashed the WTO when he unilaterally imposed major restrictions on China including changing bound tariffs, but above all by restricting China and its companies at the cutting edge of technology. China, can easily bring down the higher tariffs that it imposes on manufactures to US levels without suffering any net damage at all. Some increase in the net imports of luxury goods, high tech good etc. are likely.
But China would see an increased import penetration in agriculture, given the fact that despite China being technically very efficient in agriculture, its agriculture in general cannot compete with the US since China being much more land scarce. Neither would the EU or India be able to compete with the US.
India would have to protect its main grain and milk economies, which absorbs much of the labour in India. Vegetables are less tradable, and in fish and meats (but perhaps not chicken) we have natural advantage from the consumption side as well, adding to the production side comparative advantage. It is here where Indian negotiators would have to be careful. However, US itself could see much competition from the even more land abundant CAIRNS group of countries, some of whom have also lower labour costs (Thailand, Argentina, Canada, Brazil).
The ‘Trump Reciprocity’ factor
Much of the thinking around “Trump Reciprocity” is also somewhat different from that of the WTO and General Agreements on Tariff and Trade (GATT) before that. Therein one started with the assumption that in a round of negotiations for an ultimately multilateral agreement, countries start with different levels of (weighted) average tariffs, say a lower level e.g. 10% (usually by an advanced country) and a higher level say 30%, usually by a Least Developed Country (LDC).
And then each cuts the average by say 50% to bring down the tariffs to 5 and 15% respectively. This means it was reciprocal in the change, but not reciprocal on the absolute tariffs, and has the advantage that it would have a lower probability of being injurious in the transition to lower tariffs. Of course, once some countries reach zero, what should its partners be made to do is an open question.
Within these reductions is also the idea that there ought to be a movement to convergence across the chapters. But agriculture has always been a sore point. Pure trade theory has been too abstract to recognise that global optimality in agriculture is not possible, since two out of three factors here are not tradable – land and labour. Hence dynamic countries like Japan, China, Korea , India which are land scarce will protect their agriculture for many more years to come. Hence the weighted average approach made sense.
The US claim that non-tariffs are significant in the EU and in China, by the citation of stray examples are not convincing enough. Not only phytosanitary conditions, but even technical standards have been used by all the big powers to create some barrier for their retreating products. The Trump position is that this is obvious since the US has a trade deficit with China, EU, Mexico, Vietnam, Japan, Korea, Canada, India, and Thailand.
With EU, the deficit arises largely on account of the protection that agriculture enjoys in the EU, but also because of a quagmire of regulations. With Mexico, since it has become the conduit for exports via foreign investments from Japan, the Asian tigers and Japan. In the case of Vietnam, Korea and Japan it is because these are highly competitive in manufactures almost to the point of having an absolute advantage when considered together over much of the range of manufacturers, with Vietnam, and India at the lower end and Japan and Korea at the lower end, and China all over. Trump reciprocity would not hurt their economies if they can continue to protect their agriculture.
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The fact that barriers and tariffs are behind the trade deficits of the US is quite untenable, if we look at the issue in macroeconomic terms where capital flows are integral to the world economy. The dollar remains the reserve currency par excellence, and this is not going to decline anytime soon. China, the only credible economy has tied itself internally under Xi, externally it has few friends, and its ability to credibly uphold global capitalism is laughable.
So, the US has to (as it has been) create the dollars required by the global economy, especially by global portfolios, and that cannot happen without it running a substantial and steady current account deficits. Trump’s advisers would be unnecessarily stirring up a storm that could hurt the US, if they do not understand this simple law of the way economies work. Uncertainties would only increase the demand for dollar liquidity. So Trump’s other agenda of the continued hegemony of the US over the globe is incompatible with actually bridging the trade gap.
The writer is Professor and Chair, Centre for Public Policy and Governance, and former Professor of Economics and Policy, Indian Institute of Management, Ahmedabad. morris@iima.ac.in.