Trump's Tughlaqian tariffs and how it could unleash economic and financial uncertainty in India
To understand President Trump's Tughlaqian reciprocal tariffs decision on Thursday, let's rewind to what JD Vance had to say in his address on March 18, 2025 at the American Dynamism Summit organised by a Silicon Valley venture capitalist firm.
The US Vice President remarked there that the governments of the last 40 years have failed to understand the implications of the core premise behind globalisation. That is, "we can separate the making of things from the design of things". It was also assumed that the rich countries would move further up the value chain, when manufacturing is done by the poor nations.
Vance further mentioned that "as they (the poor countries) got better at the low end of the value chain, they also started catching up on the higher end. We were squeezed from both ends." He also highlighted the fact that "cheap labor cannot be used as a substitute for the productivity gains that come with economic innovation."
Labour arbitrage was never the solution to economic progress
It is true that labour arbitrage (the practice of companies reducing labor costs by employing workers in places with lower wages) cannot take a business or a society too far. We do want the labour cost to go up so that people can live a better life. Many of our business, economic and political leaders of the past have encouraged choices based on labour arbitrage and not engineering and human ingenuity, which I call the good old Toyota Way.
However, Vance is being unfair to people in poorer countries. We all know that the ability to learn and do better is neither confined to a geographical boundary nor is defined by the level of household earnings or riches of a nation. Riches, however, do help to take risks, and deal with uncertainty, particularly in business. But the US businesses have not been investing in areas that mattered the most for their economy, as Vance has mentioned in this address.
Impact of a global market-based system
A market-based system, by its very design, ensures that the relative benefits of increased economic activity are not shared equally among people and businesses. It prizes knowledge over skills and skills over pure physical effort. It benefits capital more than labour, as capital enables risk-taking. If business leaders can influence policies (e.g., weak consumer regulation, high barriers to entry, etc.) to their advantage, the households bear the cost either in the form of higher prices and limited choices and/or higher taxes.
Consequently, it is important that our business, economic and political leaders make choices that focus on helping households too. The US has not done that to the extent required. For example, the Chinese households have benefited from higher real wage growth (> 2.0% per annum for the last four decades) whereas the growth in the US real wage has been about 0.49% per annum. At the same time, all the leaders in the US and China knew, all along, that the households in their respective countries were benefiting differently. Both the countries have not paid adequate attention to the problem of inequity and inequality.
In a global market-based system, the businesses too benefit differently. A recent study by NBER estimated that the overall profitability of the US firms has increased significantly following China’s entry into the World Trade Organisation and the increase was driven by foreign profitability of S&P 500 firms that spend significantly more on R&D and sales and marketing. On the other hand, “the domestic profitability of US firms remained flat, and firms employed more capital to generate sales.”
However, the increased competition in the domestic market helps households with getting lower-priced goods from poorer countries and, thereby, maintaining their quality of life even when their real wages are not going up. Walmart, Dell, Apple, Amazon, along with many other large US firms, have helped the US households get cheaper products from China, Mexico, Vietnam, and many other countries. As a result, these firms are some of the most valuable firms in the world.
However, given that the median household earnings have not kept pace (for nearly half a century) with wealth and earnings for the upper quadrant of the US households, the US is having to use emergency provisions to create regulatory arbitrage for its businesses – both large and small and domestic and the global. It is hoping to solve a five-decade old problem through a unilaterally announced trade policy.
I am reminded of our own hastily implemented policy for eliminating corruption through demonetisation and the GST and improving investments and employment through Performance Linked Incentives. Neither has corruption been eliminated nor we have achieved accelerated employment growth.
The laziest form of arbitrage
The proposed US policy of raising tariffs is the 'regulatory arbitrage' crutch that the US is offering its businesses. It is, in turn, expecting that these businesses will invest and create well-paying manufacturing jobs – five million of which were lost from 1997 to 2024. It is an attempt at unwinding policies that have helped the US as well as its partners – though not everyone in the US or among its partners was benefited. It is raising tariffs to a level not seen for nearly a century in the US.
Regulatory arbitrage has limited effectiveness even when compared with the labour arbitrage strategy that the US has used during the last few decades.
Regulatory arbitrage is the laziest form of arbitrage. It encourages businesses to game the system, as is being sought through selective exemptions. In addition, if the US can impose tariffs unilaterally, the partners can retaliate with tariff as well as non-tariff measures, as we have seen during the recent months. Not to forget that the consumers too can become activists, if the policy choices are seen as unfair. We are seeing that in parts of Europe, Mexico and Canada.
The probability of US success now depends on China, EU, Mexico and Canada's policy decisions. If the US does not start the negotiation process immediately and if these countries choose to retaliate with higher tariff or non-tariff measures, we will end up with:
· Higher inflation resulting in lower consumption, lower savings and higher household debt, not only in the US but in its partner countries too. The second order effects will spread to countries like India, who are not even major global players. If higher inflation gets transmitted to wages, the businesses will face higher costs.
· Deep $ depreciation, one of the US policy objectives, will not only feed inflation but also cause flight of capital from the US. We must remember that the US runs a large current account deficit. If Europe is able to absorb some of this capital in accelerating their defence investment plan, the US may end with a smaller share of global capital.
· On the positive side, $ depreciation can help large export-oriented US firms report higher earnings, without an increase in volume. But that will help the same set of firms that have gained from globalisation. It would not help the households who will have to deal with higher cost of living or the businesses that sell to these households.
· Financial markets will have to deal with higher degree of uncertainty, causing increased volatility. Once more helping speculators and traders and not necessarily the households and businesses that the policy is intended to help.
· If the US partners choose to retaliate through tax and non-tax measures on the US service exports, the trade war can become uglier, hurting much larger number of people across the world.
In short, if the negotiations do not get completed soon enough (say, next two to three months), we will end up with lower trade growth, lower economic growth, higher financial market volatility, acrimonious relationships, increased household stress and may be higher government debt.
In such a situation, it is unlikely that the manufacturing jobs will come back to the US. Foreign investors from China, Japan, Korea and the EU may commit but will not invest in view of higher uncertainty. Domestic firms facing higher cost of capital or higher wages or both may neither invest in capital-intensive nor in the labour-intensive businesses. Financial traders and speculators will ask for rate cuts and ‘liquidity on tap’, guaranteeing themselves Trump as well as the Fed Put.
If the US succeeds in achieving its objectives of improving its exports and reducing its imports, it is likely to become a zero-sum game – a game where the US will grow faster and we will experience slower growth in rest of the world, particularly China, EU, Canada and Mexico. India may gain through higher service exports to the US, though.
Impact on the Indian Economy
India is not a major trade partner of the US, i.e., the US does not depend on us for any of their critical needs, except for drugs and pharmaceuticals (USD 8.7 billion exports during FY 23-24). During recent years, our electronics exports have gone up significantly, but we account for a small share of the US imports. We, of course, depend on the US as our goods exports to the US are nearly 20% of our total exports. Our dependence on the US increases further once we account for our export of services. We will, therefore, be forced to negotiate with the US and accept lower tariffs on imports from the US.
Consequently, India will accept the US terms and allow the US firms greater access to the Indian market. Our exporters will have to absorb increased costs arising from additional duties or accept a lower volume of sales. Our domestic producers too will face competition, as the US exporters gain greater access to the Indian market with lower duties and lower non-tariff barriers.
The US is also expecting India to dismantle non-tariff barriers, a move that will help them export an additional USD 5.63 billion worth of goods.
The Government of India has already accepted that we are in a weak bargaining position and had started making concessions even before the US announcement in the wee hours of Thursday.
India will have to deal with the economic and financial uncertainty
Like the rest of the world, the Indian economy too will face short-term uncertainty, as different countries calibrate their response to these unilateral US policies. As discussed above, if China and EU retaliate and it takes longer than a couple of months to negotiate, we will experience a decline in global trade and, therefore, lower growth across the world. Our current trajectory of growth in domestic demand is unlikely to come to our rescue. Our growth may decline from the current level, particularly if the government continues its obsession with fiscal consolidation.
As mentioned earlier, we may experience higher global inflation. If the Indian businesses choose to pass on the additional cost to their customers, we will either experience higher inflation or lower volume or both. Consequently, the RBI will be faced with a difficult choice on interest rates – to lower them to drive growth or maintain or increase them to deal with inflation.
If the financial market volatility in the US remains high, it is likely that the Foreign Institutional Investors will increasingly look for exit from the Indian market. Our current valuation multiples (higher than what are warranted by our economic conditions) create an incentive for them to book profits and wait for a better day.
If the US does succeed in weakening the dollar, we will see INR appreciating further from the current level – something that is good for the Indian borrowers and the importers, benefitting foreign exporters including those from China.
In summary, the unilaterally announced US tariffs are likely to enhance uncertainty across the world, with just a promise of enhanced wages/earnings for the households and businesses that were disadvantaged for decades.
