Given the turmoil over US trade policy over the last two months, let me start by taking stock of the state of affairs. By my account, the US currently has a 10 per cent universal (and allegedly minimum) tariff; 25 per cent on steel, aluminium, and autos with exemptions for those that are USMCA compliant; and 20 per cent tariff on smartphones and other selected electronics covering about $ 95 billion and 145 per cent on the remaining $350 bn imports from China.
This leaves the US average effective tariff at over 25 per cent with that on China at 110 per cent. Take a moment to let that sink in. Just four months ago, the average tariff was 3.5 per cent with 10.5 per cent on China! That’s not all. It is likely that the US will impose global tariffs on semiconductors and other electronics, pharmaceuticals, copper, etc, in the coming weeks. We also await the outcome of negotiations underway with countries, including the EU and India, on whom additional reciprocal tariffs have been imposed. If these negotiations fail, then some countries could easily see the higher reciprocal tariffs re-imposed.
It is, therefore, unsurprising that we at J P Morgan see a 60 per cent chance of a global recession, with the US in recession and a sharp slowdown in China in the second half of the year.
There are many who believe that the tariff blitz is an opening gambit and that the US and its trading partners will eventually compromise to a lower tariff regime. Relatedly, many are engrossed in intricate discussions on what the US “truly” wants, how best to negotiate, and which countries and sectors can emerge as winners or end as losers.
In my view, all this misses the forest for the trees. Neither the harshness of the tariffs nor the resulting damage to the global economy, however painful it might end up being, are central. Nor are the objectives of the tariff policy that range from eliminating the trade deficit, reshoring manufacturing, to raising revenue to fund tax cuts. Instead, what is salient is that it is a broadside against the extant global trading system that the US built under its own leadership over the last 60 years.
The broad (and loose) reason cited for the broadside is that in focusing on keeping global trade “free,” the US has borne persistently high trade deficits and substantial loss of manufacturing because of “unfair” practices by other countries. Relatedly, being the global hegemon also imparted an exorbitant privilege to the US dollar as the world’s reserve currency. But instead of viewing this as an enormous benefit (as most economists do), the current administration also holds that the privilege has kept the currency artificially overvalued relative to economic fundamentals, which, in turn, has exacerbated trade deficits and hastened the loss of manufacturing.
Both the theoretical and empirical underpinnings of these arguments are questionable. For example, most economists will point out that large trade or current account deficits (that is, foreign borrowings) reflect low domestic savings, often a result of big fiscal deficits. The most effective way to bring down the external deficit is to cut fiscal borrowing. Tariffs have rarely helped in lowering trade deficits or reshoring industry over the medium term. However, debating the pertinence of the underlying reasons or the efficacy of tariffs, despite their proliferation in recent months, is also irrelevant in my view. They are unlikely to change US trade policy.
Instead, we need to realise that the economic structure of almost every country — developing, emerging, or advanced — is based on the extant global trading system, warts and all. Advanced economies are structured around the initial and end stages of a supply chain (such as design, marketing, and distribution), while emerging markets are built on the middle or manufacturing stage. Developing countries supply intermediate commodity inputs. And they are all tied together by the global trading system with industrial and macro policies safeguarding the respective structures of each country.
This is, of course, a caricature of the global economic system. But it serves to make the point that if the global trading system changes, so will the structure of almost every economy.
For India, it is not just a matter of negotiating down the reciprocal tariffs or a bilateral trade agreement. If the world’s largest economy turns autarkic, it will force every other country to do so to varying degrees. The US imported around $4.1 trillion in goods and services last year. That’s more than the entire GDP of India, the fifth-largest economy in the world.
India’s aim of becoming a global manufacturing hub will need to be trimmed. Instead, domestic demand will need to become the bigger driver of growth. This is not an easy task, as we have learnt the hard way over the last few years.
We will have to consider things that are almost unthinkable in India. For example, raising consumption necessarily means lowering savings. The cornerstone of our policy framework since Independence has been based on the belief that India is a supply-constrained economy. Critical to easing that constraint is increasing savings to fund investment. The pervasive financial repression spanning banking, currency markets, bond markets, and insurance will need to be liberalised to raise household income and lower precautionary savings. Structural reforms in land, labour, education, and health, so far, have been seen through the lens of whether they promote large-scale operations at the lowest cost to turn India into a global manufacturing hub. Now they will need to be assessed differently.
India’s impressive expansion of infrastructure has been largely externally oriented. Airports, ports, and interstate highways have been built to connect the country to the outside world. If India is to become more domestically oriented, then so must its domestic trade and infrastructure. As of now, there is no direct road, flight, or train from Kanpur to Coimbatore!
The recent US trade policy changes constitute a generational shift in global economics. It targets a core global arrangement around which almost all economies have been built for the last 60 years. The impact is not just uncertain, but it is gravely underestimated.
The writer is Chief Emerging Markets Economist, J P Morgan. Views expressed are personal
Just four months ago, the average tariff was 3.5 per cent with 10.5 per cent on China! (AP file photo) 
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