Biz & Economy

Explained: What Happens In A Trade War?

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U.S. President Trump has always verbally maintained his distrust and dislike for China, but recently he put it to action. China’s trade regulations require foreign companies to hand over detailed propriety information in order to sell or produce products in China. Apparently, China is using this information to repackage American technology and selling it back to U.S. consumers. As a result of these “unfair trade practices”, the U.S. has a trade deficit of nearly $375 billion with China.

 To ‘punish’ China, US President Trump has slapped $34 billion worth of tariffs on select Chinese imports and in retaliation, China put tariffs on some American goods. That means, for the prescribed list of goods, China will have to pay an extra ‘tax’ to sell in the U.S. and vice versa, bringing up the cost price of a huge array of products on both sides.

This ‘trade war’ will have far-reaching consequences on every part of the global economy – from the end consumers to local industries as well as international trade. Here are 5 things that happen during a trade war.

1. Everything becomes more expensive for everyone

Here’s a quick example to understand this – If the U.S. puts a tariff on its tea imports from China, Chinese tea in the U.S. will become more expensive than American tea because the increase in the cost price (thanks to the tariff) will push up the selling point. This will drive down the demand for Chinese tea, and therefore the supply. As a result, lesser Chinese tea will be imported. But tea drinkers will still want to buy tea. They can now buy local American tea, driving up the demand for local tea. But since there is now an overall shortage of tea in the market without the Chinese tea, the price of American tea will also go up. And the end user will still have to pay more for tea, whether American or Chinese.

The price hikes don’t only come from the tariffs on the end products. But also add up as essential resources required in the supply chain are tariffed too.

Like what happened to Korean washing machines when Trump announced the tariffs. Initially, Samsung and LG thought they’d make up for the cost hike by just making more washing machines, they even said they’d hire 200 more workers to do it. But it wasn’t that simple. There was a tariff on the metals that were the raw materials for washing machines, there was a tariff on the industrial machines used to bend the raw materials into the washing machines and there was a tariff on the vehicles and fuel used to transport the machines. A hike at every level means you now have to pay: Cost of raw materials (+tariff)+ cost of production (+tariff) + cost of transport (+tariff) + tariff on the actual washing machine = $$$!

For India, goods like nuclear reactors, boilers, mineral fuels, aircraft, space crafts, medical equipment, which are imported as products for end use are going to get more expensive because of this. With India’s Treasury already being drained by the rising global crude oil prices and a falling rupee rate, India cannot afford higher prices for its end users caused by this trade war.

2. Affects nearly every country in the world

International trade is very rarely unilateral or bilateral. In most cases it is multilateral.

For example, if the U.S. puts a tariff on smartphones imported from China, the high-cost price will result in a drop of demand for Chinese smartphones and to cut its losses, China may manufacture fewer smartphones. This doesn’t affect China alone. The metal used for making the body of the phone comes from South Korea, and the tech components, like the computer chips, used in the phones come from Taiwan. As a result of this manufacturing slow down, the economies of South Korea and Taiwan suffer too. Not only that, if the U.S. was further exporting its surplus Chinese smartphones to say the U.K., this export will slow down too and Chinese smartphones in the U.K. will become more expensive, affecting U.K.’s economy as well.

Like smartphones, other products like cars, solar panels, chemicals impact economies like the European Union, Mexico, Canada even though the current conflict is mainly between the U.S. and China. It’s not just these 2 giants that are affected; it’s the entire world.

For India, exports worth $22,000 million like pharmaceuticals, apparel, and textiles, automobiles, machinery are exported after they are manufactured in India using imports like chemical, mechanical parts, oil, etc. from other countries. Producing these products for export will now become more expensive and less lucrative.

3. But it’s all worth it because it results in the growth of local industries

Let’s look at the American tea vs. Chinese tea example again. If either way, the result is a price hike, why would the American government introduce such a tariff? Because with less Chinese tea in their domestic market, the tea industry in America will flourish and their domestic economy will get stronger as a result. And as the local industry expands, so will the supply of tea, eventually bringing down the price too.

For years, the U.S. has been outsourcing the production of their goods and execution of it’s services to developing economies in the East like India, China, Malaysia, Philippines, etc. This has led to the emergence of these Asian economies, but it has been slowly draining employment opportunities, intellectual property and capital for the U.S. Realising this, the U.S. government under President Trump is now pushing an “America First” policy, in order to boost their local industries.

Even before their conflict with China, Trump put a 25% tariff on all steel imports and 10% on aluminum back in March, to boost its own heavy metals industry.

Today, the Trump Administration claims the U.S. relies too much on other countries for its heavy metals, and that it couldn’t make enough weapons or vehicles using its own industry if an actual armed war broke out, and its metal exporter withdrew support to the U.S. Taxing foreign steel and aluminium will mean US companies will buy local steel instead. The thinking is that will boost the US steel and aluminum industries, as more companies will want to buy their goods. Steel and aluminum prices will go up in the US because there will be less of these goods coming in from abroad – so the greater demand for local steel will push up the price, lifting profits for domestic steelmakers. This will also lead to more employment opportunities in this sector.

4. In order to minimize this effect, countries become ‘protectionist’

In such a situation, all other countries involved in international trade become cautious or ‘protectionist’ and concentrate on expanding and strengthening their local markets so that they can have a domestic backup, in case their international trade falters.

Historically, India has always focused on domestic market or ‘protectionist’, trade war or not. But with the Modi Government’s recent push to expand or international trade, especially by inviting foreign direct investment (FDI), this problem is manifesting in India too. India has a trade deficit with China, which means we import more than we export to them. This equation may not be affected, because China is merely retaliating to reduce its losses, it isn’t being protectionist. On the flip side, India has a trade surplus with the U.S., we export more than we import from them. This means we need them to continue buying from us because we depend on their money for our income. If they reduce their imports altogether, our current account deficit will only widen.

After the tariffs on steel and aluminum, India will have to pay  $241 million worth of duty to the US for their heavy metal trade. To compensate for this, we’ve proposed imposing duties on 30 goods imported from the US.

In this case, if every country is trying to strengthen their domestic economy, they tend to pull out of foreign markets (securities and equity) and invest in their local markets. This means an outflow of money from India by foreign investors. After the July tariff announcement, our FDI inflow fell by 63% and our capital market indices like the BSE Sensex and NSE Nifty dipped by 262 points and by 89.40 points, respectively.

5. It’s not all bad, this ‘war’ can also be an opportunity for many countries

In the short term, this ‘war’ could actually be a boon for India and other emerging economies. While the U.S. and China fight it out, these nations could fill the vacuum created due to increased tariffs.

They’ve already made it easier for India to export non-Basmati rice, removed import duties on anti-cancer drugs and agreed to share hydrological data.

When China strategically chose to put a tariff on Soybean because it would directly impact American farmers, especially those in the American heartland a.k.a. Trump’s main voter base. To make up for this vacuum, they slashed tariffs on soybean from India, South Korea, Bangladesh, Laos, and Sri Lanka from 3% to 0. Considering that China imports 100 million tonnes of soybean, this is a huge opportunity for countries who can replace the U.S. in exporting soybean to China. This goes for products like textile, garments and gems and jewelry too.

However, the biggest opportunity is in geopolitics. Today, India’s economy is one-fourth of China’s and one-eighth of America’s, but in less than 10 years India will overtake China as the world’s most populous nation. Our GDP will still be significantly smaller than China’s and America’s but larger than Japan’s and Germany’s, making us the world’s third-largest economy.

As the trade war escalates, we have to rethink our long-term strategy with both superpowers.

Explained: What Happens In A Trade War? was last modified: by
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