Trump Induced Tariff War: Global Implications and Potential Alternative | Arun Kumar

(This article is an enlarged version of the article titled ‘Trump’s policy flip-flop on tariffs indicates he may have a goal, but not so much a plan’. In The Leaflet, April 21, 2025)

President Trump’s seems to believe that to achieve his goal of Make America Great Again (MAGA) he has to bully the rest of the world, including the closest allies. But he is quickly realizing that is not working. So, one is witnessing rapid policy flips and flops since February 1 when new tariffs were announced. That indicates, he did not work out how to achieve his goal and consequently, the world is facing a chaotic situation. He may have wanted to thwart China’s rapid rise but that required the support of his closest allies, Canada and EU. Instead, he has antagonized them by attacking them right from the start.

Tortuous Path

Look at the policy twists and turns in April. On April 2, ‘protectionist tariffs’ on its trading partners were announced. Most other big trading partners also announced that they will retaliate. So, on April 9, he postponed implementation by 90 days, except in the case of China. Other nations also held back their retaliation but China retaliated in spite of Trump’s threat of punitive tariffs on any nation that retaliates. This set off a chain of retaliations and the tariff levels between the two escalated to 125% levied by China and 145% by the US.

Such tariffs makes trade between these two nations unviable because prices of items imported by them from each other could double. Even if producers reduce their margins of profit, prices would rise substantially. And, if the dollar weakens further as a result of loss of confidence in the US economy, its inflation rate would be even higher.

Next, the US backtracked on high tariffs on electronic gadgets (like, mobile phones), due to its heavy dependence on their import and pressure from the CEOs of corporations. But, a day later, US announced that special tariffs would be levied on these items within two months. China then retaliated by restricting the exports of rare earths, a commodity in which it has a monopoly and which are crucial for manufacture of semi-conductors.

President Trump has announced that he would levy heavy tariffs on pharmaceuticals which had been exempted till now. But he also said he would reduce tariffs on auto sector – it was among the first to face high tariffs. Next, China, one of the largest buyers of passenger airplanes retaliated by telling its airlines to stop taking delivery of Boeing planes.

Now, in a toning down of the rhetoric, President Trump has called for a ‘fair deal’ with China. But his Treasury Secretary, Mr. Bessent and the Chinese officials have said no negotiations are going on. Mr. Bessent invoked the strong ties between Trump and Xi Jinping to argue that a settlement would be reached. Prior to these statements, Trump said that the tariffs will come down but not become zero. This is vague and the Chinese responded by rejecting these overtures and said that US should stop threatening them and lower the sky high tariffs first. The Chinese have also moved ahead with financial plans to replace the dollar in their trade with global South and others and promote Shanghai as a financial hub.

The financial markets have reacted to these flip flops with wild swings, adding to uncertainty. To get his way, he is attacking everyone who suggests caution. The US Fed Chair, Jerome Powell, cautioned Trump about his agenda. Trump reacted by asking how can Powell be retired early. This is not possible without undermining the autonomy of the US Central Bank. To push his agenda, he does not mind destabilizing the long established institutions of US. He has attacked the autonomy of Universities. He has replaced the heads of CIA, FBI, etc. and now wants to replace the head of the Income tax department.

Mr. Bessent attacked the IMF at its annual meeting for its prognosis that the US economy will slow down due to the tariff war and the consequent uncertainty. The tariffs Trump has proposed are under the emergency powers provided for in WTO. But, there is no emergency and in affect, WTO negotiations over the last 30 years are being undermined. Further, the levy of tariffs by Trump is being questioned in the US since it is not in the President’s powers but that of the US Congress. So, the matter is likely to be challenged in the US Courts.

Strategy half baked

Clearly, President Trump had not worked out how he would achieve his goal of unilaterally gaining from global trade. For him, the large US current account deficit of $1.13 trillion in 2023 is proof that USA is being taken advantage of. But, he forgets that the US runs such huge deficits year after year because of the dollarization of the world economy. It implies that the rest of the world is financing US prosperity and enabling it to live beyond its means by supplying cheap exports. This is especially true for the developing world which supplies cheap wage goods, given its low wages.

The federally mandated minimum wage in 2024 in the US is $7.25, but, many states pay above $10 and even $16.28. In China, in Guangdong, the minimum hourly wage is about $1.2. Thus, apart from other factors, the wage differential enables a company using the same technology in China as in the USA to produce the item much cheaper.

So, while President Trump presents his argument for levying tariffs as one of fairness, it is the US that has been benefiting at the expense of other nations. So, not only does he want the US to continue to live beyond its means, he wants to extract more concessions. His strategy for doing so is to deal individually with his trading partners rather than collectively as been the case under WTO since 1995. He wants to cut ‘90 deals in 90 days’.

His strategy is to scare nations into submission, dangling before them the carrot of the large US market. But, China is receiving special treatment for two reasons. First, the US has the largest deficit in trade with it and second, it has become a threat to US’s global strategic dominance.

China and USA Implications

China’s exports to the US in 2024 were $440bn (2.4% of its GDP) while its imports from USA were $145bn (0.5% of US’s GDP). If this trade is substantially reduced due the high tariffs on non-electronic gadgets, the Chinese economy would be impacted much more than the US economy. Yet, China has not backed down.

China would have to sell what it was selling to the US in other markets. Fearing this, other countries worry about dumping of Chinese goods at large discounts. That would impact production of the dumped items in those countries. This could set off a tariff hike on Chinese goods by the countries fearing dumping. Thus, the tariff war could become generalized with more long lasting and more worrying impact on global economy.

The USA would also have to find markets for its exports which were till now going to China. Since Trump has proposed high tariffs on its biggest trading partners and they propose to retaliate, US exports to its trading partners will decline sharply due to the higher prices of its goods. Thus, US’s entire exports of $3.1 trillion (11% of its GDP) would be impacted.

In effect, the trade war initiated by the USA will impact a much larger per cent of the US GDP compared to China. Since, most of what the USA sells to the rest of the world, can be obtained from alternative sources, the impact would be disproportionately larger on the US economy than on other economies.

One way or the other, production in the two largest economies in the world would be hit because of the decline in the sales to each other and to other countries. Since these two economies produced $46 trillion of the total world GDP of $107 trillion in 2023, almost 43% of the world output would be adversely impacted and that could tip the world economy into recession even if the impact of higher tariffs on other nations output is not counted. Due to the protectionist tariffs, some increase will occur in the USA but that will not be able to compensate the fall of demand from the trading partners and also from within the US.

The IMF in its latest projections is expecting a 1% drop in the rate of growth of the US economy. It has ruled out a recession for the moment. But given the huge uncertainty, it is hard to predict the shape of things in the coming months. Projections from the past are meaningless given the uncertainty. Trade negotiations with key trading partners have just started and negotiations between US and China are yet to start.

Most financial institutions present a rosy picture so as to boost the markets. But these become unrealistic when there is a shock and a downturn. For instance, during the 2008 financial crisis, while analysts had predicted a recession and the economy started to decline from February 2008, the IMF was predicting a more than 1% growth. It was behind the curve. It was only when Lehman Brothers collapsed that it changed its projections from positive to negative growth.

Supply Disruptions

In the era of globalization that accelerated in the 1990s, production is based on long supply chains. The division of labour has increased so that inputs for production come from a variety of sources. For instance, automobiles produced in the USA may have components from India, China and Mexico. Mobile phones may be assembled in India or China based on components procured from other countries and sold in the USA. So, across the board tariffs on goods imported by the US would lead to price increase of components and therefore of the final product, even if it is finally produced in the US and there is no tariff on it.

Further, since differential tariffs are sought to be applied to countries, an item imported from country A may become more expensive than if it is sourced from country B which faces lower tariffs. Thus, in the case of textiles India may benefit since the tariff proposed on India is 26% while that on Vietnam is 46% and Bangladesh is 37%. But, it is possible that over time, tariffs make the production of certain textiles profitable in the US itself. This is what President Trump wants. That would lead to a reduced import of textiles into the US and impact India’s exports in spite of the advantage that India may gain in tariffs.

Costly Local Production

Why does US import so much of textiles? Because local production is more expensive than imports given the high wages in the US. Further, production of textiles in the US depends on imported inputs and their prices will rise due to tariffs. That will further raise the cost of production of textiles in the USA. So, the prices of textiles will see a big rise whether it is Indian textiles selling in the US at the proposed higher tariffs or the increased US production.

Further, as trade switches from country A to B or local production in the USA increases, supply chains will have to switch around and new capacity set up in country B or within the USA. Both these take time. In the meanwhile, shortages will emerge adding to the pressure on prices. Inflation in the USA will also rise due to the repatriation of migrants willing to work at much below the minimum wages. Thus, one way or the other, inflation will kick up in the US. Even if commodity prices fall due to the expectation of recession taking hold.

It will not be just in the textile sector or in the US, similar phenomenon would be witnessed in other sectors and countries. Companies would try to cut their margins to mitigate a part of the impact of higher tariffs but this would also lead them to squeeze wages and consequently worker’s incomes. Even if the nominal wages don’t fall, demand in the US will fall as prices rise and that will impact production and employment adversely both in the US and the world. DOGE is cutting employment in the government and reducing good jobs.

So, demand in the US would decline. While local production may rise in the US and other countries, that will take time while the impact of inflation due to tariffs and supply bottlenecks and fall in employment will be immediate. Thus, the negative effects will be felt much sooner than any positive ones and the world would move towards stagflation and possible recession.

India a Minor Player

India needs a nuanced approach and not go it alone. Small economies have few bargaining chips and would have to give in to the concessions demanded by the US. If the US economy goes into a long term recession due to Trump’s policies and lack of trust in the US, those putting all eggs in US basket could lose out.

India has a $45 billion trade surplus with the USA. Trump has been calling India ‘tariff king’ and wants concessions. This surplus is small in the overall global reckoning but he wants it reduced. So, negotiations are likely to be one sided with India conceding. Indian government has been bending over backward to mollify Trump and has already unilaterally cut back key tariffs. It is weak since it produces 3.4% of world GDP and has 1.8% share of merchandise exports. It claims to be one of the first to be negotiating a trade deal.

A trade deal is not easy due to India’s technological weaknesses. It has not benefitted from previous bilateral and FTA agreements. It has been negotiating with EU for 23 years and with Britain since 2021 end without reaching a conclusion. The US wants big concessions, especially in agriculture and that would be difficult to concede given poverty in that sector.

Alternative Strategy

President Trump’s recent wavering on policies is perhaps due to the realization that his moves will hurt the US more than others. The CEOs of big US corporations have expressed their unhappiness. The public protest against Trump’s policies, whether against attacks on universities, cut in size of government, issue of migrants or tariffs may be another factor.

Trump’s bullying is not working because its largest trading partners are ready to levy retaliatory tariffs. The alliance of the rich countries is fraying and trust in the existing world order is dissipating. If nations negotiate individually with the US they will be forced to concede.

The rest of the world needs to act in concert. EU and Canada may join such a grouping given that they were bullied first. A joint approach offers an opportunity to the world to return to a softer form of capitalism and a fairer global order than the one initiated in Marrakesh in 1994. This external pressure would supplement the internal pressures building up in the US. There is already a decline in the US’s credibility as reflected in the rise of US Treasury Bonds yields.

The alternative global strategy has a chance to succeed because Trump has simultaneously attacked all other countries including its allies. If BRICS and EU act in concert the US economy will hurt and bullying will stop within months.

It is not that the rest of the world will not be impacted given that the US is the biggest market, but if they hang together they would be less impacted. It appears that China has understood this and is trying to build a coalition of the willing. It has opened talks with EU and S E Asian nations and offered concessions to India. This will also benefit India in its US negotiations.

Conclusion

China will no doubt have to play a central role by assuring other nations that it would play fair and not resort to dumping. Many nations worry that China may dump its surpluses as in the past. But dumping subsidizes other nations and cannot persist over decades because that would imperil one’s own prosperity. The substantial increase in China’s per capita income would not have been possible with continuous dumping. Apart from other factors, China has built its strength based on its R&D efforts and its wages being a fraction of those in the advanced countries. India has even lower wages but China out competes it.

President Trump has misdiagnosed the problem faced by the USA. It is due to the basic crisis of capitalism and not due to higher tariffs levied by other countries. A new division of labour has been emerging in the world between high technology and intermediate technology production. The latter relocating in the lower wage developing countries.

This undermines so called good employment in the US. Protectionist tariffs cannot resolve this problem and will only aggravate it. They would have to be levied permanently and that would undermine living standards in the US.

In brief, it is the contradictions of free market capitalism that are playing out. If the rest of the world acts in concert, in spite of difficulties, it will force the US to retreat and possibly lead to a more equitable world trading system. President Trump’s policy flip flops indicate his confusion and that he does not have a path for achieving his goal.

(Author: Arun Kumar, Retired. Professor of Economics, JNU and the author of ‘Indian Economy’s Greatest Crisis: Impact of the Coronavirus and the Road Ahead’ 2020.)