The trade war between the US and China has heightened tensions in global markets and increased volatility in international prices, especially in some key commodities.
While the US tries to ‘correct’ its worsening trade deficit with China by raising punitive tariffs across key sectors like steel and aluminium, China has retaliated by launching tariff lines across sectors that are likely to hurt US exports the most.
However, given the highly interconnected nature of today’s trade, the repercussions of the bilateral trade war are likely to be felt multilaterally across countries, sectors and businesses.
One of the core principles of economics is that free trade can potentially benefit everyone. While the past is riddled with stories of how free trade has catapulted nations into prosperity — the most notable in the recent past being the East Asian Tigers and China — yet, there is growing evidence to suggest that free trade brings with it losers and winners.
If the redistribution of wealth between the losers and winners is drastic, this can generate resentment. This partly explains the growing backlash against free trade, especially in the West. These were the countries which benefited the most from free trade in their early stages of development in the 19th and 20th centuries.
However, towards the end of the 20th century and in the beginning of the 21st century, as the lower-income countries began gaining manufacturing competitiveness through their abundant but cheap labour, the manufacturing base of the western countries gradually began to erode as multinational corporations (MNCs) started shift their manufacturing centres to the lower income countries, like China, Vietnam and Bangladesh.
The richer countries continued to specialise in the tertiary and other highly skilled sectors, which could employ only a limited amount of the vast manufacturing labour that was now left without jobs. Thus, while free trade benefitted the richer nations as a whole, the gains from trade were captured by the top few, widening inequality in these nations.
The growing protectionism in the West needs to be seen in this light. Coming to the context of trade in general, the recent trade war is unlikely to be long lived. Both US and China are mutually dependent on each other. While punitive tariffs can give short-term benefits by redistributing the gains from trade, the longer solution is not to restrict free trade but use other redistributive measures, such as income or wealth taxation.
India is a small player in the global trade scenario, making up less than 2 per cent of global trade. Yet, the recent trade war is likely to have a negative fallout not just on our steel and aluminium exports but also our current account deficit (CAD) and the worsening of the rupee.
The way forward is to engage multilateral forums like the World Trade Organization (WTO), strengthening multilateralism, and using trade diplomacy with our major trading partners, notably the US and China. At the same time, steps to enhance export competitiveness need to continue, as raising labour-intensive exports is the surest way to promote sustainable growth.