THIS paper analyses the developments in the ongoing trade war between the U.S. and China and the resultant impact of the trade restrictions on India and some other countries of the South Asian region. Apart from economic changes produced by import substitution and production relocation, this paper reflects on the effects of a weakening World Trade Organization (WTO) and trade relations influenced by geopolitics on South Asia. The impacts on India – the largest economy of the region with close strategic ties with the U.S. – are likely to be different from the rest of the region, including the possibility of formalization of trade ties with the U.S. through a bilateral agreement.

Manifesting in large-scale tit-for-tat tariffs between the U.S. and China, the trade war began in March 2018 with unilateral trade actions by the U.S. on steel and aluminium imports. The tariffs imposed – 25% on steel and 10% on aluminium – were, however, not country specific and app-lied to all steel and aluminium imports into the U.S. with some exceptions. The tariffs were imposed under Section 232 of the U.S. Trade Expansion Act of 1962. This little used provision in the U.S. trade law – employed for only 30 investigations in the last five decades – justified the steel and aluminium tariffs in the interest of ‘national security’. Soon after, the U.S. employed Section 301 of the Trade Act of 1974 to impose more tariffs on a large number of imports from China with the justification that unfair economic practices by China were hurting the interests of American firms in China.

The EU, Canada, Russia and several other countries reacted to U.S. tariffs on steel and aluminium through retaliatory tariffs on U.S. imports or formal complaints at the World Trade Organization (WTO). China reacted to all U.S. tariff increases by imposing counter-tariffs on U.S. exports to China. By early 2019 the U.S.-China bilateral tariff war covered more than 7,000 items traded between the two countries. The WTO has also witnessed a flurry of disputes filed over U.S. tariffs: China was the first to file a complaint and was subsequently joined by several other countries including India, Russia, Thailand, the EU, Mexico, Canada, Brazil and Singapore.

The 30 November 2018 announcement by the U.S. and China of a temporary ‘ceasefire’ in this trade war for a period of 90 days brought temporary relief. Both sides agreed to withhold further escalation of tariffs with the objective of arriving at a mutual understanding on their differences on trade. However, even if they succeed, it is not clear if the tariffs already announced by both on each other’s products would be recalled. Furthermore, the U.S. is yet to indicate any intention of clawing back the steel and aluminium tariffs. On the contrary, it might impose more tariffs on national security grounds depending on the outcome of ongoing investigations on automobiles and auto components.

 

The U.S.-China tariffs primarily affect their bilateral trade, but their impact is felt globally due to trade distortions since both the U.S. and China would look to source cheaper imports from other countries. In the longer term, such import substitution will be followed by relocation of parts of supply chains from the U.S. and China to elsewhere. While these are some of the visible impacts of the tariff war, there are less visible but wider impacts, as the U.S. and China stay locked in their battle for global economic supremacy. These impacts arise from more unilateral trade actions grinding international trade cooperation to a halt and WTO becoming irrelevant and trade getting driven by geopolitics as opposed to markets. South Asia as a region, and India as a country, would be influenced by these various impacts.

The short-term economic impact of U.S. steel tariffs would vary between India and other South Asian countries. None of the South Asian countries, including India, are among leading exporters of steel to the U.S. market. India is the 10th largest steel exporter to the U.S. accounting for two per cent of its steel imports, which is much less than those of Canada, Brazil or South Korea.

 

Conventional wisdom suggests India’s overall trade prospects will not be affected to a very great extent by the Section 232 steel tariffs. The argument is supported by a recent study on the impact of steel tariffs that finds ‘bigger and richer’ countries, including China, India, Russia, Japan, which account for almost one-third of steel exports to the U.S., being much less affected, compared with ‘small and poor’ countries. The latter group, including Bangladesh, Sri Lanka and Pakistan from South Asia, account for just around four per cent of the total steel imports by the U.S.¹ Smaller exporting countries are clearly at a disadvantage in overcoming the rising prices of their exports and might, over time, be pushed out of the American market if the current tariffs persist. Although it is difficult to predict if the South Asian economies might also be displaced, the possibility cannot be overlooked.

The U.S.-China tariff war might also produce some opportunities for South Asia in the form of import substitution and production relocation possibilities. Assuming that current tariffs will persist, both the U.S. and China would search for alternative sources of cheaper imports. Strategic geography puts South Asia at an advantage in this regard. Studies on import substitution point to Pakistan being a major beneficiary, with India and Bangladesh also likely to benefit.²

The predictions are based on greater demand from China as it looks to replace more expensive U.S. imports in sectors of high import dependency, such as agriculture, automobiles and medical devices. While Brazil and Argentina might be alternative sources of agricultural imports for China, India too is a good option, particularly for soybean. It can also be a prominent source of auto imports given the presence of multiple global assemblers. On the other hand, Pakistan’s prowess in medical devices is well established and can be a strong source of supply for China.

 

India, Vietnam and Malaysia are major Asian countries poised to benefit from longer-term production relocation decisions of major global businesses. Several factors would determine the eventual prospects. But India is likely to be ahead of the rest of South Asia due to its large domestic market and a rapidly expanding middle class with a high propensity to consume that makes it a prominent choice for relocation of final assembling operations of automobile and electronic supply chains.

India is also progressing better than the rest of the South Asian region in bringing down costs of doing business. This is evident from the latest global Ease of Doing Business (EODB) rankings. Supply chain managers would decide on relocation not just on the basis of low locational costs, such as from availability of raw material and labour customized for specific operations, but also progress of ‘possible’ locations on trade facilitation and reducing the cost of doing business across borders. While India is still behind several emerging market and advanced economies in this respect, in recent years it has performed better than the rest of South Asia, as well as a competitor economy like Vietnam.³

Both the import substitution and production relocation impacts for India would be higher if the U.S. imposes tariffs on automobiles and auto parts under Section 232. As long as automobiles assembled in China encounter high tariffs in the U.S. market, global auto assemblers might relocate elsewhere, including in India, in order to supply the United States. A similar logic applies to auto assemblers in the U.S. facing high tariffs in China and Europe. Section 232 tariffs might change these perceptions as they would be product specific, not location specific. Their exporting automobiles from India to the U.S. might be almost as expensive as exporting from China, depending, of course, upon the type of vehicles and the precise tariffs on them.

 

Tariffs on auto parts and components would encourage import substitution, particularly from countries that might continue to enjoy some exemptions in the U.S. market. Automobile assembling operations in major Asian economies like China, Japan, Taiwan, Korea, Thailand and India rely heavily on sourcing components from specific vendors in different locations. Tariffs on vehicles and parts would influence costs of these backward and forward linkages and India, as well as South Asia more generally, will not be an exception.

The U.S. proclivity under President Trump to resort to unilateral trade actions and bypass global trade rules underscores its attempt to marginalize a global trade order, which it had been instrumental in creating itself. The Trump administration made it clear from the beginning that on trade issues, U.S. domestic laws and national interests would supersede WTO rules. Notwithstanding such emphasis, the U.S. continues to stay engaged at the WTO in challenging the actions of other countries that have retaliated to its steel and aluminium tariffs. This reflects a new character of the U.S. trade policy: overall defiance of multilateral trade rules along with selective utilization of the same rules.

 

Until now, the WTO has not been able to prevent escalations in the U.S.-China tariff war. The current scale of trade hostilities between the world’s two largest economies is unprecedented in the history of the WTO. The WTO is completely unprepared to react to unilateral trade restrictive measures taken on security grounds like under Section 232. These might set a dangerous precedent for similar actions by other WTO members.

South Asian countries have been active participants at various discussions in the WTO meetings. Their reliance on the WTO’s trade rules for greater participation in world trade is also because of their limited involvement in FTAs outside the WTO. Among South Asian countries India has been the most involved, but its involvement is much less compared with that of Japan, Korea and China. Its engagement in FTAs has been cautious given the skepticism within the Indian establishment and industry on trade agreements. India’s notably defensive approach at the ongoing 16-country Regional Comprehensive Economic Partnership (RCEP)⁴ negotiations is a pertinent example.

Domestic opposition to FTAs is also visible in other South Asian economies like Sri Lanka, which is finding it difficult to execute FTAs. Given the low engagement of South Asian countries in FTAs, a sustained decline in the importance of the WTO is not encouraging news for India and the region. Over time, if bilateral and regional FTAs become the way forward for India and South Asia’s major trade partners, India and South Asia might lose out on many global trade advancements leading to an even lower share in global trade.

 

The inability of the WTO to rein in the tariff war points to a far-reaching change in the character of global trade. Many trade relations in the world might get increasingly fashioned by geopolitics outside the sphere of global trade rules. The tendency has implications for South Asia’s trade relations. As the U.S. and China look for ways and means to curb each other’s economic significance and access in global markets, they would look for opportunities to influence other countries in limiting commercial engagements with their main economic rival while expanding their own.

An example of how future trade relations might get dictated by geo-politics is the U.S.-Mexico-Canada (USMCA) trade agreement. The USMCA would replace the nearly three-decade old North American Free Trade Agreement (NAFTA). USMCA restricts its members from entering into FTAs with ‘non-market’ economies – the obvious reference being to China.⁵ This marks an attempt by the U.S. to discourage its security partners and allies from entering into FTAs with China, or similar other countries with whom it has difficult political relations.

 

Allies of the U.S. like Canada are already experiencing the downsides of the U.S.-China geopolitical rivalry in the sphere of global business as is evident from the arrest of the Huawei CFO by Canada under alleged U.S. pressure. It is only natural that China has resorted to similar tactics by arresting Canadians. Indeed, the possibility of China using its geopolitical leverage to tacitly encourage South Asian countries like Pakistan, Sri Lanka, Bangladesh and Nepal that are heavily dependent on Chinese investments and trade with China to divert trade away from China’s political rivals is distinct.

As it gets fashioned by geopolitics, trade responds less and less to market based incentives, making global and regional trade rules more irrelevant. The pushback has serious implications for India and other South Asian economies, which are relatively small players in global trade and engages in global trade largely through WTO’s rules. The low engagement of India and the rest of the South Asia region in FTAs make them particularly vulnerable to pressures to enter into trade relations based on geopolitics in order to maintain their presence in global trade.

The trade war might, however, bring in substantive changes in India’s relations with the U.S. These might be formalized through a bilateral agreement as a consequence of the ongoing trade war. India joined several other countries in protesting against U.S. steel and aluminium tariffs at the WTO and also announced retaliatory tariffs on U.S. imports of around $240 million to India. However, it is yet to apply these tariffs, which were to come into effect from 4 August 2018, following commencement of bilateral talks with the U.S. While either side has not shared the content of the talks, they might be focused on a bilateral trade deal. The possibility gains traction given that President Trump himself has alluded to such a possibility.⁶

The U.S. penchant for talking bilaterally to major trade partners for working out trade deals more ‘accommodative’ of U.S. trade and business interests might see it pushing India hard towards a trade pact. It has already renegotiated existing trade deals with Canada, Mexico and South Korea and has persuaded Japan to enter into bilateral trade talks.

 

In framing a bilateral deal, India would be under ‘pressure’ to bring down tariffs on several U.S. products, including automobiles and agriculture. While India has already agreed to buy more U.S. imports, including oil, for correcting the bilateral trade imbalance, it might find it much more difficult to accept other U.S. demands. Reducing tariffs on U.S. agricultural imports is a politically unacceptable decision given that the Modi government is going into general elections in the backdrop of widespread farmers’ distress in the country. Lowering tariffs on automobile imports too would encounter stiff resistance from domestic auto assemblers. The U.S. is also likely to demand flexibility from India on its data localization policies, which directly impact business prospects of major U.S. companies in India such as Amazon, Walmart, Google and Facebook.

Like it has with some of its other security partners, the U.S. is likely to employ geostrategic clout and an expanding defence engagement to get India to agree to a trade deal. For India, the prospect would involve overcoming major domestic political opposition. At the same time, India cannot afford to entirely overlook U.S. demands on trade given that the U.S. is its second largest trade partner and one of the few countries with which India enjoys a bilateral trade surplus. Against this backdrop of the trade war, FTA talks with the U.S. pose significant strategic challenges for India.

 

In conclusion, India and the South Asian region face multiple uncertainties following the trade war and mounting economic hostilities between the U.S. and China. While there might be some selective opportunities arising from import substitution and production relocation for India and the rest of the region, the long-term structural impacts of a weak WTO and the increasing geo-politicization of trade will have serious negative consequences for the region. As the largest South Asian economy, India needs to analyse these developments carefully. Its evolving economic and geopolitical ties with the U.S. following the trade war, including a possible trade deal, will have implications for the rest of the region. Smaller South Asian countries, which might be inevitably drawn into the geoeconomic turf battle between the U.S. and China, are more vulnerable to adverse impacts of trade driven by geopolitics.

 

Footnotes:

1. Chad P. Bown (PIIE), Euijin Jung (PIIE) and Eva (Yiwen) Zhang (PIIE), ‘Trump’s Steel Tariffs Have Hit Smaller and Poorer Countries the Hardest’, 15 November 2018, Peterson Institute for International Economics (PIIE), Washington DC; https://piie.com/blogs/trade-investment-policy-watch/trumps-steel-tariffs-have-hit-smaller-and-poorer-countries (accessed on 17 December 2018).

2. Sam Jacobs, ‘The US-China Tariffs List is 7,705 Items Long – Here’s who could sell Them Instead if There’s a Trade War’. Bloomberg.com, 21 November 2018; https://www.businessinsider.com.au/us-china-trade-war-tariff-list-import-substitutes-2018-11 (accessed on 18 December 2018).

3. Amitendu Palit, ‘Trade War: India Can Gain in the Long Term – Here is How’, Financial Express, 6 December 2018; https://www. financialexpress.com/opinion/trade-war-india-can-gain-in-the-long-term-here-is-how/1404775/ (accessed on 17 December 2018).

4. RCEP includes ten ASEAN economies (Brunei, Cambodia, Lao PDR, Indonesia, Malaysia, Myanmar, Philippines, Thailand, Singapore, Vietnam) and Australia, China, India, Japan, Korea and New Zealand. Once concluded, it would be the largest FTA in the world in market size measured by economic output and population.

5. ‘Trump’s New North American Trade Deal Also Aimed at Bigger Target: China’, The Washington Post, 3 October 2018; https://www.washingtonpost.com/world/asia_ pacific/trumps-new-north-american-trade-deal-is-also-aimed-at-a-bigger-target-china/2018/10/03/5290686c-c705-11e8-9c0f-2ffaf6d422aa_story.html?noredirect=on&utm_term=.20c911d86a05 (accessed on 17 December 2018).

6. ‘New Delhi Wants Trade Pact to Keep US Happy’, Livemint, 2 October 2018; https://www.livemint.com/Politics/0caiYwprVUU4EEVcwLMhAM/Trump-says-tariff-king-India-wants-trade-deal- with-US-to-k.html (accessed on 17 December 2018).