Former Treasury Secretary of the United States, who is equivalent to our Finance Minister, Larry Summers, has said that the ongoing trade war between the US on the one side and China and India on the other side may lead to a global recession which would be harmful for all the countries of the world.
His analysis is as follows: First, American businesses would be hurt because the tariffs on imports will increase the cost of raw materials for them. Second, the retaliatory tariffs imposed by China and India will reduce their exports.
Third, companies will have difficulty in procuring the raw materials they need, such as aluminium from India. Fourth, this will lead to a loss of confidence among businesses. The confidence among the households will also decline as they face higher prices for the goods. Businesses and households would scale back spending leading to a recession.
An entirely different outcome is also possible, however. Let us consider each of the points one by one. First, while American businesses would indeed be hurt because the tariffs on imports will increase the cost of raw materials and intermediate goods for them.
However, they will establish factories to produce the goods that were being imported till now. An American supplier of iron castings imported from China told me that foundries have restarted in the US because Trump has banned the use of imported castings in government constructions.
The high cost of intermediate goods will therefore be temporary. In a short time, increase in manufacturing will take place in the US to produce those same goods. Second, the retaliatory tariffs imposed by China and India will indeed reduce the exports of American companies. However, America imports much more than it exports. Therefore, the gains to American businesses from the reduction of imports will be much more than the loss of exports.
Third, indeed American companies will have difficulty is procuring the raw materials such as aluminium from India. However, this could lead to import substitution. We have seen that America has started shale oil production in response to increasing price of oil. Such developments would reduce the impact of the high cost of imports. There will nevertheless be some negative impact of this.
Fourth, Mr Summers says that the trade war will lead to a loss of confidence among businesses. The confidence among the households will also decline. I think exactly the opposite is more likely to happen. More production will take place in the US because imports will be expensive. That will lead to creation of more jobs in America and an increase in confidence and spending. It will rev up the economy. There will be no recession in the US.
Question arises, why are many economists predicting a recession? Reason is that the trade war is likely to be harmful for the multinational corporations (MNCs) that have set up factories in China to manufacture goods for the US markets. American MNCs will not find it profitable to import goods produced by them in China. The retaliatory tariffs imposed by China and India will also reduce their exports from the US.
Therefore, there will arise a loss of confidence among the MNCs. The confidence among the Chinese households will also decline as the MNCs scale back their production in China. This could lead to a recession in China. My assessment is that a trade war will be good for a net importer like America and bad for a net exporter like China. The two impacts will cancel each other and there will be no impact on the global economy.
A trade war may instead be good for the global economy. The trade war will shift the global production from large MNCs to relatively smaller domestic businesses. The MNCs use huge automatic machines while smaller businesses use more labour. This shift will lead to fewer loss of jobs in the MNC factories and larger creation of jobs in the domestic factories. There will be a net addition in global jobs.
That will increase the overall demand and revive the global economy. Indeed, the people will have to pay more for the imported goods because of higher tariffs. However, in my assessment, this cost will be much less than the benefits from the creation of jobs.
Also, the revenues generated from the higher import tariffs can be used to fund the creation of infrastructure or the welfare activities leading to the creation of yet more jobs and improvement in the standard of living of the people.
The conclusion is that a trade war will be beneficial for countries that import more. Trade war will shift production from overseas to the domestic economy and provide jobs. The higher import tariffs will generate revenues for infrastructure and welfare.
These benefits will be more than the loss to the US exporters because the US imports more and exports less. The position of China will be exactly the opposite because it exports more. Trade war will shift production from China to the US and lead to a loss of jobs.
The higher import tariffs that China imposes on US imports will generate less revenues for infrastructure and welfare because China imports less. Thus, a trade war will be beneficial for the US and the global economy; though it will be harmful for China and the MNCs that produce in that country. A number of economists are hyping up the loss to the US from high cost of imports and loss of exports; and creating a false fear of a global recession because they are peddling the interests of the MNCs rather than the American or the world’s people.
The position of India is similar to that of the US. We import more and export less. Therefore, a trade will be beneficial for us, though it will surely be harmful for our exporters. The US has imposed high tariffs on the exports of steel and aluminum from India. We should use this as a trigger to impose not equal but higher import duties on goods from the US as well as China.
It is unfortunate that the Indian government has delayed the imposition of the retaliatory tariffs and is trying to prevent a trade war and, in the process, protecting the interests of the MNCs and sacrificing the interests of the Indian people. Author was formerly Professor of Economics at IIM Bengaluru