Why India should lie low if a US-China trade war erupts

trade war between the US and China seems about to erupt. India may find trade and non-trade barriers rising in both the US and China and will need to steer its way carefully through the two-way gunfire.

US president Donald Trump has just imposed import duties of 25% on steel and 10% on aluminium. In January he had imposed duties of 30% on solar panels and 20-50% on washing machines. He has pulled out of the Trans-Pacific Partnership negotiated by his predecessor Barack Obama and forced re-negotiation of the North America Free Trade Area with Canada and Mexico.

His main trade target is China, with whom the US had a trade deficit of $375 billion in 2017. China has so far tried warning Trump about possible retaliation while trying to talk its way out. Now that Trump seems intent on trade war, China can meekly surrender or retaliate. It will very likely retaliate, since its leadership hates to lose face. It is now economically strong enough to seriously hurt the US.

China is a big importer of US soybeans, maize and meat. If it shifts these purchases to other countries, US farm producers — a powerful lobby — will suffer. China has been buying thousands of aircraft from Boeing, and can shift to Europe’s Airbus. It has reluctantly begun heeding intellectual property rules on pharmaceuticals, films and music, but can retaliate by selectively targeting US companies in these fields.

China can impose non-tariff barriers on American banks, insurance companies, airlines, and other service industries. Finally, it holds $1.3 trillion of US treasury bonds in its forex reserves, and can dump these on the market. That will cause US bond prices to crash and US interest rates to skyrocket.

This risks inviting fresh retaliation by the US, followed by further retaliation by China. Each salvo will bring cheers from protectionist lobbies, but also hurt both economies, as protectionism typically does. Higher tariffs on steel and aluminium can render uncompetitive US products using these metals (like cars and machinery), and this could destroy rather than create more US jobs. Higher duties on solar panels have raised the cost of new solar plants and hence US electricity costs.

If China stops imports of agricultural products or aircraft from the US, it will have to pay a higher price to alternative suppliers. If it dumps dollars, it will suffer big losses even as it hurts the US. Yet China can argue that tough retaliation alone will dissuade Trump from imposing even more anti-China measures.

Trump is targeting not just China but all exporters to the US. At his last meeting with Narendra Modi, he blasted India’s 70% import duty on motorcycles that hurt Harley-Davidson. Modi offered to cut the duty to 50%. Trump sneered this was peanuts. Harley-Davidson already has two factories in India and so has not asked for lower duties. But Trump would like Harley-Davidson to shut its Indian factories and produce only in the US.

He has warned India to slash its trade surplus with the US. In Washington, Indian and US officials have agreed to trim the trade surplus based on comparative advantage. The most competitive US industries are defence, aircraft and energy (oil and gas). India has agreed to step up its imports of all three. But Trump has warned he will demand much more. India is too weak to stand up and retaliate. It should smile, try to pacify Trump, and limit the damage.

China also knows that fighting the US singlehanded is difficult. It may well ask other countries to join hands in opposing US trade barriers and threatening joint retaliation. The European Union may be interested. So too may some Asians. None of them dares take on the US unilaterally, but could be open to forming a really wide coalition.

What should India do in such circumstances? It certainly must not take the lead in forging an anti-US front with China. Its strategic relationship with the US needs to be nurtured, even if that is painful. If, however, an anti-US trade coalition gathers force, especially in multilateral forums like the WTO, India could unobtrusively join that crowd, making sure it does not stand out. The best hope must be that Trump’s tactics will backfire, hit the US economy, and help boot him out in the 2020 election.

That is far from certain. Anyway, this is not a time for India to have any illusions about exercising global or regional leadership. Its approach should be that of an ant among raging elephants.

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