President Donald Trump has announced ‘Liberation Day’, the day he imposed high tariffs on imports into the US, to liberate his country, hostage to its own generosity in the form of low-cost access to the huge US market. His announcement to impose tariffs on nearly all of its trade partners has rattled global markets. Trump’s dramatic tariff imposition is a reversal of more than a century of U.S. policy. His supporters feel it was a much needed prescription to fix what fundamentally ails the United States, namely its inability to compete in manufacturing with mostly all the countries in the world.
Let us go back and turn a few history pages. In February 1973 a new system emerged as the world economy ruled by a fiat U.S. dollar, wholly untethered by the gold standard. And experts feel that date marked the loss of U.S. manufacturing advantages over the rest of the world. No longer would international accounts settle the traditional way. In the old system, when goods flowed in and money flowed out, prices would adjust, falling in the importing country and rising in the exporting country. With all trade accounts settled in one paper currency, there was an infinite demand for dollars abroad. They could be held as assets by anyone’s banking system. That meant they never came home to the United States.
Although it would have resulted in falling production costs, allowing U.S. manufacturing to flourish but that did not happen for several reasons. The United States just kept printing and printing, for decades all the way to the present. Costs of production kept rising while income stayed flat. The United States outsourced its productive capacity to the world.
Japan ate into traditional U.S. industries like pianos, watches, and cars. Then China caught on. Over 20 years, the United States lost everything else: textiles, clothing, steel, tools, shipbuilding, appliances, toys, and nearly everything else. After reform efforts toward market economics shepherded poor countries like Vietnam and Cambodia found advantages in manufacturing too. In the US, there was unlimited demand for low-priced products from abroad; all it had to do was keep the shipments of dollars going, which were in turn deployed to build up more manufacturing to beat anything and everything the United States could produce.
After 50 years of this, the US is left with vast stuff always being imported while retaining mostly only two reliable exports: natural resources of oil and gas, plus products and services rooted in finance. Richard Nixon’s new system ended up changing life in America forever.
Trump sees this problem and seeks dramatic change to fix it. He has taken huge steps to effectively dismantle the world trading order built over 80 years. His choice of weapon is the bluntest one any nation has: the use of tariffs as sanctions. The theory is that these sanctions will create a level playing field in which U.S. industry can thrive again. But what about the new U.S. manufacturers that will be helped? If such manufacturing were not previously viable and only now viable with tariffs, there simply cannot be an export market for them. That’s because whatever they make—whether clothing, tools, ships, meat, or whatever—will be available more cheaply from other countries.
There is a true danger associated with the creation of a new class of industries that get fired up by tariffs but will forever depend on sustaining these tariffs to sell only to Americans at higher prices than they can buy from abroad at cheaper prices. This turns the United States into a walled garden. That is not competitiveness.
Tariffs are simply taxes. This will do nothing to achieve the goal of reducing U.S. trade deficits with the world. Those only come down if the US becomes a net exporter again. That simply cannot happen so long as the U.S. is not competing on production costs and price. Honestly, these are scary times and “liberation day” is not making one more confident in the future.
India does not have many choices. India’s trade in goods with the US is important, but its trade in services is even more important. IT services and IT-enabled services are vital for the Indian economy. These service exports give India valuable soft power, those who deliver services onshore generate valuable remittance income. Retaliation for the sake of retaliation carries the risk of dragging the service sector into the fray.
