Tariff war

As US President Donald Trump has opened another front in the trade wars through tariff war, let’s understand the what, why, and how of this issue from a broader perspective.

Recently, President Donald Trump announced plans to impose reciprocal tariffs on multiple countries, escalating his trade war. “I’ll be announcing that next week—reciprocal trade—so that we’re treated evenly with other countries,” Trump said. “We don’t want any more, any less.” This move aligns with his campaign promise. During his election campaign, Trump had said that “tariff” is his “favourite word in the dictionary” and that he would use tariffs to boost domestic manufacturing in the US. 

As anticipation builds, policymakers and economic analysts around the world are anxiously awaiting his decision on imposing tariffs on various nations. Although tariffs contribute roughly 2% to the US’s annual revenue, the Trump administration believes that increasing them could help offset certain costs.

Tariffs are taxes or duties imposed by a government on imported goods and services. Their objective is to make foreign products more expensive compared to domestically produced goods, thereby encouraging consumers to prefer local products. Tariffs also act as a protective measure for domestic industries against foreign competition. Additionally, they serve as a source of revenue for the government.

The mechanics of tariffs are simple: when goods cross into a country, the government imposes a fee. These fees can either be a percentage of the goods’ value (ad valorem tariffs) or a fixed amount per unit of goods (specific tariffs). Tariff rates vary depending on the product, its country of origin, and any existing trade agreements between the nations involved.

Governments use tariffs for various purposes, including protecting sensitive sectors like agriculture and manufacturing, addressing trade imbalances, and generating revenue. However, there are several possible reasons behind the recent US government’s plan to impose new trade tariffs against various nations.

Udit Misra explains it– “let’s imagine a scenario, where domestic US car manufacturers sell a car for $120 and Chinese cars are imported and sold for $100. It is quite likely that overtime, Chinese car imports rise as US consumers prefer to buy the cheaper car. This has three broad implications.

One, the US domestic car manufacturing firms lose out because of low sales. Two, US trade deficit balloons.  Three, consumers are getting cheaper cars.”

“In this context, Now imagine what would happen if the US was to impose a tariff of 50% on all Chinese car imports. The US government may decide to do so for one or more of the following three reasons:

Protect US domestic industry (in this case car industry): After tariffs, the Chinese car would now cost $150 and as such will be costlier than the US car ($120). Arguably, the demand will shift to US car makers and the whole industry will be better off financially.

Raise government tax revenues: The US government may decide to raise some money by taxing a product that seems to be selling well.

Forcing the Chinese car manufacturers to set up a factory inside the US: Foreign Direct Investment (FDI) is a good way to ensure that domestic consumers get better or cheaper cars without domestic workers losing out jobs.”

Hence, we can say that following reasons broadly drive Trump’s recent fresh trade tariff threats:

1. Trump’s affinity for tariffs: Trump’s inclination towards tariffs dates back to before the 2024 US presidential election. In his first term, he initiated a tariff war with China, India, and several other countries, largely to resonate with his core voter base.

Ravi Dutta Mishra writes- “Trump’s tariff plans in his second term have been set in motion to achieve his political and economic goals of curbing immigration and attracting manufacturing back to the country. He has announced the establishment of an External Revenue Service (ERS) to tax imported goods entering the US.”

2. Push Canada and Mexico to curb illegal flow: On February 1, US President Donald Trump ordered the imposition of a 25% additional tariff on all imports from Canada and Mexico, and a similar 10% levy on Chinese goods entering the US. On February 3, he announced a 30-day period pause on the implementation of the new tariffs on Canada and Mexico, even while retaining the 10% blanket additional duty on imports from China. According to BBC, these tariffs aim to push Canada and Mexico to tackle illegal immigration and drug trafficking.

3. Additional revenues: A key reason is undoubtedly boosting government tax revenues by taxing a well-selling product.

Amartya Lahiri writes- “The more likely reasons for the tariffs are President Trump’s long-expressed love of tariffs as a marker of economic power; and the federal government’s desperation for additional revenues.

Corporate and personal income tax rates had been reduced under the Tax Cuts and Jobs Act of 2018 during Trump’s previous administration. These are popularly known as the Trump tax cuts and they are scheduled to expire in 2025. A key goal of President Trump is to extend or make those tax cuts permanent.

The revenue shortfall of the US federal government is where tariffs can play a role. The United States imports around $4 trillion of goods annually, of which 15.6 per cent come from Mexico, 12.6 per cent from Canada while China accounts for 13.5 per cent, a collective import share of almost 42 per cent. Simple arithmetic reveals that at current levels of imports from these three countries — 25 per cent tariffs on Canadian and Mexican goods with a 10 per cent carveout for energy imports from Canada (which account for a quarter of Canada’s exports to the USA) along with 10 per cent additional tariffs on imports from China — can raise upwards of $320 billion annually. This is almost 70 per cent of the annual cost of extending the tax cuts.”

The primary goal of international trade is profit for exporting countries, while importing countries are driven by the needs of their people or the luxury demands of specific sections of society. In this context, maintaining balanced tariffs is crucial for both sides. However, when nations prioritize their own interests at the expense of the other party, it often leads to tariff hikes. This, in turn, triggers retaliatory actions through various means, escalating economic tensions. In many cases, countries respond by imposing their own tariffs, sparking trade disputes or even trade wars, as witnessed in the recent US-China tensions.

The country on whom tariffs are imposed (China in this example) has several options on how to retaliate.

1. Dumping: China can choose to absorb the tariff and sell the cars for $100 instead of $150. They may choose to do this in the hope that overtime they would be able to drive the US car makers out of the market, and once they have achieved monopoly in the market, they can raise prices and recover all losses.

2. Pass on the tariff costs to consumers: The most likely action, however, is that Chinese firms will just add the 50% tariff ($50 in this case) to the price of the car. In this case, it is the US domestic consumer who will end up paying the tariff. In turn, this will raise prices and lead to inflation in the US while the Chinese remain largely unaffected. There is another perverse outcome in such cases: The domestic car makers may also raise the prices from $120 to $140 (still below $150 of the Chinese cars). This way US car makers will be able to earn more without necessarily having to improve the quality of the car or by improving efficiency of manufacturing a car etc. They enjoy a bonus just because the US government has put “protectionist” tariffs. The government will also earn more revenues in this case. However, the US consumers will bear the cost.

3. Trade war: As the US imposed a 10% levy on Chinese goods entering its market, China subsequently retaliated by imposing import taxes of 10–15% on select US imports, including crude oil, liquefied natural gas, coal, farm machinery, pickup trucks, and large-engine cars. Such situations eventually lead to a trade war, where countries retaliate by imposing or increasing tariffs on each other’s products.

In reality, the response is a mix of these strategies. But the important thing to remember is that almost always, tariffs hurt domestic consumers while attempting to favour domestic producers and government finances. A wholesale trade disruption could raise prices, and inflation, without even achieving the original goals of protecting domestic industry.”

Despite repeatedly criticizing India’s tariff structure, Trump, in his first executive order on February 1 imposing trade tariffs, did not include India. This indicates that bilateral trade negotiations might be planned for Prime Minister Narendra Modi’s scheduled visit to the US. However, it is certain that India’s economy and some sectors will be impacted by Trump’s new trade tariffs. Let’s understand this further.

“The marked shift in American trade policy under Trump, which increasingly aims to seek “reciprocal” market access in both developed and developing nations alike, could leave India’s top goods exports to the US—pharmaceutical products, gems and jewellery, and marine products—particularly vulnerable to tariffs under the second Trump administration. During his first term, Trump had targeted Indian steel and aluminium exports. That aside, there is a risk of an across-the-board tariff on all items entering the US, which could hit overall demand for imported goods in the country.

If imposed, the impact of tariffs on India could be disproportionately high, as the US is India’s largest trading partner, with bilateral trade in 2023 crossing $117 billion. India is also vulnerable to changes in American trade policy, as the US market is India’s largest export market for both goods and services. Most importantly, the US is the only country with which India has a trade surplus, making it a crucial source of US dollar earnings.”

However, the current 10 per cent tariffs imposed on Chinese goods would also create an opportunity for more Indian goods to enter the US market.

Thus, we see that India has already begun lowering tariffs to favour US exports in a bid to avoid Trump’s tariffs. Duties on items primarily exported by the US, such as motorcycles with an engine capacity below 1,600cc, ground installations for satellites, and synthetic flavouring essences, among others, were slashed in the Union Budget 2025-26 presented on Saturday.

 “The big worry for India is: Are Indian exporters ready and capable to make use of the opportunity when a new trade war happens or will India become one of those markets that is used to pass through Chinese goods to the US, without much value-addition at the domestic level?”

Even if the current 10 percent tariffs imposed on Chinese goods present an opportunity for India to expand in the US market, a trade war that drives up inflation in the US may not be in India’s interest, as America is India’s largest trade partner and foremost export market. Thus, the impact of the new tariff policy on India depends not only on the Trump administration’s policy but also on how India responds to it.

“It is possible that Trump will use the threat of imposing tariffs as a negotiating tool…However, tariffs could also trigger an increase in the cost of production of other goods, pushing up inflation.. As per reports, there is also the concern that the higher tariffs in the US will push exporting nations to look for alternative markets, with India a likely target. An increase in supply, “dumping”, some have said, could further put pressure on prices…The Indian government will have to assess the situation carefully.

Trump’s latest tariff announcement comes just ahead of Prime Minister Narendra Modi’s US visit. There are indications of the Indian government showing pragmatism in dealing with Trump. The government should leverage the goodwill Delhi enjoys in Washington, negotiate with the new administration, and take advantage of the opportunities that arise in an increasingly uncertain global environment.”

Qn) What are the key areas of reform if the WTO has to survive in the present context of ‘Trade War’, especially keeping in mind the interest of India? (UPSC CSE 2018)