Trade War: Likely Impact on India
| DOI | 10.1177/0015732519886793 |
| Published date | 01 February 2020 |
| Date | 01 February 2020 |
| Subject Matter | Articles |
Trade War: Likely
Impact on India
Rekha Misra1 and
Sonam Choudhry1
Abstract
The global financial crisis triggered the built up of domestic pressure in some
countries to introduce protectionist measures against imports. The present dis-
cussion regarding the ‘trade war’ and ‘de-globalisation’ intensified after both the
US and China escalated the tariff rates on imports originating in the US and
China. This study evaluates the potential economic effects of the substantial tariff
hikes by these two major economies on Brazil, Russia, India, China and South
Africa, particularly for India. The study adds to the existing literature on the
trade war by examining potential impact on India’s exports, that is, both direct
and indirect losses as well as benefits arising due to the trade war using the eco-
nomic model based on the trend in trade flows, similarity index and supply chain
networks using World Input-Output tables. The study uses the Vector Error
Correction Model to empirically evaluate the pass-through of the tariff hike on
Indian exports using bilateral real effective exchange rate (REER)-consumer price
index and REER-product price index. The study finds that the US–China trade
tussle may provide some opportunities in short to medium run for India as gains
through trade deflection would be higher than the losses due to trade reduction.
However, in the long-run, further escalation of tariffs will have negative impact
at the global level.
JEL Codes: F1, F62, F68
Keywords
Protectionism, tariffs, real effective exchange rate, supply chain
Article
1 Department of Economic and Policy Research, Reserve Bank of India, Mumbai, Maharashtra, India.
Corresponding author:
Sonam Choudhry, Department of Economic and Policy Research, Reserve Bank of India, Mumbai,
Maharashtra 400001, India.
E-mail: sonamchoudhry@rbi.org.in
Foreign Trade Review
55(1) 93–118, 2020
© 2020 Indian Institute of
Foreign Trade
Reprints and permissions:
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DOI: 10.1177/0015732519886793
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94 Foreign Trade Review 55(1)
Introduction
The debate around protectionism is as early as the literature on political economy.
Karl Marx and Friedrich Engels did not favour free trade but considered protective
system as conservative. There has been a growing debate in economic literature
(François Quesnay, Turgot, Adam Smith, Jeremy Bentham, David Ricardo and
many more) about the benefits of ‘real global integration’ largely seen in the form
of uninhibited cross border flows of not only goods but also labour and technology.
However, the recent period has seen resistance to real integration where free eco-
nomic and trade policies have made way for inward looking nationalist policies.
In the recent time period, a distinct feature of the post-global financial crisis
world has been enhanced proclivity towards protectionism (Evenett et al., 2017).
The contraction in income and employment witnessed in the immediate aftermath
of the crisis lent further credence to protectionist policies. A noteworthy develop-
ment in this regard has been the tariff action undertaken by the US against China
and the retaliation thereof from China during 2018.
The enhanced role of the global supply chains in today’s world has resulted in
greater interconnectedness of the global economy, which implies that the impact of
this trade war will not be confined to the countries directly involved. The profound
presence of the global supply chain networks has led to the fragmentation of produc-
tion processes across the world; foreign value added accounted for 28.3 per cent of the
total world exports in 2011 (latest available). The tariff escalations would have a cas-
cading impact on economies through their links with the US and China. The impact
on individual economies may vary depending on their integration with the world
economy and participation in the global value chain (GVC) networks. An individual
economy may witness a decline in its exports or trade reduction if its production lines
are significantly integrated with either of these two major economies engaged in a
bilateral tariff war. Alternatively, tariff hikes may translate into gains or ‘trade deflec-
tion’ for an economy if it takes over the supply lines vacated by the economy hit by the
tariff imposition (Aschauer, 1871; Eichengreen, 1981, 1983, 2016).
India’s integration in the global economy has been increasing over time. The
integration in the GVCs is relatively small, given the size of the economy, but that
has also been increasing in recent times. Given this, it is expected that the ongoing
trade wars are going to impinge on India’s trade profile. This impact is likely to be
by way of moderation in India’s exports and would be felt in terms of India’s
participation in the supply chains of exports from both the US and China. In addi-
tion, there is going to be an indirect impact, which would be by way of trade
deflection where India’s exports may benefit, as Indian goods get an opportunity
to occupy the space vacated by the goods exported from the US and China to each
other due to duty hikes. This study adds to the existing literature on trade war by
examining the potential impact of trade war on India’s trade flows. The article
attempts to analyse both aspects of the potential impact on India’s exports, that is,
losses and benefits arising due to the trade war.
The study is organised as follows: Section II of the article presents stylised
facts about the trade war. Theoretical underpinnings are discussed in Section III.
Section IV presents the estimates regarding reduction in India’s exports due to the
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