Sanjeev Ahluwalia | Trump’s DOGE and hidden costs of ‘reciprocal tariffs’

It is a measure of the randomness of the policy changes in the United States that the left hand no longer knows what the right is doing, or more appropriately, neither of its two right hands know what the other is up to.

Consider that Elon Musk, reportedly working overtime, sleeps in the DOGE office, to reduce the US fiscal deficit to one half by cutting $1 trillion of government expenditure. US federal staff are being terminated and entire agencies, like USAID, rendered obsolete. To some, this speaks of the kind of “strong action” that all governments should take to cut flab -- and who could argue that governments, the world over, are not flabby.

The problem is that even as Mr Musk sculpts the US government to shed generational lard, the White House is doing exactly the opposite by remaking the foreign trade rules which could take away billions of dollars from consumers and businesses in the US and in exporting countries as US import tariffs increase. Higher import tariffs are the answer to a recurring US deficit in goods trade, which started in 1970 and has grown since. In reality, it might only boost tax revenue, which would need to be recycled to compensate Americans for the ensuing inflation as imports become more expensive and more goods are manufactured at home, at higher prices, than for those imported at present. But yes, there might be more jobs for the MAGA boys.

This is similar to India’s tariff strategy to protect domestic employment in agriculture, at great cost to Indian middle-class consumers and taxpayers.

Never mind that turning inwards runs contrary to everything the United States has achieved over the past half century -- global military dominance after 1989, innovation and technology smarts, domestic competitiveness and institutional commitment to liberty and equity, a stellar record of encouraging open markets globally, along with being the cheer leader for democracy.

Today, unconventional wisdom within the White House is narrowly focused on trying to benefit by charging more to access its huge market (18 per cent of global goods import) via tit-for-tat “reciprocal tariffs” (RT) at the same tax rate, as charged for import in each country.

The most efficient way to maximise the benefits from global trade is to limit the power of governments to tax overseas trade. However, this might not be the most equitable way since it privileges entrenched economic power whilst constraining weak economies. More significantly, such a move would deindustrialise much of the world, as hyper-competitive Chinese manufactures -- some subsidised by the State -- would flood global markets, pushing China’s economy to the levels of economic dominance enjoyed by the United States after the Second World War, when it had a share of 28 per cent in global GDP, the next biggest was the UK with a share of 6.5 per cent.

Such is the antipathy which China’s hawkish trade and investment strategy evokes that there are few takers for replacing an American hegemon with a Chinese one.

The Chinese economy has levelled off at a share of about 17 per cent of global GDP versus 26 per cent for the US in current dollars, though both still grow at more than the average global GDP. A deal between Presidents Donald Trump and Xi Jinping could get China some breathing room to grow, possibly, in exchange for dialling back the geopolitical power usurpation that China plans.

Consider also how contrary RT are to the three principles of tax effectiveness -- simplicity, efficiency, and equity. First, RT would be complex and unstable. Each change in import tariff across all countries exporting to the US, for every specific product or product group, would need to be constantly monitored and protocols developed for updating RT. The administrative costs would be considerable for all countries.

Second, RT would be a very inefficient because they are likely to increase “deadweight loss”, which is the result of diminution of trade prospects due to regulatory constraints, like RT, which either deny access to domestic markets or increase the cost of access. RT might also force countries to physically ban the import of certain products in which they are uncompetitive, rather than deter their import via high tariffs. Why would this be worse than the present? Consider the case of big motorcycles or monster trucks. India could just ban the import of these petroleum fuel-guzzling anachronisms. The US would retaliate by a reciprocal ban, which would be infructuous since India exports no big motorcycles or trucks to the US. Nevertheless, a mutual ban on such imports would be a worse option because even the possibility of future manufacture of such products in India would be closed, though Harley-Davidson, an American company, might at a future date, find it profitable to manufacture in India and supply globally.

How equitable would the RT scheme be? It defies logic how it could possibly be fair to impose a differential tax on the same product imported from two different countries. Consider a chair imported from lower middle-income India being taxed at a higher rate than one imported by the US from high-income EU, merely because the specific or average EU import tax on chairs is lower than the import tax in India. RT exports from the EU would grow, while Indian exports of chairs would shrink. Indian producers have no easy way of avoiding domestic economic inefficiencies ranging from regulatory friction to the higher cost of credit, logistical or electricity supply for industries and continued reliance on human labour versus robots, all of which add to the higher supply cost in India. A differential tariff could make producer margins in India unviable, leaving the US consumer with no option but to pay more for European chairs.

Some believe that the “reciprocal tariff” threat is just a bluff intended to force countries to go cap in hand to the US and beg for preferential treatment, which means, each country identifying the least cost way to appease the US. Some might be allowed to retain nod and wink non-tariff barriers (like the EU carbon border adjustment mechanism) while others like rare mineral rich and strategically located Greenland might simply opt to become part of the US. Large developing nations like India, wedded to autonomy, might have to pay a price in military hardware supply or nuclear power project contracts. After all, there is never a free lunch. In retrospect, paying obeisance to Beijing instead might have been a better alternative.

The writer is a former IAS officer, governance and economic regulation expert and Distinguished Fellow, Chintan Research Foundation