US Tariffs: What About Notion of ‘Free Trade’?

President Donald Trump is keeping the pot boiling with daily major announcements. Globally, the trade front changes are creating turmoil and uncertainty among nations and financial markets. ‘Are they on or off?’ - Nations are left guessing. Should they retaliate or wait? If they retaliate, Trump promises to increase the tariffs further and if they wait, it would look like Trump has cowed them down. Indian officials are keeping quiet but have lowered tariffs on goods of interest to the USA.

In the State of Union Address to the joint houses of the US Congress, Trump spelt out his strategy. He declared that there will be reciprocal tariffs on all – friends or foes. He twice mentioned India which he has characterized as ‘tariff  king’. In the address he said, “Whatever they tariff us, other countries, we will tariff them”. He added, “That’s reciprocal, back and forth.” and, “Other countries have used tariffs against us for decades, and now it’s our turn to start using them against those other countries”.

‘Tariff’, he said, was “a beautiful word”.

He twice mentioned India which he has characterized as ‘tariff  king’.

Tariff War

On March 4, tariffs kicked in on US’s biggest trading partners, Mexico, Canada and China. China and Canada retaliated by imposing tariffs on imports from USA. In February, when the tariffs were announced it was taken as a bullying tactic to extract concessions. Some felt that ultimately tariffs may not be levied, given their adverse implications for all. On March 5, a one month pause on auto tariff increases was announced. On March 6, a one month pause on tariffs on goods from Canada and Mexico was announced. By March 11, tariffs on steel and aluminum had been imposed on all imports. Back to square one - uncertainty persists.

But tariffs were not an issue with Canada and Mexico since they were a part of the free trade agreement under the United States–Mexico–Canada Agreement (‘USMCA’) (earlier NAFTA). President Trump’s excuse has been that the synthetic drug fentanyl is coming from these countries. The Canadian Prime Minister has argued that this is just a ruse since the amount of this drug entering the US from Canada is miniscule and the real intention is to make the Canadian economy collapse. While announcing reciprocal tariffs, he called the US move “dumb” since the citizens of both US and Canada will be hurt.

China also did not accept the fentanyl argument and called US tariffs as blackmail. It retaliated and significantly imposed controls on rare metals of which it produces 90% of the world output. Mexico delayed its announcement while the US has flip flopped on levying tariffs.

India is negotiating a trade deal with the US. Trump has stated, “They want to cut their tariffs way down now because somebody’s finally exposed them…”. But, India has officially denied this. Cutting tariffs on US goods entering India will have implications for agriculture and industry. In the Budget for 2025-26, tariffs on items of interest to the US were reduced. 

Is Trump dealing with nations one at a time so that the other nations do not band together? He is clearly using the threat of tariffs to get concessions for USA – but, it could boomerang on the US. 

Warren Buffet has characterized the imposition of tariffs by the US as an “act of war”.

He is clearly using the threat of tariffs to get concessions for USA – but, it could boomerang on the US. 

Aim of Tariffs

Trump is using the threat of imposing tariffs to force industry back to the US. Tariffs on goods entering the USA will raise their prices so that demand may shift to goods produced in the USA. But, this is not so simple. Not only will ramping up internal production take time, it would be more expensive given higher wages in the US. Alternate sources of imports from other countries may be possible but that too will take time and be more expensive. So supply lines will get disrupted, production will be impacted, prices will rise and demand will decline. 

All this will give rise to stagflationary conditions. These will be aggravated by Trump’s desire to curtail government – a rightwing agenda. To activate it, he has set up DOGE (Department of Government Efficiency) under Elon Musk, who is cutting back government expenditure by firing staff and closing departments like the USAID and Education. Its effect will be both to reduce demand and curtail public services. All this could tip the US economy into recession.

There are two contradictory tendencies at play:

1) Freeing the market from government intervention by reducing it.
2) Using government to force industry to relocate to the US.  

He wants to bring these jobs back from China, India and Mexico. But then the prices of these goods which are of daily necessities will rise in the US

Trade negotiations

President Trump’s grouse which he has sold to the American public is that the world has been unfair to the US. Is this so?

The US has dominated the world and has had its way on political, economic and trade fronts, especially after the collapse of the Soviet Union towards the end of 1991. The developing world had no alternative but to accept the hegemony of the advanced capitalist countries led by the USA.

The ‘tariff war’ implies a major setback to the prevailing global trade regime prevailing in the era following the creation of WTO in the mid-1990s. The move to replace GATT with WTO began with the weakening of the Soviets in the early 1980s. The new issues were introduced in the Uruguay Round of GATT negotiations in Puenta Del Este in 1987. The Dunkel Draft, largely based on the interests of the advanced countries, came in 1990 and the WTO agreement was signed in Marrakesh on April 15, 1994 and WTO came into being on January 1, 1995. While GATT was only for trade in industrial goods, WTO also brought into trade negotiations agriculture, services, intellectual property rights, etc. 

This was a comprehensive trade deal which heavily favoured the advanced capitalist countries by enabling them to penetrate the markets of the developing world. The developing world resisted the Dunkel Draft but was told to “take it or leave it”, that is, join WTO or leave. Not joining was not an option for the developing countries since their biggest trade partners were the advanced capitalist countries and they would have to bargain with them bilaterally and accept their coercion. The choice was to be coerced bilaterally or multilaterally. The developing world chose the latter and signed on in Marrakesh.

The US led the negotiations in the WTO and got what it wanted. Often the developing countries did not even get to know what negotiations were going on in the WTO rounds. The advanced countries not only gained markets but their investments and intellectual property rights got protection. In return for the markets, the advanced countries allowed the developing countries certain concessions like protection for their critical production and access to markets for some goods. For instance, India sought protection for its agriculture since the vast majority of Indian farmers are poor. The bargain in WTO was among unequals. 

The developed world has a monopoly over high technology while the developing world operates with low and intermediate technologies. So, the former is able to charge monopolistic prices. For instance, they produce computer chips, aircrafts and financial services and charge monopoly prices. No wonder, the richest companies in the world are the technology companies.

The developing countries have to compete with each other to sell globally. They are forced to sell cheap in the international markets. For example, textiles are produced by China, India, Bangladesh, Vietnam, etc., and they compete with each other and sell cheap. So, the terms of trade go against the developing world which benefits the advanced countries. They get the common items of day to day consumption cheap and that keeps their inflation rate low. 

Now the gloves are off and unbridled exploitation is in, something that is consistent with the global rightward drift.

A division of labour between high and intermediate technology production emerged. While benefitting the advanced economies, it also meant that industries producing intermediate technology items shifted from the advanced countries to the developing world. This is what President Trump points to and says that the latter have stolen “our jobs”. He wants to bring these jobs back from China, India and Mexico. But then the prices of these goods which are of daily necessities will rise in the US, given its much higher wages than in the developing countries. The forced repatriation of so called ‘illegal migrants’ will further increase labour costs in the US and spur inflation.

Free Trade argument

In December 2001, China joined the WTO and due to its rapid march on the technology front, quickly captured markets and built up huge trade surpluses and foreign exchange reserves. The US is trying to prevent its rise as a global power by restricting its access to advanced technology, imposing tariffs, etc.. 

Under WTO, the argument for opening up markets has been that ‘free trade’ is optimal. Due to comparative advantage, everyone is supposed to benefit. But this holds only under ideal conditions, called the ‘first best’ situation. However, in reality markets fail due to distortions so the world is ‘second best’ and free markets do not lead to optimality - government intervention is required.

For the developing world, lacking in advanced technology and capital, opening up the economy is an invitation to its fragile economy being swamped by foreign goods. India has been the loser in the Free Trade Agreements it has signed. The promise of greater import helping it to produce cheap and boost exports caused a severe balance of payment crisis in 1989. Actually, free trade has not benefitted most of the developing world. 

WTO represented a liberal face of capitalism which recognized that unequals cannot be treated equally. So some special provisions were provided for the weak. The US was a party to this and gained from WTO as markets opened up with trade as a share of GDP rising globally. 

Now the gloves are off and unbridled exploitation is in, something that is consistent with the global rightward drift. The economic and military might and monopoly over high technology is being used to bully other nations, including allies. 

If the Canadian economy collapses it may accept becoming the 51st state of the US. The US wants to extract concessions from the EU as well. It wants to decrease its defense aid while forcing the Europeans to spend more. The military industrial complex of the US would decline due to this. 

What President Trump misses is that if the USA tries to produce most things within its own borders, so will other nations. There will be deglobalization and likelihood of global recession. This will reverse the many advantages that have been accruing to the US. Dollarization has enabled the US to live beyond its means. This will decline as its trade grinds down and impact standards of living in the US. 

US’s biggest trading partners are reacting and promising to impose tariffs on US imports. The country imports much more than it exports so global trade would contract and impact the trading partners. This can be mitigated partially by nations sticking together and increasing trade among themselves to compensate for the loss of trade with the US. This is the real challenge for the world – will other nations be able to act in concert? The world has never been in a ‘free trade’ scenario and now a different scenario of managed trade is unfolding.

Arun Kumar is a Retired Professor of Economics at the Jawaharlal Nehru University.