Indira Rajaraman: Use the fiscal need driving US tariffs to negotiate a deal with it

To get a handle on a tariff disadvantage of that size, we need to circle back to 1971, when under the Generalised System of Preferences (GSP) proposed by an arm of the United Nations (UNCTAD), India and other developing countries were allowed preferential tariffs. 

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The GSP scheme of the US was enacted in 1974, when its average MFN rate (uniform ‘most favoured nation’ tariff for all countries) was 4%. In June 2019, the US terminated India’s eligibility and then closed the scheme altogether at the end of 2020. The closure of GSP was a difficult transition for exporters targeting the US market. And the GSP offered just a 4% advantage, at most.

No compensation in the form of currency depreciation or margin reduction is possible in the face of a 25–30 % relative disadvantage. There is, however, a protective back-to-back contract for intermediate good exports, currently in use in the context of global supply chains. Very simply, the buyer offers to cover any rise in tariffs for the duration of a particular contract. This is reasonable for intermediates, which are tailored to buyer specifications, at a known tariff-inclusive price. Auto components and textiles, the two worst-affected intermediates at a 50% tariff, could have protected themselves had they seen the tariff rise coming. 

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In a series of destination-specific research studies I once did, I found that the market share response to relative changes in the value of the Indian rupee, versus the currency of major competitors, was extremely sensitive across destinations for large-volume, low-margin exports (like leather), but not products higher up the value chain (footwear parts), where quality and timely supply clearly mattered more. But a 25-30 % tariff disadvantage is hard to battle even at the upper end of the value chain.

Who would ever have thought that pursuit of fiscal revenue from trade tariffs would drive a major retreat from free trade in the US? And that is basically what it is, since the base tariff has been upped to 10% on all imports into the US. 

Twenty years ago, when India was being harangued about poor fiscal revenue performance, I wrote the following in a paper for an International Monetary Fund (IMF) conference in January 2004: 

“Compression of the fiscal deficit in the first half of the nineties was pushed through in the face of a decline in revenue from trade taxes which remains uncompensated. The trade tax reform by itself was growth-enhancing. However, the decline in public expenditure, which was achieved through compression of capital expenditure, by as much as 4 percent of GDP over 1991-97, was not. The joint welfare and growth outcomes of such reform processes remain unexplored in the theoretical  literature." 

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In the context of my exhortation to hyphenate trade and  fiscal revenue reform, the  standard IMF prescription to compensate for falling trade tax revenues was a domestic value added tax (VAT), which in smaller developing countries was a disaster from a revenue perspective. It was the basic reason why they  suffered, and still do, from mountains of external debt. 

But in India, fortunately, the transition to a VAT, which graduated to universal adoption by all the states in 2005, slowly became a revenue success over time. And the goods and services tax (GST) too, after some terrible initial glitches, has on the whole been a revenue success (so far). 

To investigate the historical role of revenue from import tariffs in the developed world, I constructed time-series covering 1870-1996 for the US and Canada of yearly data on customs duty rates, along with revenue from imports and from income taxation, as a percentage of (current nominal) GDP (Global Policy, 2012). In both countries, as revenue from income taxation rose, duties on imports were reduced and customs revenue correspondingly fell.

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Today, entrenched inequality in the US has made it politically infeasible to raise income tax revenue even in the face of a looming fiscal crisis. This is what has led to the rise in the base tariff levied. The tall tariff peaks, driven by other considerations, actually hurt US tariff revenue. A tariff of 50% is prohibitive, it chokes off imports to zero. Countries so affected need to use that to negotiate their way down to an optimal revenue-maximizing tariff which will favour the US exchequer. 

Impossible? Not necessarily. A negotiating  strategy that will appeal to the fiscal interests of the US may find receptive ears. Well worth a try. Exporters facing a closed US market cannot easily switch to other destinations. 

No amount of subsidies or loan write-offs can compensate for the disaster of losing production capacities and skills built up painstakingly over decades.

The author is an economist.