#297 Beyond the Perturbations

Tariff Effects, Ideas for Deregulation, and the Future of Technology Geopolitics

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Programming Note: AtU will be on a summer break over the next two weeks. Regular programming resumes on May 4.

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Global Policy Watch: Pause And Effect

Insights on global issues relevant to India

— RSJ

Ten days since ‘liberation day’ we have no clearer picture of the objectives of Trump and his economic team. In this period, we have what seems like a full-blown trade war between the US and China, threats of retaliation, exemptions and a pause on the insane tariff chart that Trump had brandished, and the bond market getting spooked and, in turn, spooking Trump. Countries are working overtime to diversify from a whimsical, unreliable administration bent on destroying the global trading system, which it built and benefited most from in the past eight decades. Add to that more unhinged rhetoric emerging from Trump about seeking ‘reparations’ from EU for providing security, defence and development aid since World War 2 and the EU contemplating retaliatory action on the US services exports (tech and financial services primarily) and you have a possibility of complete global reset in the next couple of years. That is if Trump adheres to his one core unwavering belief that the US should have a balanced trade with its partners. For US trade to balance, it has to find ways to make goods worth almost $1 trillion (the overall trade deficit it runs) domestically. That is an impossible task in any timeframe unless, of course, Trump runs the US economy to the ground and demand collapses. Regardless of the pause and the window available for countries to work out deals with the US, there is no escaping from the fact that Trump will raise trade barriers, and US demand of goods from other countries will fall in the coming years. And this will coincide with China running a historic trade surplus of $1 trillion and itching to export (or dump) more because of its mega investment in green tech and automation. Despite its efforts, nobody is in a hurry to ally with China to create an ex-U.S. global trade order. This unplanned pincer attack of a closed US and an overinvested China will be hard to negotiate for most economies of the world.

Anyway, we will revisit the four questions that arose when the ‘liberation day’ announcement was made and see if we have a better sense of the answers now.

First, is this a real attempt to balance trade and get manufacturing back to the US, or, is it just a bargaining ploy for other strategic concessions that Trump wants from the trading partners?

There is a MAGA constituency that has tremendous nostalgia for the good old days of factories, men working with their hands, US-made goods, and company towns; in short, some kind of working class utopia. Then there are tariff ideologues like Navarro who believe persistent trade deficits with countries are a result of skewed industrial policies, currency manipulation, and suppression of wages. There are national security strategists who believe some kind of recovery in domestic manufacturing prowess is critical in the hi-tech space to stay ahead of the growing might of China's hardware capabilities. And there is Trump, who has been raging against Japan, imported cars and the loss of manufacturing jobs since the 80s and who believes tariffs are the ultimate recourse. In different ways, these voices want high tariffs to force companies to set up US manufacturing bases and bridge the trade deficit. This is the hardline camp that believes a year or so of upending the global order will eventually be good for the US while any continuation of the status quo will lead to a collapse of the US as a world power.

Pitted against these are the likes of Bessent, who believe any hard reset of the global trading order through high tariffs and trade wars will lead to market crashes, inflation and depression, whose impact will play out for much longer than anticipated. This chaos and the political isolation that will be a result of this won’t be good for the US. So, the best course of action is to use the shock of the tariff rates to negotiate individually with countries to reduce trade deficit over a decade or so. In the process, be tough with those who negotiate hard or retaliate while working out a glide path to bring down trade deficit to a reasonable level (not zero necessarily) with other pliable partners. Trump has one leg in this camp too because he can’t resist the idea of countries queuing up to him to kiss his ring (or ass as he remarked last week) while he lords over his court.

Moreover, these bilateral deals with exemptions sought by countries and companies allow him to seek favours and benefits for his family, companies, and supporters. There are already available vehicles in the shape of overvalued TruthSocial stock, meme coins, and investment funds run by his family members and friends. The only real target for trade war for this camp is China and, to some extent, the EU. So, for this camp, in the next 90 days, there will be some kind of rudimentary deal worked out with most trade partners that will eventually only keep the 10 percent global tariff while escalating the trade war with China till it comes to the negotiation table. So, which of the two camps is likely to prevail? My guess is Trump will support the rhetoric of the first camp to keep his MAGA supporters happy but will eventually go down the option of negotiating bilateral deals (in 90 days or more).

Second, is this the first stage of eventual de-dollarisation of global trade and the end of the US dollar as the global reserve currency? As I have written earlier, the US current account deficits continue to remain high because it can sell its treasuries to other central banks looking to park their dollars in safe assets instead of doing any break work to reduce the deficit. It is a system that works well politically for everyone. Exporting countries don’t need to bring the surplus dollars home and the US can continue to print its way out of any trouble. The easy access to holding US financial assets is what supports the trade deficit through an overvalued dollar and a low-yielding 10-year T-bill. This has meant that over two-thirds of the global trade is conducted through dollars, and a similar share of global securities are issued in them. This gives the US enormous leverage over the global financial system and in a way a control over other central banks because it remains the sole supplier of the dollar. An easing or tightening by the US Fed will need to be mirrored by other central banks to support their currencies.

Why would the US want to give up these advantages? Going back to the first point, the answer is a desire to balance trade. De-dollarisation of global trade would mean a lower demand for the US dollar and a correction in the value premium it commands. This will enable US exports to be more viable and imports to be dearer. Or so the thinking goes. Though how that squares with higher tariffs favoured by the same lot which will strengthen the dollar is not clear. On the balance, after some more of this dust settles, this desire within the US policy circles to move the world away from dollar as the reserve currency will die a slow death. There’s just too much to unwind if this agenda is pushed for in the short term, and the benefits are not clear. The better course of action is to continue to reduce federal debt through DOGE or whatever else and aim for some reduction in the trade deficit through bilateral trade deals.

Third, is this tariff war going to help China or the US more? The short answer is neither because, as I have mentioned, a closed US economy and an over-capacitised China is bad news for everyone, including themselves. The US will have inflation and a period of recession as it tries to build capacity to re-shore all the manufacturing that it wants to bring home, while China will further be mired in a high debt, low consumption and low inflation cycle like Japan of the lost decades. The rest of the world will suffer from the dual consequences of this scenario. However, the more likely scenario (as discussed above) will be the Trump administration working out some bilateral deals with key trading partners and then seeking a high price to be imposed as a bloc on China till it brings its domestic industrial policy and currency management in line with fair trade practices. This is a plausible scenario, and it will be China’s worst nightmare. China has already seen the limit of its power, and despite the near total bad faith behaviour by the US in the 90 days of the Trump administration, no one has sought to work actively with it to create an alternative bloc with China at its centre. No one trusts it because of its track record. So, it is possible that after the 90-day pause, China will find itself standing alone with high tariffs on its exports, no access to US markets and a new low-tariff trade order imposed by Trump that it can’t access. I don’t know if this was Trump’s plan all along, and if it was, why it couldn’t be done with fewer lunatic moves, but it is possible we may get there. Then the question will be whether China comes back to the negotiating table or lashes out against this. I suspect China is waiting for a bit, but it will move for a trade deal before the 90-day period runs out. Its hand is weakened by its domestic economy.

Fourth, what will this mean for India? A general slowdown in global trade and a weaker economy in the US in the short run will impact India negatively. Regardless of any outcome, this is almost certain for the next year. India’s best course of action is to remain under the radar, do a bilateral deal with key exemptions and minimise the impact of Trump wanting a balanced trade with as many sops and freebies it can offer. Eventually, if the China tariffs remain high and a US trade agreement is signed, India will see some investment from global MNCs in setting up a manufacturing base. Will this offset the impact of a relatively closed US and a desperate China looking to dump its excess capacity or lashing out militarily? We can’t be sure. On balance, the advantage of a functioning democracy with a large market and an alternative option as a manufacturing base should mean it should work out well for India in the medium term. That is if all the other assumptions made above hold for long. With Trump, that’s never assured.

Coda: Here’s Paul Krugman about the still enormous impact of the trump tariffs as they stand despite the April 9 rollback:

“It’s true that for the time being Trump has scaled back some of the tariffs displayed on his big piece of cardboard last week. For example, unless we have another policy swerve, the European Union will now face a 10 percent tariff over the next three months rather than a 20 percent tariff. But the tariff on China, our third-biggest trading partner after Canada and Mexico, has gone from 34 percent to more than 130 percent. And we still have high tariffs on steel, aluminum and so on. In effect, observers who claim that tariffs have gone down are missing the biggest part of the story.

Economists who have actually run the numbers, like those at the Yale Budget Lab, estimate that the April 9 tariff regime will raise consumer prices more than the April 2 regime because of the extraordinarily high tariff rate on Chinese imports. Specifically, the budget lab estimates that the latest version of Trump’s trade war will raise consumer prices by 2.9 percent. This is roughly ten times the probable impact of the infamous Smoot-Hawley tariff of 1930.”

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India Policy Watch: A Deregulation Agenda

Insights on current policy issues in India

—Pranay Kotasthane

The Deregulation Commission, announced by the PM earlier this year, will likely be set up soon. Assuming that happens, what should be on its agenda? Here’s my attempt.

We often approach this question sectorally. While sectoral recommendations will reduce the existing regulatory burden, they won’t dismantle the incentives that produce harmful regulations in the future. Sure enough, regulatory cobwebs will start appearing yet again. Instead, we must introduce regulatory discipline to change incentives that produce lousy regulations.

Governments essentially do three things: produce, finance, or regulate. The first two functions involve substantial government spending. We also have a law that prevents governments from overspending—the Fiscal Responsibility and Budget Management Act (FRBM). While the law isn’t strict enough, governments take fiscal discipline somewhat seriously because of this law.

Unfortunately, there is no such law for regulatory discipline—arbitrariness is the default state of affairs. Thus, the Commission could recommend a Regulatory Responsibility Act on the lines of the FRBM Act. Such an act should enshrine the following regulatory management principles:

1. Uncouple steering functions from rowing ones. This idea comes from Osborne & Plastrik’s classic work, Banishing Bureaucracy. By steering, we mean policy and regulatory organisations because they determine the direction of the sector in which they operate. For example, SEBI decides the rules that guide financial markets, while the finance ministry makes policies concerning the role of financial markets in the economy. Service and compliance organisations are known as rowing functions because they are concerned with execution in order to reach a destination that steering organisations have decided on. For example, BMTC is a service delivery organisation.

   
   Uncoupling steering and rowing allows the government to centralise and coordinate its steering functions so that it can more effectively concentrate on policy and direction while decentralising rowing so that managers have the power to improve service delivery and compliance.

2. By default, every service delivery function should allow the presence of private players unless restricted by law.

3. Private companies and government-run companies must be treated equally.

4. A foreign business entity operating in India must be treated on the same lines as a domestic private entity. If a different treatment is needed, it needs to be specifically justified.

5. Trade and price restrictions should not be allowed without a cost-benefit impact report that is made public for citizen comments.

6. Every government should table an Annual Deregulatory Statement in the appropriate legislature.

Some version of these principles can constrain the government’s regulatory powers.

With the principles out of the way, let’s discuss the areas requiring deregulation today. While India needs factor-market reforms, i.e., the liberalisation of land, labour and capital, this change narrative has become stale.

Deregulation needs a fresh new narrative. One approach could be to identify a few supremely crucial domains for economic growth and then deregulate land, labour, and capital in those domains. I think there are three: cities, human capital, and firms. Deregulation for these three areas could have a disproportionate effect on economic growth. Here are some half-baked ideas for your comments.

Deregulation for Firms

Here are some deregulation ideas to help firms scale up.

1. Inputs:

   1. All non-tariff barriers, such as Quality Control Orders, must be eliminated. They shouldn’t be allowed unless there is a demonstrated cost-benefit analysis. Increasing tariffs should also require a detailed justification, not just a perfunctory notification by the Directorate General of Foreign Trade.

   2. The building standards for existing industrial land use must be changed. This Prosperiti report provides specific ideas.

2. Outputs: price and quantity controls on firm outputs should require an extraordinary justification. Unless there is proven harm to citizens, fixing prices of firm outputs should be disallowed.

3. Finances:

   1. Increase the lower threshold for companies that must comply with the CSR law.

   2. Saurabh Chandra argues that advance tax payments should be made twice yearly to reduce firms' compliance burden.

   3. Saurabh also argues that a permissive environment for venture capital movement in and out of India would go a long way. Currently, funding organisations create structures outside India because moving money out of India is tough.

Deregulation for Cities

Deregulation in cities would require the consent of state governments. Assuming some states were to come on board, we should:

1. Dismantle the license-permit-quota raj that constrains urban land development. More on this here.

2. Deregulate the urban mass transport sector—allow private players to exist along with government-run options.

3. Devolution is a part of deregulation. Start with fiscal deregulation by sharing a fixed proportion of GST with city governments.

Deregulation for human capital

1. Reduce the restrictions on setting and scaling up new medical colleges. More on this here.

2. Deregulate fees for management quota seats in private colleges.

3. Further deregulate the higher education sector by allowing foreign universities to set up India campuses easily. Treat them at par with an Indian private university. Streamline onerous regulations of foreigner registrations that deter teachers from teaching in India.

4. Abolish the Emigration Clearance Not Required (ECNR). More on this here.

What would your deregulation agenda look like?

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Global Policy Watch: The Long View

Insights on global issues relevant to India

— Pranay Kotasthane

The ongoing geopolitical chaos can disproportionately influence our thinking about the future. But if one looks beyond them, an optimistic reading of the current global technology geopolitics landscape is possible. Here are four trends we mustn’t ignore.

1. Every geopolitical contestation creates opportunities for third countries.
   The US-USSR competition created conditions for Japan and South Korea to upgrade themselves. Technology transfers and exchanges with the US were forthcoming, and they were the base on which domestic technology capabilities were built. Similarly, the US-Japan 'calculator wars' ended up helping Taiwan, China, and South Korea (again). Similarly, the US-China structural competition is throwing up opportunities for other countries.

2. Geopolitically difficult times lead governments to prioritise innovation policies. This focus could create non-linear technology breakthroughs this decade. We are already seeing some of this happen.

3. Interdependence won't go away.
   There's no way tech decoupling can be sustained for long. After forming some base capabilities, governments will likely declare victory on resilience, and we might return to accepting technology interdependence. The recent climbdown on American tariffs on China-made electronics and semiconductors is a case in point. While today's dominant narrative sees every technology dependence as a strategic vulnerability, that narrative can change over time. We are at the pendulum's other extreme and will likely return to the middle.

4. China’s tech story has more weaknesses than the headlines suggest. It would also prefer a world where technology interdependence is a norm rather than the exception. The role of FDI and foreign inflows of ideas and talent in China's current tech developments is underrated. China’s export controls on materials, equipment, and minerals, hounding foreign businesses, etc., are first and foremost harmful to China's long-run technology story. More on this here.

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HomeWork

Reading and listening recommendations on public policy matters

1. [Books] Here’s a list of some recent titles on technology geopolitics that might interest AtU readers:

   1. The Tech Cold War by Ansgar Baums & Nicholas Butts

   2. House of Huawei by Eva Dou

   3. Geotechnography by Samir Saran & Anirban Sarma

   4. The Tech Coup by Marietje Schaake

   5. World Builders by Bruno Macaes

   6. China's Drive for the Technology Frontier: Indigenous Innovation in the High-Tech Industry by Yin Li (2022)

   7. Technology and the Rise of Great Powers by Jeffrey Ding

2. [Podcast] Listen to this Puliyabaazi on young men's challenges in India.

   Struggles of Young Men and Boys भारत में लड़कों की परेशानियाँ—कुछ अनकही बातें।

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