Trump's Tariff Tantrums Will Hurt America But Offer India A Golden Opportunity

In 1930, as the Great Depression deepened, the U.S. Congress passed the Smoot-Hawley Tariff Act, one of the most infamous protectionist policies in history.

It was championed as a way to shield American farmers and manufacturers from foreign competition. However, it instead triggered a retaliatory trade war. Countries from Canada to Germany responded with their own tariffs, and global trade collapsed by nearly 65% over the next few years (Irwin, 2017).

Instead of protecting jobs, the tariffs exacerbated the downturn, decimating American agriculture and manufacturing. It is a classic case of how protectionism, when wielded as an economic weapon, often backfires.

Fast forward nearly a century, and history is repeating itself under Donald Trump’s aggressive tariff policies. Just as Smoot-Hawley crushed exports and deepened unemployment, Trump’s tariffs have led to widespread supply-chain disruptions, retaliatory levies, and industrial slowdowns.

President Trump has unveiled a sweeping set of new tariffs targeting key U.S. trading partners, with the stated aim of reducing the trade deficit, revitalizing domestic manufacturing, and addressing broader economic and security concerns.

Among the most significant measures are the 25% tariffs on all steel and aluminum imports, which have triggered swift retaliation from the European Union and Canada. The EU has responded with a 50% tariff on American whiskey, motorcycles, and motorboats, alongside planned levies on poultry, soybeans, and other goods. As a response, Trump has now threatened to impose a 200% tariff on alcohol from the EU.

Meanwhile, Canada has imposed a $20.6 billion tariff package on U.S. imports. Trump has also implemented a 25% tariff on most goods from Mexico and Canada, with certain exemptions for energy products and potash. While Mexico has held back on retaliatory measures, Canada has continued to target U.S. agricultural and consumer goods.

China has been a primary target of Trump’s trade policies, facing an additional 10% tariff on top of previous measures, with Beijing countering through tariffs on U.S. coal, liquefied natural gas (LNG), crude oil, and agricultural products.

The tensions escalated in March, with the U.S. imposing another 10% tariff hike, prompting China to retaliate with increased tariffs on U.S. agricultural exports, including wheat, corn, and meat products, while also restricting exports to 15 American firms.

Trump has further threatened a 25% tariff on European Union imports, though this has yet to be implemented. His administration has also announced “reciprocal tariffs” to match those of any country imposing trade barriers on U.S. goods, targeting China, the EU, India, Mexico, and Canada. In addition, Trump has proposed new tariffs on copper, lumber, automobiles, semiconductors, and pharmaceuticals.

Impact of this on the USA

The macroeconomic impact of China’s tariffs on U.S. imports extends beyond direct trade losses. It is affecting inflation, GDP growth, and global supply chain realignments.

Some past estimates suggest that the latest round of Chinese tariffs alone could add 0.2-0.3 percentage points to U.S. inflation, primarily due to import substitution effects, which increase consumer prices as firms adjust supply chains to alternative markets.

This effect was evident during the 2018-2019 U.S.-China trade war when a study published in American Economic Review found that U.S. tariff increases raised consumer costs by an average of $900 per household annually.

Beyond inflation, trade restrictions have measurable effects on GDP growth. A Federal Reserve study estimated that the 2018-2019 U.S.-China tariff war reduced U.S. GDP growth by 0.3-0.4 percentage points per year, primarily due to lower capital investment and weaker export demand.

A more recent paper published in the American Economic Review confirmed that the negative growth effects stemmed from tariff-induced uncertainty, which discouraged private-sector investment and lowered industrial production.

This is particularly relevant given that U.S. firms exported $120 billion worth of goods to China in 2023, with key sectors such as aerospace, semiconductors, and agricultural products facing retaliatory tariffs that could further dent manufacturing output and reduce business expansion plans (U.S. Census Bureau, 2024).

China’s ability to circumvent tariffs through supply chain realignment exacerbates these effects. Vietnam’s exports to the U.S. surged by 40% between 2018 and 2023, reflecting the broader trend of Chinese manufacturers relocating final assembly to third-party countries to bypass tariffs.

The World Bank estimates that Southeast Asia’s share of U.S. imports increased by 12 percentage points between 2018 and 2022, with Vietnam, Malaysia, and Thailand emerging as primary beneficiaries. These shifts pose long-term risks to U.S. exporters, as Chinese firms establish deeper trade ties with alternative markets, permanently reducing American firms’ access to the Chinese consumer base.

Historically, prolonged trade disputes have eroded bilateral trade volumes and business confidence.

The 2018-2019 tariff escalation led to a 15% decline in U.S. exports to China, disrupting supply chains and causing stock market volatility, with the S&P 500 dropping by nearly 6% in May 2019 alone following tariff announcements. Additionally, global foreign direct investment (FDI) flows contracted by 35% between 2018 and 2020, partly due to trade war-induced uncertainty.

The financial markets have already started reacting to the Trump administration’s aggressive tariff policies. According to recent analysis by Fleming, Agnew & Meyer, since the announcement of new tariffs affecting $1 trillion worth of imports, the S&P 500 has dropped 4.2% year-to-date, while the Dow Jones Industrial Average (DJIA) has declined 9.3% from its December peak, wiping out nearly all post-election gains.

The NASDAQ has fallen 6.3%, its worst quarterly performance since Q3 2022, reflecting investor concerns over rising input costs for tech and manufacturing companies. The VIX index, which measures market volatility, has surged 27% since early February, indicating heightened uncertainty.

Credit markets have also been impacted, with BBB-rated corporate bond yields rising by 32 basis points to 5.8%, making debt financing costlier for businesses. As a result, investor sentiment has turned bearish, with major asset managers revising their 2025 GDP growth forecasts downward to 2%, from 2.7% in January, in line with deteriorating business confidence.

Consumer sentiment has deteriorated as tariff-induced inflationary pressures begin to bite. The University of Michigan’s Consumer Sentiment Index fell 12.3% since January, dropping to 57.9, its lowest level since November 2022. Long-term inflation expectations have surged to 3.9%, the highest in 32 years, signaling fears of sustained price increases.

Import prices have risen by 2.7% in the first two months of 2025, pushing up costs for U.S. manufacturers and retailers. The National Federation of Independent Business (NFIB) Small Business Optimism Index has declined for four consecutive months, with investment plans falling by 8 percentage points since the tariffs were introduced.

Meanwhile, retail sales have slowed, dropping 1.3% in February, as consumers cut back on discretionary spending in response to higher prices. Major retailers such as Kohl’s and Dick’s Sporting Goods have reported weaker-than-expected sales forecasts, underscoring concerns about weakening consumer demand.

Adding to the bearish outlook, Dow Theory, a century-old market indicator, has flashed a strong warning for investors. The Dow Jones Transportation Average (DJTA), a key barometer of industrial and consumer demand, has plummeted 19% from its November peak, putting it on the brink of a bear market. Transportation stocks have suffered their worst weekly decline since September 2022, as major airlines and logistics firms report deteriorating financials.

The Dow Theory suggests that for a stock market uptrend to be sustained, both industrial and transport stocks must rise together, yet with both indexes declining sharply, the market is signaling a reversal. The weakening performance of industrials and transport stocks, combined with tariff-induced cost pressures and slowing consumer demand, suggests that Trump’s trade policies have already triggered a broad market correction.

A Theoretical Lens on Trump Tariffs

Central to this misunderstanding is his rejection of the doctrine of comparative advantage, a theory propounded by David Ricardo in 1817. It articulates that all nations benefit by specializing in sectors where they possess relative efficiencies, even if one nation holds absolute advantages in producing all goods.

Imposition of tariffs on essential inputs like steel, aluminum, semiconductors, and other intermediate goods, inadvertently will harm domestic industries that depended heavily on these imports, thereby inflating their costs and undermining competitiveness.

Protectionism, as seen in Trump’s policies, often neglects the complexities of global supply chains and market structures. Ricardo’s principle of comparative advantage, later expanded upon by Paul Krugman (1979), suggests specialization and free trade enhance efficiency, productivity, and overall welfare.

Krugman demonstrates that even markets dominated by firms with economies of scale achieve greater efficiency and consumer benefits through trade liberalization. Protectionist measures, by increasing input costs, reduce these potential efficiency gains, as exemplified by the increased input costs faced by U.S. manufacturers due to Trump’s tariffs.

Moreover, trade protectionism inevitably leads to retaliatory measures from trading partners, creating a negative spiral where all involved economies suffer, a scenario well-articulated by the game-theoretic insights of Bhagwati (1958).

This theoretical prediction is clearly being observed in practice in the tariff confrontations initiated by Trump against major trading partners. In the past and even now,  these nations responded by imposing reciprocal tariffs targeting critical U.S. exports.

A stark illustration of this dynamic is evident in the experience of American agriculture and manufacturing sectors post-tariffs.

For instance, China, previously the largest importer of American agricultural produce, imposed tariffs in response, causing significant economic distress to U.S. farmers. Soybean farmers faced plummeting prices and oversupply, becoming increasingly reliant on government subsidies, thereby illustrating Bhagwati’s concept of immiserizing growth.

One typically wouldn’t associate Bobby Axelrod from the show Billions when he talks about trade and tariffs. In retrospect, he somehow reminds me of Trump, more confrontational than cooperative. Yet, the real Axelrod we should discuss here is Robert Axelrod, whose seminal book, The Evolution of Cooperation, remains one of the most influential texts in understanding trade dynamics and international relations.

Axelrod rigorously applied game theory and specifically iterated prisoner’s dilemma frameworks to demonstrate how stable cooperative equilibria can spontaneously emerge even among rationally self-interested actors.

Axelrod’s key theoretical contribution revolves around the conditions under which cooperation is evolutionarily stable. He posits that repeated interactions, combined with reciprocal strategies, such as ‘tit-for-tat,’ which involves initial cooperation followed by responsive retaliation, can sustain mutual trust and discourage opportunistic defection.

Translated into international trade contexts, this theoretical model predicts that retaliatory tariff policies (defection) lead countries into suboptimal retaliatory equilibria, resembling trade wars. Axelrod’s equilibrium analyses further illustrate how cooperative equilibria, where trading nations mutually refrain from tariff escalations, are sustained by credible threats of retaliation and stable expectations of future interactions.

Instead of incentivizing reciprocal cooperation, this strategy risks entrenching retaliatory tariffs, leading nations toward suboptimal Nash equilibria.

What should India do?

The potential impact of tariffs imposed by Trump is a significant concern for India. President Trump has frequently raised the issue of what he perceives as unfair trade practices and higher tariffs levied by countries like India on American goods.

If the US goes ahead with “reciprocal tariffs” from 2 April,  it could lead to substantial losses for India’s export sectors. Citi Research analysts estimated these potential losses to be around $7 billion annually, with particularly vulnerable sectors including automobiles and agriculture, as well as chemicals, metal products, jewellery, and pharmaceuticals.

India Ratings and Research also suggested that India’s exports to the US could decline, leading to a drop in GDP growth. President Trump specifically highlighted that India charges auto tariffs higher than 100 percent, indicating a clear target for potential retaliation.

In light of this threat, India should strategically consider a significant shift in its own tariff policies. India’s current trade regime is characterised by high, uncertain, and complex tariffs, making it particularly vulnerable to retaliatory actions.

Manufacturing tariffs in India average 13.4 percent, which is considerably higher than in the US or Europe, and agricultural tariffs are even greater. This level of protectionism has hindered India’s own development, including the “Make in India” initiative, by increasing costs for domestic manufacturers who rely on imported inputs.

From an economic standpoint, reducing import duties under external pressure from trade partners like the US might appear counterintuitive initially, but such liberalization could significantly boost India’s productivity.

Economic theory suggests that lower tariffs enhance market competition, driving inefficient domestic firms to innovate or exit, thereby reallocating resources to more productive businesses (Melitz, 2003). Additionally, reduced trade barriers encourage the inflow of superior technology and practices from abroad, generating productivity spillovers and raising overall economic efficiency (Grossman & Helpman, 1991).

Therefore, a more strategic approach for India would involve unilaterally reducing and simplifying its tariff structure. Instead of maintaining broad, high tariffs across numerous sectors, India should consider lowering overall rates, perhaps adopting a more uniform tariff or a two-tiered system with lower tariffs on inputs to boost competitiveness. Removing non-tariff barriers like the Quality Control Orders (QCOs) that complicate trade is also crucial.

The present situation offers an opportunity for India to lower tariffs and reform its trade policies to directly fuel economic growth by enhancing competitiveness and supporting emerging industries. This move towards a more liberal trade regime, similar to the transformative reforms of 1991, would not only mitigate the risks of harsh retaliatory tariffs from the US but also enhance India’s attractiveness as an investment destination and better position it to capitalise on global trade opportunities.

Trump Tariffs also gives India an opportunity to strengthen bilateral and regional alliances. As global trade becomes more region-centric, India can strategically leverage this shift by actively pursuing favorable trade agreements. FTA with the UK and EU and BTA with the USA are already under negotiation.  

India’s position could improve significantly by negotiating advantageous terms in emerging regional trade frameworks. This strategic engagement would help India consolidate its economic interests. However, the Commerce Ministry should become more proactive in pursuing these negotiations.

Further, the shift towards regionalization and escalating trade uncertainties have created conditions conducive to attracting investment from alternative global sources. Although China may refrain from investing in India’s strategic sectors due to geopolitical considerations, regions seeking to diversify away from China could see India as an attractive manufacturing destination.

The differential cost of capital across various regions further highlights India’s potential as a competitive manufacturing and investment hub. Capitalizing on the “China plus one” approach, India can position itself as a viable, stable alternative manufacturing base, leveraging its comparatively favourable cost of capital and strategic location.

Therefore, as America rediscovers why “tariff tantrums” never end well, courtesy of Trump’s Smoot-Hawley sequel, India finds itself staring at a golden opportunity. While Trump’s protectionism is doing a fine job disrupting American supply chains and keeping economists employed (writing papers on economic self-sabotage), it might unintentionally offer India a pathway to the freer, smarter trade regime it always needed.

Ironically, the U.S. President’s misguided policies could become India’s accidental liberalization guru, perhaps Trump deserves a thank-you tweet, tariffs permitting.