Subsidies and international trade

The primary international trade challenge facing countries in manufacturing is that they must compete with China. To achieve this, they must bridge a significant competitiveness gap. Econ 101 points to increasing productivity (through the likes of improving worker skills and using the latest technologies), investing in infrastructure, lowering the cost of capital, and easing regulations. 

This overlooks an important aspect. A critical requirement to compete with China is to maximise economies of scale. In most sectors, this, in turn, cannot be achieved without being export-focused. This, in turn, draws attention to export promotion policies, especially important to bridge the competitiveness gap arising in particular from China’s massive economy-wide indirect subsidies. 

This is especially important with component manufacturing, the next stage of value addition in India’s manufacturing strategy. The low domestic market volumes and the need to maximise economies of scale mean that Indian manufacturers must aim to Make in India for the World. 

India does not have anywhere near the fiscal resources to match China in providing economy-wide subsidies. It must rely on direct and targeted export subsidies. But, despite the near complete paralysis of WTO and egregious violation of its provisions by the major economies (read US and China), India has been surprisingly reluctant to support industrial policies that support the promotion of exports.

The WTO’s Subsidies and Countervailing Measures (SCM) Agreement categorises two kinds of “prohibited” subsidies - those “contingent on export performance” (Article 3(1)(a)), and those “contingent on the use of domestic over imported goods” (Article 3(1)(b)). It allows for subsidies that are specific to enterprises, industries, and regions. When the SCM and other WTO Agreements were being negotiated in the nineties, it was thought that only the subsidies contingent on export performance would be trade-distorting in any significant manner. It was also thought that the subsidies specific to enterprises, industries, and regions (or the economy as a whole) could not be sustained at the scale required to distort trade in particular products, much less global trade in general. 

China has proved otherwise. This necessitates a wholesale revisit of the WTO itself. 

In this context, it’s useful to place the issue of trade-related (or export promotion) subsidies in perspective.

For a start, as Lorenzo Rotunno and Michele Ruta show, there has been a sharp rise in the use of domestic subsidies in industrial policy, especially aimed at manufacturing, and by developed and emerging economies. They categorize subsidies into four groups - production subsidies, direct transfers (including state aid and grants), policies resulting in a loss of government revenues (tax breaks), and policies wherein the government assumes risk related to the beneficiaries’ actions (loans). 

They show that trade finance and export subsidies and incentives are the two main types of export promotion policies. While both have declined over time, the latter now dominates and is still employed by several countries. 

They analyse the impact of domestic subsidies on international trade flows. 

Exports of subsidized products from G20 emerging markets increase 8 percent more than exports of other products, with no evidence of selection. The gravity estimates confirm that subsidies promote international relative to domestic trade. These spillover effects are concentrated in some industries, such as electrical machinery, and are stronger when subsidies are given through tax breaks than other policy instruments. 

Reka Juhasz and co-authors have a new paper that uses supervised machine learning tools on data from policy announcements in the Global Trade Alert (GTA) database to analyse policy language (instead of policy instruments) to categorise industrial policies (IPs) across the world over the 2010-22 period. They define industrial policy as deliberate government action aimed at altering the composition of the domestic economy to achieve a public goal. Their findings:

The new data on IP suggest that i) IP is on the rise; ii) modern IP tends to use subsidies and export promotion measures as opposed to tariffs; iii) rich countries heavily dominate IP use; iv) IP tends to target sectors with an established comparative advantage, particularly in high-income countries.

The graphic below points to the eight most commonly used industrial policy instruments, which highlights that export-related measures (mainly trade financing) are the second largest category of IP interventions. In fact, export-related measures run a close second to non-export subsidies among IP interventions. 

This figure reveals that most export-related IP measures are deployed via trade-financing, and, to a lesser extent, financial assistance in foreign markets… export-related IP measures tend to operate by providing financing as opposed to directly incentivising exporting… much industrial policy seems designed to facilitate participation in export markets... Finally, this finding highlights that modern industrial policy requires fiscal resources and high administrative capacity. Specifically, states need sufficient fiscal revenue to subsidize firms and promote exports, as well as the administrative capacity to identify which firms to support.

Michael Pettis and Erica Hogan point out that focusing on direct subsidies conceals the true extent of trade-distorting subsidies. Instead, they show that indirect subsidies have become the main instruments of export promotion. The table below captures commonly used indirect trade subsidies.

For example, surplus economies typically have undervalued currencies as part of their trade strategies. Having an undervalued currency subsidizes manufacturing at the expense of households because households are all net importers—as they do not produce for the purpose of exporting—while net exporters are mostly manufacturers. An undervalued currency makes the manufacturing sector in that country more competitive, while reducing households’ consumption capacity… repression of interest rates below the neutral real interest rate has also been a powerful cause of financial transfers from household savers to manufacturers, as seen in Japan in the 1980s and China in the 2000. Further, overspending on transportation and infrastructure serves as an especially significant transfer from households to manufacturers in China today. Other transfers include centrally directed systems of credit, low penalties for environmental degradation, repressive labor laws, and restrictions on worker mobility.

They argue that such indirect subsidies constitute a transfer of wealth from households to manufacturers. They write 

Economies that heavily subsidize manufacturers at the expense of households will typically have: larger manufacturing shares of GDP than their trade partners, since manufacturers must migrate to jurisdictions where workers are paid the lowest relative to their productivity to remain globally competitive in a hyper-globalized world; lower consumption shares of GDP than their trade partners, reflecting the cost of the subsidies on consumers; and large, persistent trade surpluses, as the repressed household income used to pay for manufacturing subsidies makes it impossible for domestic household consumption to balance trade. When all three conditions hold, it is almost certain that repressed household demand is subsidizing manufacturing. And, indeed, we see this reduction of household consumption and increase in trade reflected in economic data for surplus countries (and the opposite trend for deficit countries). 

Yet another instrument used by China to distort trade is its State Owned Enterprises (SOEs), which systematically cut back on imports during trade wars. Chinese SOEs make up a fifth of Chinese imports from the US, providing the country with a valuable trade policy instrument that others don’t have. 

Felipe Benguria and Felipe Saffie examined the period from early 2018 when the first Trump administration initiated a trade war with China, and found that US exports fell relatively more during the trade war in products with a high Chinese import share by SOEs. It found that while tariffs account for an 8% reduction in trade, SOEs account for another 4% decline. They also find that the period of decline in US exports to China in sectors with a higher SOE share also saw an increase in Chinese imports from the rest of the world, pointing to further evidence in favour of the SOE effect. 

They write also about how China may have used its SOEs as a retaliatory weapon against the US tariffs. 

We have also found evidence that the SOE effect was stronger among industries located in Republican–voting US counties, suggesting a political motivation just like the literature has found for tariffs. Our work is the first to provide evidence on the use of state–owned enterprises as tools of trade policy, in any context… We have shown that while US exports facing Chi- nese tariffs were gradually rerouted toward other markets, this was not the case for exports facing the reduced demand by Chinese SOEs.

A World Bank report finds that subsidies have larger trade-distorting effects than even tariffs.

Subsidies create trade-distorting effects for both agriculture and manufacturing exports... Subsidies can be more distortive to trade flow than existing tariffs barriers. The distortionary effect of subsidies on trade, expressed in ad valorem equivalents, is estimated at 15 percent for agriculture and 8 percent for manufacturing… Trade-distorting subsidies can displace trade and production in other trading partners, with important repercussions for developing countries… A disproportionally large number of programs are implemented by major trading countries that have the economic heft to distort global markets for goods and services.

It also finds that the prevailing global trade rules are ill-equipped to deal with subsidies. As indirect subsidies have become the main distorting factors in international trade, and also given its own current dysfunctional state, it’s time to revisit the WTO’s provisions. 

In any case, since 2019, after the US refused to allow appointment of members to the Dispute Settlement Body that hears appeals from members, the WTO has become a toothless organization. This has also encouraged a revival of bilateral and multilateral associations, and countries have come together to also settle their disputes through negotiations. This trend will only be accentuated as the US under President Trump becomes more and more unilateral in its trade engagements. In fact, the reciprocal tariffs announced by the US signals a clear regime shift back to the pre-WTO era. 

Global trade order after the China shock and resultant Trump tariffs

The China shock and the resultant Trump tariffs have surely ended the three decades of WTO-based global trade order. It sets the stage for the emergence of a new global trade order. In this context, commentators have pointed to a Mar-a-Lago accord on the lines of the Plaza Accord of 1985. What are the possible contours of the new trade order?

This post examines four proposals and makes certain observations on the way forward. 

Since the victory of Donald Trump, two of his close associates have advocated institutional solutions to address the problem of persistent large trade deficits. 

Robert E Lighthizer has advocated a new trade regime among countries with democratic governments and mostly free economies to achieve a long-term trade balance. The countries outside the regime will pay a higher tariff while those within would pay lower tariffs, which, however, could be adjusted over time to ensure balance. If a country runs large and persistent surpluses, others would raise tariffs on it so as to bring it down over a reasonable time. This would ensure balance within the entire group over time, and not across country pairs or smaller groups every year.

Stephen Miran has pointed to the dilemma faced by a country whose currency serves as the global reserve currency between maintaining its economic competitiveness and ensuring global liquidity. The global demand for dollars keeps the currency overvalued, which erodes manufacturing and export competitiveness and leads to persistent deficits. To lower the deficit without diminishing the dollar’s global influence, he proposed a deal between the US and its trade partners. The deal will involve the foreign holders of US Treasuries switching from short-term to perpetual dollar bonds, in return for access to the US market and its security umbrella. This monetisation of the American role in the post-war Western alliance is effectively a “protection racket”. 

In a Foreign Affairs article, Michael Pettis argues that any sustainable solution to America’s large trade deficit is to “reverse the savings imbalance in the rest of the world” or to “limit Washington’s role in accommodating it”, and that tariffs do neither. 

He places the blame for the global economic imbalance on wage suppression in certain countries, which allows them to attract investment and produce far more than their suppressed demand. 

Businesses that shift production to countries where labor costs are lower relative to workers’ productivity can produce goods more cheaply, making their products more attractive globally… wage suppression puts downward pressure on domestic consumption while subsidizing domestic production. This results in a rising gap between production and consumption which, if it remains within the economy, must be balanced by raising domestic investment (which can further exacerbate the gap between production and consumption). Otherwise, the gap invariably reverses, either via raising wages or by cutting back on production.

But in a globalized economy, there is another option: running a trade surplus. This allows the country to export the cost of the gap between consumption and production to trade partners. This is why, in 1937, the economist Joan Robinson referred to the trade surpluses that resulted from suppressed domestic demand as the consequences of “beggar-my-neighbor” policies. It is also why, at the Bretton Woods conference in 1944, Keynes opposed a global trading system that allowed countries to run large, persistent trade surpluses. A system that accommodated these surpluses, he said, would encourage countries eager to expand manufacturing to subsidize it at the cost of domestic demand. The result, Keynes explained, would be downward pressure on global demand as countries fought to remain competitive by suppressing wage growth. The countries most successful at doing so would become the winners of global trade. Their share of global manufacturing would expand while that of their trade partners contracts.

At the time that Keynes and Robinson were writing, the cost of beggar-thy-neighbor policies came mainly in the form of higher unemployment, as higher exports—unbalanced by higher imports—undermined manufacturers in trade deficit countries and forced them to lay off workers. But after the world abandoned the Bretton Woods system in the early 1970s, governments—including the U.S. government—learned to allay the costs of unemployment either by lowering interest rates to encourage consumer lending or through unrestricted deficit spending. The United States thus disguised the employment consequences of running a consistent trade deficit, but it did so through surging household and fiscal debt…

Some major economies exert less control over their domestic economies in favor of more global integration, whereas others choose to retain control over their domestic economies, perhaps by controlling wage growth, or determining domestic prices and allocation of credit, or restricting trade and capital accounts. To the extent that the latter set of states intervene to prevent their domestic economic imbalances from reversing, they effectively impose their internal imbalances on countries that retain less control over their trade and capital accounts. If they choose industrial policies aimed at expanding their manufacturing sectors, for example, they are also implicitly imposing industrial policies on their trade partners, albeit ones that result in a relative contraction in those partners’ manufacturing industries.

If globalization is to thrive, the world must revert to a kind of globalization where countries export in order to import and where a country’s production, consumption, and investment imbalances are resolved domestically—not foisted on to trade partners. The world requires, in other words, a new global trade regime where countries agree to restrain their domestic imbalances and match domestic demand with domestic supply. Only then will states no longer be forced to absorb one another’s internal imbalances.

He therefore proposes a customs union, starting with a small group of like-minded countries that will expand gradually to include more countries.

The best outcome would be a new global trade agreement among economies that commit to managing their domestic economic imbalances rather than externalizing them in the form of trade surpluses. The result would be a customs union like the one proposed by the economist John Maynard Keynes at the Bretton Woods conference in 1944. Parties to this agreement would be required to roughly balance their exports and imports while restricting trade surpluses from countries outside the trade agreement. Such a union could gradually expand to the entire world, leading to both higher global wages and better economic growth… 

States that join would agree to keep trade between them broadly balanced, with penalties for members that fail. But they would also erect trade barriers against countries that don’t participate in order to protect themselves from imbalances outside the customs union. Trade would not be expected to balance bilaterally, of course, but rather across all trade partners. Its members would have to commit to managing their economies in ways that would not externalize the costs of their own domestic policies. In that system, every country could choose its own preferred development path, yet it could not do so in ways that inflict the costs of domestic imbalances on trade partners…

Many countries, especially ones that have structured their economies around low domestic demand and permanent surpluses, might initially refuse to join such a union. But organizers could start by gathering a small group of countries that make up the bulk of global trade deficits—such as Canada, India, Mexico, the United Kingdom, and the United States—and bringing them into it. These states would have every incentive to join, and once they did, the rest of the world would eventually have to participate.

He also makes the provocative argument that the “US would be better off without the global dollar”. 

The most effective way is likely to be by imposing controls on the US capital account that limit the ability of surplus countries to balance their surpluses by acquiring US assets. While this may at first seem to go against current US policy under Trump, who wants to increase foreign direct investment, if done correctly capital controls would in fact have little effect on direct investment. A less effective way is through controls on the US trade account, with bilateral tariffs an especially clumsy way of addressing the root causes of trade imbalances.

The dominance of the dollar in global trade and finance has long been assumed to be a net benefit for the American economy, but this assumption is increasingly being challenged. While it benefits Wall Street and global owners of moveable capital, these benefits come at a cost to American manufacturers and farmers. In a world where some countries actively manage their external imbalances and others do not, the US dollar’s role as the primary safe currency has made America the chief enabler of global economic distortions. Addressing these imbalances requires a fundamental re-evaluation of the rules governing global trade and capital flows.

In another article in Foreign Affairs, Kurt Campbell and Rush Doshi offer a very comprehensive proposal to build an alliance against China. They argue in favour of America forging alliances with like-minded partners to create a meta-economy that can outcompete China. 

They place China's economic strengths in perspective.

If one looks narrowly at goods rather than services, China’s productive capacity is three times as large as that of the United States—a decisive advantage in military and technological competition—and exceeds that of the next nine countries combined. In the two decades after China joined the World Trade Organization, its share of global manufacturing quintupled to 30 percent while the U.S. share halved to roughly 15 percent; the United Nations has estimated that, by 2030, the imbalance will grow to 45 percent and 11 percent. China leads in many traditional industries—producing 20 times as much cement, 13 times as much steel, three times as many cars, and twice as much power as the United States—and increasingly in advanced sectors as well...

China—thanks in part to ambitious industrial policy efforts such as Made in China 2025—produced almost half the world’s chemicals, half the world’s ships, more than two-thirds of electric vehicles, more than three-quarters of electric batteries, 80 percent of consumer drones, and 90 percent of solar panels and critical refined rare-earth minerals... China was responsible for half of all industrial robot installations worldwide (seven times as many as the United States), and it is a decade ahead of anyone else in commercializing fourth-generation nuclear technology, with plans to build over 100 reactors in 20 years. The last great power to so thoroughly dominate global production was the United States, from the 1870s to the 1940s… 

This industrial and innovative strength can be activated for military purposes. China’s navy, already the largest in the world, will add a staggering 65 vessels in just five years, reaching a total size 50 percent larger than the U.S. Navy—roughly 435 vessels to 300. It has rapidly increased its ships’ firepower, surging from one-tenth of the United States’ vertical launch system cells a decade ago to likely exceeding U.S. capacity by 2027. Although China lags the United States in aviation, it has broken a long-standing technical barrier by building jet engines at home and is now rapidly closing the production gap, with the ability to build more than 100 fourth-generation combat aircraft annually. In most missile technologies, China is probably the world’s leader: it boasts the first antiship ballistic missile, impressive air-to-air missile range, and the largest stockpile of conventional cruise and ballistic missiles. And in a growing number of military fields, from quantum communications to hypersonics, China is ahead of any competitor. These advantages, built over decades, will persist even if China stagnates.

They write about the perils of underestimating China.

American observers tend to underestimate China’s ability to innovate, mistakenly assuming it simply copies and reproduces Western innovations. Like the United Kingdom, Germany, Japan, and the United States before it, China’s manufacturing strength creates a foundation for innovative advantage. State investment helps, too; it now rivals the United States’ investment in science. And China’s large population provides a deep talent pool and competitive scale. In ten industries of the future, according to a recent report from the Information Technology and Industry Foundation, China is near the leading edge of innovation (or better) in six.

They argue that despite all its challenges, in the medium-term China will be able to manage them enough to remain strongly competitive with the US.

Even if its weaknesses prove more severe than projected, China will remain vastly more powerful than any past U.S. competitor on the metrics most relevant for competition. Washington may have overestimated past rivals, including Germany, Japan, and the Soviet Union. But China is the first to outmatch the United States in size alone, as well as in several strategically relevant areas. Stagnant or not, Beijing will remain more formidable than any past challenger.

So what should America do? They argue that America must draw on its vast network of allies to achieve scale and outcompete China. 

To achieve scale, Washington must transform its alliance architecture from a collection of managed relationships to a platform for integrated and pooled capacity building across the military, economic, and technological domains. In practical terms, that might mean Japan and Korea help build American ships and Taiwan builds American semiconductor plants while the United States shares its best military technology with allies, and all come together to pool their markets behind a shared tariff or regulatory wall erected against China. This kind of coherent and interoperable bloc, with the United States at its core, would generate aggregate advantages that China cannot match alone...

For Washington, three realities must be central to any serious strategy for long-term competition. First, scale is essential. Second, China’s scale is unlike anything the United States has ever faced, and Beijing’s challenges will not fundamentally change that on any relevant timeline. And third, a new approach to alliances is the only viable way the United States can build sufficient scale of its own. Altogether, this means that Washington needs its allies and partners in ways that it did not in the past. They are not tripwires, distant protectorates, vassals, or markers of status, but providers of capacity needed to achieve great-power scale. For the first time since the end of World War II, the United States’ alliances are not about projecting power, but about preserving it. 

During the Cold War, the United States and its allies outclassed the Soviet Union. Today, a slightly expanded configuration would handily outclass China. Together, Australia, Canada, India, Japan, Korea, Mexico, New Zealand, the United States, and the European Union have a combined economy of $60 trillion to China’s $18 trillion, an amount more than three times as large as China’s at market exchange rates and still more than twice as large adjusting for purchasing power. It would account for roughly half of all global manufacturing (to China’s roughly one-third) and for far more active patents and top-cited journal articles than China does. It would account for $1.5 trillion in annual defense spending, roughly twice China’s. And it would displace China as the top trading partner of almost all states. (China is today the top trading partner of 120 states.) In raw terms, this alignment of democracies and market economies outscales China across nearly every dimension. Yet unless its power is coordinated, its advantages will remain largely theoretical. Accordingly, unlocking the potential of this coalition should be the central task of American statecraft in this century.

In terms of operationalising this alliance, they make specific suggestions.

The starting point for the United States can be long-standing bilateral alliances (such as those with Japan and South Korea) and multilateral alliances (such as NATO), along with newer partnerships (such as the AUKUS defense technology agreement with Australia and the United Kingdom) and less institutionalized groupings (such as the Quad, which also includes Australia, India, and Japan). But rather than simply celebrating these frameworks or expanding their membership, the task ahead is to deepen their function—to make them foundations for capacity-centric statecraft across multiple domains. These relationships have too often operated on the assumption that the United States provides security while others contribute political support or, at best, niche capabilities. It has been largely security-centric, too—focused on deterrence, access, and reassurance—while leaving economic coordination, industrial integration, and technological collaboration as emerging but still secondary concerns. The traditional model was simply not designed to compete with a systemic rival on the order of China. It is dangerously inadequate to the demands of the moment.

The U.S. approach to alliances and partnerships in recent decades has been shaped by a combination of strategic habit and structural hierarchy. Now, it must become a platform for generating shared capacity across all critical domains—not just military ones. That will require a level of coordination and codependence that is unfamiliar and will at times be uncomfortable for both the United States and its partners. For military power, creating scale requires capacity to flow in both directions, including investment in the weaker parts of the U.S. defense industry and more generous provision of advanced U.S. military technologies to allies who historically have not received it. For the economy, scale means building a shared tariff and regulatory wall against China’s excess capacity while constructing new mechanisms to coordinate industrial policy and pool allied market share. For technology, the challenge will similarly be to erect common investment rules, export controls, and research protections to prevent technology transfer to China while undertaking joint investment. These steps mark the difference between a coalition that is aligned in principle and one that is fused in practice. That shift—toward shared capacity as the foundation of strategy—will allow the United States and its partners to compete at scale and at speed…

The United States needs to construct what the historian Arthur Herman has called an Arsenal of Democracies: a networked defense industrial base built on joint production, shared innovation, and integrated supply chains… More ambitious efforts might involve joint ventures with Japanese and South Korean shipbuilders (which are two to three times more productive than U.S. firms); partnerships between Europe’s missile manufacturers and U.S. companies; or recruiting Japanese or Taiwanese firms to build legacy microelectronics in the United States… The United States’ own capability must also flow outward to allies… Sharing technology quickly is the key to ensuring that Australia builds nuclear submarines, that Asian allies have sufficient antiship cruise missiles and ballistic missiles, that Taiwan can deter Chinese invasion, and that India is able to turn the Andaman Islands to its east into a fortress that Beijing cannot ignore. In practice, this could mean harmonizing export-control laws, aligning procurement standards, and coordinating investment in chokepoint components, from semiconductors to optical equipment…

South Korean weapons can help Europe rearm and reindustrialize. French nuclear technology can support India’s submarine program. Norwegian and Swedish missiles can help Indonesia and Thailand defend their waters. Pooling capacity requires thinking across alliances, with the United States facilitating collective action.

This alliance would have geopolitical dimensions… 

Globally, the United States could pursue a new version of U.S. President Richard Nixon’s “Guam Doctrine,” which devolved responsibilities to partners after the Vietnam War. That would empower regional states—what former Australian Prime Minister John Howard called “deputy sheriffs”—to take the lead on security challenges in their neighborhood: Australia in the Pacific islands, India in South Asia, Vietnam in continental Southeast Asia, Nigeria in Africa. In practical terms, the next time a South Asian country faces challenges, the United States would defer to India’s judgment on what might serve regional stability or counter China’s influence rather than seek to advance its own preferences.

… and economic dimensions.

Instead, the United States and its allies and partners must find scale together, through a defensive moat against Chinese exports. Building a protected common market could start with coordinated tariffs on Chinese goods. But because tariffs can be easy to circumvent, a better approach might be to use coordinated nontariff barriers, including regulatory tools… Another tool is “preferential plurilateralism”—selectively opening allied and partner markets while creating higher barriers for Chinese goods. This approach, broadly supported by figures across the political spectrum, from Robert Lighthizer, the U.S. trade representative during Trump’s first term, to prominent Democratic legislators, echoes aspects of the early post–World War II trading system, which gave preferential treatment to members of the free world over autocratic rivals. If the era of free trade agreements is over for now, then sectoral agreements with allies could offer promising avenues for pooling markets while avoiding political sensitivities. Coordinated industrial policy instruments would also be useful, such as a new international industrial investment bank that would make loans to firms in strategic sectors to diversify supply chains out of China, especially in key sectors such as medicine and critical minerals. And coordinated efforts to remove barriers to allied and partner investment could, for example, allow the bypass of national security review.

A few observations:

1. All four proposals mentioned above have a common feature. They require the mobilisation of allies and, effectively, the creation of a new alliance against China. I’m not sure that, after all that has happened in the last 100 days, the Trump administration has the capital, much less the inclination, to mobilise this alliance. It would want an imperial alliance with it at the centre, with the vassals surrendering to its hegemony. The Plaza Accord and other instances of Western alliance did not emerge under such hostile circumstances. 

I’m not sure of any kind of Mar-a-Lago accord being done and implemented in good faith during the Trump regime. However, it’s quite possible that if the Trump administration wreaks havoc on the world economy and is succeeded by a Democrat President, it might trigger a cathartic mobilisation among the US and its allies. That might be the Overton Window to create a new global trade order. However, it’s most likely that the Trump administration’s policies would have created irreversible norms in areas like decoupling from China, the reshoring of US manufacturing, and burden sharing on defence by allies. Most importantly, it would have stigmatised the practice of egregiously subsidised export-led growth. This may well be the best outcome to hope for.

2. The proposal made by Doshi and Campbell is comprehensive and is the ideal configuration. Their case for an alliance among like-minded countries to combat China’s scale is particularly important and even an essential precondition for any meaningful effort to combat China’s manufacturing dominance. It would be a throwback to the immediate post-war era of alliance-building and collective commitment to combat communism and the Soviet Union. Here, though, the primary objective would be to create the economic scale in markets, supply chains, and manufacturing to outcompete China. 

It would also be a full-scale open declaration of Cold War 2.0 between a new alliance of democracies led by the US and another of autocracies led by China. Perhaps this ideological framing, with all its associated values, can be the glue to mobilise and cohere this new coalition. 

3. Even if an alliance materialises, the operationalisation of any proposal to continuously pursue balanced trade among allies will itself be an immense challenge. The distortions arising from such complicated forced incentives can be unpredictable and self-defeating. Perhaps the biggest political economy challenge would be in getting countries to exercise voluntary self-restraint and raise tariffs. Why would emerging economies voluntarily give up their comparative advantages and forego one of their major drivers of economic growth and job creation? 

4. If trade deficit is the issue, then why should it be confined only to merchandise trade and exclude services trade? Would the US force its Big Tech and Wall Street firms to exercise similar self-restraint and refrain from exporting their services to other countries and running up large trade surpluses? 

5. As mentioned earlier, merchandise trade deficits cannot be seen in isolation and are a function of the stage of development (Engel’s law) and structure of the economy, its comparative advantage, and the role of the US Dollar as the global reserve currency. If the US wants to continue its exorbitant privilege (unlimited borrowing in its currency), then the dollar (and Treasuries) must be the global reserve currency and (therefore) default safe-haven asset, and it should not be averse to running large trade deficits. This effectively means that the US cannot achieve a trade balance without also balancing capital flows, which comes in the way of its role as the holder of the global reserve currency. 

6. The US multinational corporations and technology firms have been among the biggest beneficiaries of globalisation and the dollar’s role as a reserve currency. A major share of their benefits has come at the cost of the US domestic manufacturers and the American labour. It’ll be America’s political choice on whether it wants to enjoy the exorbitant privilege by continuing policies that support Big Business at the cost of labour or reconcile itself to a reduced role for the US dollar with policies of the kind advocated by the likes of Michael Pettis. 

7. It’s common to find an idea itself becoming discredited due to its unbridled or unqualified pursuit or poor execution. China leveraged the forces of outsourcing and unbundling of supply chains, advances in ICT, the long period of global economic and political stability, trade liberalisation, and the emergence of the WTO and its membership there to push the boundaries of trade and manufacturing. Its state-directed capitalism used a combination of economy-wide repression (of wages, financial markets etc.), massive subsidies, and disciplined industrial policy to pursue manufacturing and merchandise trade dominance at a staggering and unprecedented scale. 

Its consequences for the world economy have been devastating, not only in destroying the manufacturing bases globally but also in discrediting the very idea of comparative advantage and global trade that has been one of the main sources of post-war economic prosperity. The Trump administration’s single-minded focus on imports and trade deficits owes almost entirely to China’s beggar-thy-neighbour trade policy. 

8. Developing countries like India should be careful not to lock themselves into a trade deal that centres on balancing bilateral trade deficits. India’s aspiration for sustained high growth is critically dependent on exports. The US is the world’s largest market, and it’s natural for emerging economies to run merchandise trade surpluses with developed economies. The proposals of Lighthizer, Miran, and Pettis do not even acknowledge these realities and instead propose a one-size-fits-all trade balancing. 

If India’s manufacturing push succeeds, it’ll invariably run large surpluses with the US. For example, if Apple decides to source all its 60 million US iPhones from India, that alone will significantly increase India’s trade surplus with the US which is already reasonably high at around $40 bn even without too much manufacturing exports. Add in more such exports from the reconfiguration of other supply chains, and it’s most likely that India emerges among the top five countries with which the US has a trade deficit. Will it then not require India to try to balance Therefore, it cannot bind itself to a treaty that caps its trade balance with the US. 

One tactical approach would be to ride out the Trump regime. It could target an opportunistic trade deal with the Trump administration without committing to any long-term binding targets. A tactical deal to buy time for a comprehensive bilateral or multilateral deal in four years!

9. India’s trade negotiation strategy is also weakened by its recent trade policies involving increased tariffs and non-tariff barriers (like the Quality Control Orders). President Trump is right in some ways in calling it the “tariff king”, at least among the major economies. It will now have to make significant concessions in many sectors in terms of liberalising its trade policy. 

This immediately creates two problems. One, on the economic side, having raised high protective barriers, even a normalisation of tariffs and removal of the recently erected non-tariff barriers would be a step change and abruptly expose the domestic manufacturers to foreign competitors. Two, on the diplomatic side, since negotiations are going on with others, most notably the EU, there will be pressure from them to offer the same terms given to the US.

More on the China shock

David Autor and Co. popularised the phrase China Shock with their 2016 paper documenting the loss of over 2 million jobs in concentrated pockets of America due to factory closures arising from cheap Chinese imports. This recent article nicely captures the China Shock in the US. 

While I have not come across similar rigorous studies, it’s fair to argue that an even bigger shock is happening in many developing countries. And with the Trump tariffs and the displacement of Chinese merchandise from the US market, this shock is likely to get amplified.

The heavily subsidised and cheap Chinese exports threaten developing countries like India at two levels. One, they destroy domestic manufacturing bases and economies through factory closures and job losses. Two, Chinese firms outcompete their counterparts from export markets. 

I have blogged here and here documenting the world economy’s China problem, and especially how it impacts the developing countries. This post is in continuation of those earlier posts. 

A recent article in Bloomberg pointed to the ‘China Shock’ on emerging economies that compete with China. Sample this about Indonesia

Southeast Asia’s biggest economy lost roughly a quarter-million jobs in the textiles and apparel industry over the last two years, according to the Indonesia Fiber and Filament Yarn Producer Association, which has estimated another half-million are at risk in 2025—effectively wiping out one of four jobs in the sector in a matter of years. That pace is considerably faster than the “China Shock” that claimed as many as 2.4 million US jobs from 1999 to 2011.

This shock is being felt across developing countries. 

This trend appears to have been hastened by the Trump tariffs initiated in 2018.

China explains the import surge across developing countries since 2018. 

Or take the example of renewable energy equipment exports from China. 

In 2022, for instance, China sent roughly 65 percent of its wind turbine exports to high-income countries, according to BloombergNEF. By 2024, however, it was sending more than 60 percent to low- and middle-income countries. Beijing has laid out plans to build factories that assemble solar panels in Nigeria and electric vehicles in Indonesia.

At the aggregate level, this trend is inevitable given the large and widening difference between China’s shares of domestic manufacturing and domestic consumption in the world economy.

After the bursting of the 2020 property bubble, in its search for an economic growth engine, China doubled down on manufacturing and exports. Exports took off vertiginously, and its trade surplus nearly tripled to touch $1 trillion in 2024. Since the country has managed to retain its global export share and significantly increase its share of global manufacturing value addition (tripled in 2005-20) despite a significant drop in the share of exports to the US, the displaced exports have found their way to developing countries. 

Interestingly, even as China’s manufacturing share has rocketed, its share of global consumption has lagged far behind despite a spurt in the 2005-15 period. 

This wedge between consumption and production has widened and is a good measure of the excess capacity accumulated. 

The short story is that China suppresses domestic wages, and thereby demand, and maintains manufacturing excess capacity far above its domestic demand (and therefore explicitly aimed at export markets). Worsening matters, this excess capacity is also supported by economy-wide subsidies that distort not only world trade but also the global economy itself. This excess capacity is a massive negative shock to the world economy. In this context, it’s foolish for countries like India to eschew any kind of export-targeted subsidies in their Production-linked Incentive (PLI) or other schemes for fear of violating their WTO obligations. 

With the economy weakening, the achievement of President Xi’s ambitious 5% growth target for 2025 is impossible without increasing exports. This has now come to a head with the astronomical Trump tariffs, raising questions about even sustaining existing exports. For all the brave talk about “fight till the end”, it cannot be denied that at more than $500 bn of exports (it’s probably an underestimate given the re-routing via Hong Kong, etc.), the US is not only the largest export market but more than three times the second largest market, Japan. The Chinese economy will be seriously hurt without finding alternative outlets (either to re-route to the US or as destination markets) for a significant share of these exports. 

But with the US government closely scrutinising trends on imports and deficits with its trade partners, re-routing and increasing exports generally will be a challenge. Further, the only large markets that can absorb a part of this are Europe, East Asia, India, Brazil, and Mexico. In all these countries, their own tariff and non-tariff walls are coming up to keep out Chinese exports. The European Commission President von der Leyen has already warned that the EU would be watching any re-routing of displaced exports. These trends will only increase with time. 

Mexican President Claudia Sheinbaum this month said her country would review tariffs on Chinese shipments, linking growing violence in places such as central Guanajuato state to large-scale job losses in its shoe and textile industries… Sheinbaum said on March 6. Mexico has already raised tariffs on textile and apparel imports from China to as much as 35%... Sanan Angubolkul, the head of Thailand’s Chamber of Commerce, warned this month that the situation is “very critical, and there’s no time to waste” as the nation deals with a surge of electrical appliances, clothing and other Chinese goods. The country last year extended a 7% value-added tax on imported goods below $50 to mitigate the impact of Chinese e-tailer Temu, owned by PDD Holdings Inc. Malaysia added a 10% sales tax on online purchases of low-value goods last year, while Indian authorities have taken a range of measures, including anti-dumping probes on items as diverse as Chinese solar cells, aluminum foil and mobile phone components. Vietnam’s government, meanwhile, ordered Temu and Shein Group Ltd. to suspend operations in the country last year, citing incomplete business and tax registration paperwork.

This pushback from its trade partners is also reflected in record numbers of trade disputes against China at the WTO. There were 198 trade investigation cases against China in 2024, double its tally in 2023 and nearly half of all disputes lodged last year at WTO. This comes on top of 21 investigations launched by the European Commission on Chinese products, compared to nine in 2023. 

More than half of the trade cases against China last year were initiated by developing countries, indicating that western countries’ objections to Chinese overproduction were widely shared. The data showed 117 cases were initiated by emerging economies, including 37 from India, 19 by Brazil and nine from Turkey. The flood of low-cost output from China has even unnerved some of Beijing’s closest partners. Russia recently imposed “recycling fees” to impede booming Chinese car imports, which have taken up almost two-thirds of the local market in the wake of western sanctions on Moscow. Pakistan, to which China is the largest sovereign donor, opened five trade cases in 2024 focused on rising imports of printing paper, self-adhesive tape and chemical products.

To summarise, we have a few clear pointers on the China shock and its consequences. The US shaped the existing global trade order, built around the WTO. This trade order has had one mega beneficiary, China, and a few smaller beneficiaries, especially in the developing world. This has allowed China to pursue a beggar-thy-neighbour trade policy at a staggering scale, whose costs in terms of factory closures and job losses are now becoming evident across the world. The backlash has culminated in the Trump tariffs that have brought an end to this era of globalisation. Similar walls of protectionism are springing up across the world. 

Even in the best-case scenario, the age of ultra-low tariffs and the use of exports to drive sustained high growth is over. It’s hard to look beyond a world of curtailed globalisation and increased reliance on domestic markets to drive high growth rates. It's also fair to argue that those countries who are more dependent on trade to drive growth will be more adversely impacted by these trends. In any case, the entrenched consumption-production imbalance will be unsettled one way or another.