Mentor’s Comment: After the 2024 U.S. election, the government raised tariffs on AI hardware, increasing costs and making the U.S. expensive for building AI technology. These tariffs disrupt global supply chains and push companies to move data centers abroad. India’s growing tech sector positions it as a key alternative to the U.S. and China in this changing AI rivalry and supply chain realignment.

Today’s editorial explains how the USA raised tariffs on AI hardware and the impact of these tariffs. This information will help with GS Paper II (International Relations) and Paper III (Indian Economy).

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Let’s learn!

Why in the News?

After the 2024 U.S. presidential election, new high tariffs on AI hardware could significantly change the global supply chains that support artificial intelligence (AI) development.

What is the effect of 2024 U.S. tariffs on AI supply chains and costs?

• Increased Hardware Costs: Tariffs have raised import duties up to 27% on critical AI components, making AI infrastructure significantly more expensive in the U.S. Eg: Imports of data processing machines worth $200 billion from countries like China, Taiwan, Vietnam, and Mexico are now tariff-affected.
• Disruption of Global Supply Chains: Tariffs have caused companies to rethink and relocate data center construction abroad due to higher costs in the U.S. Eg: Some firms are shifting operations to China, which was ironically a key target of the tariffs.
• Reduced Innovation and Investment: Tariffs create uncertainty, discourage investment, and slow innovation due to higher costs and fragmented supply chains. Eg: Studies show that a standard deviation increase in tariffs could reduce output growth by 0.4% over five years.

Why is India seen as a potential third option in the U.S.-China tech rivalry?

• Strategic Geopolitical Position: India is being positioned as a neutral and reliable alternative amidst U.S.-China tensions. Eg: India is increasingly chosen for data center locations and AI collaborations as companies seek to reduce dependence on China.
• Growing Tech and AI Sector: India’s AI and digital engineering sectors are among the fastest-growing within its IT industry. Eg: IT exports have grown at 3.3% to 5.1% annually in recent years, with a major focus on AI services.
• Skilled Workforce: India produces about 1.5 million engineering graduates every year, many with strong AI-related skills. Eg: This talent pool supports global R&D needs, especially in software and algorithm development.
• Policy Support and Investment: The Indian government is heavily investing in semiconductor and AI infrastructure. Eg: AMD’s $400 million design campus in Bengaluru and multi-billion-dollar fab proposals are part of this initiative.
• Comparative Cost Advantage: Lower labor costs and an expanding tech ecosystem make India economically attractive. Eg: Companies find operations in India more cost-effective compared to both the U.S. and China.

How do tariffs influence AI innovation and efficiency?

• Disruption of Global Supply Chains: Tariffs increase the cost of critical AI components, slowing innovation and access to cutting-edge technologies. Eg: A 27% tariff on AI chips in 2025 made the U.S. one of the most expensive places to build AI infrastructure.
• Shift Toward Efficiency Over Raw Power: Rising hardware costs push companies to focus on algorithmic efficiency and model compression instead of raw compute. Eg: AI model usage costs are falling rapidly (by ~40x/year) due to optimisation rather than increased hardware.
• Deadweight Loss and Slowed Productivity: Tariffs reduce trade volume and create inefficiencies that neither benefit producers nor consumers, slowing innovation cycles. Eg: Studies show a 1 standard deviation rise in tariffs can cut output growth by 0.4% over 5 years.

Where is India investing to boost its AI and semiconductor sector?

• Semiconductor Manufacturing Facilities: India is setting up large-scale chip fabrication units to reduce dependency on imports. Eg: A ₹2,500 crore semiconductor chip manufacturing facility is being established in Lucknow under the India Semiconductor Mission.
• Public-Private Partnerships (PPPs): Collaborations with global tech companies are being encouraged to build domestic capacity. Eg: HCL and Foxconn are jointly setting up a semiconductor unit near the Yamuna Expressway in Uttar Pradesh.
• AI Skilling and R&D Initiatives: Programs are being launched to train talent in AI and expand research. Eg: The ‘AI Pragya’ initiative aims to upskill 1 million individuals in areas like AI, data analytics, and cybersecurity.

What are the challenges for India? 

• Dependence on Imported Hardware: India relies heavily on imported semiconductor components, which makes its AI ambitions vulnerable to global supply chain disruptions and tariffs. Eg: Tariffs on AI hardware can increase costs, slowing India’s AI infrastructure development.
• Limited Semiconductor Manufacturing Capacity: India currently has insufficient domestic chip manufacturing facilities, making it difficult to compete with established producers like Taiwan and China. Eg: India has announced semiconductor fab proposals but is still far from meeting demand for advanced chips.

Way forward: 

• Boost Domestic Manufacturing: Accelerate investments in semiconductor fabs and public-private partnerships to build self-reliant AI hardware supply chains, reducing dependence on imports and mitigating tariff impacts.
• Enhance R&D and Skilling: Strengthen AI-focused research, innovation, and workforce training programs to develop specialized hardware solutions like custom ASICs, driving cost efficiency and global competitiveness.

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