Decoding tariff wars – key takeaways from Trump’s 2018 US-China conflict: Part 3

The US-China trade war underscores that while trade conflicts initially appear disruptive, they also stimulate strategic adaptability and resilience

Introduction

In my previous two articles published in the Daily FT, we explored the immediate impact of President Donald Trump’s 2025 reciprocal tariff regime on Sri Lanka and potential strategies for navigating this economic turbulence. The 44% tariff imposed on Sri Lankan exports to the US, derived from a theoretical 88% reciprocal tariff calculation, has raised critical questions. Many readers reached out, curious about how exactly the US government calculated this strikingly high figure. This article clarifies the math behind that calculation, delves deeply into the lessons from the earlier US-China trade conflict (2018-2019), and provides key insights for Sri Lanka based on how two global giants responded and adapted.

How was the 88% tariff calculated?

First, it is important to understand the math behind Trump’s reciprocal tariff. The US administration applied a standardised formula, explained below, to all countries to arrive at these reciprocal tariffs:

Reciprocal tariff formula:

Reciprocal tariff rate = Trade Deficit / [Elasticity (ε) × Pass-through Rate (φ) × Import Volume]

Here’s what each component means:

• Trade deficit: The difference between US imports from and exports to a particular country. For Sri Lanka, this deficit stood at approximately $ 3 billion in 2024.
• Elasticity (ε): Price elasticity of import demand measures how sensitive the import quantity is to price changes. The chosen elasticity of 4 suggests a 1% increase in import prices results in a 4% reduction in imports. This number (ε=4) is sourced from academic studies by Broda and Weinstein (2006), Simonovska and Waugh (2014), and Soderbery (2018), who studied price sensitivity extensively during previous trade disputes.
• Pass-through rate (φ): The tariff pass-through rate indicates how much of the tariff cost reaches US consumers. A rate of 0.25 means only 25% of tariffs directly impact consumer prices, while exporters absorb the remaining 75%. This conservative estimate is based on Cavallo et al.’s (2021) comprehensive analysis of the US-China trade war tariffs from 2018-2019.

Plugging in Sri Lanka’s numbers:

• Trade deficit = $ 3 billion
• Import volume (to US) ≈ $ 3.41 billion (2024)
• ε = 4, φ = 0.25

Calculation:

= 3 billion / (4 x 0.25 x 3.41 billion) = 88%

Thus, the headline reciprocal tariff for Sri Lanka is approximately 88%. Recognising potential economic damage, the actual applied rate was capped at 50% of the calculated reciprocal rate, leading to a final tariff of 44%.

Elasticity and pass-through: Why these numbers?

The elasticity (ε=4) and pass-through (φ=0.25) figures are standardised for all countries, ensuring a consistent and equitable method of tariff calculation. Critics argue this uniform approach doesn’t account for diverse market dynamics, but the administration defends it as an efficient and equitable mechanism. These figures were directly influenced by detailed economic studies from the earlier US-China trade war, offering a realistic yet conservative measure of tariff impacts.

Deep dive: The 2018-2019 US-China trade war

The US-China trade war provides rich lessons on tariff impacts, cost absorption, supply chain resilience, export diversification, and inflation dynamics.

Impact on the United States

Initially, the Trump administration imposed tariffs on approximately $ 360 billion worth of Chinese goods, ranging from electronics and machinery to consumer products. Companies such as Apple, Caterpillar, and Whirlpool initially faced sharp cost increases. For instance, the price of imported washing machines rose approximately 12% within months. However, a detailed study by Cavallo et al. (2021) found only a modest pass-through of tariffs onto consumers, estimating that only about 25% of the tariff increase translated into higher retail prices.

Economic consequences in the US:

• Consumer costs: Contrary to initial fears, consumer prices increased moderately, as importers, distributors, and Chinese exporters absorbed most tariff costs. US importers saw squeezed profit margins rather than significantly higher retail prices.
• Inflation: US inflation did see minor spikes, yet remained generally subdued, partly due to competitive pressures that limited the full pass-through of tariff hikes.
• Sectoral disruption: Certain sectors, notably agriculture, automobiles, and electronics, faced significant disruption. US soybean exports to China plunged by approximately 75%, severely affecting American farmers.
• Supply chain shifts: American companies started diversifying supply chains away from China, with Vietnam, India, and Bangladesh emerging as alternative manufacturing hubs. A clear example was apparel sourcing, shifting markedly toward Southeast Asia.

Impact on China

China swiftly retaliated, imposing tariffs on roughly $ 110 billion of US exports, targeting soybeans, pork, automobiles, and aerospace products. This strategic retaliation aimed at politically sensitive sectors in the US heartland.

Economic outcomes in China:

• Export pressure: Chinese manufacturers faced substantial margin compression. However, they mitigated damage by aggressive cost absorption and currency depreciation strategies, reducing export prices by nearly 8-10% overall.
• Supply chain adaptation: China quickly began repositioning its manufacturing strategies, enhancing domestic consumption, and promoting exports to alternative markets in Asia, Europe, and Africa.
• Technological independence: The conflict accelerated China’s push for technological self-sufficiency, significantly reducing dependency on US technology, especially in semiconductors.
• Inflation dynamics: Contrary to expectations, China experienced relatively stable inflation levels, managed effectively by monetary policy easing and targeted economic stimulus measures.

Comparative analysis and strategic insights

Corporate responses and cost absorption strategies

Companies across sectors and geographies adapted quickly. Notable examples include:

• Apple Inc.: Shifted production of certain devices from China to Vietnam and India, showcasing strategic flexibility in global sourcing.
• Nike and Adidas: Boosted sourcing from Vietnam and other countries, demonstrating supply chain diversification to mitigate tariff impacts.
• Tesla Inc.: Established the Shanghai Gigafactory to localise production and shield itself from tariff volatility, showcasing proactive market-entry strategies.

Global lessons and implications

1.Limited inflation pass-through: One major learning was that tariff-induced inflation remained significantly lower than initially feared. The effective tariff pass-through to consumer prices was minimal, largely absorbed by corporate margins.

2.Export diversification as a necessity: Tariff pressures accelerated diversification of export markets and production locations, underscoring the importance of agility in global supply chains.

3.Technological autonomy: Countries increasingly focused on technological self-reliance. The US-China conflict highlighted vulnerabilities in relying heavily on foreign technologies and components, prompting strategic shifts towards self-sufficient ecosystems.

4.Currency and monetary policy: Strategic currency devaluation and monetary policy easing played a vital role in mitigating export pressures, as demonstrated by China’s targeted interventions.

Implications for Sri Lanka

While not extensively covering strategies for Sri Lanka here (detailed in Part 2), clear lessons emerge:

• Market diversification: Emphasis on expanding trade relationships beyond traditional Western markets, potentially focusing on ASEAN and Africa.
• Supply chain adaptability: Encouraging firms to build resilient and flexible supply chains to rapidly adjust to external shocks.
• Cost absorption and productivity: Exploring productivity enhancement measures to manage margins and remain competitive internationally.

Conclusion

The US-China trade war underscores that while trade conflicts initially appear disruptive, they also stimulate strategic adaptability and resilience. The reciprocal tariff calculation (88% reduced to 44%) may seem alarming, but historical precedent suggests such shocks can catalyse beneficial shifts in business practices and national strategies.

As Sri Lanka faces this new economic reality, insights from global giants like China and the US can provide invaluable guidance. Proactively absorbing lessons from the past can position Sri Lanka not only to weather the storm but to emerge stronger and more resilient.

References:

• Cavallo, A., Gopinath, G., & Neiman, B. (2021). The Behavior of U.S. Imports During the 2018–2019 Tariff Hikes. NBER Working Paper.
• Broda, C., & Weinstein, D. (2006). Globalization and the Gains from Variety. Quarterly Journal of Economics.
• Simonovska, I., & Waugh, M. (2014). The Elasticity of Trade: Estimates and Evidence. Journal of International Economics.
• Soderbery, A. (2018). Trade Elasticities, Heterogeneity, and Optimal Tariffs. Journal of International Economics.