Trump tariffs on Sri Lanka based on misguided thinking

According to the Office of the United States Trade Representative, an agency that is part of the executive branch i.e. the Presidential administration of the US, the reciprocal tariffs are calculated at the tariff rate needed to reduce US trade deficits to zero. This is, however, immediately contradicted by the fact that the US is imposing a 10% tariff on imports from countries such as Australia and the UK, with which it has a trade surplus, according to that same office

The Trump administration has decided to impose a preliminary 44% tariff on US imports from Sri Lanka, claiming that the US is reciprocating an equivalent 88% tariff that Sri Lanka places on Sri Lankan imports from the US including so-called currency manipulation and trade barriers. According to Sri Lanka Customs, the highest duty that is imposed on any imported good is 20%, and the Sri Lankan Rupee, while being a closed currency (meaning that it is not freely available to exchange outside of Sri Lanka) is now a floating rather than a fixed currency and not being manipulated by the Central Bank of Sri Lanka to stay at a certain value with respect to other currencies. Import restrictions due to the economic crisis have largely been lifted. The 88% touted by the US is therefore bewildering. That is, until one looks at the aggregate trade figures between Sri Lanka and the US and comprehends that the US President and his advisors misunderstand trade.

According to the Office of the United States Trade Representative, an agency that is part of the executive branch i.e. the Presidential administration of the US, the reciprocal tariffs are calculated at the tariff rate needed to reduce US trade deficits to zero. This is, however, immediately contradicted by the fact that the US is imposing a 10% tariff on imports from countries such as Australia and the UK, with which it has a trade surplus, according to that same office. The calculation used is the US trade deficit (US exports minus imports) with that country divided by US imports. For Sri Lanka, the trade figures according to the Trade Representative are as follows:

•  US total goods trade with Sri Lanka was an estimated $3.4 billion in 2024.
•  US goods exports to Sri Lanka in 2024 were $368.2 million
• US goods imports from Sri Lanka totalled $3.0 billion in 2024
•  The U.S. goods trade deficit with Sri Lanka was $2.6 billion in 2024

The US President Trump has stated that another reason for tariffs is to bring industries back to the US, the idea being that by making imports expensive, the American consumer will opt for the relatively cheaper American made goods. There is faulty thinking in this again. Firstly, the reason the American consumer bought foreign made goods is because they are quite cheap in comparison to American made goods, which are expensive because labour and materials are costly there

The trade deficit (rounded to 2.6 billion) divided by US imports from Sri Lanka (3.0 billion) gives a value rounded to 88%. The assumption is that if one increases the cost of US imports from Sri Lanka by 88%, the demand from the US will fall by an equivalent 88% (according to the Trade Representative, they have made assumptions of price elasticities of any good to give a nice unitary value). The assumption is then that the US will continue to export at the same above figure of $368.2 million while imports from Sri Lanka will fall from $3.0 billion to $368.2 million, thus eliminating the US trade deficit with Sri Lanka.

There are many problems with this thinking. Firstly, the price elasticity of demand for any imported good (the percentage decrease in quantity imported in response to a percentage increase in price, assumed by the Trade Representative to be 

1) varies by the good. Some products, such as petroleum are said to be price inelastic, meaning that the decrease in quantity demanded is proportionally less than an increase in price. This is because petroleum is at this time an essential and much needed good in society and while a price increase may deter or prevent some consumers from buying it, most others find themselves still buying petroleum at the higher price because they need to, and in some cases forgoing other goods so as to be able to afford it. Alternatively, some goods are price elastic, meaning that a decrease in quantity demanded is proportionally more than an increase in price, and so a small increase in price would cause a great decrease in quantity demanded. To use a unitary price elasticity in their calculation instead of fine-tuning it to the specific goods imported from the country to achieve their ends is careless; the equivalent of using a sledgehammer instead of a needle.

2) Even assuming that the US is successful in reducing US imports from Sri Lanka to $368.2 million, there is no reason to believe that US exports to Sri Lanka will remain at $368.2 million. Firstly, because countries in a trade war tend to retaliate tit-for-tat, so Sri Lanka could respond by imposing their own tariffs on Sri Lankan imports from the US and making those imports more expensive and thus reduce their quantity demanded (if Sri Lanka does not retaliate, the US’ other trade partners are almost certain to). Even assuming that Sri Lanka does not retaliate with their own tariffs, the economic distress caused by the US tariffs will affect Sri Lankan consumers greatly, hobbling their ability to buy US goods. According to the Observatory of Economic Complexity, in 2023, 21.6% of Sri Lankan exports went to the US, over half of which were garment related. The garment industry provides sizable employment to Sri Lankans, and reduced demand for their goods will result in downsizing, reducing incomes and consumption, including of imported goods such as those from the US. Similarly, if Sri Lankan exports are reduced, foreign exchange with which Sri Lankans use to buy goods from other countries are also reduced. In other words, Sri Lankans will not have the US dollars with which to buy US goods. If the supply of US dollars falls in the foreign exchange market, the dollar will appreciate in value relative to the rupee and so imports will be more expensive. There appears to be no second-order thinking on the US’ part on the impact of tariffs.

3) On a fundamental level, trade deficits are not equivalent to tariffs. Trade deficits are not subsidies as the US President Trump often claims. Trade deficits are when the home country imports more from a foreign country than it exports to it. There are many reasons why they may exist; when domestic savings is exceeded by domestic investment (meaning that the amount that domestic residents are lending abroad is less than the amount foreigners are lending to the home country), or simply because a foreign country holds goods that the home country needs and that exist only there – for example Sri Lanka imports oil from the Middle East because it does not produce it at home. They are also not inherently a bad thing. I run a permanent trade deficit with my supermarket  ; I buy many things from there and they have yet to buy anything from me, but this arrangement is satisfactory to me because I receive the goods that I want and I do not need to have them buy from me in order to do so. Similarly, employers run a trade deficit with their employees; the employers buy services from the employees and the employees do not buy anything from their employers. Trade partners get what they need from each other or else they would not agree to the trade. The real value in trade is in the goods they provide, and the money gained is valuable really only in the goods that it is used to buy or has the potential to buy.

The US President Trump has stated that another reason for tariffs is to bring industries back to the US, the idea being that by making imports expensive, the American consumer will opt for the relatively cheaper American made goods. There is faulty thinking in this again. Firstly, the reason the American consumer bought foreign made goods is because they are quite cheap in comparison to American made goods, which are expensive because labour and materials are costly there. Depending on the elasticity of the goods in question, the American consumer may not be able to afford the American made goods even if tariffs exist. Secondly, in our current globalised world, the production process takes place over many different countries, with different inputs coming from and stages of production occurring in several places even if the goods are ultimately assembled in the home country. Placing blanket tariffs would drastically affect American industries such as the all-important car industry. Again, there is no careful consideration by U.S. policymakers of the consequences of their actions. There are some cases in trade relations where protective tariffs can be advocated for; to encourage the growth of so-called infant industries in a developing country that otherwise could not compete against cheap goods from abroad made by mature foreign industries, or to combat so-called dumping of goods made below cost by industries supposedly unfairly subsidised by their governments. Such instances, however, are usually carefully analysed, applied and then adjudicated by international organisations such as the World Trade Organisation. 

What the current US administration is doing cannot be said to be careful, and does not serve anyone’s interests, least of all its own. The US will impoverish itself at least as much as it tries to do the world, and may learn, as the 19th century American reformer and economist Henry George remarked, that “[what] protection teaches us, is to do to ourselves in time of peace what enemies seek to do to us in time of war.”

(The writer is an economics graduate with an MSc Economics from KU Leuven, and MA (Hons) Economics from the University of Edinburgh)