Trump tariffs and the “American boomerang”

At a time that even the US wants to increase tariffs on imports, is there a problem if Sri Lanka too increases its import controls to promote local production?”

This is a question that I received from a reader of my column. He had sent it, referring particularly to my recent articles in this column on Sri Lanka’s protectionist policies resulting in higher domestic prices of rice and other foodstuffs.

If and when Sri Lanka also develops to the US level in the future, we can then engage in this comparison in a meaningful way. As of now, the two countries are “worlds apart” from each other in terms of development standards. Besides, the US under the new Donald Trump administration is considering an increase in its current 10 per cent tariffs on imports to 25 per cent.

Countries like Sri Lanka would be adversely affected by the freeze on USAID projects.

In contrast, Sri Lanka’s import regime is already characterized by multiple taxes such as tariffs, numerous para-tariffs, VAT and other domestic taxes, while they all can easily result in 100 per cent or more on most of the country’s imports. The question is, therefore, from the current level of import protection in Sri Lanka, in which direction must we move – up or down?

Hot topic of the day

Trump’s tariff hikes and expenditure cuts among other controversial policy initiatives have today become a hot topic of debate all around the world. I thought of taking this issue for today’s discussion as well. However, it is not our purpose to support or oppose any side of the debate, but rather to expose the economic problem that has led the US to adopt its new policies—the American boomerang!

Neither have I seen any alternative solutions proposed by the opponents to the Trump’s tariff hikes and expenditure cuts. Rather the discussions are limited to the question of why the US should resort to this move.

I do accept the fact that these policies would be detrimental to the US economy as well as to the global economy, including Sri Lanka. Pro-nationalist policies of a highly globalised and influential economy like the US obviously hurt the entire world. The costs of adjustment to a “new world order” would be ruthlessly painful for everyone.

But what is the US problem? And how fair it is for the world to say that the US should remain quiet about its own problem? Since the discussion is lengthy, I have to skip some of the background details, which you can find in my previous writings about the US economy in this column.

Here are some of them published recently: “Mighty dollar” as the reserve currency” on December 8, 2024; “Bullion price, again on the rise!” published on November 17, 2024; “In debt we trust” published on October 13, 2024.

Spending unwarranted

The US is still the wealthiest economy in the world, sharing more than a quarter of the world’s income, which is equivalent to US$28 trillion. However, the country spends much more than what is warranted by its income levels locally and internationally.

For instance, in the fiscal year 2024, US government spending was $6.75 trillion, while its total revenue was $4.92 trillion, resulting in a budget deficit of $1.83 trillion. Deficit means borrowings, which have been growing every year.

Outstanding public debt of the US exceeded $35 trillion in 2024, which is about 123 per cent of the country’s GDP. About 20 years ago, the country’s public debt stock was only $12 trillion. While the interest payments on public debt also rose to $1 trillion in 2024, the US government must keep rolling over its debt with more borrowings every year. The question is that “isn’t this something the US should be mindful of?”?

With respect to external finance too, the US keeps importing much more than it exports resulting in a growing trade deficit. As of 2023, while US exports amount to $2.1 trillion, its imports were $3.4 trillion. Accordingly, there was a $1.3 trillion merchandise trade deficit.

This massive trade deficit must be covered every year with borrowings from abroad. Net financial account inflows show over $900 billion, reflecting the US borrowings from abroad to cover about 70 per cent of its trade deficit. The balance may be covered with service exports and primary incomes from abroad. Shouldn’t this be a concern for the US policymakers?

Ticking bomb

The US debt pile due to its annual rolling over with further borrowings is a ticking bomb—it’s growing and growing and growing…! But the problem, which is unknown to many, is “Can it grow forever?”

It is not necessary to repeat the discussion on this problem that I presented in one of my previous articles on “In debt we trust” published in this column on October 13, 2024.

The problem, however, has a historical trait. The US economy became the world’s superpower since the early 20th century, surpassing the global dominance enjoyed by the UK. Given the accumulated wealth in terms of the world’s largest gold stock, the US dollar also became the legitimized international currency in 1944 under the Bretton Woods Agreement.

The US also had to start throwing its wealth all around the world, both intentionally and effectively, and accumulating a debt pile. At that time, there were “three worlds” in the world: the First World, comprising the rich Western democratic countries; the Second World, comprising the Soviet Union and its Communist allies; and the Third World, which were the “underdeveloped” countries and which were receiving political independence at the time.

US President Harry Truman declared in 1947 that the US would provide political, military, and economic assistance to all democratic nations under threat from external or internal authoritarian forces. This threat that he referred to was originating largely from the Soviet Union in the context of the then Cold War.

And what was initiated that day under the so-called “Truman Doctrine” continues to date—throwing money all around the world. Tax revenue, money printing, and borrowings must now get multiplied to bear the cost.

Demand for US debt

The second issue was the fact that the US dollar became the international reserve currency. In other words, the US dollar has legitimate international acceptance all around the world. Despite some other currencies, such as the Euro, British pound, Japanese yen, and a few others too gaining international acceptance as reserve currencies, about 60 per cent of world reserves are still denominated in US dollars.

Here is the irony: The US can run a growing trade deficit because the resulting trade deficit can be covered by selling US debt to the rest of the world. About a quarter of US debt in terms of Treasuries is held by foreign governments as their reserve assets. The top 3 foreign debtors to the US are Japan, China and the UK.

Moreover, world trade has been growing fast over the past 50 years due to liberalization policy reforms in developing countries. Many Asian countries continued to expand their exports since the 1990s, while they also include China and India, the world’s two largest countries by population.

So, why does it matter? As these newly exporting countries continue to expand their exports, they must store their trade surplus in reserve currency assets. This means that they must increase their demand for US debt, as a large part of the international reserves in any country is held in dollar assets.

A difficult choice

Somebody must address the debt problem stemming from over-spending from both the government budget and international trade. Isn’t it logical that the Trump administration is trying to deal with the century-old US debt problem by reducing imports with higher tariffs and cutting down public spending around the world? Apparently, there must be alternative ways to do that too

I have no dispute over the potential economic chaos resulting from Trump’s policies within the US economy as well as in the rest of the world. The world economy is likely to shrink, resulting in slower growth and trade flows and reduced incomes and employment.

The adjustment cost of a new economic order, emanating from the new US policies, would be felt all around the world. It is because the US economy cannot move forward simultaneously in two different directions—localization and globalization.

(The writer is Emeritus Professor at the University of Colombo and Executive Director of the Centre for Poverty Analysis (CEPA) and can be reached at sirimal@econ.cmb.ac.lk and follow on Twitter @SirimalAshoka).