Globalization and liberalized trade reduced poverty, raised living standards, and increased national wealth globally. However, the failure to address uneven domestic outcomes in many countries fueled economic discontent and enabled protectionist policies, including the trade wars initiated by the Trump administration, says Dr Asanka Wijesinghe, Research Fellow at the Institute of Policy Studies.
In this interview with Echelon, he examines how these dynamics unfolded and their implications for Sri Lanka. While he argues that the current US trade policy is unlikely to succeed, he notes that it has forced a global reckoning with long-ignored failures of globalization, disparities and policy failures.
As an economist dedicating your career to shaping better economic policy in Sri Lanka, what does this all mean to you?
My first exposure to this discipline was in the applied economics department in the Faculty of Agriculture at the University of Peradeniya. I was fascinated by how economists used mathematical models to solve real-world economic problems, and my path eventually led me to pursue my PhD in Agricultural, Environmental, and Development Economics at Ohio State University in Columbus, OH.
At the Institute of Policy Studies, we find practical solutions to problems, which is the chief difference between an academic institute and a think tank. The former is crucial for producing high-quality research but focuses more on scholarly recognition. In a policy institute or think tank, we go a step further, quantifying issues using data, developing actionable policy recommendations, and communicating said recommendations effectively to policymakers.
Did you ever think a tariff world war could occur?
No, because it is not logistically feasible. There are 13,000 tariff lines, 200 trade partners, and so on. We anticipated, at most, a 10% or 20% blanket tariff for all. Further, the White House used a mathematical formula for calculating ‘reciprocal tariffs’ that is economically incorrect. As an example, it misinterprets the research of Harvard Business School professor Alberto Cavallo, using elasticity values to calculate the impact of tariffs on prices. The administration incorrectly used a 25% retail pass-through rate, which inflates the result of the calculation by 400%. In other words, the tariffs are four times too large due to this factor alone. This error was impossible to anticipate.
The exceedingly high tariffs on China, up to 245%, are another example. It makes no sense, given China’s deeply embedded position as an intermediate product exporter. In 2021, after President Biden was elected, we expected him to reverse many of the Trump administration’s tariffs. He did not; that was the first time we saw the US heading toward a protectionist economic stance, irrespective of party lines. However, the Biden administration’s policies targeted semiconductors, advanced chips, and some pharmaceuticals. Such selective measures were part of a plan that intended to restrict the impact of China’s sudden rise as an economic power.
That’s not the case here. It is not selective.
What were the fundamental flaws in economic policies that led the world to this state?
Economic research shows that globalization and free trade lifted millions out of poverty, especially in South and East Asia. They helped households around the world. Many free trade agreements, like the North American Free Trade Agreement (NAFTA), benefited the US. The world’s overall wealth went up, but was it evenly distributed?
If you ask an economist, they will say free trade is the best way to maximize national wealth. However, if a country undergoes tariff liberalization, some producers will be affected because they are not competitive. Economists should share the blame for leaving this distributional effect unaddressed and not discussing this since the 1990s. Nobody thought it would lead to huge economic or political problems in countries like the US and Europe.
The US, in particular, saw a great impact within its manufacturing states. Increased import competition led these communities to experience increasingly adverse effects, such as a rise in unemployment and suicide rates, and these changes were largely irreversible.
JD Vance, the US Vice President, is from Ohio. His book, Hillbilly Elegy, explores these issues: Ohio’s deindustrialization and the families that were affected—because many moved in from other areas to work in these big factories that later shuttered. That’s what happened.
A trade adjustment package could have helped these workers move into other sectors, especially given the US’s comparatively high advantage in the service sector and high-tech manufacturing. But this did not happen. That is an example of the lack of foresight and care that brought us to this environment of economic grievances, and people like Trump will always be there to take advantage of it. That is the nature of politics.
What should Sri Lanka’s next steps be?
Our immediate focus should be on avoiding the proposed 44% tariff. It would drastically reduce Sri Lanka’s exports and have serious economic consequences, such as a fiscal deficit. No immediate alternatives or markets can replace US demand for Sri Lanka’s products, so we must ensure we preserve our market access; this is why our first step should be to negotiate with the US.
They will likely ask us for concessions, given they know we cannot trade at a magnitude large enough to equalize the deficit. Instead, they may ask us to make purchases in specific areas. Sri Lanka will have to consider this, but I believe we will ultimately decide on energy. For example, oil is possible because the Ceylon Petroleum Corporation is under the Sri Lankan government, making an agreement more straightforward. The issue, however, is that it will be more expensive. West Texas Intermediate (WTI) is cheaper than OPEC, but we will incur increased logistical costs due to our distance from the source. Still, if we can maintain access to this market, it would represent a net gain for us.
On the other hand, we could consider agricultural commodities like soybeans. While the government has no control over this, they could remove the Ports and Airports Development Levy (PAL) and any other import duty we may have. However, such imports would wipe out our domestic producers because they will not be competitive, but feed producers may be able to use these products more reliably. The food processing industry may do the same and reduce the price of items like eggs and poultry. It could still benefit the country if we had to compensate these producers somehow.
We lack alternative markets for key exports like apparel because our competitors are the other countries in this region. Despite India’s large middle class, it has quotas protecting its industries. We could ask India to increase these quotas, but they are incentivized against this, given they have to protect themselves similarly. Additionally, this falls into the category of long-term solutions. We should work on them since it is clear that depending on a single market is not feasible, but we have more immediate issues to deal with.
Would more prominent corporations invest more outside our borders?
It is possible. Certain countries, such as Kenya, have a much lower tariff, at 10%. Kenya could export ready-made garments duty-free under the US African Growth and Opportunity Act (AGOA). While every country is under a universal 10% tariff, alongside the MFN they already pay, they may become more competitive in the US market if the proposed increases go into effect again. Businesses could move some of their operations to Kenya or even shut down activity in Sri Lanka altogether.
In hindsight, what could Sri Lanka have done to soften the blow?
We could not have foreseen that a reciprocal tariff as steep as 44% would be imposed on Sri Lanka. However, given the overall protectionist policy of the Trump administration, we may have been able to anticipate what they would want and what they would target, perhaps allowing us to develop a cohesive response. Countries like India and Vietnam had responses ready virtually the day after the tariffs were announced.
The sentiment was that we would not be affected. Some thought that the tariffs would benefit us by driving trade but it was wishful thinking because we saw Trump float the idea of global tariffs during his presidential campaign. The issue became even clearer when he targeted Canada and Mexico, which are historically among the US’ key allies. His agenda is more extreme than during his first presidency.
Are we seeing an irrevocable shift in the world order, and what does that mean for Sri Lanka?
Yes. The world is transforming from the unrestrained globalization of the 1990s to a more fragmented, protectionist state. At the moment, China, Canada, and other countries are filing cases against the US with the WTO’s Dispute Settlement Body (DSB). With its reciprocal tariffs, the US is violating the WTO’s Most-Favoured-Nation (MFN) principle, which ensures that a country cannot discriminate between its trading partners.
Sri Lanka is a WTO nation, beholden to the same principle. This means we are obligated to treat every country equally, so we cannot reduce our tariffs for the US alone. We would have to reduce them for all our WTO trade partners.
While the DSB is functional and can deliver a verdict, the US can appeal the said verdict at the WTO Appellate Body. The members of the Appellate Body act as judges, but no appeals can be heard right now as the former members have completed their terms, and the US has been blocking new appointments since 2017.
Some are calling for a new global alliance that excludes the US. 80% of trade may happen outside the US, but it is still not possible. The US is powerful, and the other countries are not reacting as a unified whole. Only the EU is attempting to act as a group. Individually, countries like Vietnam are trying to get concessions. This stands out from how the world behaved with the 1990s WTO and NAFTA. This is a new world order, and it is not sustainable. It is destructive for everyone, and it will be enormously costly.
Do you think the SAARC region will be inspired to deepen trade ties?
South Asian countries are among the least integrated regions. For example, the ASEAN region trades more with its members, but the problem is that we are competitors. About 80% of Bangladesh’s exports are ready-made garments. India is involved in low-tech manufacturing, and Pakistan is the same. Simply put, we do not buy each other’s goods. That might be the most crucial reason affecting our bilateral, intra-regional trade.
On the other hand, our push towards more integration, such as a South Asia Free Trade Agreement (FTA) and bilateral trade agreements, is half-hearted and ineffective. The presence of restrictive trade practices, such as extensive sensitive lists and complex rules of origin, further inhibit meaningful liberalization. Some progress has been made, such as with Sri Lanka taking advantage of tariff preferences under an agreement with India to process and re-export products like food, oil, and copper, but this is limited in scale.
Unfortunately, even increased regional trade cannot offset the impact of losing major markets like the US and EU. SAARC countries are dependent on external markets to survive. Therefore, while beneficial, deeper ties within SAARC would not help with the current situation.
What are the worst-case and best-case scenarios for you?
Suppose a competitor like Vietnam or Cambodia negotiates a better deal while Sri Lanka grapples with a 44% tariff. In that case, their products will be far more attractive in the US market. There is no silver lining if we get a 44% tariff. It is all bad news.
On the other hand, should we find a way to preserve the current status quo where we are paying a 10% tariff while China’s is far higher, we might see some business come our way. We could expect certain benefits in that scenario.
According to the de minimis rule, the US did not tariff imports under $800. That is being eliminated for Chinese imports, affecting firms like Alibaba and Shein. Even Amazon will be affected. If we can meet the demand for such goods instead, we can benefit, but we lack the digital payment infrastructure to capitalize on it effectively. Platforms like PayPal would help us connect with US customers. This type of business is also done by SMEs, which tend to be unfamiliar with digital finance. Most don’t even have a website, running their businesses with social media accounts.
We need infrastructure development in the financial and digital spheres to exploit any demand China cannot meet. However, if the 44% tariff is still in effect at the end of the pause period, our options will be bleak.
Can you offer hope?
Negotiations are the way to go. The US will ask what we can buy. Since we cannot buy new products, such as new Boeing planes, a more realistic option is to divert our purchases from other countries to the US. Oil and natural gas are examples of this.
The other strategy is identifying products we have already purchased from the US. Sri Lanka is a major importer of soybean residues in the form of soybean meal. For products like this, we can change the import duty. We would have to change the duty for every other WTO country as well, but the risk of market disruption is low given that the market is concentrated in the US. It will not significantly impact other suppliers.