Why Tariffs Remain Trump’s Core Economic Weapon: Rebalancing America’s consumption model, recalibrating global trade—and how it affects Sri Lanka.

The return of Donald Trump to the political stage has revived an economic doctrine that, while controversial, remains central to his worldview: tariffs. Trump has once again placed tariffs at the heart of his economic policy playbook, even adding a universal 10% tariff on all imports. To some, this move seems paradoxical. How can a pro-business leader advocate for policies that often raise costs for American firms and consumers? Yet beneath the populist rhetoric lies a deeper macroeconomic logic that merits examination.

Tariffs as a Tool of Rebalancing, Not Just Retaliation

Traditionally, tariffs are seen as a protectionist tool that distorts trade, raises consumer prices, and provokes retaliatory action from trading partners. And indeed, the first-order effects of tariffs are just that. They make it more expensive for American businesses to import goods, including firms like Apple that rely on complex global supply chains. These costs are frequently passed on to consumers in the form of higher prices. However, Trump’s approach to tariffs reveals a more strategic ambition: to rebalance the American economy away from excessive consumption and towards higher domestic savings and investment.

Trump believes that America faces a structural overconsumption problem, one which has serious macroeconomic consequences. When a country consumes beyond its means, it must finance the gap by borrowing from abroad, leading to persistent trade deficits and an accumulation of external financial obligations. The financial flows that fund these deficits are the mirror image of the trade imbalance, and Trump's view is that the only sustainable solution is for America to save more, invest more domestically, and consume less.

This line of thinking is not entirely unfounded. The United States saves just 17% of its GDP, while the average among high-income countries is closer to 23%. At the same time, the US invests about 22% of GDP, a figure that is roughly in line with its peers. The shortfall between domestic saving and investment—approximately $1.3 trillion annually—represents the capital the country must import. Trump’s goal, through tariffs and other policies, is to reduce that reliance on foreign capital by increasing domestic savings. With consumption accounting for roughly 81% of GDP, one of the highest rates among G7 countries, this rebalancing effort appears to be a central plank of his economic worldview.

Geopolitical De-Risking Masquerading as Economics

Trump's tariff policy also reflects a broader geopolitical shift, where trade tools are increasingly being used to achieve strategic ends. In a world that appears more fractured and unstable, the idea of reducing exposure to adversarial supply chains has gained significant traction. From Trump's perspective, protectionist measures are not merely about economics but about national security and sovereignty.

This approach has led to the use of tariffs as a means of encouraging American companies to reconfigure their supply chains. The intent is to move away from dependencies on countries like China and instead build manufacturing capacity within the US or in allied nations. This process, sometimes referred to as "friendshoring" or "reshoring," is presented as a way to secure critical industries and reduce strategic vulnerabilities. The pandemic and rising tensions with China have only strengthened this rationale, making protectionism seem more palatable as a form of geopolitical risk management.

The Negotiator’s Playbook: Tariffs as Bluff and Bait

Another dimension of Trump’s tariff approach lies in his use of economic threats as negotiation tactics. Throughout his first term, Trump often announced tariffs only to delay or modify them depending on the status of negotiations. This unpredictability was part of a broader strategy to keep trade partners off balance and to extract concessions at the bargaining table.

In Trump’s playbook, the mere threat of tariffs is sometimes more powerful than their implementation. Countries were forced to reconsider their trade balances and often responded by agreeing to purchase more American goods or by lowering their own tariffs. Trump's trade deals with Mexico, Canada, and China all contained elements of this strategy. His methods may appear erratic, but they have at times produced tangible results, albeit with significant side effects.

Economic Costs: Who Pays the Price?

While tariffs may serve geopolitical and macroeconomic goals, they also impose real economic costs. The initial data from April's personal-consumption expenditures index showed a modest increase of just 0.1% in goods prices, but this likely reflects temporary factors. Many firms built up inventory ahead of expected tariff hikes, allowing them to delay price increases.

As these buffers are depleted, consumers are likely to feel the full impact of tariffs in the form of higher prices. These effects are typically regressive, hitting lower-income households hardest since they spend a greater share of their income on goods. Additionally, American manufacturers that rely on foreign inputs may find themselves squeezed by rising input costs, undermining their competitiveness.

Sri Lanka’s Exposure: Collateral Damage in a Superpower Skirmish

The implications for smaller, export-reliant economies like Sri Lanka are substantial. The imposition of a 44% tariff on Sri Lankan apparel exports to the United States, while hypothetical, illustrates the risks. With apparel comprising over 60% of Sri Lanka’s exports to the US, such a tariff would be devastating.

Order volumes would fall, leading to cancelled shipments and reduced production. This would disproportionately impact the rural female workforce, many of whom depend on apparel industry jobs. The negative effects would cascade through the value chain, from fabric and packaging suppliers to logistics providers and SME exporters.

Financial institutions would also be affected. Banks offering trade finance to exporters could see a fall in fee-based income and an uptick in loan defaults. SMEs reliant on working capital lines may find it harder to stay afloat, raising credit risk in the banking sector. Households tied to the garment industry may also struggle to repay personal loans, further exacerbating financial stress.

The macroeconomic consequence of such a shock would be felt most acutely in Sri Lanka’s foreign exchange reserves. Lower export earnings would reduce the supply of foreign currency, undermining the Central Bank’s ability to stabilise the rupee or fund essential imports. This dynamic could trigger currency depreciation, raising the cost of vital imports like oil, fertiliser, and medicine.

If left unaddressed, the situation could compromise Sri Lanka’s ability to meet foreign-currency debt obligations, threatening the success of the IMF programme and damaging investor confidence. A weakening reserve position would make it more difficult to manage macroeconomic stability.

Impact on Foreign Direct Investment

Sri Lanka’s attractiveness as an FDI destination, particularly for export-oriented sectors, would also be affected. Investors are likely to reconsider Sri Lanka as a regional hub if access to the US market becomes costlier. Countries like Vietnam and Cambodia, which are actively lowering tariffs and forming new trade agreements, may gain an edge in attracting long-term investment.

Additionally, China's ongoing yuan depreciation is placing downward pressure on export prices globally, making Chinese goods more competitive. This may affect Sri Lanka’s market share in key third-party destinations. However, a weaker yuan also lowers the cost of imported intermediate goods, offering a mixed blessing for domestic manufacturers depending on how their supply chains are structured.

The Limits of First-Order Thinking

The effects of tariffs are rarely linear or confined to the industries directly affected. As companies shift supply chains and governments engage in bilateral negotiations, the trade landscape becomes increasingly complex. Tariffs may prompt a reallocation of global sourcing strategies, with decisions based not just on cost but also on political and reliability considerations.

Retailers might diversify away from politically exposed markets, and governments may use tariff threats as leverage in broader diplomatic negotiations. The real impact of trade barriers lies in these second- and third-order effects. Simple models of revenue loss fail to capture the full picture.

Historical Context and Lessons from Trade Wars

Looking back, trade wars have often caused more disruption than benefit. The US-China trade war of 2018-2019 is a clear example. While Trump aimed to reduce the trade deficit, the conflict led to higher input costs for American businesses, retaliatory tariffs on US exports, and broad-based disruptions in global trade.

Even countries not directly involved, like Sri Lanka, felt the effects through shifts in buyer behaviour and increased currency volatility. During past periods of heightened protectionism, smaller economies have often struggled to secure investment and trade flows, particularly when larger economies negotiated bilateral deals that excluded them.

In the current environment, the trend towards regionalisation is accelerating. Trade is increasingly being conducted within blocs, and countries without preferential access face structural disadvantages. Sri Lanka, lacking deep trade agreements, risks being marginalised unless it actively secures new partnerships and lowers its own trade barriers.

Our View: What Should We Be Watching?

At AXIYA, we believe there are several key developments to monitor closely. The first is sourcing behaviour by global apparel retailers in the second half of the year. Any major shift away from Sri Lanka could signal deeper structural changes. The second is the trajectory of the yuan and its impact on global input costs and competitiveness. Third, we must observe how the Central Bank and Treasury respond in terms of foreign reserve management and macroeconomic policy.

We are also watching FDI flows into apparel and logistics zones, which serve as leading indicators of global investor confidence in Sri Lanka. Finally, changes in trade policies by peer countries like Vietnam should be tracked as benchmarks for competitiveness.

Closing Reflection: What Trump Understands—And Misunderstands

Trump’s instincts about America’s macroeconomic vulnerabilities are not entirely wrong. The country does face a structural imbalance between consumption and savings, and it is heavily reliant on foreign capital. However, the solution may not lie in blanket tariffs, which can be blunt and counterproductive.

Trade is no longer just about efficiency—it is about resilience, sovereignty, and risk mitigation. But economic policy must be calibrated with precision. A strategy that relies too heavily on coercion and uncertainty risks alienating allies, distorting markets, and undermining long-term prosperity.

For countries like Sri Lanka, the challenge is to stay agile in a world that is fragmenting into blocs. Sri Lanka must position itself strategically, diversify export markets, and secure favourable trade arrangements. For AXIYA, staying informed, flexible, and forward-looking will be essential as the rules of global commerce continue to shift.