(Continued from yesterday)

Domestic Market Development

While Sri Lanka’s relatively small domestic market (22 million people) limits the potential for inward-focused development, there may be opportunities to reduce import dependence in certain sectors and develop stronger linkages between export industries and domestic suppliers. This could create more balanced growth and reduce vulnerability to external shocks.

Policies to support domestic market development might include,

•  Import Substitution in Strategic Sectors: Targeted support for domestic production of essential goods and inputs to export industries, reducing dependency on imports.

•  Strengthening Domestic Supply Chains: Developing stronger linkages between export-oriented firms and local suppliers to increase domestic value addition.

•  Addressing Income Inequality: Policies that increase purchasing power among lower and middle-income Sri Lankans could expand the domestic market for locally produced goods and services.

Such approaches would need to avoid the pitfalls of earlier import substitution models that created inefficient, protected industries. The focus should be on developing competitive domestic capabilities rather than simply erecting barriers to imports.

Policy Recommendations

Based on the analysis of both short-term and longer-term strategies, several specific policy recommendations emerge for Sri Lanka,

Industrial Policy Reforms

Sri Lanka should develop a comprehensive industrial policy that goes beyond the current focus on export promotion to address structural vulnerabilities revealed by the tariff shock. This policy should,

•  Identify priority sectors for diversification based on a realistic assessment of Sri Lanka’s competitive advantages and global market opportunities.

•  Provide targeted support for research and development, skills training, and quality infrastructure in these priority sectors.

•  Reform regulatory frameworks to reduce barriers to business formation, innovation, and growth.

•  Develop specific strategies for upgrading within existing export sectors like textiles, helping firms move into higher-value activities.

Investment in Innovation and Skills

Human capital development represents a critical foundation for economic resilience and diversification. Sri Lanka should,

•  Align education and training systems more closely with emerging economic opportunities, emphasizing technical skills, digital literacy, and innovation capabilities.

•  Support university-industry collaboration to develop applied research relevant to Sri Lanka’s economic challenges.

•  Facilitate knowledge transfer through diaspora engagement, international partnerships, and strategic foreign direct investment.

•  Develop innovation hubs and incubators focused on priority sectors for diversification.

Sustainable Debt Management

The tariff shock highlights the importance of building greater resilience into Sri Lanka’s approach to external debt. Recommendations include,

•  Advocating for reforms to international debt restructuring frameworks that would explicitly link repayment obligations to export performance, similar to the London Debt Agreement model.

•  Developing contingency clauses in future debt agreements that would automatically adjust payment terms in response to external shocks beyond the country’s control.

•  Prioritizing concessional financing over commercial borrowing where possible to reduce vulnerability to market sentiment.

•  Building stronger foreign exchange reserves during periods of stability to provide buffers against future shocks.

Social Protection for Affected Workers

Finally, Sri Lanka must develop more robust systems to protect vulnerable workers during economic transitions. Recommendations include,

•  Establishing a dedicated adjustment assistance program for workers displaced by trade shocks, providing income support, retraining, and job placement services.

•  Developing community-based support initiatives in regions highly dependent on export industries.

•  Engaging international partners to support these efforts through technical and financial assistance.

•  Ensuring that economic diversification strategies explicitly address employment creation for workers with different skill profiles.

Implementing these recommendations would require significant political will, institutional capacity, and international support. However, the current crisis created by President Trump’s tariffs also presents an opportunity to address long-standing structural vulnerabilities and build a more resilient economic model for Sri Lanka’s future development, just like what Sri Lanka did post economic crisis, such as tax reforms, SOE reforms and cost reflective pricing.

CONCLUSION

The imposition of sweeping tariffs by the Trump administration represents a profound disruption to the global trading system with far-reaching consequences for economies around the world. As we have seen throughout this analysis, these tariffs are not merely technical adjustments to trade policy but potentially transformative shifts that challenge fundamental assumptions about economic development, international cooperation, and the distribution of benefits and costs in our interconnected global economy.

For Sri Lanka, the 44% tariff rate imposed on its exports to the United States threatens to undermine a fragile economic recovery and reverse hard-won progress following the devastating crisis of 2022. With the United States accounting for 23% of Sri Lanka’s exports and the textile industry, which employs 350,000 workers, particularly vulnerable to this trade shock, the human consequences could be severe. Projected losses of $300 million in annual export earnings not only threaten jobs and livelihoods but also raise serious concerns about Sri Lanka’s ability to service its external debt obligations, despite recent restructuring efforts.

Sri Lanka’s experience illuminates broader structural vulnerabilities in the global economic system. The export-led development model promoted by international financial institutions for decades has created deep dependencies on continued access to wealthy consumer markets, particularly the United States. When this access is suddenly restricted through unilateral policy decisions, developing countries bear disproportionate adjustment costs with limited capacity to cushion the impact. The international trade and financial architecture offer inadequate mechanisms to address such shocks, with debt sustainability frameworks failing to properly account for trade performance and multilateral institutions lacking effective tools to prevent or mitigate the damage.

This situation calls for both immediate crisis response and longer-term structural reforms. In the short term, Sri Lanka must pursue diplomatic engagement with the United States, provide targeted support to affected industries within its fiscal constraints, and implement emergency measures to protect vulnerable workers. Over the longer term, strategies for market and product diversification, value chain upgrading, regional integration, and domestic market development offer pathways to greater resilience, though none provides a quick or easy solution to the current challenge.

Beyond Sri Lanka’s specific circumstances, President Trump’s tariffs may accelerate broader shifts in global trade patterns. We may see increased regionalization of trade, a greater role for China as both market and investor for developing economies, production relocation to avoid tariffs, and renewed interest in South-South cooperation and domestic market development. These shifts could fundamentally reshape the global economic landscape in ways that create both risks and opportunities for developing countries.

The tariff shock also highlights the need for more fundamental reforms to the international economic system. A more equitable approach to trade and development would recognize the structural challenges facing developing economies and provide meaningful policy space for them to pursue diversification and resilience-building strategies. Debt sustainability frameworks should explicitly link repayment obligations to export performance, acknowledging the fundamental importance of trade capacity to debt service ability. And multilateral institutions should develop more effective mechanisms to prevent unilateral actions that disproportionately harm vulnerable economies.

For Sri Lanka specifically, this moment of crisis also presents an opportunity for reflection and reform. The country’s heavy dependence on a narrow range of exports to a small number of markets has created vulnerabilities that predate President Trump’s tariffs. A comprehensive strategy for economic diversification, encompassing both products and markets, could create greater resilience against future shocks while potentially opening new pathways for more inclusive and sustainable development.

Ultimately, the story of Trump’s tariffs and their impact on Sri Lanka reminds us that behind abstract economic policies and trade statistics lie real human lives and communities. The textile worker in a factory outside Colombo, the small business owner supplying packaging materials to exporters, the rural family dependent on remittances from a daughter employed in the garment industry, these are the people who will bear the true cost of these tariff policies. Their futures hang in the balance as global economic forces shaped by decisions in Washington ripple outward to distant shores.

As the international community responds to this disruption in global trade, we would do well to centre these human impacts in our analysis and policy responses. A truly equitable international economic system must not only facilitate the efficient exchange of goods and services but also ensure that the benefits of global integration and the costs of economic adjustment are distributed fairly between wealthy and developing nations. President Trump’s tariffs have exposed how far we remain from this ideal, and how urgently we need to work toward a more balanced and inclusive model of global economic cooperation.

Rethinking Trade Metrics: It’s the Current Account, Not Just the Trade Balance

While the Trump administration frames its tariff decisions around bilateral trade deficits in goods, that gives a very skewed picture. The true measure of how our economies are actually connected between nations is the current account, which includes not just the balance of goods, but also services, investment income, and transfer payments.

Take Sri Lanka, while it may appear to run a surplus in goods trade with the U.S., that surplus is more than offset by,

•  Payments for U.S.-based tech and streaming services (Google, Netflix, Apple)

•  Outbound tourism and overseas education costs

•  Interest payments on sovereign debt owed to institutions like the IMF and World Bank, whose returns flow back to major shareholders, including the U.S.

This broader deficit in the current account illustrates that Sri Lanka is not exploiting the U.S., but rather taking part in a back-and-forth economic relationship that is already tilted toward the American economy.

Basing tariff policy solely on trade deficits in goods completely misses this bigger economic picture, and risks harming the very development partners whose growth would ultimately benefit the global economy, including the United States.

(Concluded)

(The writer served as the Minister of Justice, Finance and Foreign Affairs of Sri Lanka)

Disclaimer:

This article contains projections and scenario-based analysis based on current economic trends, policy statements, and historical behaviour patterns. While every effort has been made to ensure factual accuracy using publicly available data and established economic models, certain details, particularly regarding future policy decisions and their impacts, remain hypothetical. These projections are intended to inform discussion and analysis, not to predict outcomes with certainty.

by M. U. M. Ali Sabry
President’s Counsel