Sri Lanka: Institutions, Economic Policies and Economic Growth

By Alia Ahmad
(Swedish International Development Agency, 1999)

Sri Lanka’s economic progress has been under close scrutiny for many years, especially since the economic liberalisation programme implemented by the UNP government in 1977.

Several studies have focussed on reform measures adopted by and, in some cases imposed on, various Sri Lankan governments and the impact of those policies on the performance of the Sri Lankan economy.

The latest version of an international review of the Sri Lankan economy and its future has been done by the Swedish International Development Agency (SIDA). The report, authored by Alia Ahmad, a Swedish economist, is entitled Sri Lanka: Institutions, Economic Policies and Economic Growth and available from SIDA in Stockholm.

The SIDA report provides a snapshot of the recent history of economic policies implemented by the Sri Lankan government and considers the implications of the role that the state has played in the economy.

Sri Lanka is unique in several ways both within the region and among developing countries generally. In spite of being a low-income country, Sri Lanka has achieved relatively high performance with respect to several indicators of human development.

For example, while average per capita share of the national income (GDP) in Sri Lanka was only US$700 last year, the purchasing power equivalent of that average income in domestic prices was over US$3000, well above any of its South Asian neighbours and on par with many rapidly industrialising economies.

In terms of non-economic factors, Sri Lanka performs even better. Life expectancy of the average Sri Lankan remains high at 72 years, well above India’s 62 years and Pakistan’s 60 years, and ranking among the highest in Asia.

Adult literacy is another indicator that places Sri Lanka well above its economic ranking. Sri Lanka’s rate of 90% is exceptional compared to India’s 52% and Pakistan and Bangladesh’s 38%.

Yet not all is well in the Sri Lankan economy. Its successes are problematic for at least two reasons – the economy could have performed much better and the successes are not guaranteed to continue into the future.

However, as Ahmad notes in the report’s opening paragraph, Sri Lanka has ‘failed to utilise [its] human resources efficiently and achieve rapid economic growth’. This, Ahmad cites, ‘has been one of the major causes of social tension in the country’.

The report presents a stark warning to Sri Lanka that healthy economic growth, the key to economic success and, by extension, the promotion of human development, has been curbed in the recent past.

The SIDA report examines the institutional framework within which the Sri Lankan economy operates. This review of the interaction between state and market provides interesting observations.

Under the assumption that the state needed to intervene in the economy to correct ‘market failures’, the SLFP pursued highly interventionist policies from 1956 to 1977. These socialist policies had a favourable impact on human development but economic growth suffered during this period.

Since 1977 however, Sri Lanka has pursued a more free market approach. The private sector of the economy has been allowed more freedom within a market-oriented economy. These reforms resulted in higher rates of growth in the first years after implementation but cracks soon appeared and have continued to act as a dampener on growth and development.

As Ahmad observes, ‘Sri Lanka is still far from an efficient, competitive market economy that can ensure rapid growth with equity. The moderate rate of growth is associated with high inflation, unemployment, a persistent fiscal deficit and widespread regional disparity in per capita income.’

These inefficiencies have resulted in a stagnating agricultural sector, a sluggish industrial sector and a highly government controlled financial sector. Not surprisingly, the report implicates the government’s handling of ethnic tensions in this malaise.

Most obviously, the war effort of the Sri Lankan government, which is estimated by some to be at least 35% of the government’s total expenditure, has constrained growth and development.

Resources that could be devoted to improving the welfare of all Sri Lankans have instead been diverted to fund military operations. There have been huge losses of human and physical resources. Output from agriculture and fisheries is reduced, especially in Tamil areas. The unstable investment environment meanwhile discourages potential foreign investment, seen as a key to initiate growth.

While the report notes the central role played by the political process in fuelling ethnic tensions, it points out important economic factors that have indirectly contributed to the crisis.

The Tamil population has increasingly found itself in economically backward part of Sri Lanka. Little investment and economic development in the North and East led to high rates of unemployment, relatively slower growth and fewer economic opportunities for residents of the North and East.

These high levels of youth unemployment and limited job creation within the economy have in turn been a factor in the popular uprisings among Sinhalese youth as well as in the rise of the Tamil liberation movement.

The socialist, interventionist policies of the 1960s and 1970s fuelled inequalities by providing the opportunity for the securing of economic resources through political means, an avenue exploited by the politically dominant Sinhalese political parties and their cronies.

In more recent times, the market economy has failed to act as a moderator of the conflict. In theory a free market should allow individuals, regardless of their ethnicity or political connections, to further themselves and should minimise politically motivated interventions in the economy.

Likewise, a free market that is open to the global economy should curb ethnically discriminatory policies and create more opportunities for disenfranchised groups to take advantage of the external market.

However, this has not necessarily been the case in Sri Lanka. In fact, the SIDA report concludes quite the opposite:

‘In general, it is suggested that economic liberalisation has led to increased social tension because of persistent unemployment, trade union pressure in the face of a shrinking public sector and regional inequality.’

One of the reasons why market reforms have not worked is because the institutional framework in which the market is situated has not been reformed adequately. Unfortunately, the discriminatory political interventions that were supposed to be curbed have persisted even after reforms.

‘Since stable economic growth can take place only in a peaceful environment, a reform of the political institutions and an avoidance of regional inequality in the development process should receive top priority.’

While this conclusion seems to be clear to Ahmad, SIDA and many other foreign observers, successive Sri Lankan governments have been reluctant to enact any significant reform of Sri Lanka’s discriminatory and corrupt political institutions. Nor have they been willing it seems to correct the regional inequalities that continue to plague Sri Lanka.

The SIDA report also contains some advice for foreign donors who have helped to keep the Sri Lankan economy afloat through massive injections of aid and development loans.

‘The multi and bilateral donors should concentrate on promoting political institutions to deal with ethnic conflicts, encouraging economic activities that reduce regional disparity in income opportunities and youth employment.’

It would indeed be a boon for all Sri Lankans, not just Tamils, if this advice is followed when next President Kumaratunga goes to the ‘Paris Club’ asking for huge amounts of aid and promising, once again, to enact significant reform.

Review by Puthu Sivaguru