Sri Lanka chased out of Eden by Greedy Elite

Long known as Serendip by Arab traders, the “discovery” of Sri Lanka by Europeans gave rise to the delightful term “serendipity”. Renowned as a “Garden of Eden” for centuries, it then saw an exemplary example of “social democracy” in the post-colonial world with extraordinary social services.

Once the envy of other developing countries, particularly in Asia and Africa, its ruling class has long been its downfall. The slow but steady weakening of this early post-colonial order allowed for new rapacious elites.

Pioneer of “neoliberalism”

Until the mid-1970s, Sri Lanka’s mixed economy spent more than most developing countries on social benefits. After rising oil prices and global stagflation, and before Margaret Thatcher and Ronald Reagan, the country’s first executive president, Junius Jayawardene, pioneered “neoliberal” reforms from 1977.

Along with the deregulation of the economy and drastic cuts in government social spending, it experienced premature deindustrialization, with the share of manufacturing output falling from 22% in 1977 to 15% in 2017.

“Economic liberalization has led many import-substituting industries to shut down [and] …caused the collapse of the domestic loom sector, in which women predominated. By 1986…more than 120,000 jobs had been lost,” according to researcher Balasingham Skanthakumar.

Government tax revenue fell from 18.4% of national income in 1990-92 to 12.7% in 2017-2019, and a pandemic nadir of 8.4% in 2020. Non-tax revenue – mainly from state-owned enterprises – fell by more than half.

The island’s export/production ratio fell from 39% in 2000 to 20% in 2010 and 17% in 2020. From 2000, foreign direct investment remained below 1.8% of production, before fall to 0.5% in 2020.

The island’s economic growth has declined since 2012, compounded by declining investment, exports and government revenue. A $1.5 billion bailout from the International Monetary Fund in 2016 necessitated austerity measures, cutting government spending, hurting growth and welfare.

After the abrupt end of ethnic conflict in the north a decade ago, precious government spending went to massive questionable infrastructure projects that enriched the corrupt ruling elite, not education and healthcare.

The share of pre-tax income of the top 1% has risen from 14.9% in 1980 to 20.6% in 2021, while that of the bottom half has fallen from 16.6% to 14.1%. The wealth share of the top 1% has fallen from 25.8% in 1995 to 31.5% in 2021, while that of the bottom half has fallen from 4.6% to 3.7%.

Meanwhile, the Gini measure of income inequality has risen sharply, from 0.325 in 1985 to 0.514 in 2018. Instead of tackling growing inequality, government policies have made it worse, fueling social unrest, met by increasing repression.

Two recent developments have made matters worse. First, bombings of churches and luxury hotels in Colombo in April 2019 drastically reduced tourist arrivals by four-fifths before the pandemic, significantly reducing foreign exchange earnings.

The pandemic has hurt not only economic activity, but also foreign exchange reserves to pay exorbitant prices for tests, treatments, equipment, vaccines and other COVID-19 related needs.

Tax cuts galore

The ethno-populist policies of many successive governments have added fuel to the fire. Securing political support by cutting taxes, they succeeded in mobilizing majority Sinhalese Buddhist sentiment against Tamils, Muslims and Christians.

The government cut taxes at all levels, collecting only 12.7% of national income in revenue in 2017-2019, one of the lowest shares among developing countries. Taking inspiration from former President Donald Trump, this ratio fell to 8.4% in 2020.

A man wears a headband with a slogan as he waves the Sri Lankan national flag in Colombo on July 17, 2022.
ARUN SANKAR/AFP via Getty Image

Its value added tax rate was reduced from 15% to 8%, while the business registration threshold was raised from 1 to 25 million Sri Lankan rupees per month. Other taxes and the “pay-as-you-earn” system have been abolished.

The minimum income tax threshold has been raised from 500,000 Sri Lankan rupees a year to 3 million, and few earn that much. Personal income tax rates have not only been reduced, but have also become less progressive.

The corporate tax rate has been reduced from 28% to 24%. With a one-third drop in taxpayers between 2019 and 2020, the tax base has shrunk.

As more of the population paid less tax, the government’s popularity grew, especially among the middle class. As elsewhere, tax cuts have not stimulated investment and growth.

As falling tax revenues squeeze government revenue and spending, foreign borrowing — at higher rates, with shorter maturities — has increasingly financed budget deficits.

Debt in default

In recent months, the island nation has defaulted on its foreign debt for the first time ever. As increasingly expensive commercial debt grew, the dollar-denominated share of its external debt rose sharply, from 36% in 2012 to 65% in 2019.

In the New Cold War, its predicament was mistakenly attributed to a Chinese “debt trap”. China has undoubtedly been the last source of new “official” debt, but China’s share of its external debt is around one-tenth. Unsurprisingly, independent studies have found no truth to the Chinese debt trap story.

Faced with currency and budget constraints, the government declared a 100% “organic farming” nation in April 2021. The ban on all fertilizer imports worsened the perfect storm that was looming.

Abandoned in November, the policy drastically reduced agricultural production, necessitating more food imports. Falling tea and rubber production have also reduced export earnings, exacerbating foreign exchange shortages.

Instead of directly addressing the cumulative challenges faced, massive foreign borrowing from commercial sources (accounting for almost half of public debt), with shorter maturities and higher interest rates, has enabled choices of “fiscal populist” policy. But it effectively threw the box down the road, exacerbating the inevitable collapse.

Anis Chowdhury, Adjunct Professor, Western Sydney University (Australia), held senior positions at the United Nations from 2008 to 2015 in New York and Bangkok.

Jomo Kwame Sundaram, a former economics professor and United Nations Under-Secretary-General for Economic Development, received the Wassily Leontief Prize for Advancing the Frontiers of Economic Thought in 2007.

The opinions expressed in this article are those of the authors.

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