Elephants, cinnamon, areca nuts, pearls, gems, tobacco, shells, coconuts, coconut oil and arrack were Sri Lanka’s main exports in the sixteenth century, mainly to India and cinnamon and spices to Europe. By the early seventeenth century, Sri Lanka was split into two political units; the Portuguese controlled coastal districts and a few ports, and the interior was ruled by the Kandyan Kingdom.

Rice and some textile imports from India supplied the coastal settlements. The Portuguese monopolised the prized cinnamon trade, but they and the Dutch, who subsequently occupied the coastal belt, allowed the rice trade to continue, only controlling the spice trade, which had high European demand.

In many ways, the trade history of rice explains how Sri Lanka squashed free markets and killed enterprises, thereby misallocating capital since its people gained self-determination 75 years ago.

Sri Lanka’s long history of importing rice was also profitable for occupiers, who taxed the import trade. Around half of the island’s rice requirement was locally farmed, and the rest was imported. Imports supplied coastal areas, and the coffee plantation workforce while the locally farmed crop was consumed in the villages.

After British intervention in economic activity ended in 1833 as part of wide-ranging reforms reflecting a changed attitude towards the economy by the state, rice imports grew fivefold to five million bushels (1 bushel = 25.4 kgs) in the 25 years to 1865.

After the British granted self-determination to the people and left in 1948, Sri Lanka’s elected leaders were more statist than the British after 1833. They believe that industrial policy, protectionism and hand-outs are efficient ways to allocate limited resources and capital and that it would lead to economic prosperity.

Policies were both led by a belief that free trade hurts people and the self-serving need to gain and hold power. Governments led by the United National Party, the Mahajana Eksath Peramuna, and the SLFP, all tried to outdo each other on how much free rice they could distribute. It all culminated in 1970 when on the campaign trail the SLFP’s Sirimavo Bandaranaike promised free rice even if it had to be brought from the moon (see chart 1). However, providing two measures of rice (0.9kg) per person per week proved too much.

Today, local rice production meets almost the entire local demand. However, during most of the 20th century, Sri Lanka imported almost 50% of the demand. In the 1950s, when the population was 8 million, not just rice but half of Sri Lanka’s food was imported (See chart 2).

Importing food itself is not a problem. Sri Lanka had been importing rice for several centuries before 1948. However, utilising government revenue earned mostly by taxing external trade to import rice for free distribution to the entire population was a massive resource misallocation. By 1970, after paying for the imported rice distributed for free, the government had virtually no resources left for investment. Private investment was discouraged, exports were taxed and businesses were taken over by the state. Starved of investment and enterprise Sri Lanka entered a dark period.

Historians date the years around the mid-eighteenth and early-nineteenth centuries, as when the first and second Industrial Revolutions took place in Britain. Leaps in technology, ambition and wealth then enabled Britain to war, coerce and deceive its way across the world to source raw materials, and new markets and flex its geopolitical ambitions.

Not long after arriving in Sri Lanka in 1796 the British established contact with the king in Kandy and contracted to replace the Dutch as protectors. In less than two decades the British supplanted both the occupying Dutch and the Kandyan kingdom. Britain and several other powerful European bullies carved out fiefs all over the world.

Economic logic suggests that backward countries might borrow the know-how and learn from the mistakes of those successful ones to emulate and even surpass them, even when they were previously subjugated. Some of the UK’s former overseas territories have done just that.

To remove the distortionary effect of exchange rates economists use GDP per capita on a purchasing power parity (PPP) to compare the standing of economies. Put simply, the market exchange rate will indicate how many Sri Lankan rupees can be had for 1,000 British Pounds. On the other hand, PPP exchange rates indicate how many Rupees will be required in Sri Lanka to buy a typical basket of products and services worth 1,000 British pounds.

In GDP per capita purchasing power parity (PPP) terms, the economies of the United States, Australia, Canada and Singapore, all occupied by Britain at some point in the last two hundred years, have surpassed the United Kingdom. Singapore’s GDP per capita, measured at purchasing power parity, at $116,000 was 120% more than the UK’s, in 2021.

Sri Lanka’s per capita GDP at purchasing power parity of $14,700, is only 29% of the UK’s.

The principal reason for the acceleration of poorer countries is their higher returns on capital compared to rich ones, which led to more investment, thereby generating higher economic growth rates. However, investors will not flock to all poor countries to take advantage of the returns arbitrage. Large flows of globally mobile investment capital require several other factors before they will find higher returns attractive.

On the eve of the British abandoning South Asia, Sri Lanka had many things in its favour not limited to its young and growing population, the region’s best infrastructure and self-government

On the eve of the British abandoning South Asia, Sri Lanka had many things in its favour not limited to its young and growing population, the region’s best infrastructure and self-government. In the later decades its educated workforce, good primary healthcare and electrification spread the wealth.

Chart 1

POLITICAL REGIMES, ELECTION PLEDGES AND POLICY ON RICE

For several decades following the end of the British occupation, Sri Lanka offered free or subsidized rice to the entire population

However, in the last three decades, capital seeking higher returns bypassed Sri Lanka for South East Asia. Sri Lanka, after failing to catch up with the UK is now losing ground to the best in Asia. Vietnam’s rise is a case in point. In 1990 Sri Lanka’s GDP per capita in PPP terms was double that of Vietnam’s at 2,385 dollars. According to estimates for 2022, Sri Lanka’s GDP per capita in PPP terms of $17,000 will only be 9% higher (See chart 3). If as forecast Sri Lanka’s economy contracts in 2023, Vietnam, which is a $366 billion economy, will overtake Sri Lanka measured at purchasing power parity.

Away from the headlines, Sri Lanka faces a slow burning malaise: its weak economic growth. Productivity of labour, land and capital, the rich world’s ultimate source of high living standards, is at a slow burn rate of growth. Sri Lanka’s labour productivity growth from June 2013 to September 2022, was at an annual rate of 1.62% (See chart 4).

Chart 2

RICE FARM PRODUCTIVITY

Food imports as a % of total imports

What economists refer to as GDP growth is generated by funnelling in labour and capital (land too can be a factor of production in some cases) to output consumer goods and services that contribute to people’s living standards. There are two ways to increase the output of consumer goods and services. The first is to allocate more labour and capital.

The second, and more long-term growth-generating system, is to improve the efficiency of how labour and capital are combined, for greater output from the same inputs. Economists refer to this combination as total factor productivity (TFP) and more loosely as technology or knowledge. The theory goes that to effectively combine the factors of production at speed and scale (efficiently), depends on such factors as the skill and education level of the workforce, the quality of managers and scientific know-how.

Countries with high living standards, combine the factors of production efficiently. It’s a virtuous cycle, the better a country is at TFP the more globally competitive its consumer goods and services become, winning market share and premiums at the expense of producers in other places. The opposite; a vicious cycle is also true when inefficiency leads to a higher cost of capital and labour that flees to other markets.

Chart 3

LOSING GROUND

Sri Lanka vs Vietnam GDP per capita PPP, current international $’000

While total factor production is difficult to measure, its outcome global competitiveness in exports is measurable. Sri Lanka’s export competitiveness and by extension the competitiveness of its consumer goods makers and services firms have been eroding for decades. From a height equivalent to 39% of GDP in 2000, exports in 2021 have fallen to 16.9% equivalent by 2021. Ironically Sri Lanka’s economy’s forecast shrinking by 9.2% in 2022 and 4.2% in 2023 (according to the World Bank) will grow the share of exports in the economy. In contrast, it exported the equivalent of 93% of its GDP in 2021. Investors are rushing to establish a production and services base in Vietnam. For the last 25 years Vietnam has on average attracted the equivalent of 6% of its GDP in foreign direct investment. In Sri Lanka, the number is 1.5%.

Data shows that Sri Lanka’s stagnation accelerated in the late 1990s. Declining GDP means faltering faith in free markets and limited money for public services. Such states become sidelined. Limited resources fire up populism that turns politics toxic. Populism then leads to an ugly fight about identity.

As new investment dries up, as has happened in Sri Lanka, it leads to an entrenching of tired and inefficient old businesses and institutions, less money for public service and faltering faith in free markets. As vicious cycles go, politics, bureaucracy and businesses become impossible to dislodge out of their feeble productivity. The inefficiency and the lack of growth drive people, and capital away, thus reducing the inputs available for total factor productivity. Sri Lanka is now living through this limited opportunity to flourish.

Chart 4

LABOUR PRODUCTIVITY

Sri Lanka’s labour productivity growth, % change quarter on quarter

Politics is increasingly an arms race, with pledges of more money for security, healthcare or handouts, depending on the mood. While people view handouts and security as necessary; it comes with downsides. When handouts, like free rice, are offered or people work in areas where there are few productivity gains, improvements in living standards are harder to induce.

Sri Lanka’s advantages from its geographical location to a relatively educated workforce have not gone away. However, under dishonest, incompetent and unserious, leaders Sri Lanka is inflicted with high barriers to trade and enterprise, depleted resources on unproductive state-owned ventures and now faces an ageing electorate.

For their success politicians are concerned with preventing bad things from happening to people and compensating them, when they do. However, the free imported rice experiment from 1948 to 1977 should have been a lesson to Sri Lanka’s boosterish politicians.

Facing a crisis, the government, in 1977, diverted resources away from free rice to infrastructure. It accelerated a massive irrigation and electricity generation infrastructure build called the Mahaweli. Free markets were let to determine prices including that of rice. Investment flowed into agriculture, mostly in rural areas, into new and existing farms and rice and other crops output grew, as productivity and inputs rose. Within a few years, families that depended on free rice found plenty of affordable rice to buy in the market. From 1975 when food was 50% of total imports, it declined to 20% by 1980.

Sri Lanka, admired for its economic potential in 1948, made a hash of that opportunity because its leaders misallocated resources. Its second opportunity came at the beginning of the 1990s to join global supply chains, as China, Vietnam and others have done. That opportunity was also passed.

Sri Lanka’s 52 largest state-owned enterprises lost a staggering Rs800 billion in 2022. For perspective, the forecast government revenue from PAYE tax in 2023 is just Rs100 billion.

No one cheers when a family falls into poverty or small business shutters. But sustaining handouts, bailouts, and government inefficiency is the thin end of the wedge.

If Sri Lanka is to avoid a bleak future it must grasp reform. This will require leaders with vision and courage and an electorate that will suck it up until the hard work is done.