Long known as Serendip by Arab traders, the "discovery" of Sri Lanka by Europeans spawned the delightful term "serendipity." Reputed as a "Garden of Eden" for centuries, it later saw an exemplary instance of "social democracy" in the post-colonial world with extraordinary social services.
Once the envy of other developing countries, especially in Asia and Africa, its ruling class has long been its undoing. The slow, but steady undermining of this early post-colonial order has enabled rapacious new elites.
Pioneering "Neoliberalism"
Until the mid-1970s, Sri Lanka's mixed economy spent more than most developing countries on social provisioning. Following oil price hikes and global stagflation, and before Margaret Thatcher and Ronald Reagan, the country's first executive President Junius Jayawardene pioneered "neoliberal" reforms from 1977.
Besides deregulating the economy, and drastically cutting government social spending, it experienced premature deindustrialization, with manufacturing's share of output falling from 22 percent in 1977 to 15 percent in 2017.
"Economic liberalization drove many import-substituting industries into closure [and] ... caused the collapse of the domestic handloom sector, in which women predominated. By 1986 ... over 120,000 jobs had been lost," according to researcher Balasingham Skanthakumar.
Government tax revenue fell from 18.4 percent of national income in 1990-92 to 12.7 percent in 2017-19, and a 8.4 percent pandemic nadir in 2020. Non-tax revenue—mainly from state-owned enterprises—dropped by more than half.
The island's exports/output ratio fell from 39 percent in 2000 to 20 percent in 2010 and 17 percent in 2020. From 2000, foreign direct investment remained under 1.8 percent of output, before falling to 0.5 percent in 2020.
The island's economic growth has declined since 2012, worsened by declining investments, exports and government revenue. An International Monetary Fund $1.5 billion rescue package in 2016 required austerity measures, squeezing government spending, hurting growth and welfare.
After the ethnic conflict in the north was brutally ended a decade ago, precious government spending went to dubious massive infrastructure projects enriching the corrupt ruling elite, not education and health care.
The pre-tax income share of the top 1 percent rose from 14.9 percent in 1980 to 20.6 percent in 2021, while the bottom half's fell from 16.6 percent to 14.1 percent. The top 1 percent's wealth share rose from 25.8 percent in 1995 to 31.5 percent in 2021, as the bottom half's dropped from 4.6 percent to 3.7 percent.
Meanwhile, the Gini measure of income inequality rose sharply from 0.325 in 1985 to 0.514 in 2018. Instead of addressing rising inequality, government policies have worsened it, fueling social unrest, met by increasing repression.
Two recent developments made things worse. First, bomb blasts in Colombo churches and luxury hotels in April 2019 drastically cut tourist arrivals by four-fifths before the pandemic, slashing foreign exchange earnings.
The pandemic has hurt not only economic activity, but also foreign exchange reserves to pay exorbitant prices for COVID-19 tests, treatments, equipment, vaccines and other needs.
Tax Cuts Galore
Ethno-populist policies of many successive governments have added fuel to fire. Securing political support by cutting taxes, they successfully mobilized majority Buddhist Sinhalese sentiment against Tamils, Muslims and Christians.
The government cut taxes across the board, collecting only 12.7 percent of national income in revenue in 2017-19—one of the lowest shares among developing countries. Taking a cue from former President Donald Trump, this ratio fell to 8.4 percent in 2020.
Its value-added tax rate was cut from 15 percent to 8 percent, while the business registration threshold was raised from 1 to 25 million Sri Lankan rupees monthly. Other taxes and the "pay-as-you-earn" system were abolished.
The minimum income tax threshold was raised from 500,000 Sri Lankan rupees annually to 3 million, with few earning so much. Personal income tax rates were not only cut, but also became less progressive.
The corporate income tax rate was cut from 28 percent to 24 percent. With a one-third drop in taxpayers between 2019 and 2020, the tax base shrank.
As more of the population paid less tax, the government's popularity rose, especially among the middle class. As elsewhere, the tax cuts failed to spur investment and growth.
With declining tax collection squeezing government revenue and spending, foreign borrowing—at higher rates, with shorter maturities—increasingly financed budget deficits.
Defaulting Debt
In recent months, the island nation has defaulted on its foreign debt for the very first time. As more costly commercial debt loomed ever larger, the dollar denominated share of its foreign debt rose sharply from 36 percent in 2012 to 65 percent in 2019.
In the new Cold War, its predicament has been misleadingly attributed to a Chinese "debt trap." China has undoubtedly been the latest source of new "official" debt, but China's share of its foreign debt is about a tenth. Unsurprisingly, independent studies have found no truth to the Chinese debt trap story.
Facing foreign exchange and budget constraints, the government declared a 100 percent "organic farming" nation in April 2021. Banning all fertilizer imports compounded the looming perfect storm.
Dropped in November, the policy drastically cut agricultural output, with more food imports becoming necessary. Falling tea and rubber output also reduced export earnings, exacerbating foreign exchange shortfalls.
Instead of squarely addressing cumulative challenges faced, massive foreign borrowing from commercial sources (accounting for nearly half the public debt), with shorter maturity and higher interest rates, has enabled "fiscal populist" policy choices. But, this has effectively kicked the can down the road, exacerbating the inevitable meltdown.
Anis Chowdhury, adjunct professor, Western Sydney University (Australia), held senior United Nations positions during 2008-2015 in New York and Bangkok.
Jomo Kwame Sundaram, a former economics professor and United Nations assistant secretary-general for economic development, received the Wassily Leontief Prize for Advancing the Frontiers of Economic Thought in 2007.
The views expressed in this article are the writers' own.
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