Working Papers in

Trade and Development

Economic Policy Shifts in Sri Lanka: The Post-

conflict Development Challenge

Prema-chandra Athukorala
and
Sisira Jayasuriya

September 2012
Working Paper No. 2012/15

Arndt-Corden Department of Economics

Crawford School of Public Policy
ANU College of Asia and the Pacific
Economic Policy Shifts in Sri Lanka: The Post-
conflict Development Challenge

Prema-chandra Athukorala
Arndt-Corden Department of Economics,
College of Asia and the Pacific
Australian National University
Prema-chandra.athukorala@anu.edu.au

and

Sisira Jayasuriya
Department of Economics,
Monash University
Sisira.Jayasuriya@monash.edu

Corresponding Address:
Prema-chandra Athukorala
Arndt-Corden Department of Economics
Crawford School of Public Policy
The College of Asia and the Pacific
The Australian National University
Coombs Building 9
Canberra ACT 0200

Email: prema-chandra.athukorala@anu.edu.au

September 2012
Working Paper No. 2012/15
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 Economic Policy Shifts in Sri Lanka: The Post-conflict Development
Challenge

Prema-chandra Athukorala
Arndt-Corden Department of Economics,
College of Asia and the Pacific, Australian National University
Prema-chandra.athukorala@anu.edu.au
and
Sisira Jayasuriya
Department of Economics,
Monash University
Sisira.Jayasuriya@monash.edu

Abstract: The end of the long civil war in Sri Lanka in 2009 generated widespread expectations of a
peace dividend that would enable Sri Lanka to embark on a period of sustained economic growth, but
recent developments have dampened that optimism, rekindling fears that Sri Lanka’s tale of missed
opportunities may continue. After showing remarkable resilience during decades of war and conflict the
Sri Lankan economy has failed to capitalise on the window of opportunity presented by the end of the
military conflict. In the aftermath of military victory, there has been a sharp reversal of trade liberalisation
and a marked shift back towards nationalist-populist state-centred economic policies, reflecting the
pressures of resurgent nationalism, an unprecedented concentration of political power in a small ruling
group, and the influence of ssome powerful vested interests. Unfortunately a return to the failed past
policies of inward oriented development strategies offers no viable solutions for the problems confronting
small, capital and resource poor countries in today’s globalised world. Sri Lanka must change both its
political practices and economic policies drastically and urgently to cope with the huge development
challenges facing it in an environment of global economic turbulence.

Key words: Sri Lanka, trade liberalization reforms, civil war, post-conflict development

JEL Codes: F13, O20, O38, O53

Forthcoming in Asian Economic Papers

1

Economic Policy Shifts in Sri Lanka: The Post-Conflict Development

Challenge1

Sri Lanka had been trapped for a quarter of a century in a long, bloody and seemingly intractable
separatist war until 2009 when the government crushed the separatist forces and achieved a
decisive military victory. This victory was widely welcomed by the majority of the Sri Lankan
population and by the international community despite unease about the conduct of the military
during the conflict. The end of the war generated a surge of optimism about the economic
prospects for Sri Lanka, with widespread expectations of a peace dividend that would enable Sri
Lanka to embark on a period of sustained economic growth.

The immediate post-conflict period appeared to validate that optimism. The government
was well entrenched with a commanding majority within the legislature and strong popular
support (at least among the majority community). It faced a deeply divided and politically
weakened opposition. Initially the international community was reluctant to subject the Sri
Lankan government to any serious political pressure over its handling of the war and reported
atrocities, though the EU decided to terminate preferential access to the EU for Sri Lankan
garment exports, and aid and assistance flowed in from traditional Western donors and
international agencies as well as from China and India. The tourist industry, which had been
heavily impacted by the war, recovered strongly. Internal political stability and the international
acceptance of the legitimacy of the government enabled the government to raise additional funds
through commercial borrowings and undertake large public expenditure programmes. It appeared
as if the window of opportunity presented by the end of conflict had been grasped by the
government to steer the country towards political reconciliation and economic growth.

1
Without implication, we thank Dushni Weerakoon for sharing her insights, data and unpublished material, and
participants at the meeting of the Asian Economic Panel, Keio University, Tokyo on 16-17 September 2011 for their
comments and suggestions.

.
2

With renewed confidence in the country, Sri Lanka experienced a substantial economic
recovery. GDP growth in 2010 reached 8%, up from 3.5% in 2009, inflation came down from
22.6 % in 2008 to 6% in 2010, unemployment fell from 5.7% in 2009 to 4.9% in 2010, the fiscal
deficit narrowed, foreign reserves went up, and the Colombo stock market, having nearly
doubled in value in 2010, was the second best performer among global markets for two years
running. But, as the large and rapidly growing literature on post-conflict recovery has shown,
though a resurgence of growth in the immediate aftermath of an end to a violent conflict is often
observed, there is no guarantee that such a recovery would be maintained over the medium to
long term. 2 In Sri Lanka’s case, it did not take long for the early optimism to fade. By 2011
developments in the economic policy front as well as in the political arena started to raise
concerns about the sustainability of the recovery. In early 2012, in the context of slowing
economic growth, a sharp deterioration of the current account and rapidly declining foreign
reserves, the authorities were compelled to undertake a series of measures that involved a
substantial devaluation of the currency, unpopular measures to curb public expenditures and
increased reliance on short term commercial borrowings in international capital markets.

In this paper we examine the Sri Lankan experience, recognising that a range of factors
including the specific historical background and the nature of social and political institutions
interact in complex ways to determine the post-conflict economic and political evolution of
countries and communities. In particular, we consider how the nature of the political coalition
that enabled the military victory has, in turn, had a major influence on the post-conflict economic
policies in ways that may undermine the country’s long term growth prospects. Though we do
not address it explicitly in this paper, the Sri Lankan experience also has relevance for the
broader debate on the role of ethnic diversity on economic development, where it has been
argued that ethno-linguistic fractionalisation and associated political polarisation results in
under-supply of public goods and higher levels of rent seeking activity. 3

The paper is structured as follows. In section 1, we provide a brief historical background

to the conflict and its economic consequences as well as the political economy context that

2
For reviews of literature, see the recent World Development Report 2011 devoted to ‘Conflict, Security and
Development’ and Coyne and Mathers (2011).
3
See for example Collier and Hoeffler (2004); Collier (1999); and Easterly and Levine (1997)
3

shapes policy making in the post-conflict period. Section 2 discusses recent macroeconomic
developments with particular attention to role of public sector investments, fiscal deficit and
external financing issues and their impact on investment and export performance. In Section 3
we discuss the relationships between these issues and the political economy context, and assess
the likely evolution of policy and medium term prospects for the economy.

Background to the Ethnic Conflict and Separatist War

The Sri Lankan separatist war that plunged the country into twenty five years of violence and
destructive conflict has complex historical, political and economic roots. It is necessary to have
some understanding of this background to understand the nature of current developments and to
assess the likely future trajectory of Sri Lanka’s political and economic evolution. 4

Sri Lanka is a small, multi-ethnic and multi-religious island nation located at the southern
tip of India, with per capita income (in 2009) of US$1990 (or in PPP terms, $4720) 5. Despite its
low income level, from the 1950s it enjoyed a reputation for having social or other human
welfare indicators such as literacy and life expectancy comparable to economies with much
higher incomes. In 2008, life expectancy was 70 for males and 78 for females, and adult literacy
was over 90%. It remains the most affluent country in South Asia in terms of both income and
broader welfare indicators with a Human Development index value of 0.658, ranked 91 overall -
but well above its South Asian neighbours – so that it is often described as the ‘best in South
Asia’. However, this masks the steady long deterioration of its relative position in Asia.

Sri Lanka ranked as one of the most prosperous and developed Asian countries in the
immediate post-independence years and well into the 1950s, with per capita income (and other
development indicators) placing it not only well above its South Asian neighbours but also ahead
of countries such as (South) Korea and Thailand (Table 1). It had a vibrant democracy, an open
economy with strong commodity exports (tea, rubber and coconut products), a high level of
4
We do not discuss in detail the complex economic, political and historical roots of the separatist struggle. A more
detailed discussion of the post-independence economic and policy history up to the early 1990s, including the
economic background to the social and ethnic conflicts that erupted in the 1970s and 1980s is in Athukorala and
Jayasuriya (1994). For discussions that focus on the socio-ethnic conflicts in Sri Lanka, see Abeyratne (2004);
Dunham and Jayasuriya (2000), Richardson 2005, Wilson (1988).
5
Figures sourced from World Bank (2011)..
4

education, an absence of extreme poverty and inequality, good physical infrastructure and
governance structures and was ‘an oasis of stability, peace and order’ (de Silva, 1982) in a region
of violent turmoil and conflict. Thus unsurprisingly it was widely seen as ‘the best bet in Asia’
(Wriggins 1960). Sri Lanka also had strong publicly funded programmes that had been initiated
during colonial rule and then extended during the late 1940s and early 1950s by the post-colonial
governments. These provided literacy, basic health care and key staple foods to the population
enabling the country to maintain and build on the already relatively healthy social indicators it
inherited from the colonial era.

But the early promise of strong economic growth was not sustained. From the mid-1950s
prices of its key export commodities began to experience a long secular decline, though
periodically interrupted by ‘tea booms’, Sri Lanka entered a period of periodic balance of
payments crisis, import restrictions and slow growth. Import restrictions, initially imposed to
address payments difficulties, became increasingly more restrictive as the development strategy
shifted to ISI policies and pervasive state interventions in the economy under the influence of so-
called ‘socialist’ populist-nationalist ideology. 6 The nationalist-populist Sri Lanka Freedom
Party (SLFP) alternated in government with the right-of-centre United National Party (UNP) that
espoused more liberal pro-market policies. By the mid-1970s Sri Lanka had become one of the
most inward oriented economies of the world, with an economy dominated by extensive state
ownership and control of major industries and extremely stringent and restrictive trade, exchange
and price controls and rationing.

Growth slowed down and virtually ceased during the early 1970s under the stresses of the
first oil and commodity price shocks. Sri Lanka rapidly fell behind the fast growing East Asian
economies (Figure 1).

The reasons for Sri Lanka’s growth slowdown have been the subject of much debate.
Many analysts, particularly those associated with international donor agencies such as the World
Bank, argued during the 1960s and particularly during the 1970s that government expenditures
on health, nutrition and education (which were often described as ‘consumer subsidies’) which
6
Sri Lanka’s strong leftwing socialist political parties were initially opposed to import restrictions on consumer
goods. However, during the 1960s they shifted their position and became ardent supporters of ISI policies
Athukorala and Jayasuriya 1994).
5

delivered high levels of social indicators were primarily responsible for the slowdown by
diverting government resources away from directly growth-oriented investments. Others have
pointed to the role such social expenditures played in maintaining political stability at low cost –
Sri Lanka’s expenditure on police and military was among the lowest in the world, and argued
that the primary cause of the slide to slow growth and stagnation was the turn away from
international trade that underpinned ISI policies, aggravated by an environment that was hostile
to long term private investment. 7

The emergence and subsequent dominance of nationalist ideology in Sri Lankan politics
also undermined the ethnic harmony that had made Sri Lanka the exception in South Asia when
violent bloodletting accompanied independence in British ruled India. Until the time of
independence all major political parties were multi-ethnic in composition and mainstream
politics was dominated by class, rather than ethnic or religious based political differences. But
my the mid-1960s all major political parties had acquired a distinct ethnic colouration as even
the two main left-wing parties that had been staunch defenders of ethnic equality gradually
embraced policies that catered to the extreme nationalistic views of the majority Sinhalese
community.

A combination of slow economic growth, rapid population growth and the state
domination of the economy led to the minority Tamil community (about 20 %) subject to
discrimination as employment avenues were increasingly subject to patronage politics and access
to political power. In the Sri Lankan system of parliamentary democracy, the preferences of the
majority Sinhala community who comprised around 70% of the population determined who won
government and controlled the state. 8

The state-bias in economic policies meant that the slow growing pool of employment was
concentrated in the state sector. The government, as was the case in many developing countries
pursuing similar policies, had become the ‘employer of last resort’ and the public sector

7
For a useful review of this debate, see Osmani (1994).
8
One of the first acts of the post-colonial government was to abolish citizenship rights and disenfranchise around a
million people of ‘One of the first acts of the post-colonial government was to abolish citizenship rights and
disenfranchise around and rubber plantations. This was opposed by leftwing parties at the time but they too came to
accept this over time.
6

outpaced the private sector in employment creation, at least in the ‘formal’ sector. The public
sector share of GDP had increased to around 15% by the mid-1970s from less than 6% in 1961
and it accounted for over 50% of employment (and 60% of value added) in the ‘organized’
manufacturing sector by the late 1970s. 9 This had a particularly severe effect on the employment
opportunities of Tamil youth because, as in many other countries in similar circumstances,
political patronage had become a major factor in public sector employment. 10 Tamil youth were
further disadvantaged in gaining public sector employment by the imposition of proficiency
requirements in Sinhalese for public sector employment and the de facto race-based quotas for
entry into higher education institutions. This deepened Tamil dissatisfaction with the Sinhalese
dominated government and political parties and provided the breeding ground for separatist
ideologies among the Tamil youth, which spawned several radical movements among whom the
‘Liberation Tigers of Tamil Eelam’ (LTTE) subsequently established its dominance.

Dissatisfaction with the economic consequences of ISI policies and slow growth were not
confined to the Tamil youth. In the late 1960s large numbers of Sinhalese youth embraced a new
radical political movement, the Janatha Vimukthi Peramuna (JVP – the People’s Liberation
Front), which was influenced by Maoism and theories of rural insurrection but also embraced
Sinhalese Buddhist nationalism. This movement organized an armed uprising of rural youth in
1971 which was brutally crushed by the government. It was not accidental that the leaderships of
both the Tamil and Sinhalese radical nationalist movements were drawn from the most
economically disadvantaged rural peasantry and fishery communities in the North in the case of
the Tamils and in the South in the case of the JVP 11; it simply reflected the fact that their
political radicalization had common economic roots.

The impact of the global recession of the early 1970s and government policy responses
led to food shortages, rationing and cuts to consumer subsidies which made the centre-left SLFP
led government extremely unpopular. A massive electoral backlash in 1977 saw a new UNP
government swept into power pledged to ‘open economic policies’.

9
See. Athukorala and Rajapatirana (2000).
10
See World Bank (1979) for a discussion of the role of political patronage in public sector employment.
11
Hettige (2004), Richardson (2005), Moore (1993), and Obeyesekere (1974).
7

The government launched a series of fundamental liberalisation policy reforms in 1977

and 1978 that marked a decisive break with decades of ISI policies. 12 With these reforms Sri
Lanka pioneered policy liberalisation in South Asia, a decade or more ahead of its neighbours.
The results of policy liberalisation, enhanced by a massive flow of aid and assistance from
international donor agencies and countries into large infrastructure projects and the establishment
of ‘free trade zones’, were dramatic.

Growth surged, from an average of 2.9% during 1970-77 to over 6% during 1978-83. Sri
Lanka attracted foreign investors into the labour intensive garments sector and this led to the
establishment of a dynamic labour intensive export industry linked to international supply
networks. The tourism sector also started to boom, and Sri Lanka appeared set to establish itself
as a prime tourist destination. Sri Lanka enjoyed the advantages of an early entrant into these
industries where it had strong natural comparative advantage. This was a golden window of
opportunity for Sri Lanka. China was yet to start its liberalisation; other countries such as India
and Vietnam were more than a decade away from such reforms. The country seemed poised to
embark on a trajectory of rapid growth that would enable it to emulate the dynamic East Asian
economies.

But this was not to be.

The new government not only failed to maintain the initial pace of liberalisation but also
diverted resources into a huge foreign aid supported public investment programme and to
employment expansion in public enterprises. Government spending rose sharply; food subsidies
were drastically cut but increases in transfers to loss making favoured state enterprises offset
these budget savings. 13 While some of the investment projects in irrigation, land development
and hydro-power power had some economic rationale, other components of this public sector
investment programme, such as the construction of a new capital and a large scale house building

12
For details on the reform process, see Rajapatirana (1989), Athukorala and Jayasuriya (1994), Moore (1997),
Dunham and Kelegama (1997), Snodgrass (1998) and Athukorala and Rajapatirana (2000).For a review of the Sri
Lankan experience with trade policy reforms from a comparative South Asian perspective, see Panagariya (2002).
13
Real government spending on food subsidies were slashed by nearly 70% during 1979-82, while annual transfers
to loss making state owned enterprises expanded; the transfer to the national airline, for example, at times exceeded
the total food subsidy during the 1980s.
8

programme, had questionable economic value. To the extent that this public sector spending
boom generated inflationary pressures and Dutch Disease effects, it undermined the impact of
trade liberalisation by weakening the incentives for growth of labour intensive export industries.

The economic policy changes were accompanied by a series of political measures that
were later to have a profound impact on the social and political environment of the country.
From the outset the new government exhibited authoritarian tendencies in the political arena.
The constitution was changed, and the Westminster system of parliamentary democracy was
replaced with a system that centralised executive power in the hands of a President. It
intimidated both Sinhala and Tamil opposition groups, at times using physical force,
disenfranchised the ex-Prime Minister, and effectively forced out the leading opposition group in
parliament - a Tamil ethnic-based party led by moderate leaders committed to non-violent
political activity. Trade unions, which had been traditionally aligned with the left parties, were
dealt a severe blow in 1980 when tens of thousands of public sector workers were dismissed for
going on strike.

In this context, ethnic tensions heightened in the country. The implementation of the
trade liberalisation policies and the composition and the regional investment focus of the public
investment programmes were perceived as discriminatory by important sections of the Tamil
minority. This was particularly the case in relation to agricultural trade liberalisation and land
development programmes. 14 The virtual expulsion of the oppositional Tamil members of
parliament, the collapse of the political influence of the left-wing parties that had abandoned
their previous opposition to Sinhala chauvinism after forming a coalition with the SLFP, and
heavy handed tactic used against Tamils protestors aggravated the alienation of the Tamil
community from the Sinhala dominated political mainstream. These led to a sharp radicalisation
among the Tamil youth and many rejected the moderate leaders of the Tamil ethnic political
parties and embraced new, radical movements committed to a separate state through armed
struggle.

An attack on security forces by an armed group of the LTTE in July 1983 led to a violent
anti-Tamil pogrom and mob attacks in the southern parts of the country, including the capital,

14
See Bandara and Jayasuriya (2009), and Dunham and Jayasuriya (2000).
9

Colombo (the ‘Black July’), producing hundreds of thousands of Tamil refugees. There were
widespread allegations of the complicity of sections of the armed forces and government
supporters in these attacks. In any case, the manner in which the riots were handled by the
government deepened Tamil resentment against the Sinhala dominated government and
sympathy and support for separatism. This was the start of the secessionist war led by the LTTE
which, until crushed by government forces in 2008, established a de facto separate state in parts
of the North and East of the country, and dominated political, social and economic life for the
next twenty five years.

The Sri Lankan experience offers some lessons of broad relevance to the debates about
economic development and ethnic diversity. The ethnic conflict with its attendant economic
costs in Sri Lanka were rooted not simply in the existence of ethnic diversity in the country but
was also the result of the embrace of ISI policies by significant sections of the political elite. If a
development strategy had been adopted that permitted greater scope for employment creation
outside the state sector, as was the case in Malaysia, the evolution of the economic and political
15
history of Sri Lanka may have been substantially different. It is not irrelevant to this issue that
until the dominance of ISI strategy in economic policies, the Sri Lankan political scene was
marked by sharp class, rather than ethnic, conflicts and polarisation.

It must be noted that the social and political tensions of the 1980s were not confined to
the Tamil community. With the eruption of the civil war and phasing out of the public sector
investment program the economy lost momentum and growth slumped. By the late 1980s,
discontent and radicalization among Sinhala youth was widespread and led to a second JVP led
armed uprising, this time on a much larger scale than in 1971, which virtually paralyzed the
Sinhalese dominated Southern parts of the country. By the time it was crushed in 1989, at a large
cost in human and economic terms, Sri Lanka had moved towards a major economic crisis that
necessitated recourse to the IMF and the implementation of a series of radical reform measures.

15
See Bruton (1992) for a comparative study of Malaysia and Sri Lanka.
10

Economy and Society: From the Second Wave of Reforms to the End of the War

This second wave of reforms marked an important watershed in the economic policy arena. It
involved an ambitious privatization programme, further tariff cuts and simplification of the tariff
structure, removing exchange controls on current account transactions and several important
liberalisation measures in the foreign investment regulations, which strengthened the outward
orientation of the economy. This package of reforms not only strengthened incentives for the
expansion of labour intensive export industries and re-infused dynamism into the economy; it
also established a policy orientation that replaced the traditional left-right ideological divide and
established a de facto consensus across the political spectrum on the basis of a pro-market open
liberal economic policy regime (Dunham and Kelegama 1997).

After 17 years in government, the United National Party (UNP) lost power at the 1994 general
elections to the Peoples’ Alliance (PA), a centre-left coalition led by the Sri Lanka Freedom
Party (SLFP) which had governed the country during most of the era of economic dirigisme.
However, there was no significant change in the broad direction of economic policies; the gains
from export-oriented industrialization had been impressive enough to set the stage for ‘leading
the left to the right’ (Moore 1997, p. 1009). Indeed, the new government extended the
privatization and deregulatory policies and pursued trade and macroeconomic policies that were
largely indistinguishable from the previous government. All in all, by the mid-1990s Sri Lanka
appeared to be ‘at the point of moving into an important policy phase marked by shifting the
agenda away from protection and towards achieving a stable and predictable economic policy
environment’ (Cuthbertson 1997, P. 47).

Over the next two decades the country experienced severe internal political instability,
the conflict with the LTTE dragged on at a huge cost to the economy 16, and the economy was
buffeted by several serious external shocks including the 1997 Asian Economic Crisis, the 2004
Asian Tsunami, surge of world oil and food prices during 2007-2008, and the global financial crisis
that followed. Nevertheless, the Sri Lankan economy demonstrated a remarkable degree of

16
Arunatilake, Jayasuriya and Kelegama (2001) estimated that the cost of the war from 1983 to 1996 was, at a
minimum, equivalent to twice Sri Lanka’s GDP. The cost during the post-1996 period, when the conflict escalated,
is likely to have been much higher.
11

resilience; GDP growth averaged 5.3% in the 1990s and 5.5% per annum during 2000-09. 17 The
Human Development index improved from 0.558 in 1990 to 0.658 in 2010 while the headcount
index of poverty came down from 22.7 in 2002 to 7.7% in 2009/10. The economy benefitted
from a strong boom in tea prices in the mid-1990s, but even allowing for that, Sri Lanka’s
growth performance during this period appears nothing short of remarkable in the circumstances.

Arguably, these reforms and the basic continuity of the policy thrust through several
changes in government were instrumental in enabling the economy to turn in this robust
economic performance. This is not to imply that government policy making during this period
was in any way the ideal. The political conditions strengthened the role and power of the state in
economic life as military expenditures and the absence of transparency in many transactions
created avenues for large scale rent extraction. Thus many privatization measures were carried
out in ways that enabled favoured businesses and government officials to engage in corrupt
practices, resulting in a public backlash against privatization that continues to influence policy
and perceptions to this day. Corruption was particularly, but not solely, associated with the
privatization process, and administrative and managerial inefficiency were pervasive. Large and
increasing defence expenditures and political constraints on government spending produced
chronic fiscal deficits and inflationary pressures throughout this period. Governments and
monetary authorities resisted currency depreciation despite serious overvaluation until compelled
to implement adjustment measures when payments problems left them no choice. 18 The trade
liberalisation process suffered a setback because of the pressure for raising additional revenue
from import tariffs to finance the ballooning war budget. The planned reduction of tariffs into a
single band had been abandoned by the late 1990s and from then on tariffs were changed
frequently in an ad hoc manner. But, despite all this, when the period as a whole is considered
taking into account the fact that this was a period of conflict and war and a time of severe stress
and uncertainty, this record of economic growth was quite impressive.

17
Data given in the paper, unless otherwise stated, are from Central bank of Sri Lanka, Annual Report (various
issues).
18
These policies precipitated capital flight and a currency crisis in 2000, a forced a steep devaluation in January
2001, followed by an IMF package; GDP growth was negative in 2001. The resulting electoral backlash led to the
defeat of the government in parliamentary elections in December 2001.
12

Despite the unsettled conditions, the reforms dramatically transformed the economic
landscape of Sri Lanka (Snodgrass 1998, Athukorala and Rajapatirana 2000, World Bank 2004).
The share of manufacturing in GDP rose from around 10% in the mid-1970s to over 20% (about
two percentage points higher than the share of agriculture) by the dawn of the New Millennium.
The export structure of the economy underwent a remarkable transformation from land-intensive,
plantation exports to labour-intensive manufacturing. The share of manufacturing in total
merchandise trade increased from 5% in the mid-1970s to over 70% in the same period, ending
the historic dependence on three primary commodities (tea, rubber and coconut products). This
successful diversification of the export structure effectively ended the prolonged (1955–1975)
deterioration of the terms of trade (Athukorala 2004). The export-oriented manufacturing sector
emerged as the major generator of employment opportunities in the economy, accounting for
over a half of total employment growth during the 1980s and 1990s. With the gradual erosion of
the dominant role of state-owned enterprises (SOE), the private sector was largely responsible
for the country’s economic dynamism. In a summing up of the Sri Lankan experience under
market-oriented policy reforms, World Bank’s Sri Lanka Development Policy Review of 2004
noted that ‘It would be hard to find a more convincing case of trade and industrial transformation
of a small island economy through market-friendly policy reforms’ (World Bank 2004). Hence
it is understandable that the end of conflict would generate much optimism about the future
trajectory of the economy, both inside and outside the country.

Against this backdrop, in the next section we will look at the post-conflict situation, including
the political context, to identify the policy challenges and assess the prospects.

Revival of Economic Nationalism

The government’s military victory in 2009 followed the election of President Mahinda Rajapakse
in a tightly contested Presidential election in 2005. The new government sharply increased the
military budget, rejected political compromises, escalated the military campaign and, supported
and assisted by the Western powers, neighbouring India and Pakistan, as well as, importantly,
China, decisively crushed the LTTE in 2009. He was acclaimed as a national hero, at least by the
13

Sinhalese majority, as the leader who liberated the country from the scourge of LTTE terrorism;
he promised the electorate that he would deliver peace and economic prosperity, the fruits of
victory, to the people who had suffered and sacrificed. On the back of the military victory,
President Rajapakse consolidated his power by calling fresh parliamentary and presidential
elections soon after, decisively defeating the opposition (and incarcerating the military
commander who after leading the campaign against the LTTE had turned against him and
challenged him for the Presidency). Immediately after the elections, the constitution was amended
removing the two-term limit on the tenure of the president (Uyangoada 2010).

In the aftermath of the military victory, the political message that came through the
various pronouncements and proclamations of the government and the leaders was the strong
assertion of Sinhala Buddhist hegemony in the socio-political life of Sri Lanka. This was also
mirrored in the economic policy statements of the government and a strident economic
nationalist rhetoric harked back to the populist programmes of the 1960s and 1970s (Government
of Sri Lanka (2010 and 2011), though prospects of an impending payments crisis had compelled
the government to enter into a Stand-By Arrangement (SBA) with the IMF in February 2009,
only a few months prior to the military victory (IMF 2012).

But this post-victory shift in economic policy rhetoric was not quite a surprise. The
medium term development strategy presented at the elections in 2005 in the Mahinda Chinthana:
Ediri Dakma (Mahinda Vision: A Vision for the Future) had already signaled a more populist
tone (Government of Sri Lanka 2006). It had proclaimed the need to achieve ‘balanced growth’,
through rapid infrastructure development of rural and conflict-affected parts of the country and
through the promotion of small and medium enterprises (SMEs), while conspicuously avoiding
any references to further liberal policy reforms. The role of the state was emphasized while
privatization of key state enterprises (banking, power, energy, transport and ports) was explicitly
ruled out. It was an eclectic program that was designed to appeal to the government core rural
constituency, as well as the military and small business, while attempting to not alienate big
business and international investors, agencies and international donors. The populist policies
received strong backing from an anti-liberalization lobby with strong vested interests and
ideological support from a group of senior academic economists who used the failure of reform
14

policies to meet initial expectations to argue that the failure of so-called ‘neo-liberal’ policies
demonstrated the need for returning to a more nationalist economic program. 19

But, as shown by the behaviour of the People’s Alliance (of which Mahinda Rajapakse
had himself been a key leader) a populist election manifesto did not necessarily mean that the
policy shifts signalled in it would be actually implemented after an election victory. In fact in
1994 the People’s Alliance had gone to the elections with an even more strongly populist
manifesto, only to continue – albeit with some minor changes in emphasis - the previous
government’s pro-market liberal policy programme once in government. When Rajapakse
became Prime Minister in 2004 (subsequently becoming President in 2006), it was not
immediately apparent that he would undertake a significant shift in overall economic policies.
Though the appointment of a close political confidante who had no banking experience or
economics background to the position of Governor of the Central Bank was a clear sign that
economic policy at every level would be subject to the political goals of the government,
government policy measures appeared to be motivated by the aim of mobilising resources for an
all-out military offensive to crush the LTTE, rather than by a significant change in economic
policy direction. It was only after the military victory in 2009 that the Rajapakse government
made its policy shift open and explicit. Clearly it felt politically strong enough to disregard both
the domestic critics of its economic policy direction and the directives of international agencies.

Purcell and Ahsan (2011) have documented how Sri Lanka systematically erected new
trade barriers through the introduction of various new import taxes, which keeping the standard
Customs Duties (which come under the surveillance of the World Trade Organisation) virtually
unchanged. 20 By 2009 the Sri Lankan tariff schedule included nine import taxes in addition to
the standard customs duty. Of these nine taxes, five were ‘Para-tariffs’: taxes applied only to
imports with no domestic equivalent, and hence added to whatever protection was provided to

19
In assessing the actual outcome, they downplayed (or overlooked) the incomplete and staggered nature of the
reform process in assessing actual outcomes (Rajapatirana 2004), while ignoring Sri Lanka’s own past experience of
failure with inward-oriented policies.

20
See also Pursell (2001a and 2011b).
15

domestic production by customs duties. These were the ports and airport development levy (5%
of the CIF value of imports), the customs (import duty) surcharge (charged as 15% of import
duty), the Export Development Board cess (ranging from 10% to 35%; levied on the CIF value
plus a 10% imputed profit margin), the regional infrastructure development levy (applied on
automobile imports as 5%, 7.5% or 10% of FOB value, based on engine capacity). The four
remaining import taxes were: the value added tax (12% to 20%), the Social Responsibility Levy
(1.5% of import duty, other import surcharges and excise duties), the national building tax (3%,
payable on a self-assessment basis by importers, manufacturers and service providers with a
quarterly turnover exceeding Rs 650,000) and excise duty (7% until 2007 and 10% since October
2007). These did have a domestic equivalent or approximately equivalent taxes; hence they were
roughly as neutral in terms of protection. In addition to these, a special commodity levy was
imposed on imports of a small number of ‘essential’ commodities.

The outcome of these various taxes and levies was a major reversal of trade liberalisation
from 2004 onwards; the total (customs duty + para-tariff) protection rates, went up slightly between
late 2002 and early 2004, but then more than doubled between 2004 and 2009 (see Table 2 for
summary of estimates by Pursell and Ahsan, 2011). The average protection rate for agriculture
increased from 28.1% to 49.6%, for industrial products from 10.7% to 24.1%, and for all imports
lines from 13.4% to 27.9%. These protection rates are not only very high by world standards, but
also show clearly that the trend towards lower average tariffs which started in about 1982 and
continued until the turn of the 20th century has been reversed. Further, the tariff structure has also
become extremely complex again with a high degree of dispersion. After allowing for para-tariffs
there are 75 different total protection rates ranging from zero to more than 90%. A large number
(42%) of industrial tariff lines have low TPRs of below 10%, while a third (32.2%) of tariff lines
have TPRs of 35% or higher, with many clustering in the range of 35% to 60%.. Almost 40% of
agricultural TRPs are within a range of 70% to 80%, while only a few (6.7%) are below 10%.

The TRPs on almost half (46.1%) of agricultural tariff lines exceed 50%, clearly breaching
Sri Lanka’s Uruguay Round commitment which bound nearly all agricultural tariffs at 50%. There
has been a notable increase in NTBs since 2000, particularly relating to agricultural products.
Politically ‘sensitive products’ such as rice, potatoes have been subjected to special import licensing
16

under which the volume of imports permitted is subject to frequent changes. As a consequence,
the trade openness of the Sri Lankan economy, measured by the trade-to-GDP ratio has been
falling for several years with a particularly pronounced fall from 2008 onwards (Figure 3).

The creeping economic dirigisme is not limited to import trade regime alone. In 2008 the
parliament passed the Strategic Development Projects (SDP) Act, empowering the minister in
charge of the Board of Investment (BOI) to grant exemption to ‘strategic development projects’
from all taxes for a period of up to 25 years. In the Act a strategic development project is
defined as be ‘a project which is in the national interest and which is likely to bring economic
and social benefits to the country and which is also likely to change the landscape of the country,
primarily through provision of goods and services which will be of benefit to the public,
substantial inflow of foreign exchange, substantial employment, and technology transfer’
(Government of Sri Lanka 2008, p. 3). This definition leaves a great deal of room for discretion
in the investment approval process. 21

Another measure affecting foreign investments has been the increase in the minimum
level of investment required for a company to qualify for a five-year tax holiday under the BOI
scheme. Up until 2010 this was US$ 500,000 but was then increased to US$ 3 Million for
projects in all sectors. This minimum threshold seems excessive when compared to that in other
countries in the region: Malaysia 65,000; Thailand 65,000; South Korea 50,000; India 2,100
(Word Bank 2010).

The privatization program was abandoned following the regime shift in 2005. Initially the
policy of the new government was not to privatize, but to restructure and improve performance of
the existing ventures, if required with private sector involvement while retaining government
ownership of at least 51%. However, following consolidation of power after the war, the
government has embarked on further expansion of the role of SOEs in the economy by re-
nationalizing of some previously privatized ventures, revitalizing closed-down SOEs, undertaking

21
Projects identified under the SDP Act are largely confined to investments in relation to information technology
and business process outsourcing, tourism and infrastructure (Ekanayake 2011).
17

new nationalizations, and setting up of new state controlled ventures. An expropriation law,
entitled ‘Revival of Underperforming Enterprises and Underutilized Assets Act’, passed in
November 2011 empowered the government to acquire and manage 37 ‘underperforming’ or
‘underutilized’ private enterprises. These enterprises (some of which are said to be profit making,
according to media commentaries), include 7 enterprises with foreign capital participation
(including Colombo Hilton).The Act thus obviously violates the existing constitutional guarantee
against expropriation of foreign owned assets. Both the Fitch Group and Moody Corporation, two
major credit rating agencies, have warned that the bill would erode investor confidence and
potentially affect Sri Lanka’s investment rating (Goodhand 2012).

Another notable recent development in the Sri Lankan policy scene which marks a clear
departure from the industrial policy over the past three decades has been the promotion of a
domestic car industry. The present cascading tariff structure in Sri Lanka, characterized by very
high import tariff on completely-built automobiles (300%) coupled with low tariffs on car parts and
components (5% to 10%), has made local assembly of certain models of automobiles highly
privately profitable. 22 In January 2010 the government introduced an excise duty rebate exception
scheme as a further incentive for such companies. Currently excise duty is charged on all vehicles
produced, assembled or imported into Sri Lanka at 25%, 48% and 65%, depending on the engine
capacity. Under this rebate scheme, automobiles assembled in Sri Lanka are eligible for complete
exemption from these duties provided the domestic content is not less than 30% of the exactor price
and the value of locally manufactured components accounts for at least half of the domestic content.
There is also anecdotal evidence that government procurement practices provide further assistance
to local automobile assemblers: a company involved in assembly of jeeps has been provided an
assured market under a sales agreement signed with the Sri Lankan Army.

22
Since 2006 four assembly plants have been set up under the approval of the Ministry of Industry and Trade. Micro Car
Company (2006), Union Enterprise (2008), Universal Auto Assembly (2008), and Frontier Automobile (2010). All
these plants are fully locally owned, but operate under licensing arrangements with car makers in China (Union
Enterprise and Frontier), Korea (Micro Car) and India (Frontier). All four firms are engaged in simple assembly of
imported completely-knocked-down (CKD) units of outdated models which have already been scrapped from their
production schedule by the parent companies.
18

Global Economic Environment and Post-Conflict Developments

By the time the war ended in 2009 the external environment had changed in an unfavourable
manner and the scope for ‘independent’ government action had significantly narrowed. The
global economy was reeling from the impact of the global financial crisis and the subsequent
recession. Sri Lanka, as a net food and energy importer had already been badly hit by the global
food price surge of 2007-08 and the high oil prices and growth had slowed in 2008. GDP growth
slumped further in 2009, falling below 4% though government spending had surged immediately
after the end of the conflict due to election spending and the demands for urgent reconstruction
expenditures. The already large fiscal deficit ballooned from 7.7% of GDP in 2008 to 9.9% of
GDP in 2009 - breaching the agreement reached with the IMF in February 2009 to cut its fiscal
deficit to 7% of GDP.

Despite this somewhat hesitant start to post-war economic recovery, Sri Lanka appeared
set to enjoy its peace dividend by 2010. The external sector (foreign reserves, export earnings)
benefitted from improved global economic conditions, domestic agricultural production
recovered thanks to better weather, tourism recorded an impressive recovery, remittances from
Sri Lankan overseas workers increased, and unemployment fell, GDP grew at 8%, and inflation
remained relatively low. The good growth performance continued through 2011, despite a sharp
weather-related fall in agricultural output. The Sri Lankan equity market boomed. 23 The
government appeared to have succeeded not only in winning the military battle but also to have
discovered a strategy for sustained economic growth.

As can be seen in Table 3, the main drivers of this GDP growth were the non-tradables
industries (construction, transport, utilities, trade and other services), reflecting the important
role of the major public sector construction and infrastructure development projects. These
sectors accounted for over two-thirds of the total increment in real GDP between 2005 and 2011.
Manufacturing grew only at a modest rate, resulting in a decline in its share in GDP from 18.5%
during 2000-04 to 17% by 2011. Within manufacturing, the largest contributor to growth was the
food, beverages and tobacco product sector where the production is predominantly domestic market

23
Coyne, Dempster and Issacs (2010) claim that movements in the Sri Lankan stock market index have been a good
indicator of the feasibility or prospects of the sustainability of peace.
19

oriented; Sectors such as textile and garment, rubber and plastic products, and non-metallic mineral
products where export production is concentrated, recorded much slower growth.24

A large scale reconstruction effort with public sector involvement was clearly necessary
after a quarter century of destruction, neglect and decay of essential physical infrastructure.
While such projects can give rise to some real exchange rate appreciation and Dutch Disease
pressures, such effects are temporary; construction and rehabilitation of infrastructure
strengthens the productive base of the economy and enables expanded production of both
tradables and non tradables, thereby delivers growth benefits over time. 25 However, many
government infrastructure projects, such as a modern port and other facilities (being built with
Chinese assistance), are located in the Southern regions of Sri Lanka - the heartland of the
electoral support base of the Rajapakse family. The prioritisation and economic efficiency of
these 'flagship projects' are questionable, and they share many similarities with some components
of the public investment programme of the UNP government of 1977.

Even when largely foreign funded, these projects pull in substantial domestic resources
for counterpart funding and contribute to the fiscal deficit. According to the IMF (2010), in 2009,
the failure to meet the deficit target was due to government spending on ‘faster than
programmed, lumpy disbursements for a couple of large foreign financed infrastructure projects
and for their counterpart funds’ (p. 4). 26 They also open up avenues for lucrative contracts and
rent extraction by those who control the levers of state power.

Inefficient public investment projects of this type may not become a major impediment to
a sustainable growth recovery if they are a minor part of the overall investment programmes and
the government is in a strong fiscal position. But this is not the case in Sri Lanka; chronic fiscal
deficits have been a feature of Sri Lanka’s macroeconomic policy environment for decades and
successive agreements with the IMF that promise deficit reduction have been breached with

24
Thus the statement made by an IMF review team in mid-2012 that ‘the sectoral composition of Sri Lanka’s economy
has not changed significantly since its last Review’ (IMF, 2012: p. 5) is not consistent with the actual data.
25
See Adam and Bevan (2006) for an analytic discussion of these issues related to inter-temporal economic impact
of public infrastructure projects.
26
http://www.imf.org/external/pubs/ft/scr/2010/cr10333.pdf
20

monotonous regularity. The consequences have been grave. They have constrained the
government’s ability to finance high priority investments in physical infrastructure, health and
education, crowded out private investment, generated inflationary pressures and real exchange
appreciation, and eroded the competitiveness of tradable sectors, contracting net exports and
giving rise to periodic payments crises and boom-bust cycles. 27

In contrast to the 1977 public sector investment boom that came in the context of a major
liberalisation programme involving a major currency depreciation – which at least partially offset
some of the negative real exchange rate appreciation pressures - the Rajapakse government’s
public investment programme was implemented with a strong Central Bank commitment to
maintain the ‘dollar value of the Rupee’ by resisting any pressures for nominal depreciation.

The results were predictable. Before long the real exchange rate appreciated placing net
exports under pressure, raising concerns about the widening of the current account. The stated
objective of government’s macroeconomic policy was to achieve a ‘stable exchange rate regime’
through appropriate coordination of exchange rate policy, and fiscal and monetary policies
(Department of National Planning 2010). But, in reality, while the Central Bank managed to
maintain a stable nominal exchange rate based on the balance of payments support provided under
the SBA, and foreign borrowing based on the market-confidence provided by the SBA, 28 fiscal and
monetary policy excesses continued to fuel domestic inflation (Figure 2).

The immediate government response was in line with its nationalist-populist policy
thrust. The government began to resort to administrative import controls in a systematic way to
address the emerging payments deficit, accelerating the trend that had been noticeable since the
election of President Rajapakse in 2005. This backsliding in trade policy is not an accident. In
fact this is quite consistent with the nationalist-populist rhetoric of the government and the
ideology espoused by its principal policy advisors. Not accidentally, these policies also favoured

27
For a discussion of some aspects of Sri Lanka’s fiscal deficits and public debt issues, see IMF (2009) at:
http://www.imf.org/external/pubs/ft/dsa/pdf/dsacr09310.pdf
28
There was also some foreign fund flows to the treasury bill market following the opening of that market to
foreign investors (with an aggregate ceiling of 10% of the outstanding treasury bill issues) (CBSL 2010).
21

the interests of business groups in import competing industries who have given strong political
support to the government.

A real exchange appreciation in a period of global economic slowdown was certainly not
good news for Sri Lanka’s net exports. In the face of a persistent erosion of the competitiveness
of tradable industries, limited trade restrictions were not sufficiently effective to address the
widening current account deficit even in the short term. Sri Lanka’s exports to GDP ratio fell
from 26% in 2005 to 17.8% in 2011. The current account deficit widened to 2.2% of GDP in
2010 and to 7.8% of GDP in 2011; it’s financing required increasing reliance on foreign non-
concessional and commercial borrowings. As a result, the share of non-concessional loans and
commercial borrowing in Sri Lanka’s outstanding foreign debt increased sharply from 7.3 per
cent in 2006 to 42.9 per cent in 2011 and its net international reserves rapidly fell to a precarious
level. The Central Bank policy of attempting to maintain the clearly over-valued currency
resulted only in the depletion of much of the foreign reserves as it was finally forced to abandon
its attempt to maintain a ‘strong Rupee’ in February 2012. The Rupee rapidly depreciated by
some 25% against the US dollar by August 2012. Whether this nominal exchange rate adjustment
would bring about necessary current account adjustment through real exchange depreciation, or
whether the country will sink into a debt trap and an eventual financial crisis, will depend on the
government’s readiness and ability to engineer necessary adjustments on the domestic fiscal front.

But this would not be an easy task. The budget deficit as a percentage of GDP increased
from 7.7% in 2008 to 9.9% in 2010, far above the 7% target for the year under the SBA. Achieving
the SBA target necessitated cutting public spending, but the government failed to resist strong
domestic pressure to increase expenditure on civil service and armed forces, which constitute
important political lobby groups. Loss-making public enterprises also continued to remain a huge
drain on the fiscal position. Notwithstanding the ballooning budget deficit, the central
government’s debt as a percentage of GDP remained within apparently manageable level (around
86%), but this was a rather deceptive indicator of fiscal health of the country: a shift in government
borrowing from relatively high-cost domestic to foreign sources combined with the ‘stable rupee
22

policy’ resulted in reduction of the external debt stock in current rupee terms.29Funds generated
through the sovereign bond issues were also used to retire part of high-interest domestic debt.
Thus three years after the end of the war, Sri Lanka faces a volatile global economic
environment with a weakened economy, policy instability, very low reserves and a historically
unprecedented level of commercial debt. Its attempt to pursue a path of nationalist populist
economic policies has led the country into a situation very different to what was anticipated by
the government and its policy advisers.

Prospects and Challenges

After showing remarkable resilience during decades of war and conflict the Sri Lankan economy
has failed to capitalise on the window of opportunity presented by the end of the military
conflict. Sri Lanka’s tale of missed opportunities continues. We have provided a brief narrative
of the outcome of the government’s attempt to follow the military victory with an economic
strategy rooted in the nationalist-populist ideology of the 1960s and 1970s. It has, as was
predictable and inevitable, ended in failure. Policies based on the past paradigm of inward
oriented, state centred and directed economic development offer no viable long term solution to
the huge challenges facing Sri Lanka or other small, capital and resource poor countries. These
policies, as we described earlier, failed not only in economic growth terms but also contributed
to the political alienation of minorities leading to violent ethnic conflicts by allowing political
patronage to influence access to employment and public infrastructure.

It would be a tragedy if Sri Lanka were to forget the bitter lessons of the past. It has
already paid a heavy price for the past missed opportunities, and past. It is no longer the
pioneering liberalising country of the late 1970s. It is now forced to compete for foreign
investment and export markets with the giant labour rich economies of China and India as well
as with countries such as Vietnam and Bangladesh. Further, it faces a global economy that is in

29
The Central Bank raised US$2000 million through sovereign bond issues during 2007-2010 at an
interest rates of 6.25-6.5% (with is almost half of the rate applicable to domestic borrowing) (CBSL 2010).
In addition there was massive borrowing from China, mostly at concessional rates, to fund infrastructure
projects.
23

deeper trouble than at any time since the 1930s. In these difficult circumstances, there is no room
anymore for using the state as the 'employer of last resort'. Sri Lanka can benefit from
continuing growth in the Asian region, but only if can articulate and implement a development
strategy that enables it to leverage its comparative advantages, attract investments and participate
in international production networks to generate productive mass employment. That requires
fundamental reforms to policy and governance structures.

But such changes will encounter resistance from powerful political economy forces.

Political power, including control over the security forces, has been concentrated to an
unprecedented degree in a small group around the President and his immediate family; this is
also the case with state finances where control over the majority of government spending is
directly in the hands of the President and his close family group. While macroeconomic
pressures can, and to some extent already have, produced some shifts in economic policy as the
political elite manoeuvres to maintain economic stability without letting go of their political
power and control over state resources that are the basis for rent extraction and political
patronage. But, particularly in the current environment of global economic instability and
shocks, sustainable long term growth requires a political regime whose commitment to
fundamental economic and political reforms will be credible and sustained. But with the situation
in Sri Lanka increasingly exhibiting striking parallels with the Marcos regime in the Philippines
and the final phase of the Suharto regime in Indonesia, the likelihood of a fundamental change in
economic policy and governance under the present regime appears very slim indeed.

The policy reforms initiated in 1977 and sustained over the next three decades produced
far-reaching changes in the structure and performance of the Sri Lankan economy, though the
country suffered from political turbulence and civil war for much of the period. But the conflicts
prevented the economy from capturing the full benefits of reintegrating with the global economy:
political instability led to policy instability, massive war financing generated macroeconomic
instability, and heightened risk perceptions dampened investor confidence. Nevertheless, trade
liberalisation enabled it to capitalize on the country’s comparative advantage in labour intensive
activities. Despite political conflicts and policy uncertainty, this policy configuration ensured
handsome profits in labour intensive export production, which is usually characterised by a short
payback period in a labour abundant economy, and fostered rapid export growth. What the Sri
24

Lankan experience over the past three decades has clearly demonstrated is that an outward-
oriented policy regime, even when severely strained by political and macroeconomic instability,
can yield a superior development outcome compared to a closed-economy regime. Viewed from
this perspective, recent developments in the policy scene do not augur well for the future of the
Sri Lankan economy.

In highlighting the importance of economic policies, we do not intend to underestimate

the need for a political process that addresses the legitimate and deep seated grievances of the
minority Tamil population to ensure a sustainable peace that is essential for economic
development. The continued incarceration of thousands, the denial of long standing demands for
regional autonomy and withdrawal of concessions that had been previously granted, the rejection
of any serious attempt to examine allegations of war crimes, and the strident assertion of the
Sinhala Buddhist pre-eminence in Sri Lanka have all contributed to a deepening sense among the
minority Tamils that they will continue to be treated as second class citizens despite the rhetoric
of reconciliation and equality of treatment. There are already signs of popular dissatisfaction
with the rising cost of living, perceived widening of inequalities, the economic and political
privileges of the political elite. 30 But, as Sri Lanka’s past history has shown, political stability
and social peace will be the first victims of economic stagnation or crisis; they can be averted
only if the current direction of both political practice and economic policy are changed sharply,
decisively and urgently.

30
In 2012 there were several instances of popular protest actions, including mass demonstrations by thousands of
workers in the export processing zones against an alleged police killing of a young worker that quickly took on anti-
government overtones and a prolonged and unprecedented strike by university academics which prompted the
government to close all universities.
25

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Uyangoda, Jayadeva (2010), ‘Sri Lanka in 2009: From Civil War to Political Uncertainty’, Asian
Survey, 50(1), 104-111.
Wilson, A. Jayatatnam (1988), The Break-up of Sri LANka: The Sinhalese-Tamil Conflict,
Honolulu: University of Hawaii Press.
World Bank (2004), Sri Lanka Development Policy Review (Report no 29396-LK), Washington,
D.C.: World Bank.
World Bank (2010), Investing Across Borders 2010: Indicators of Foreign Direct Investment
Indicators in 87 Countries, Washington, D.C.: World Bank.
World Bank (2011), World development Report 2011, Washington DC: World Bank.
Wriggins, W. Howard (1960), Ceylon: Dilemmas of a New Nation, Princeton: Princeton
University Press.
29

Table 1: Sri Lanka and Selected Asian Countries: Purchasing Power Parity GNP Relative to
USA, 1950, 1960 and 1970

1950 1960 1970

Sri Lanka 11.4 12.5 9.3
India 7.1 7.4 6.0
Pakistan 9.0 6.8 8.1
Indonesia --- 5.8 4.8
Malaysia 14.6 15.1 15.6
Philippines 10.3 11.5 10.8
Singapore --- 16.6 24.2
South Korea 7.6 8.7 12.8
Thailand 9.6 9.6 11.9

Note: --- Data not available.

Source: Kravis, Heston and Summers (1983)
30

Table 2: Sri Lanka: Unweighted Average Protection Rates1, 2002, 2004, 2009 and 2011
Customs duties Para-tariffs Total protection
rate
November 2002
Agriculture (HS 01-24) 21.1 5.2 26.3
Industry (HS 25-87)2 7.6 2.5 10.1
All tariff lines 9.6 2.9 12.5
January 2004
Agriculture (HS 01-24) 24.6 3.5 28.1
Industry (HS 25-87)2 8.8 1.9 10.7
All tariff lines 11.3 2.1 13.4
December 2009
Agriculture (HS 01-24) 24.6 25.0 49.6
Industry (HS 25-87)2 10.3 13.7 24.0
All tariff lines 12.4 15.5 27.9
January 2011
Agriculture (HS 01-24) 25.4 21.4 46.8
Industry (HS 25-87)2 9.1 10.6 19.7
All tariff lines 11.5 12.2 23.7
Notes:
1. All protection rates are percentages of cif import value.
This predominantly reflects manufacturing protection. Mining (less than 3%) accounts
for a tiny share of industrial output.
Source: Pursell and Ahsan (2011)
31

Table 3: Sri Lanka: Sectoral Composition and Growth of GDP

Composition (%) Growth
2011 2010 2011
Agriculture 11.2 7.0 1.5
Tea 1.0 13.8 -0.9
Paddy 1.5 17.5 -8.4
Other food crops 3.6 4.4 2.5
Industry 29.3 8.4 10.3
Manufacturing 17.3 7.3 7.9
Construction 7.1 9.3 14.2
Services 59.5 8.0 8.6
Wholesale and retail trade 23.6 7.5 10.3
Transport and communication 14.3 11.9 11.3
Banking, insurance and real estate 8.8 7.5 7.9
Government services 7.1 5.4 1.2

Source: IPS (2012) based on Central Bank of Sri Lanka, Annual Report, various years.
32

Source: Based on data compiled from World Bank, World Development Indicators database.
33

Figure 2: Trade Orientation of the Sri Lankan Economy, 1959-2010 (%)

80.0

70.0

60.0

50.0
Trade/GDP (%)

40.0

30.0

20.0

10.0

0.0
1959
1961
1963
1965
1967
1969
1971
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
Source: based on data compiled from Central bank of Sri Lanka, Annual Report (various years)
34

Figure 3: Sri Lanka: Real exchange rate and its components, 2004Q1 – 2012Q2

170
Nonenal effective exchnage rate (NER)

150 Real exchnage rate (RER)

Relative price (RP)

130

110

90

70

50
2004Q1
2004Q2
2004Q3
2004Q4
2005Q1
2005Q2
2005Q3
2005Q4
2006Q1
2006Q2
2006Q3
2006Q4
2007Q1
2007Q2
2007Q3
2007Q4
2008Q1
2008Q2
2008Q3
2008Q4
2009Q1
2009Q2
2009Q3
2009Q4
2010Q1
2010Q2
2010Q3
2010Q4
Notes:
NER: trade weighted nominal exchange rates relating to 24 top trading-partner countries
(measured as foreign currency units per rupee)
RP: trade weights relative price (measured by the consumer price index) between Sri Lanka and
its 24 top trading partners
RER = NER*RP; an increase indicates appreciation.

Source: Compiled from Central bank of Sri Lanka, Annual Report (various issues).
35

Figure 4: Sri Lanka’s International Reserves (in Billions of US$

Source: IMF (2012)

 Working Papers in Trade and Development
List of Papers (including publication details as at 2012)

10/01 PREMA-CHANDRA ATHUKORALA, ‘Trade Liberalisation and The Poverty of Nations:

A Review Article’

10/02 ROSS H McLEOD, ‘Institutionalized Public Sector Corruption: A Legacy of the Soeharto
Franchise’

10/03 KELLY BIRD and HAL HILL, ‘Tiny, Poor, Landlocked, Indebted, but Growing: Lessons
for late Reforming Transition Economies from Laos’

10/04 RAGHBENDRA JHA and TU DANG, ‘Education and the Vulnerability to Food
Inadequacy in Timor-Leste’

10/05 PREMA-CHANDRA ATHUKORALA and ARCHANUN KOHPAIBOON, ‘East Asia in

World Trade: The Decoupling Fallacy, Crisis and Policy Challenges’

10/06 PREMA-CHANDRA ATHUKORALA and JAYANT MENON, ‘Global Production

Sharing, Trade Patterns and Determinants of Trade Flows’

10/07 PREMA-CHANDRA ATHUKORALA, ‘Production Networks and Trade Patterns in East

Asia: Regionalization or Globalization?

10/08 BUDY P RESOSUDARMO, ARIANA ALISJAHBANA and DITYA AGUNG

NURDIANTO, ‘Energy Security in Indonesia’

10/09 BUDY P RESOSUDARMO, ‘Understanding the Success of an Environmental Policy: The

case of the 1989-1999 Integrated Pest Management Program in Indonesia’

10/10 M CHATIB BASRI and HAL HILL, ‘Indonesian Growth Dynamics’

10/11 HAL HILL and JAYANT MENON, ‘ASEAN Economic Integration: Driven by Markets,
Bureaucrats or Both?

10/12 PREMA-CHANDRA ATHUKORALA, ‘ Malaysian Economy in Three Crises’

10/13 HAL HILL, ‘Malaysian Economic Development: Looking Backwards and Forward’

10/14 FADLIYA and ROSS H McLEOD, ‘Fiscal Transfers to Regional Governments in

Indonesia’

11/01 BUDY P RESOSUDARMO and SATOSHI YAMAZAKI, ‘Training and Visit (T&V)
Extension vs. Farmer Field School: The Indonesian’

11/02 BUDY P RESOSUDARMO and DANIEL SURYADARMA, ‘The Effect of Childhood

Migration on Human Capital Accumulation: Evidence from Rural-Urban Migrants in
Indonesia’

11/03 PREMA-CHANDRA ATHUKORALA and EVELYN S DEVADASON, ‘The Impact of

Foreign Labour on Host Country Wages: The Experience of a Southern Host, Malaysia’
11/04 PETER WARR, ‘Food Security vs. Food Self-Sufficiency: The Indonesian Case’

11/05 PREMA-CHANDRA ATHUKORALA, ‘Asian Trade Flows: Trends, Patterns and

Projections’

11/06 PAUL J BURKE, ‘Economic Growth and Political Survival’

11/07 HAL HILL and JUTHATHIP JONGWANICH, ‘Asia Rising: Emerging East Asian
Economies as Foreign Investors’

11/08 HAL HILL and JAYANT MENON, ‘Reducing Vulnerability in Transition Economies:
Crises and Adjustment in Cambodia’

11/09 PREMA-CHANDRA ATHUKORALA, ‘South-South Trade: An Asian Perspective’

11/10 ARMAND A SIM, DANIEL SURYADARMA and ASEP SURYAHADI, ‘The

Consequences of Child Market Work on the Growth of Human Capital’

11/11 HARYO ASWICAHYONO and CHRIS MANNING, ‘Exports and Job Creation in
Indonesia Before and After the Asian Financial Crisis’

11/12 PREMA-CHANDRA ATHUKORALA and ARCHANUN KOHPAIBOON, ‘Australia-

Thailand Trade: Has the FTA Made a Difference?

11/13 PREMA-CHANDRA ATHUKORALA, ‘Growing with Global Production Sharing: The

Tale of Penang Export Hub’

11/14 W. MAX CORDEN, ‘The Dutch Disease in Australia: Policy Options for a Three-Speed
Economy’

11/15 PAUL J BURKE and SHUHEI NISHITATENO, ‘Gasoline prices, gasoline consumption,
and new-vehicle fuel economy: Evidence for a large sample of countries’

12/01 BUDY P RESOSUDARMO, ANI A NAWIR, IDA AJU P RESOSUDARMO and NINA L
SUBIMAN, ‘Forest Land use Dynamics in Indonesia’

12/02 SHUHEI NISHITATENO, ‘Global Production Sharing in the Japanese Automobile

Industry: A Comparative Analysis’

12/03 HAL HILL, ‘The Best of Times and the Worst of Times: Indonesia and Economic Crises’

12/04 PREMA-CHANDRA ATHUKORALA, ‘Disaster, Generosity and Recovery: Indian

Ocean Tsunami’

12/05 KYM ANDERSON, ‘ Agricultural Trade Distortions During the Global Financial Crisis’

12/06 KYM ANDERSON and MARKUS BRUCKNER, ‘Distortions to Agriculture and

Economic Growth in Sub-Saharan Africa’

12/07 ROBERT SPARROW, ELLEN VAN DE POEL, GRACIA HANDIWIDJAJA, ATHIA

YUMNA, NILA WARDA and ASEP SURYAHADI, ‘Financial Consequences of Ill Health
and Informal Coping Mechanisms in Indonesia’
12/08 KYM ANDERSON, ‘Costing Global Trade Barriers, 1900 to 2050’

12/09 KYM ANDERSON, WILL MARTIN and DOMINIQUE VAN DER MENSBRUGGHE,
‘Estimating Effects of Price-distorting Policies Using Alternative Distortions Databases’

12/10 W. MAX CORDEN, ‘The Dutch Disease in Australia: Policy Options for a Three-Speed
Economy’ (revised version of Trade & Development Working Paper 2011/14)

12/11 KYM ANDERSON, ‘Policy Responses to Changing Perceptions of the Role of Agriculture
in Development’

12/12 PREMA-CHANDRA ATHUKORALA and SHAHBAZ NASIR, ‘Global Production

Sharing and South-South Trade’

12/13 SHUHEI NISHITATENO, ‘Global Production Sharing and the FDI–Trade Nexus: New
Evidence from the Japanese Automobile Industry’

12/14 PREMA-CHANDRA ATHUKORALA, ‘Sri Lanka’s Trade Policy: Reverting to

Dirigisme?’

12/15 PREMA-CHANDRA ATHUKORALA and SISIRA JAYASURIYA, ‘Economic Policy

Shifts in Sri Lanka: The Post-conflict Development Challenge