Is the Sri Lankan economy caught in a “Middle Income Trap”? Some economists have put forward the hypothesis that when a country achieves middle income level there are inherent reasons that trap the economy from further growth. It provides an “explanation” for slow economic growth after a spell of rapid growth. Is Sri Lanka’s economic [...]


Middle-income trap or debt trap?


Is the Sri Lankan economy caught in a “Middle Income Trap”? Some economists have put forward the hypothesis that when a country achieves middle income level there are inherent reasons that trap the economy from further growth. It provides an “explanation” for slow economic growth after a spell of rapid growth. Is Sri Lanka’s economic growth slowing down due to this “Middle Income Trap”?

What is the “Middle Income Trap”? It is a hypothesis that countries achieve rapid growth and move away from poverty, but that there are inherent reasons why they are unable to move into high per capita countries. Countries that have escaped poverty, it postulates, find difficulty in achieving prosperity.

A reason adduced for this is that it is easy for countries to increase per capita incomes initially as this could be achieved with low technologies and low wages. Countries lose the advantage of low wages and are unable to move up the technology ladder. As wages rise, structural changes are needed to maintain the momentum of growth. A country may have a technology gap that could make it uncompetitive in international markets.


However not all countries fall into such a trap. China that has grown at a rapid pace in the last two decades has slowed down, but there is no evidence that it is caught up in a “Middle Income Trap”. A slower growth is quite understandable owing to global conditions that decelerated growth of external markets, on the one hand, and changes within the economy such as the rise in wages. Yet China has a technological capacity and economic system that can sustain an economic momentum. Its pragmatic policies and fundamental strengths would sustain economic growth.


While India, too, has fundamental strengths such as its technical capacity, it has political constraints. The disadvantages of an unstable government and prospects of a reversal of its reform programmes that could accelerate growth are possible setbacks. Despite impressive economic growth and a reduction in poverty levels, the number of poor households is high. Social tensions, industrial disruptions and political instability are obstacles to economic growth. These rather than their middle income levels could deter rapid economic growth.

In neither of these countries and indeed in other fast developing East Asian countries is there evidence that the slowing down of economic growth is a result of their achieving middle income levels. The London Economist in a recent article reviewing the theory said: “… is the middle-income trap worthy of the name? Is there something especially treacherous about the levels of development that China is now approaching? Despite the term’s popularity, the theory and evidence behind it are surprisingly thin.”

No doubt as an economy develops there are problems that are inimical to growth. Shortages of labour of the required types and skills could be a bottleneck. There is a rise in wages due to increases in costs of living and attractions of workers to other countries that pay higher wages. Countries that neglect social infrastructure, especially education, could find themselves unable to diversify into hi-tech industry and services. These are problems arising from a lack of strategies for long run growth rather than due to a “Middle Income Trap”.

Sri Lanka’s experience

In both China and India, rapid growth resulted in large trade surpluses, huge foreign reserves and investments abroad. In contrast, our economic growth led to massive trade deficits, inadequate foreign reserves, large scale borrowing, high fiscal deficits, increases in public debt and heavy debt servicing costs. All these weaken economic growth.

The plain truth is that there are fundamental economic flaws that impede economic growth in Sri Lanka. The large fiscal deficit, the growing public debt, its crippling debt servicing costs, huge foreign debt and massive trade deficits are serious constraints on growth. Apart from these there are foundational weaknesses that deter sustained long run economic growth. These include the lack of reforms in education and inadequate development of technical and technological capacity and increasing inefficient state control of the economy.

The investment climate that was expected to improve after the cessation of the war has hardly perked. Required reforms in public enterprises, public administration, secondary and tertiary education and social infrastructure have not been undertaken. Uncertainties and unpredictability of economic policies and threats to social harmony are disincentives to investment. These and other factors impede rapid economic growth. The middle income trap is not the reason for the deceleration of economic growth.

The economy benefitted from the end of the war with several sectors increasing production, but the economy has lost steam and is slowing down. This slowing down has nothing to do with the “Middle Income Trap” hypothesis. It is the fundamental weaknesses mentioned above that militate against rapid growth.

Debt trap

The debt trap may be more pertinent an explanation rather than the “Middle Income Trap”. Yet that too is a partial explanation as the factors that determine growth are not only fundamental macro-economic imbalances, but political, social and cultural factors that impact on the economic variables.

One of most serious traps in development is the debt trap. The public debt has reached such an amount that its debt servicing cost is a serious setback. The debt servicing cost last year was higher than revenue. It was as much as 103 percent of government revenue in 2012. This means that since revenue is inadequate to even meet the debt servicing obligations, the government has to borrow for its other expenditures.

This in turn increases the public debt. Such a cyclic debt trap has serious consequences for economic growth. The International Monetary Fund (IMF) has pointed out that Sri Lanka’s public debt is one of the highest among emerging market economies at more than 600 percent of its tax revenue.

Real concern

The real concern is not that of the economy being trapped by the so called “Middle Income Trap”. The debt trap is of far more serious concern and measures must be taken to reduce it so that it does not cripple the growth of the economy. Then it would be possible to prioritise public expenditure in accordance with developmental needs of the country and bring about a greater degree of macroeconomic stability so vital for growth.

Sri Lanka’s economic slowdown is due to fundamental macroeconomic weaknesses and economic mismanagement. The increasing public debt and its foreign debt component could prove to be a serious setback to sustaining economic growth.

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