Sri Lanka’s broken promise!
View(s):The old debate between market advocates and protectionists belongs to the 1970s and 1980s. The rapid transformation of former communist states into market economies—and their swift progress toward prosperity—speaks for itself.
Open markets consistently outperform protected ones in growth, trade, investment, and poverty reduction. Countries with fewer trade barriers record stronger GDP growth, attract more foreign investment, and reduce poverty more quickly than those clinging to protectionist policies.
A tourist prepares for a round of kite surfing. Tourism is a growing sector in Sri Lanka.
“Ceylon is fortunate”
The question many ask is: “Did Sri Lanka truly prosper under its open economy?”
Sri Lanka was among the first in Asia to move from a tightly regulated closed economy to an open one in 1977. Our South Asian neighbours only followed suit after 1990.
This question surfaced among my readers after last week’s column, “Ceylon is fortunate”—a phrase often repeated by then Finance Minister J.R. Jayewardene. He meant that, unlike other South Asian countries, Sri Lanka did not need to worry about capital imports and development financing, thanks to its strong foreign exchange reserves and high export demand.
But that fortune proved short-lived. The country soon veered off course, embracing protectionist policies, heavy state intervention, and sweeping nationalisation. These policies propped up inefficient state enterprises, drove away foreign investors, and strangled the rise of an entrepreneurial class.
About 20 years of “policy detour” that pushed the economy from bad to worse, turned the country’s fortune to a misfortune and paved the way for trade liberalisation in 1977. Nearly a half a century later, now Sri Lanka is facing an unprecedented economic, social and environmental crisis.
Failure of the open economy?
The puzzle remains: if an open economy promises prosperity, why did Sri Lanka end up with slower income growth, weak job creation, sluggish trade, and persistent poverty and vulnerability?
Economic analyses of the post‑1977 period point to four underlying causes of policy failure: reforms left half‑done, political conflicts that drained momentum, repeated policy reversals that eroded confidence, and corruption that undermined institutions.
The “open economy” introduced in 1977 marked a decisive break from Sri Lanka’s closed, state‑dominated system. It meant liberalising imports by removing tariff and non‑tariff barriers, easing foreign exchange controls, and adopting a unified, flexible exchange rate. The government stepped back from excessive intervention, giving space for the private sector to thrive.
The policy package also offered incentives for foreign investment, promoted export trade, and created new institutions to support these reforms. Together, these measures signalled Sri Lanka’s entry into a more market‑oriented, globally connected economy.
Incomplete reforms
Trade liberalisation was necessary, but not sufficient. Without public sector reforms, the private sector could not operate smoothly or efficiently. The public sector, built to serve a closed economy, failed to provide the lubricant for the fast‑turning wheels of a private sector‑led open economy. The cumbersome bureaucracy and regulatory mechanisms inherited from the closed economy remained intact.
Rather than reforming the public sector, government created new institutions and zones to bypass inefficiencies. As a result, the old problems persisted—and still do today. The property rights, land laws and labour laws are some other areas that remained intact to this day.
Public enterprises, including nationalised plantations, were left untouched until the 1990s. The wave of privatisation between 1990 and 2005 failed to win public trust, tainted by corruption and favoritism. Even now, Sri Lanka maintains nearly 400 public enterprises, many irrelevant to an open economy.
A market economy only works when it runs on clear rules of the game. Yet the reform process bypassed the “rule of law” and its supporting institutions, leaving them unreformed.
Political conflicts
We might have expected a steady, continuous reform journey. Instead, Sri Lanka experienced only two major reform episodes—one in 1977 and another in 1989. After that, reforms stalled, and even the word itself became politically taboo.
Sri Lanka’s half‑baked reform process was not without reason. It was interrupted by political conflicts—the LTTE war in the North and the JVP movement in the South. Both erupted around the same time and shared similarities in their character.
The Northern conflict, led by the LTTE and other militant groups, lasted nearly three decades (1983–2009). It directly undermined investment, business, and economic progress, while indirectly weakening trade liberalisation and overall stability.
Military spending soared, forcing the government to impose new taxes and para‑tariffs—measures that ran counter to the spirit of liberalisation and complicated the open‑economy model.
Though the JVP’s armed insurgency was short‑lived, its influence on the economy outlasted the LTTE, leaving scars that were wider and deeper. Operating within democratic parameters, the JVP grew into a major political force that disrupted trade and investment, sabotaging the climate needed for reforms.
Successive governments, even to this day, struggle to deal with these wider and deeper scars and to carry out the reforms the economy so badly needs.
Policy reversals
The third factor shaping Sri Lanka’s open‑economy reform process can be seen across two distinct periods: 1995–2005 and post‑2005. The first period saw no major reforms beyond the continuation of privatisation already underway.
By then, political conflicts had left the policy regime far from a progressive, export‑oriented economy. After 2000, exports as a share of GDP steadily declined. This decline was reinforced after 2005, when the country entered a phase of policy reversal—protectionism was strengthened, focus shifted to the domestic economy, and government intervention became widely accepted.
Priorities were reoriented: competitiveness in global markets gave way to subsidies, import restrictions, and state‑led initiatives. Intervention was no longer viewed as distortionary, but as a legitimate tool to stabilise and support local producers—even at the expense of export dynamism. The fall in exports was thus framed not as mismanagement, but as the outcome of deliberate policy choice.
This domestic focus continued until the country faced the challenge of financing external debt with limited foreign exchange. Sri Lanka, which began its post‑independence journey with the “fortunate position” of strong reserves and export demand, ended in 2022 by suspending external debt payments.
If there was any serious attempt to revive export‑led growth in the past quarter century, it came only in the wake of the 2022 economic crisis.
Corruption vulnerability
The final element running through Sri Lanka’s post‑1977 policy regime was the unprecedented escalation of corruption. This is not to suggest corruption was absent before liberalisation. But the adoption of an open economy—without reforms to regulatory institutions or strong enforcement of the rule of law—created fertile ground for corruption to flourish.
What began as small‑scale, retail corruption among officials soon evolved into systemic, large‑scale corruption. Liberalisation opened new channels of economic activity, yet in the absence of accountability and institutional checks, these opportunities were captured by networks of power and influence.
Over time, corruption became entrenched, spreading across sectors and embedding itself as a defining feature of governance and economic management. The result was weakened efficiency and eroded public and investor trust.
Ultimately, the IMF reform agenda laid bare this reality: eliminating corruption vulnerabilities was a pre‑condition for unlocking Sri Lanka’s growth potential.
Conclusion
Sri Lanka’s half a century open‑economy journey promised prosperity but faltered through incomplete reforms, political conflicts, policy reversals, and escalated corruption. Trade liberalisation without institutional strength left the nation vulnerable to frequent shocks.
The lesson is unmistakable: openness by itself cannot deliver growth. Only when it is anchored in credible reforms, upheld by the rule of law, and strengthened by trust can prosperity truly take root. As we mark 78 years of Independence, one must ask—have we recognised this truth and begun to act upon it? The years ahead will reveal the answer to this question.
(The writer is Emeritus Professor at the University of Colombo and Executive Director of the Centre for Poverty Analysis (CEPA) and can be reached at sirimal@econ.cmb.ac.lk and follow on Twitter @SirimalAshoka).
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