Comment on “The Sri Lankan Economy: From Optimism to Debt Trap”

Abstract

Athukorala (2025) makes a convincing case that Sri Lanka's debt crisis of 2022 was not only due to recent, reckless economic policies—a massive tax cut, financing fiscal deficits by printing money, repaying foreign debt out of reserves—but the culmination of decades of an “anti-tradable” bias that left the economy unable to manage high levels of debt, especially in the wake of the COVID-19 crisis. The analysis is based on a sweeping tour of Sri Lankan economic history, starting before independence and ending with the current International Monetary Fund-supported program of 2023.

This longue durée helps resolve a puzzle about the country's policy direction. In the late 1970s, Sri Lanka was one of the first developing countries to liberalize trade. The economy boomed. Many people heralded Sri Lanka as a textbook case of successful trade reform (see, for example, Castro & Devarajan, 2006). Nevertheless, the country soon began adopting anti-tradable policies, which accelerated in the 2000s leading to the collapse of 2022. Athukorala observes that the trade liberalization was accompanied by laxist macroeconomic policies, such as an overvalued exchange rate, which made the reform difficult to sustain. The early 1980s also saw a massive increase in public investment, which contributed to the real exchange rate appreciation, and to the economic boom.

My comments on Athukorala (2025) are aimed at broadening the set of policies that contributed to the debt crisis, and exploring why Sri Lankan policymakers chose these policies.

In addition to anti-tradable policies, Sri Lanka has followed at least two other policies that have undermined the economy's growth. Introduced in 1958, the Paddy Lands Act requires farmers who lease land from the state (which are most farmers) to grow only paddy. Atukorala mentions the Paddy Lands Act as part of the move toward a closed economy in the 1950s. The Act is still in force—70 years later. Paddy is the least productive and least lucrative crop (World Bank, 2021). This policy has made agriculture the least productive sector in the economy and kept farmers poor.

Second, Sri Lanka has some of the most restrictive labor regulations in the world (Abidoye et al., 2009). Workers with 20 years of service receive an average of 30 months of severance pay. Not surprisingly, employment growth in the formal, private sector has been sluggish. The situation became serious in the 1980s when the youth bulge was entering the labor market. To quell violent protests, the government expanded employment in the public sector, another low-productivity sector. In addition, the public sector pays higher wages, provides better benefits, and is a job for life (Hausmann et al., 2020). This raises the reservation wage for working in the private sector, making it harder to compete in world markets.

In short, Athukorala's anti-tradable bias is part of an “anti-productivity bias,” one that has kept Sri Lanka from fulfilling its potential for decades and contributed to the perfect storm of 2022.

These policies have been pursued by left- and right-wing governments, so they could not be due to ideology. I suggest they stem from a lack of accountability. That Sri Lanka is a democracy indicates that the people of Sri Lanka could hold politicians accountable for economic policy decisions at elections. But in a country with deep ethnic cleavages (which resulted in a 26-year civil war), many people vote along linguistic or religious lines, rather than on the economic performance of the incumbent. Knowing this, politicians pursue populist policies during election times, enough to get them elected but at the cost of the economy's productivity.

Worse, policymakers have chosen directions that minimize their accountability to the people and maximize their ability to control the public. For instance, macroeconomic instability in Sri Lanka is caused, as Athukorala notes, by government financing fiscal deficits by borrowing from the central bank. While this causes inflation with a lag, the two other options for financing a fiscal deficit—borrowing from domestic capital markets and borrowing abroad—hold government accountable instantly by raising borrowing costs.

Trade liberalization makes producers accountable to world markets. Protectionism, the Paddy Lands Act, and labor market regulations enable governments to control who gets the benefits, that is, who is accountable to government.

In sum, Athukorala's valuable paper has triggered discussion on the multiple factors that led to Sri Lanka's debt crisis. In considering strategies for recovery, we should pursue policies that strengthen the public's ability to hold government accountable, rather than the other way around.