Can Sri Lanka overcome past mistakes and craft a path of development?

Today, Sri Lanka stands far below the potential it was thought to have, at independence in 1948. The expectation was that the ‘model British colony’ would rapidly develop with the many advantages it had.

However, Sri Lanka›s story has been quite disappointing, with its economic under-performance and the many mis-steps, together with a massive cognitive gap, causing a lack of strategic and innovative thinking.

At independence

With independence in 1948, the new government inherited an economy that was based on the plantations, exporting its produce and importing its needs, including the main food requirement of rice. Some express that the economy was ‘strong’, while the majority were living in poverty. However, there was a great imbalance in the economy.

After almost 450 years of colonial rule, it was natural for the upper classes, which had benefited from the socio-economic structure, to have a ‘colonial mindset’. Therefore, the ruling class continued with the colonial economy, though it was pointed out that the plantation economy had been stagnant for almost two decades, while the population was rapidly increasing.

No new growth areas were identified and developed. Many opportunities were missed, such as the development of Trincomalee and never revisited again. This was a major lapse, which if understood,  could have changed the country’s path.

The over dependence on orthodox economic theory and expecting the ‘market’ to perform, where there was hardly a functioning market, was another mistake.

The development of only one sector, that of domestic agriculture, disregarding other sectors, was another mistake, even under Hirschman’s ‘balanced vs unbalanced growth’. 

The first government created a new problem for all future governments, by running down the foreign reserves on consumption, leaving hardly anything much for  investment in development, the problem, known as the ‘forex crisis’, which  became a major issue by the early 1960s.

 World Bank mission report-1952

As the government did not know what to do, it requested advice from the World Bank. A WB mission was sent and the report published in 1952.

Though there is much criticism of the report, some of which being valid, while some aspects have to be viewed, taking account of the situation in the country at the time.

On the positive side, it recommended planning, research and development, development banking and an overall apex body to be in charge of development called the Ceylon Development Corporation (CDC) with Central Bank participation. This gives a hint of Development State Theory (DST) which came about later, which was the basis of the East Asian Miracle.

Though some of these recommendations were followed, it was not done in a coordinated manner, or with an understanding of what could be achieved.

It cautioned the government not to engage in heavy industry, until managerial skills were developed via small and medium industry, which makes sense, while recommending that negotiations with the British Admiralty for use of part of the tank farm for commercial purposes be initiated. This indicates that the development of Trincomalee, as a possible oil hub had crossed their mind and communicated the idea indirectly, which did not stir the minds of the rulers.

It should also be understood that the World Bank and the IMF today, are not the institutions that were created at the Bretton Woods summit. They have become agents of the neo-liberal agenda. This means that more dedicated south-south partnership is crucial for development.

This first phase from 1948-56, was the make-or-break stage for the newly independent country, the results of which are now well known.

Strategic and innovative thinking is key to development. Can Sri Lanka change its thinking to move from just ‘managing’ the economy to ‘developing’ the economy?

This is Sri Lanka’s missing-link, which has still not been understood

All that is now history, the question is if we have learnt any lessons from these past mistakes?

An attempt to change

With the change of government in 1956, came a change of thinking to break away from the colonial system. It was realised, though political independence was gained, economically the country was dependent on the established colonial system.

The idea of ‘Self-Reliance’ was a buzz word in neighboring India and had some effect on Sri Lanka. The idea of a development plan came about, took three years and great effort to formulate, but was never implemented.

The British military bases were taken over, including Trincomalee, but not followed up with any development.

The institutions established during colonial rule, with their strong rules and regulations, had its own path dependency well established. These institutions were not created for development but for a different purpose and therefore needed re-orientation, which was not done.

An example of why this is urgently needed could be seen by the fact that for over the past 25 years or so, there has been talk of making the BOI a one stop shop, it has still not happened.

This is what is called Historical Institutionalism, hampering the required development path.

Some have started to use the terms ‘inward’ and ‘outward’ with regard to policy followed. In Sri Lanka’s case, it should be understood that the government had no choice, and had to restrict imports and the outflow of foreign exchange, as the foreign reserves had been depleted, by the ‘outward’ nature of the first government.

Due to the lack of foreign exchange, agreements with the then USSR, enabled some industries to be established. However, there were issues with the question of management, to move these industries forward.

There were private sector initiatives in various sectors, with little support from the state, except the tariff barriers, which alone was not sufficient. 

In some sectors, Sri Lanka had started well before South Korea, but could not sustain those projects, without state support. Should not a study be done, not only of the companies that thrived on imports but on needed companies that failed in industry? If the minimum support was extended to these companies, they would have been exporters or saving millions of dollars of outflow.

Sri Lanka’s major industrial push was in the early 1960s, when some of the main industries were set up. This was mostly state led, with a few private sector initiatives.  This momentum was broken in 1965, with focus back on agriculture, partial liberalisation with the first visit to the IMF.

 The loans taken during the 1965-70 period were substantial, with repayments becoming a major issue. Repayments used up whatever resources that should have been used for development.

Then came the ‘oil shock’ that derailed many countries, followed by the Global Food Crisis. The five-year plan (1972-76) was derailed as well.

The nationalisation of the plantations, what brought it about, was required at the time and its repercussions, needs to be studied in depth. The export of non-traditional exports, saw some success.

The re-introduction of the open economy

In 1977, with the change of government, the open economy, which was in operation at independence, was re-introduced, knowing fully well why it failed during the first phase.  

The entire development process in East Asia, including Japan was well known, though the Developmental State Theory (DST) with Chalmers Johnsons ‘MITI and the Japanese miracle came about much later in 1982.

The question that needs an answer is if Sri Lanka had studied and analysed the East Asian development process, before attempting the process?

From what was seen and the manner in which Sri Lanka got going, it was clear that it had got the wrong end of it.

The missing-link, in Sri Lanka’s attempt at industrial development

When Sri Lanka changed its economic policy and decided on the ‘open economy’ Japan and East Asia was the model it said it hoped to follow, but was quite the opposite, being advised from the west, which had turned to neo-liberal thinking by then.

However, the method chosen was infested with many fundamental mistakes. These mistakes could be identified in comparison with Japan, South Korea and Taiwan, and how they got about development. It should also be recalled that the ‘foreign advice’ at the time was not in favour of industrial development, but towards ‘services’.

 Listed below are the major points, Sri Lanka did not seriously consider and became part of the many mistakes it made.

1) Sri Lanka did not have a plan

South Korea and Taiwan had many development plans, while Japan followed what is called ‘window guidance’ via the Ministry of International Trade and Industry. A plan is also expected to motivate all sections of the population to work towards a common objective, and create the ground to reach the desired objective. If Sri Lanka had done so, in the correct spirit, there would have been no need for ethnic division and the war of three decades.

2) Sri Lanka, depended on the market and market forces, to direct investment

Japan was re-building after the war and knew that the market was not functioning, while South Korea and Taiwan, were under-developed economies and knew that they could not depend on an under-developed market and all three decided on state intervention to develop the economy and the market in the process.

There has also got to be a determination to develop, education and training together with directed research and development plays a crucial role.

Sri Lanka’s dual nature of the economy, one for the privileged class and the other for the rest, created a situation where urgency was not seen or felt.

Sri Lanka knew very well that local private investment would not flow into the required sectors, while keeping the lucrative import trade open. If FDI and local private investment was not available, who was going to fill the gap?

The Market vs Intervention debate was heavily one sided, without realising that intervention was required to develop the market, if the East Asian experience was taken into account.

3) Development Banking for development

Financing the development effort is always a major issue. Development Banks were set up for the purpose, with funding from the Central Bank. (The first development bank was set up in Canada in the 1940s, as a subsidiary of the Central Bank).

Sri Lanka, got rid of its two development banks, while it needed more for each selected sector. Commercial bank funding was selective and served only a small proportion of the would-be entrepreneurs, as collateral would be an issue.

The development of the Small and Medium Sector becomes important for vertical and horizontal integration in industry. Therefore, with a weak and small SMI sector, development banking becomes critical  for the development of the sector and industrialisation in general.

4) The industrial development process and stages not understood

The development of industry follows a process with many stages. In an under-developed economy, industries start as infant industries and have to be developed and supported through various means.

Import Substitution Industry (ISI) is the first stage, while product development with technical input and training of human resources, improves the product to be competitive in the global market, while the input costs are managed with state support.

In the initial phase, state support  comes in many forms, with tariff barriers being one.

Though the East Asian countries followed this process of industrial development, Sri Lanka expected local companies to engage in exports, without the development process. It was like asking a kid, not knowing how to swim to jump at the deep end and drown. Teaching a kid how to swim in the shallow end and then swimming to the deep end, is what the East Asian countries did.

The few private sector companies that were bold enough to attempt, were not supported as in the East Asian countries, but made to drown, by our own government, in its eagerness for foreign loans and short- term benefits.  

Sri Lanka has first to decide which sectors of industry it needs to develop and work out a program. It is now clear that low-tech is not the way to go. Developing the High-Tech industry is not easy and requires a totally dedicated team. Are we anywhere close to such a situation?

Strategic and innovative thinking is key to development. Can Sri Lanka change its thinking to move from just ‘managing’ the economy to ‘developing’ the economy?

This is Sri Lanka’s missing-link, which has still not been understood.