September 2017

Economic Background at the independence in 1948

After a period of nearly three centuries of being ruled by different foreign forces, Sri Lanka gained political independence in 1948. At the time, Sri Lanka had an Export economy, with a dual economic structure. This comprised of Modern, and Traditional sectors. The economy mainly depended on plantation sector. It was heavily dependent on agriculture, with nearly half of the GDP coming from agricultural sector. Infrastructure facilities were developed and regionally spread during the colonisation, and included minimal facilities such as health, education, and transportation. With rationing and subsidization of essential food products, and provision of free education and health care facilities, Sri Lanka was at the initial stage of a Welfare state. Banking and financing facilities were developed around plantation, and foreign trade sectors.

There were numerous dilemmas and issues within the economy of the country that were both carried over from the colonial era, or that originated in the concerned period, which hindered the economic development of the country. Some of these are discussed below.

· Lack of a uniform view of the economy

The different stances of the political parties that ruled Sri Lanka during the period can be held accountable for the different reforms the country went through. These led to a highly complex economic policy, which was also affected by the prevailing international trends, and influence of international institutions.

The United National Party (UNP), in their regimes (1948-56 and 1965-70) followed a market oriented, liberal, and free-trade approach. This focused on the private sector, with few elements in social democracy: education, food, and health. The Sri Lanka Freedom Party, who ruled through alliances as Mahajana Eksath Peramuna (MEP) (1956-65), and as United Front coalition (1970-77), during their regimes followed a social democratic, and socialist approach. They focused on Import Substitution Industrialisation (ISI) which involved price controls, high tariff, and import and exchange controls (Lakshman, 1997).

The constant change of policies led to slow growth, instability and many more economic problems in the country. No fundamental reforms were introduced by either party, which could have favourably changed the social and economic structure.

· Consumption vs Investment

From 1948 to 1959, the liberalization approach followed by the government had adverse effects on the levels of saving and investment in the country. The little available resources were allocated in an adhoc manner through annual budgets. Both local and foreign private investment were discouraged through the government policies that concerned them. There was a high tendency for consumption, and low savings that started during the 1950s. This was mainly due to vigorous consumption patterns of private and public sectors, as well as the negative real interest rate[1]. This limited capital formation. As for public sector, revenues were heavily dependent on indirect tax on foreign trade. Nearly one third of the expenses in the budget developed on these revenues, accounted solely for welfare expenses (refer Table 1). Annual Current expenditure exceeded 60% of total expenses while capital expenditure was less than 40%, except 1957/58 period. Out of what little was invested, the largest portion was on irrigation, which gave very low returns on the capital invested. The return on capital from colonization, which was a prominent feature during the period, was less than 2%. A good example is the Gal Oya project. Budget deficits increased during the period (refer Table 2), and were financed mainly through domestic borrowings and expansionary finance (Lakshman, 1997)

· Problems in Trade and Industrialisation

Immediately after the independence, the government saw no need in modifying the economic policies of the country. Hence they continued the colonial economic structure. Much attention was given to agriculture and export of primary goods, while manufacturing for export was ignored. Until 1960, fiscal and monetary policies of Sri Lanka contained no measures concerning industrialization. The government in 1959 published a 10 year plan with greater emphasis on industrialization, but this plan was not operationalized successfully. During 1960-77 period, the governments adopted an Import Substitution Industrialization approach. With an overvalued exchange rate, high tariffs and several incentive schemes, import substitution became relatively more attractive than export trade. This resulted in an anti-export bias in the economy. Imports of intermediate and investment goods were still prominent, and the trade gap widened (refer Table 7), leading to a foreign exchange shortage. With a rising BOP crisis, the governments resorted to foreign debt to close the gap (refer Table 6), which increased the foreign debt service ratio from 7.2% in 1966 to 22.5% in 1970. The government policies of the period discouraged both domestic and foreign private capital (Lakshman, 1997).

· Presumptuous emphasis on welfare

From the very first budget after independence, nearly 40% was allocated for welfare expenses that included education, health, and food. With the rapid increase of population in the following years, governments made sure free health care and education facilities were as widely available as possible, while food subsidy and rationing continued to be an increasing burden on the budget (refer Table 1). During the 1950s and 1960s many essential food items were subsidized, and made available to the entire population above one year of age. Excluding health and education, other social welfare expenses increased by 1221% from 1950 to 1960. Cost of food subsidies alone as a percentage of the government budget rose from 9% in 1970, to 17% in 1975. Although the expense on these areas kept rising, revenues were static. This led to large budget deficits. External reserves were used up to finance the rising expenses, leading to BOP deficits towards the end of 1960s. Though attempts were made to reduce the amount spent on welfare, no real impact was felt, as governments feared loss of political power over such action (Lakshman, 1997). The commitment to welfare was a strain on public sector resources (Ponnambalam, 1981).

· Unemployment and underemployment

The population of the country kept increasing since the independence until about 1963 where Total Fertility Rate was high at 5.32%. But employment opportunities were created slower than the rate at which people were added to the labour force. Growth of employment was very low at 0.7% during the 1953-63 period. The inadequate expansion of employment opportunities was mainly due to stagnant economic conditions during the period. Unemployment among educated youth was a major problem, as 83% of the unemployed were in this group. About one fourth of the labour force was unemployed by the mid-1970s. Annual employment growth was half of the labour force growth till 1971. This large scale unemployment condition (refer Table 3) increased social tension, which resulted in a well-organized revolt against the government, by the educated and unemployed youth in 1971 (Lakshman, 1997).

· Heavy reliance and emphasis on limited areas in agriculture

At the independence, Sri Lankan economy heavily depended on the export revenue from plantation crops, tea, rubber, and coconut. This did not change until about a decade after the independence. Fall in prices, poor weather conditions, and lack of productivity improvement methods worsened profitability issues. Though constant investments were made, the performance of the agricultural sector was poor, except in 1965-70 period (refer Table 4). Tea, rubber, coconut, and paddy cultivation were given the spot light until the early 1970s, while little to no attention was given to subsidiary crops, animal husbandry, and horticulture, which had high potential for growth. The paddy farmers received a subsidy on fertilizer that made their work easier and cost lower. But the burden on the government due to the subsidy was overwhelming. About 105 colonies were developed until 1977, with the aim of increasing the land under paddy cultivation. These consumed a large portion of government investment only to be a failure at the end. A good example is the Gal Oya project which yielded a cost benefit ratio of only 0.5. Paddy farmers were offered concessionary debt facilities for farming, which were heavily defaulted (Lakshman, 1997). Though all these facilities were provided, the return was comparatively marginal.

· External imbalances

At independence, with the export dependent economy in Sri Lanka, it was closely related to world economy. The trade dependence ratio in 1960 was 65%. However, when plantation crops started losing their profitability, the export income started deteriorating. Though exports decreased, import of consumer, intermediate and investment goods kept increasing, until at one point, the current account went into a deficit, from 1960. The government could not increase the already high taxes to increase revenue. The only choice was to resort to borrow from expansionary sources, given the fact that FDI were also virtually non-existent prior to 1977 (refer Table 5). The increase of import prices was faster than that of exports, which led to the deterioration of the Terms of Trade (TOT). Further, the slowdown of economic activities in industrialized countries affected the Sri Lankan current account adversely, through reduced exports and deterioration of TOT. Lack of political commitment in reforms for BOP issues during the period worsened the imbalances.

· Overemphasis on State owned enterprises (SOE)

Due to weak private sector, the government had to establish certain industries in the country. This started in early 1950s and the government intervention heightened after the change of government in1956. Thereafter until 1977, many private owned and foreign owned companies were nationalized according to the socialist orientation of the government. Several new industries were established under state ownership, which were not profit oriented but socially oriented. The ISI approach of the government led to the establishment of industries where the country had no experience or comparative advantage in. By the mid-1970s, most of the SOEs proved to be highly inefficient. However, they had enough budgetary resource allocations, easy access to credit, and political backup. Even though inefficient, these SOEs were immune to any threat of bankruptcy, because they had Treasury backup. So they did not need to adapt their management or technology to even achieve economic profits. Most of these inefficient state enterprises being producers of intermediate products, led to the increase of production cost of downstream industries that used those intermediate products. Throughout the period, however, new domestic and foreign private investments were explicitly or implicitly discouraged through government policies (Lakshman, 1997).

Appendix

Table 1 Welfare Expenditure 1949/50-1975/76

year	Social services expense in Rs. million	Food subsidy in Rs. million	Total in Rs. million	Total welfare expenditure As a % of total govt. expenditure[2]
1949/50	156.6	35.8	192.4	24.2
1950/51	172.1	131.6	303.7	34.1
1951/52	207.5	247.8	455.3	39.3
1952/53	212.8	127	339.8	30.5
1953/54	225	12.5	237.5	25.5
1954/55	233.9	36	269.9	27.7
1955/56	256.9	79.5	336.4	27.5
1956/57	277.9	105.5	383.4	27.4
1957/58	314.4	112	426.4	29.3
1958/59	377.4	146.5	523.9	31.6
1959/60	420.2	193	613.2	35.2
1960/61	419	248	667	46.9
1961/62	431	421	852	50.4
1962/63	450	417	867	49.9
1963/64	468	431	899	51
1964/65	491	447	938	52
1965/66	499	487	986	53
1966/67	529	466	995	52.5
1967/68	597	579	1176	53.8
1968/69	643	625	1268	53.2
1969/70	733	574	1307	49.2
1970/71	747	614	1361	45.7
1971/72	1000	718	1718	40.6
1972/73	856	701	1557	40.4
1973/74	912	952	1864	41.4
1974/75	1021	1230	2251	43.7
1975/76	1223	938	2161	38.9