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The Failing Economy of Sri Lanka

The Failing Economy of Sri Lanka
this is Sri Lanka a small island nation off the coast of India home to just 22 million people the country's

economy

has a lot going for it it has a relatively skilled and literate population when compared to its direct Geographic neighbors it has highly fertile land beautiful beaches and rainforests for tourists and even strong natural resource wealth with almost a quarter of the nation's land mass being covered in valuable gemstones like Sapphires and rubies these industries were part of the reason why Sri Lanka is one of the fastest growing economies in the region in the late 2000s and early 2010s that's a region that was full of very fast-growing economies but of course as many of you are probably aware that growth did not last and earlier this year the country was plunged into a debt crisis that spiraled into a full-blown humanitarian crisis with the country's citizens been unable to afford basic necessities like food Fuel and Medicine the path to Sri Lanka's collapse is riddled with mistakes that economists can learn a lot from to avoid being repeated in their own economies but the country's Journey can give us some insight into a potentially more concerning trend for the past four decades most economists have been working off the assumption that all nations can transition from undeveloped agrarian economies to developing manufacturing-based economies and then finally on to self-sufficient service-based economies like those in the west there are examples like South Korea Taiwan and even Japan that have made this economic journey in the past Century not to mention the countries in North America and Western Europe that ultimately made this transition during the Industrial Revolution the assumption that all countries are just waiting for their turn to get rich is something that a lot of regular people and even highly educated economists subscribe to but just a few seconds of critical thinking will make you realize that this is about as silly as saying that every individual within an

economy

can get rich the story of Sri Lanka's rise and fall might be the most clear demonstration that the global economy only has so much room at the top and that becoming an advanced economy is by no means guaranteed just because a nation adopts a market system and starts doing lots of international trade in fact the very structure of our modern global economy really depends on level of inequality that most people might not be very comfortable with so how did Sri Lanka go from being one of the fastest growing economies in the world to a complete economic failure within the span of two decades how does this demonstrate that it's not possible for all nations to eventually become advanced economies and finally is it possible for Sri Lanka to recover from this current collapse and regain the improving living standards they are enjoying prior to 2020. once we've done all that we can put Sri Lanka on the economics explained National leaderboard this episode of Economics explained is brought to you 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of the companies that have used the service for the first year end up becoming shipstation customers for life the best part is that you can try it out completely risk-free by going to shipstation.com economic today for a free 60-day trial the economy of shrunker as it exists today really started in the late 2000s with the Sri Lankan government claiming victory over the ltte which was a separatist military organization that fought to create an independent state in the north of the country in 2009 the organization was declared totally defeated and the now completely unified country started investing heavily in its growth as we've already explored the country had a lot going for it and now without the threat of iron conflict it was truly able to exploit these advantages tourism slowly increased as visitors from around the world came to enjoy the country's exotic culture and pristine natural environments gemstone mining picked up and only worked to accelerate tourist interest in visiting the country agriculture expanded especially with the production of world-renowned tea products and the country was also able to fully take advantage of its greatest natural resource its people Sri Lanka has a well-developed education system with literacy rates above most developing countries which means it became a popular destination for outsourced service work offshore call centers and it operations might not be glamorous roles to countries in the west but they are incredibly lucrative for the developing countries providing these Services because they bring money into an economy in a totally sustainable way without having to export finite natural resources the skilled workers of Sri Lanka also generated income from the country by working abroad as skilled expats and setting money as remittances back home to their family we have explored the benefits and drawbacks of international remittances quite recently in our video on migrant labor so I don't want to repeat too much here but this source of cash turned out to be both a blessing and a curse for shranka the growth in the country's economy following the end of the 26-year Civil War was intense but it was also doomed from the start the government invested heavily into non-tradable Industries and by extension encourage private businesses to do the same non-tradable Industries are things like domestic Education Health Care government services construction and Retail basically industries that produce products that can't be traded internationally these industries are incredibly important but a small developing economy like Sri Lanka car is going to run into a lot of problems basing its growth of these industries alone achieving GDP growth through investment into things like infrastructure is very easy big projects like this require a lot of spending and employ a lot of workers construction projects also tend to use a lot of domestic products because construction materials like cement and gravel are too heavy and cheap to ship internationally so infrastructure spending is a great way to get money into an economy and make sure it stays in that economy infrastructure spending also has the small little added benefit of you know actually providing infrastructure roads Railways ports electric grids and everything else that goes into an infrastructure budget can make businesses and workers more efficient leading to more output and ultimately more tax revenue to pay for more infrastructure the problem is that infrastructure spending only works up until the point where the economy can fully utilize the efficiency gains from additional pieces of infrastructure spending money on infrastructure above and beyond the capacity of an economy is like a small business owner having a good year and convincing themselves that they need in the city office to allow for further expansion if the business genuinely needed the space for more employees then this might be a good investment but if a bigger office is not something that is desperately needed by the business it's obviously silly to think that a big office is somehow going to generate growth just by itself that should be obvious to basically anybody but for some reason when we scale this example up to the level of a national economy people seem to think that just building out infrastructure will somehow generate economic growth after the direct stimulus to pay for the projects themselves certain economies like the resource-rich Gulf States can get away with this kind of Reckless spending and so too can rapidly expanding Nations like China because their industrial output is growing at such a rate that indiscriminate building was really the only way to keep up but you can't build a port and expect to become a trading superpower you need to develop trading businesses and then Supply them with the infrastructure as they need it even China is starting to realize this now for countries like Sri Lanka it was much worse because all of this spending on flashy infrastructure to make them look like an advanced economy has been funded by debt taken on as a developing economy government spending was very lucrative for a lot of the population who took up jobs directly supported by these projects but that meant that the economy neglected the tradable industries that could actually support the economy in the medium to long term eventually Sri Lanka had run into a simple problem in the process of building out their economy they had gone into debt and had more money going out to pay off loans and buy imports to support the local population and they had money coming in from exports and other payments but here is where things get interesting there are lots of countries in the world that import more than they export and most of them are doing just fine if you really think about it it's impossible for all countries to export more than they import unless we were just dumping shipping containers in the ocean the United States along with a lot of other advanced economies has a huge balance of trade deficit and despite what some people will say that's just fine because there is more than one way that money can come into an economy and economists track this using the balance of payments the balance of payment payments is broken up into two separate accounts the current account and the capital and financial account these two accounts are all ways of equal value hence the name balance of payments now I don't want to get too bogged down with the details of these accounts because really all that's important is to understand how cash can come into and get out of an economy the easiest to understand is trade if an economy exports more than Imports it will have money in flows if an economy exports less than it Imports it will have money outflows an important point of note here with imports and exports is that this equation also includes the Import and Export of services for example if an American company pays a Sri Lankan company for IT consulting then that would be a service import for the USA and a service export for Sri Lanka just like regular imports and exports the money flows from the Importer to the exporter the only reason this can get confusing is that services are much harder to visualize leaving the country than stuff that gets packed into Freighters another way an economy can make money is by receiving investments from abroad these Investments can either be loans or direct purchases of assets for example a British investor buying shares in an American company economies can also have cash outflows the same way if investors within the country are investing abroad so normally economists track net foreign investments and if they want to get really technical they'll break this down into foreign direct investment and foreign portfolio Investments foreign portfolio investment is when a foreign investor puts money into an asset that they don't have direct control over for example if an Australian buys shares of Apple they won't have any direct control over the company outside of their proportional vote and shareholder decisions foreign direct investment is therefore when a foreign investor puts money into an asset that they do have direct control over most foreign direct investment is made up of real estate purchases because when people buy a house they almost always buy the whole thing and have a direct say over what they do with that property foreign direct investment can however happen on a much larger scale with foreign investors purchasing entire companies or even pieces of infrastructure normally foreign portfolio investment is preferred by the host country because it means that the economy and its people maintain control over their assets but can still raise money from abroad either way if an economy has net positive foreign investment it will have an inflow of cash coming from foreign investors and that can offset the money that they lose by importing more than they export however the problem with this is that eventually those investors will want to withdraw their money from their Investments either through rents dividends interest or from just selling the assets when they transfer this money back to themselves in their home country there will be cash outflow from the host economy of course again the opposite is also true and there are lots of economies that have massive investment inflows Norway with its trillion dollar Sovereign wealth fund receives money from all over the world every year thanks to its foreign investments another way a country can bring cash into its economy is through remittances this is when workers will go abroad and send money back to their family at home as much as five percent of the world's Workforce Works outside of their home country so this can be a significant source of Revenue especially for lower income countries with a lot of workers seeking opportunities abroad like Sri Lanka finally there is foreign aid Global foreign aid now counts for more than 161 billion dollars annually although this is increasingly coming in the form of physical assistance like sending ships full of food medicine and Equipment rather than sending money directly and hoping that an impoverished country's leadership does the right thing with it because well they often don't now by looking at all of these categories we can see that it is possible for countries to run out of money even the United States which has the distinct advantage of being able to print the world's Reserve currency still has to make sure that they don't have endless currency outflows or else the American dollar could rapidly lose its value and its unofficial status as the world's currency for international trade and finance a lot of economies particularly advanced economies can get around this problem by having foreign investments that cover their balance of trade deficits I've used this example before but a company like apple will oversee operations that takes lithium from Brazil ships it on a Greek freighter to be turned into batteries in Taiwan they'll then be sent to factories in China where they are used to make iPhones that are then sold to a German in Berlin at no point did the United States directly contribute anything to this hypothetical supply chain but an American company will make the profit from it and America itself will enjoy the tax revenue and most of the highest paying jobs that come from this process for economies that don't have the luxury of large International corporations or Investments they are into the same problem as most individuals they can run out of money this was the problem that Sri Lanka was having and it's perhaps the perfect demonstration that not all countries can get rich Sri Lanka was importing more than it was exporting and it was making up this deficit by attracting foreign investment the only problem was that this foreign investment was coming mainly in the form of loans rather than Equity Investments that took a stake in assets like a business or an infrastructure project loans need to be repaid no matter if the economy is doing well whereas foreign investors that purchase ownership in something also accept the risks that that asset might make no returns during bad periods loans to developing countries like Sri Lanka also come with higher interest rates and Loans to countries that are only just getting out of a two and a half decade long Civil War are also seen as riskier and therefore demand an even higher interest rate the loans to Sri Lankan businesses and the governments demanded large interest payments be made back every year to the countries that they were borrowing from so Sri Lanka was losing money from exports and investment returns simultaneously while the borrowed money itself was mostly being used to buy stuff that the country didn't need to expand its industry this situation was bad and the country was almost inevitably on a path to complete economic collapse and then Along Came the pandemic which only accelerated this process in the early stages of the pandemic international finance dried up because institutions wanted to hold on to their cash instead of loaning it out to risky regions like Sri Lanka the country's tourism industry which was once a growing source of cash from abroad came to a complete stop and remittances dried up as the country's overseas workers I've had to return back home or work fewer hours in industries that were heavily affected by lockdowns basically the country was already spending more than it made and was just barely being kept afloat by a combination of its few income generating Industries and taking on more loans when the pandemic rolled around it lost those few sources of income and also lost access to the loans that it could have used to ride out the economic turbulence it however did not lose its Financial Obligations to keep on paying all their expenses by mid-2022 the country had no money left and nobody would accept its domestic currency because inflation and instability destroyed its value in foreign exchange markets the country ran out of money me and had no way to pay for things like Machinery medicine or even food which it had become dependent on importing This Disaster was compounded by bizarre political moves like the government's decision to ban the use of fertilizers to force the nation's Farmers to become 100 organic this change cut food production in half and made it up to 10 times more expensive to grow the same amount of produce which meant agricultural exports like tea were no longer profitable and a country already struggling with food insecurity made it much more difficult to grow food in reality this decision may not have had as bigger impact as people think because all of Sri Lanka's fertilizers and pesticides were imported anyway and they were running out of money to pay for these supplies in fact part of the reason the government enacted this ban was so that they would stop losing the 400 million dollars a year that they were sending abroad to pay for these supplies Sri Lanka's economy is going to need to be built from the ground up and this has increasingly become the story of a lot of economies On The Rise transitioning from an undeveloped to a developing and ultimately onto an advanced economy require is a lot of things to go right it requires the development of a healthy domestic Market the training of a skilled Workforce competitive Industries and institutions that can add value beyond the country's borders and these elements all need to be nurtured in a stable environment these components also all require some level of investment which is difficult to ask as an investor there is little incentive to invest into a country like Sri Lanka it's unstable it's had a bad history of repaying its loans and the upsides are limited even if the investment goes very well their labor force is small and only getting smaller as skilled workers are increasingly looking for opportunities abroad where they can earn up to 10 times as much as they can at home and the country doesn't have much in the way of Natural Resources Beyond gemstones these days there is also an enormous amount of competition in the global economy for all of the industries that a country like Sri Lanka may have a competitive advantage in why would a company set up low-cost operations in Sri Lanka when India is right next door with a labor force 50 times larger the only chance an economy like this has to attract the investment it needs to get off the ground is by offering really high interest rates and putting up collateral if the country is paying double-digit interest rates on its loans the Investments it makes into building its economy would need to be remarkable just to cover the interest of course this situation is not unique to Sri Lanka and we are increasingly seeing countries struggle to make the same sort of transitions as Japan South Korea Taiwan China and other big winners of the past few decades unfortunately given our current systems the world simply does not have enough resources to support every country becoming an advanced economy and enjoying the way of life that comes with it and that reality will continue to create situations like the one Sri Lanka now has to recover from okay now it's time to put Sri Lanka on the economics explained National leaderboard starting as always with size Sri Lanka has a GDP of just under 84.5 billion dollars as of 2021 which is the latest year that the World Bank has figures for 2022 is going to be significantly lower than this due to the economic turbulence plaguing the nation but for now it gets a 3 out of 10. that GDP is spread out over a population of 22 million giving the country a GDP per capita of 3814 which is barely over a third of the global average again this is bound to be significantly lower in 2022 but it still only gives the country a 3 out of 10. stability and confidence is very low political tensions still run High the country has no Financial reserves and it's heavily dependent on other countries for everything it needs to operate it gets a 2 out of 10 but keep in mind that a score of one or zero means that the country is either in active Revolution or deep in Civil War growth is the reason that I made this video to begin with since the year 2000 Sri Lanka's economy has become five times larger and it's fifty percent larger than it was a decade ago again before considering this year's downturn with such strong growth it would be easy to see why businesses and the government were building out infrastructure in anticipation for the time when the economy would grow into it and had everything gone perfectly we may very well have been making a video about Sri Lanka's genius domestic Investments that let it maintain its trajectory as one of the fastest growing economies in the world unfortunately that hasn't happened but the economy does still get a 7 out of 10. finally industry this was the real problem with shranker which was that it wasn't able to develop industries that would be competitive in the global economy it was trying to become a part of Tourism and services the two things that the country did have going for it are only going to suffer more now that the first thing that people think of when they think of Sri Lanka is not relaxing around a resort swimming pool but citizens riding around their fleeing prime minister's swimming pool Sri Lanka gets a 2 out of 10. altogether that gives Sri Lanka average score of 3.4 out of 10 which puts it down here on the economics explained National leaderboard thanks for watching mate bye
the failing economy of sri lanka

Source : Economics Explained