- [Narrator] 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 are part of the reason
why Sri Lanka was one of the fastest-growing economies
in the region in the late 2000s and early 2010s,
and 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 being 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 a 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 were enjoying prior to 2020?
Once we have done all of that, we can put Sri Lanka
on the "Economics Explained" national leaderboard.
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The economy of Sri Lanka 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 armed 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 tourists' 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 sending 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 wanna repeat too much here,
but this source of cash turned out to be
both a blessing and a curse for Sri Lanka.
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, encouraged private businesses
to do the same.
Non-tradable industries are things like domestic education,
healthcare, 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
is going to run into a lotta problems basing its growth
off 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 an inner city office
to allow for further expansion.
(air whooshing) 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
was being funded by debt taken on as a developing economy.
Government spending was very lucrative
for a lotta 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
than 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, (mouse clicking)
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 payments is broken up
into two separate accounts: (air whooshing)
the current account and the capital and financial account.
These two accounts are always of equal value,
hence the name balance of payments.
Now, I don't wanna 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 it imports,
it will have money inflows. (money whooshing and jingling)
If an economy exports less than it imports,
it will have money outflows. (money whooshing and jingling)
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 that 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 wanna get really technical,
they'll break this down into foreign direct investment
and foreign portfolio investment.
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.
(money jingling) 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. (mouse clicking)
This is when workers will go abroad
and send money back to their family at home.
As much as 5% 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. (air whooshing)
Finally, there is foreign aid.
Global foreign aid now accounts
for more than $161 billion 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
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 that are on a Greek freighter
to be turned into batteries in Taiwan.
They'll then be sent to factories in China,
where they're 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're 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 2 1/2-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 onto 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
either 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've 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 outta money 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 outta money to pay for these supplies.
In fact, part of the reason
that the government enacted this ban
was so that they would stop losing the $400 million 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 on to an advanced economy
requires 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 sorta 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 and a half billion
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 three out of 10.
That GDP is spread out over a population of 22 million,
giving the country a GDP per capita of $3,814,
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 three 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 two 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 50% 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,
(numbers clicking) but the economy
does still get a seven out of 10.
Finally, industry.
This was the real problem with Sri Lanka,
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 rioting
around their fleeing prime minister's swimming pool.
Sri Lanka gets a two out of 10.
Altogether, that gives Sri Lanka an average score
of 3.4 out of 10, which puts it down here
on the "Economics Explained" national leaderboard.
Thanks for watching, mate. Bye.
(relaxed music)