Economics III: International Economics, Development, and the Sri Lankan Economy

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International Trade

Why countries trade: differences in resources, technology, and tastes. Absolute advantage (Smith, 1776) and comparative advantage (Ricardo, 1817): a country should specialize in goods with the lower opportunity cost. Example: if Country A gives up 2 units of cloth to make 1 unit of tea, and Country B gives up 3 units of cloth for 1 unit of tea, A has a comparative advantage in tea.
Gains from trade: lower prices, variety, and economies of scale; costs: adjustment costs and dependence.
Trade policy: tariffs, quotas, subsidies, and non-tariff barriers; arguments for protection (infant industries, national security, employment) and against (inefficiency, retaliation, higher prices) (Krugman et al., 2018).
Trade agreements and integration: the World Trade Organization (WTO), regional agreements such as SAFTA and BIMSTEC, free-trade agreements, customs unions, and economic integration (Wikipedia, "Economy of Sri Lanka," n.d.).

Exchange Rates and the Balance of Payments

Exchange rate: the price of one currency in terms of another; fixed, floating, and managed regimes. Depreciation makes exports cheaper and imports dearer. Factors: trade flows, interest rates, inflation, capital flows, and confidence.
Balance of payments (BOP): the record of a country's transactions with the rest of the world: the current account (trade in goods and services, primary and secondary income including worker remittances), the capital account, and the financial account. A trade deficit must be financed by borrowing, foreign investment, or reserves.
International finance: foreign direct investment, foreign loans, and reserves; the roles of the International Monetary Fund (IMF), the World Bank, and the Asian Development Bank.

Development Economics

Growth and development: development involves higher incomes and also better health, education, freedom, and sustainability (Sen, 1999).
Measures: GDP per capita, the Human Development Index (HDI) (health, education, and income), the Gini coefficient and Lorenz curve (inequality), poverty lines and multidimensional poverty indices.
Obstacles: poverty traps, low savings, weak institutions, debt, and conflict; strategies: investment in human capital, infrastructure, trade, institutions, and sound policy (Todaro & Smith, 2020).
Sustainable development: meeting the needs of the present without compromising future generations; the Sustainable Development Goals.

The Sri Lankan Economy

Structure: a developing mixed economy; services are the largest sector (about 58 percent of GDP in 2019), industry about 27 percent, and agriculture about 7 percent, although agriculture still employs a large share of workers (Wikipedia, "Economy of Sri Lanka," n.d.). Main exports include apparel and garments, tea, rubber, coconut products, spices, and gems; major earners include tourism and worker remittances.
Policy history: a more state-led approach before 1977 and liberalization from 1977, with trade and investment opening, and ongoing debates on the role of the state, the private sector, and state-owned enterprises.
Recent crisis and reform: the economy suffered a severe crisis between 2019 and 2024, linked to factors including the Easter Sunday attacks, the COVID-19 pandemic, a foreign-exchange shortage, high debt, and policy decisions; in April 2022 Sri Lanka announced a sovereign default, its first (Wikipedia, "Sri Lankan economic crisis," n.d.). Reforms followed, including an IMF-supported programme from 2023, fiscal consolidation, debt restructuring, and monetary tightening (IMF, 2023). Students should treat this as a rich case study: explain causes, effects (inflation, shortages, poverty, migration), policy responses, and the lessons for macroeconomic management, using up-to-date data from the CBSL and the Department of Census and Statistics (CBSL, n.d.; DCS, n.d.) and reporting different views on the causes fairly.
Challenges: debt sustainability, productivity, export diversification, regional inequality, climate vulnerability, and demographic change. The Northern and Eastern Provinces, recovering after the conflict, have potential in agriculture, fisheries, and tourism, along with needs in infrastructure and livelihoods.
Key institutions: the CBSL, the Ministry of Finance (Treasury), the Department of Census and Statistics, the Board of Investment, and the Securities and Exchange Commission.

Common Mistakes

Memorizing figures without understanding their meaning or checking whether they are current.
Presenting a single cause for a complex crisis.
Confusing the current account with the balance of payments as a whole.

CHAPTER 16