By Kasuni Ranasinghe, Associate Fellow SAFN

“In the case of Sri Lanka, it is clear that its own extractive institutions, whichare deeply centralized power, corruption, and economic mismanagement have contributed to its current crisis.”

The recent economic crisis in Sri Lanka has led to broader discussion about how political
institutions have influenced the economic instabilities. Daron Acemoglu and James Robinson, in
their book Why Nations Fail (2012), explain that it is possible that countries’ economies fail into
crisis when power and wealth are governed by a small group of elites. The authors name this
system “extractive institution,” and they believe these institutions prevent economic innovation
and development. In the case of Sri Lanka, it is clear that its own extractive institutions, which
are deeply centralized power, corruption, and economic mismanagement have contributed to its
current crisis.

This commentary will understand how Sri Lanka’s institutions led to its economic crisis and
what needs to be done to move inclusive institutions that foster sustainability by employing the
framework suggested in the book “Why Nations Fail.”.

1. Extractive Institution and Centralised power

“Why Nations Fail” described as the system toprotect a small group of ruling elites and not consider the public role in governance.

Centralization of power in Executive Presidency

Since the 1978 constitution, the political system of the country has centralized its power in the
executive presidency. The presidency holds significant authority, which has power to
overshadow the parliament and the judiciary sometimes. This centralisation of power fits with
the definition of an extractive institution, which “Why Nations Fail” described as the system to
protect a small group of ruling elites and not consider the public role in governance.
This concentration of power grew even stronger during the presidency of Mahinda Rajapaksha
(2005-2015) and later Gotabaya Rajapaksha (2019-2022). As the 18th amendment to the
Constitution 2010 passed, it eliminated the term limit for the presidency and allowed the
president to appoint key officials without requiring the approval of the parliament; this includes
judges (Edrisinha & Jayakody, 2015). This amendment weakened the democratic balance and
centralized power in the executive, which created a system that prioritizes the interests of
political elites over the general public.

Acemoglu and Robinson (2012) highlight in their book that in extractive institutions, elites resist
reforms that could threaten their power, possibly leading to a long-term stalemate. In Sri Lanka,
the centralisation of executive power led to the creation of economic policies to favor
high-profile investments over the highly required initiates for inclusive economic growth. These
ventures were mostly financed by foreign loans, which failed to generate expected economic
returns and instead left the country weighed down by unsustainable debt.

Corruption and nepotism network

“Chief Delegate of the Delegation of German Industry andCommerce in Sri Lanka, Marie Antonia von Schönburg, highlighted that political leaders in SriLanka often use public funds to invest in inefficient infrastructure.”

Sri Lanka’s political system is heavily influenced by island-wide spread corruption and
nepotism, which are both key features of extractive institutions. As per Transparency
International‘s 2022 corruption perception index, rank 101st amongst 180 countries. The
government and economy clearly exhibit deep-rooted corruption. During the regime of
Rajapaksha, nepotism thrived. Rajapaksa rewards their loyalists through government contracts,
top-tyre positions, and unlimited access to state resources.

Hambantota Port is the prime example for this dynamic. Port was largely funded by Chinese
loans under the Under Belt Road (BRI) initiative with a cost of $1.3 billion. However, the port
did not generate expected returns, and as a result, it was leased to a Chinese state-owned
enterprise for 99 years to cover the excessive debt (Jones & Hameiri, 2020). This situation
reflects Acemoglu and Robinson’s (2012) theory that extractive institutions promote rent-seeking
elites, where influence to extract state wealth and resources for the inner circle benefits without
contributing to productive economic activities.

As cited in the Tamil Guardian (2024), Chief Delegate of the Delegation of German Industry and
Commerce in Sri Lanka, Marie Antonia von Schönburg, highlighted that political leaders in Sri
Lanka often use public funds to invest in inefficient infrastructure. This is to showcase political
prestige rather than foster inclusive economic growth. These decisions reflect a lack of
transparency and accountability, key features of extractive institutions.

2. Economic impact of extractive institutions

Debt Crisis and fiscal management

“Mattale Rajapaksha airport, which is more often referred to as the world’s emptiest airports, is asolid example of politically motivated decisions that failed to deliver substantial economic returns”

The debt crisis is the best example for Sri Lanka’s extractive institutions. According to the World
Bank, Sri Lanka surpassed $83 billion in public debt by 2022, with the external debt-to-GDP
ratio exceeding 70%. The debt-to-GDP ratio skyrocketed from 79% in 2015 to over 120% in
2022.

The World Bank Group (2023) believed this was due to the unsustainable borrowings for
infrastructure projects that failed to generate expected returns. In the words of Acemoglu &
Robinson (2012), extractive institutions focus on short-term benefits rather than long-term.
Mattale Rajapaksha airport, which is more often referred to as the world’s emptiest airports, is a
solid example of politically motivated decisions that failed to deliver substantial economic
returns (Shepard, 2016).

Statistics evident that Sri Lanka’s fiscal mismanagement worsened the debt crisis. In 2019, the
government introduced significant tax cuts that reduced value-added tax (VAT) from 15% to 8%;
additionally, it lessened personal and corporate income taxes. The aim of the tax cut was to
stimulate both economic growth, but it caused a steep drop in government income and created a
budget deficit to over 12% of GDP in 2021 (The World Bank, 2021). This monetary oversight
pushed Sri Lanka to depend more on foreign debt and, in the long run, on the debt crisis and
external economic shocks.

Foreign Exchange Crisis and Importance Dependence

The 2022 foreign exchange crisis further highlighted the weakness caused by extractive
institutions. According to the CBSL (2023), the Sri Lankan government failed to import critical
goods such as fuel, medicine, and food due to the foreign reserve dropping to less than $ 2 billion
(by mid-2022). The Central Bank of Sri Lanka (2023) believed that several factors contributed to
this crisis, mainly the COVID pandemic and its aftermath. The pandemic hit hard on the tourism
industry, which accounted for 12% of GDP before, and it further led to a significant drop in
remittances from Sri Lankans working overseas (reprect 9% of GDP before). Additionally, it is
evident that the government failed to diversify its economy and strengthen its exports instead
focusing on a narrow range of economic activities controlled by elites (Perera, 2023). These
made the state vulnerable to external shocks such as COVID 19. Acemoglu & Robinson (2012)
argue these are typical characteristics of extractive economic institutions.

3.Social and Political fallout

“Anura Kumara Dissanayake, who led Janatha Vimukthi Peramuna (JVP) with the desire ofsystem change. JVP is a party with a long history of leftist, anti-elite politics and voters who feltdiscriminated against by economic and political institutions.”

Protest and Political Instability

The Aragalaya (Struggle) Protest Movement, which started in early 2022, revealed the growing
public frustration towards the state’s extractive political system. The movement expanded
quickly and drew people from all walks of life, including urban professionals, students, farmers,
trade unions, and the middle class (previously seen as politically passive). Protestors demanded
President Gotabaya Rajapaksha to resign and blamed his administration for the crisis. After
months of escalating protests in July 2022, President Gotabaya Rajapaksha resigned and pledged
the country. This made a pivotal moment of Sri Lankan political history (Mashal, 2022).
These moments follow a pattern described in “Why Nations Fail,” where the continuation of
extractive institutions often leads to social and political unrest. According to the book, when
elites continuously monopolized power and resources, it created a condition of instability.
Eventually marginalized groups rise to challenge this system.

However, the appointment of Ranil Wikramasinghe as the executive president, a long-time
serving politician representing an extractive institution, did not ease the protestors (Kenny,
2023). This led to radical changes to the results of the 2024 presidential election. Citizens voted for
Anura Kumara Dissanayake, who led Janatha Vimukthi Peramuna (JVP) with the desire of
system change. JVP is a party with a long history of leftist, anti-elite politics and voters who felt
discriminated against by economic and political institutions. Dissanayake’s proposals for
reducing the power of the executive presidency, fighting corruption, and restructuring the
economy boosted the struggling citizens.

4.Institutional reforms

Lessons from “Why Nations Fail”.

“Why Nations Fail” explains that if a country needs to break free from the cycle of failure caused
by extractive institutions, it must shift towards more inclusive institutions. These institutions
represent pluralism, accountability, encourage wider participation in politics, and promote
equitable economic development. For Sri Lanka, these reforms should start reducing the power
of the executive presidency and enhancing parliamentary oversight. Additionally, strengthening
independent anti-corruption bodies and affirming transparency could be the foundation of
inclusive institutions (Kelegama, 2006).

The 2024 presidential election results illustrate strong public demand for change and opportunity
for much-needed institutional reform. However, the road to reform is indeed challenging. The
success of the reform will depend on the ability and interest of new political leaders and civil
societies to form a broader coalition in support.

References

Acemoglu, D., & Robinson, J. (2012). Why Nations Fail: The Origins of Power, Prosperity, and
Poverty. Crown Business.
The CBSL. (2023). The Central Bank of Sri Lanka raises the Policy Interest Rates. Central Bank
of Sri Lanka. https://www.cbsl.gov.lk/en/news/monetary-policy-review-no-2-of
Central Bank of Sri Lanka. (2023). Annual Report 2022. Central Bank of Sri Lanka.
https://www.cbsl.gov.lk/en/publications/economic-and-financial-reports/annual-reports/an
nual-report-2022
Edrisinha, R., & Jayakody, A. (Eds.). (2015). The Eighteenth Amendment to the Constitution:
Substance and Process. CPA.
Jones, L., & Hameiri, S. (2020). Debunking the Myth of ‘Debt-trap Diplomacy’ How Recipient
Countries Shape China’s Belt and Road Initiative. Chatham House.
https://www.chathamhouse.org/2020/08/debunking-myth-debt-trap-diplomacy/6-conclusi
on-and-policy-recommendations
Kelegama, S. (2006). Development under Stress Sri Lankan Economy in Transition. Sage
Publications, New Delhi, India.
Kenny, E. (2023). Sri Lanka’s Long Road to Democratic Reform: A Conversation with Bhavani
Fonseka. International IDEA.
https://www.idea.int/blog/sri-lankas-long-road-democratic-reform-conversation-bhavani-f
onseka
Mashal, M. (2022). Sri Lanka’s President Resigns After Months of Protest (Published 2022). The
New York Times.
https://www.nytimes.com/2022/07/14/world/asia/sri-lanka-president-rajapaksa-resigns-pr
otests.html
Perera, A. (2023). Sri Lanka: Why is the country in an economic crisis? BBC.
https://www.bbc.com/news/world-61028138
Shepard, W. (2016). The Story Behind The World’s Emptiest International Airport. Forbes.
https://www.forbes.com/sites/wadeshepard/2016/05/28/the-story-behind-the-worlds-empt
iest-international-airport-sri-lankas-mattala-rajapaksa/
Tamil Guardian. (2024). Lack of transparency and consistency hinder Sri Lank’s economic
prospects. Tamil Guardian.
https://www.tamilguardian.com/content/lack-transparency-and-consistency-hinder-sri-lan
k-s-economic-prospects
Transparency International. (2022). 2022 Corruption Perceptions Index: Explore the… –
Transparency.org. Transparency International. https://www.transparency.org/en/cpi/2022
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https://www.worldbank.org/en/country/srilanka/overview
World Bank Group. (2023). Sri Lanka: How to Strengthen Debt Management at the Time of
Uncertainty. World Bank.
https://www.worldbank.org/en/news/feature/2023/07/06/sri-lanka-how-to-strengthen-debt
-management-at-the-time-of-uncertainty

Kasuni Ranasinghe is a Research Associate with The Millennium Project’s South Asia Foresight Network (SAFN) in Washington, D.C. Previously, she worked as a Research Analyst at the Institute of National Security Studies (INSS) under Sri Lanka’s Ministry of Defence. She holds a Master’s degree in International Relations and a Bachelor’s degree in Economics.