The Island that Squandered its Promise 

In the 1950s, Sri Lanka looked destined for prosperity. With higher per capita income than much of East Asia, a literate population, fertile land, and a strategic location along global trade routes, it seemed set to follow a trajectory like Singapore or South Korea. Instead, by 2022, the country became the first in Asia in two decades to default on its sovereign debt. Citizens queued for fuel, faced food shortages, and protested in the streets. How did a nation with such promise collapse so spectacularly? The story is not one of inevitable misfortune, but of choices: Sri Lanka rejected the principles of limited government, sound money, and open markets, and instead embraced decades of populism, protectionism, and debt-fueled state expansion.

From the very start of independence in 1948, the seeds of decline were planted. Rather than deepening its integration with global markets, Sri Lanka turned inward. Universal subsidies for rice, fuel, education, and health were introduced from the 1950s onward, creating fiscal burdens and a culture of dependency. Politicians competed not in strengthening institutions but in offering larger subsidies and more state jobs. As James Buchanan later observed, democratic politics often degenerates into a contest of promising benefits today while pushing costs onto tomorrow’s taxpayers. This dynamic became the defining feature of Sri Lanka’s economic life.

The state also expanded its reach into nearly every sector of the economy. Nationalization swept through industries from transport to banking, with the Ceylon Transport Board and Ceylon Petroleum Corporation becoming symbols of bloated inefficiency. These enterprises were not managed in the interest of efficiency or consumers but as tools of patronage for political elites. Frédéric Bastiat’s description of the state as an engine of “legal plunder” captures the pattern perfectly: resources were redirected from productive enterprise into politically favored channels.

Trade policy was equally damaging. High tariffs, exchange controls, and strict import bans entrenched an import substitution model that forced citizens to consume inferior local substitutes or endure shortages of basics like flour and textiles. David Ricardo’s insight about comparative advantage—that nations prosper by specializing and trading freely—was ignored. While Singapore, Malaysia, and South Korea were using exports to power rapid growth, Sri Lanka isolated itself from global markets. As Adam Smith noted long ago, the division of labor is limited by the extent of the market, and by shrinking its own, Sri Lanka limited its own future.

The 1970s marked the nadir of this experiment. Price controls, rationing, and foreign exchange restrictions grew so severe that queues for bread and kerosene became a fact of daily life. Black markets flourished, innovation stalled, and growth flatlined. Liberalization in 1977 under J.R. Jayewardene offered a temporary reprieve, reopening trade and creating export zones, but the underlying logic of fiscal populism remained untouched. Governments across parties clung to subsidies, welfare transfers, and state employment as their electoral currency. The result was a permanent budget crisis. Deficits regularly exceeded 10 percent of GDP, financed through borrowing and money printing. Milton Friedman’s dictum that “there is no such thing as a free lunch” could not have been more apt: inflation and debt were the hidden costs of endless political promises.

Meanwhile, the public sector ballooned into an unsustainable burden. By the 2000s, over 1.4 million Sri Lankans were employed by the state, far beyond productive need. This was not governance in the service of citizens but a political machine feeding itself. Crony capitalism flourished, with contracts, licenses, and state land allocated not on merit but on political loyalty. Friedrich Hayek’s warning that economic control inevitably breeds favoritism and corruption proved prophetic in the Sri Lankan case.

The Rajapaksa era brought these dynamics to their breaking point. Financing the civil war and vast infrastructure projects with foreign loans, especially from China, the government indulged in the illusion of prosperity through borrowed money. Highways, airports, and ports were built without concern for economic return. Bastiat once warned that bad economics looks only at the “seen” and ignores the “unseen.” The seen was gleaming infrastructure; the unseen was mountains of debt, wasted opportunity, and pervasive corruption.

Monetary irresponsibility compounded the problem. Rather than pursue stable, predictable policies, the Rajapaksas turned to money printing to fund their deficits, unleashing inflation that eroded savings and destroyed the middle class. Friedman’s warning that inflation is “always and everywhere a monetary phenomenon” was vindicated. The government’s 2019 tax cuts, which gutted revenue without reducing spending, only deepened the crisis. This was not serious reform but reckless populism.

Desperation bred further errors. When foreign exchange ran dry, the government responded with arbitrary bans and controls. The 2021 prohibition on chemical fertilizer imports devastated agriculture, triggering food shortages that rippled across the economy. Hayek’s critique of central planning—that no authority can possess the dispersed knowledge of millions of individuals—explains this disaster clearly. A handful of politicians believed they could reorder farming practices by decree; the result was hunger. By 2022, foreign reserves were gone, debt repayments were impossible, and Sri Lanka was forced into default. Protests erupted, and the Rajapaksa dynasty fell, swept aside by the very people it had impoverished.

The collapse was not the result of bad luck or external shocks alone. Global events such as the COVID-19 pandemic and the war in Ukraine worsened the situation, but the deeper cause was decades of rejecting basic principles of economic governance. Prosperity requires fiscal discipline, free exchange, stable money, and secure property rights. Sri Lanka undermined each of these pillars. Chronic deficits piled up debt; protectionism denied access to global markets; cronyism eroded the rule of law; and money printing acted as a hidden tax on the population. Political centralization ensured that economic decisions were dictated not by voluntary exchange but by the whims of a ruling family.

The lessons are not difficult to state, though they may be politically difficult to accept. Budgets must be balanced, with spending restrained to essential public goods rather than populist giveaways. Property rights must be respected and contracts enforced impartially, ending the crony favoritism that has plagued the state. Trade barriers must be dismantled so that Sri Lanka can benefit from regional and global markets rather than remain trapped in costly self-sufficiency. The central bank must pursue stability, free from political interference, to protect citizens from inflation. Most importantly, individuals and businesses must be allowed the freedom to produce, trade, and innovate without suffocating under state direction.

The tragedy of Sri Lanka is that it once had the potential to be a beacon of prosperity in South Asia. In the mid-20th century, its social indicators rivalled or surpassed those of East Asia. But by abandoning the principles of fiscal prudence, openness, and individual freedom, it squandered that promise. As Hayek warned, the “fatal conceit” is the belief that governments can plan prosperity better than free individuals and markets. Sri Lanka’s collapse is a textbook vindication of that warning.

The queues for fuel and food in Colombo in 2022 are more than a national tragedy; they are a cautionary tale for the world. The price of rejecting open markets and limited government is not abstract—it is empty shelves, worthless money, and lost decades of growth. Sri Lanka paid that price. Other nations, especially those tempted by populist spending and protectionist economics, would be wise to remember the lesson. Prosperity is fragile, and liberty is its only sure foundation.