| Date | May 2017 | Marks available | 4 | Reference code | 17M.2.SL.TZ0.04 |
| Level | Standard level | Paper | Paper 2 | Time zone | Time zone 0 |
| Command term | Explain | Question number | 04 | Adapted from | N/A |
Question
Sri Lanka’s economic reforms
- After Sri Lanka’s 25-year civil war ended in 2009 it became one of the world’s fast-growing emerging markets, helped by billions of US dollars worth of infrastructure investment from China. Sri Lanka’s new government plans to implement a range of market-oriented policies to open up its financial system, liberalize the Sri Lankan rupee (Sri Lanka’s currency) and make new trade deals with both India and China.
- Sri Lankan economists and corporate leaders are urging “tough” economic decisions, reducing the bureaucracy and eliminating costly inefficiencies in state enterprises. 300 state-owned firms dominate the economy, and there is pressure for them to enhance their competitiveness. One realistic option is a policy of privatization. Another policy is the establishment of 46 economic zones across the country with low tax rates. This should encourage the private sector to invest in setting up these zones.
- Improving infrastructure is also a priority. Power supply is unreliable and broadband speeds are slow in rural areas.
- Another priority is to reduce controls on exchanging currency. Sri Lankans find it difficult to obtain foreign exchange, limiting tourism and business overseas. Improving access to foreign currencies would make people’s lives easier and encourage more business.
- On a positive note, improved international relations has increased tourism. To take advantage of this, the government should now implement a strategy to further promote tourism.
- A major challenge for the government is that more than 25% of the population lives below US$2.50 per day. This is caused largely by the fact that 30 % of the population is involved in agriculture, which contributes less than 10% of gross domestic product. In addition, tackling youth unemployment and increasing household incomes are challenges.
- But perhaps the greatest problem confronting the government is the country’s massive debt burden, which is equivalent to 700% of its tax revenue. This creates a significant debt servicing problem, especially because much of the debt is foreign owned.
- Another problem is a current account crisis. Sri Lanka needs to replace its reliance on payments from Sri Lankans employed overseas with export revenues. And instead of relying on borrowing from overseas to finance its current account deficit, the country needs to attract foreign direct investment.
- There is also a need for the government to try to improve the ability for companies to do business, such as by reducing the time it takes to register a business and by improving access to credit for small companies, which would significantly stimulate the economy. Business confidence has to improve in order to stimulate new investments and economic growth.
[Sources: adapted from Sunday Times, Sri Lanka, www.sundaytimes.lk, 23 August 2015, and 
James Crabtree, 2015, Sri Lanka plans ‘big bang’ reforms, Financial Times, www.ft.com, 19 August. Used under licence from the Financial Times. All Rights Reserved.]
List two characteristics of an economically less developed country.
Define the term privatization indicated in bold in the text (paragraph 2).
Using a production possibilities curve (PPC) diagram, explain how “billions of US dollars worth of infrastructure investment from China” may affect potential economic output (paragraph 1).
Using a definition of the term opportunity cost and information from the text, explain how the servicing of debt has an opportunity cost that may affect economic development in Sri Lanka.
Using information from the text/data and your knowledge of economics, discuss the possible effects of the proposed market-oriented reforms on Sri Lanka’s economic development.
Markscheme
Level
0 The work does not meet a standard described by the descriptors below. [0]
1 Vague definition. [1]
For listing one of the following characteristics:
- low levels of GDP per capita
- high levels of poverty
- relatively large agricultural sector
- large informal sectors
- high birth rates (population growth rates)
- poor infrastructure
- underdeveloped capital markets (banking sector)
- heavily indebted
- unable to access international markets
- over-specialized on a narrow range of products
- small tax base
- dependency on primary sector exports.
2 Accurate definition. [2]
For listing two of the following characteristics:
- low levels of GDP per capita
- high levels of poverty
- relatively large agricultural sector
- large informal sectors
- high birth rates (population growth rates)
- poor infrastructure
- underdeveloped capital markets (banking sector)
- heavily indebted
- unable to access international markets
- over-specialized on a narrow range of products
- small tax base
- dependency on primary sector exports.
Level
0 The work does not meet a standard described by the descriptors below. [0]
1 Vague definition. [1]
The idea that it is when the government no longer owns a company.
2 Accurate definition. [2]
An explanation that the government sells state-owned enterprises (assets/firms) plus one of the following:
- to the private sector
- to raise revenue.
Level
0 The work does not meet a standard described by the descriptors below. [0]
1 There is a correct diagram or an accurate written response. [1–2]
For drawing a PPC (outward shift) showing an increase in the potential output in Sri Lanka or for an explanation that China’s investment in infrastructure would likely improve the quality and/or the quantity of the factor of production capital and therefore may increase production possibilities (potential economic output).
2 There is a correct diagram and an accurate written response. [3–4]
For drawing a PPC (outward shift) showing an increase in the potential output in Sri Lanka and for an explanation that China’s investment in infrastructure would likely improve the quality and/or the quantity of the factor of production capital and therefore may increase production possibilities (potential economic output).
Candidates who incorrectly label diagrams can receive a maximum of [3].
For PPC, there must be two goods or groups of goods competing for the same resources on the axes. Good A and Good B would be sufficient.
Level
0 The work does not meet a standard described by the descriptors below. [0]
1 There is a correct diagram or an accurate written response. [1–2]
For a correct definition of opportunity cost or for an explanation that money spent on debt servicing in Sri Lanka will reduce the government’s ability to spend on achieving development objectives, such as infrastructure spending, reducing youth unemployment, increasing household incomes.
2 There is a correct diagram and an accurate written response. [3–4]
For a correct definition of opportunity cost and for an explanation that money spent on debt servicing in Sri Lanka will reduce the government’s ability to spend on achieving development objectives, such as infrastructure spending, reducing youth unemployment, increasing household incomes.
Examiners should be aware that candidates may take a different approach which, if appropriate, should be rewarded.
Do not award beyond Level 2 if the answer does not contain reference to the information provided.
Level
0 The work does not meet a standard described by the descriptors below. [0]
1 Few relevant concepts are recognized.
There is basic knowledge/understanding. [1–2]
2 Relevant concepts are recognized and developed in reasonable depth.
There is clear knowledge/understanding.
There is some attempt at application/analysis. [3–5]
3 Relevant concepts are recognized and developed in reasonable depth.
There is clear knowledge/understanding.
There is effective application/analysis.
There is synthesis/evaluation, supported by appropriate theory and evidence. [6–8]
Command term
“Discuss” requires candidates to offer a considered and balanced review that includes a range of arguments, factors or hypotheses. Opinions or conclusions should be presented clearly and supported by appropriate evidence.
Responses may include:
- definition of economic development
- definition of market-oriented reforms/policies.
Possible positive effects:
- investing in infrastructure (paragraph 1) to improve infrastructure (paragraph 3), reducing the cost of economic activity
- opening up financial system (paragraph 1) may encourage foreign banks and increased lending to business, thus increased capital formation in the long-run, possible shift in LRAS to the right
- liberalizing the currency (paragraph 1 and 4) allows for greater access to credit and encourages tourism and business (paragraph 5)
- trade deals (liberalization) (paragraph 1) may promote export growth, reducing current account deficit, creating (youth) employment and increasing household incomes (paragraph 6)
- reducing bureaucracy (paragraph 2) which would reduce the cost of doing business
- privatization of state-owned enterprise may lead to greater efficiency and more reliable power supply in the energy generation industry (paragraph 2 and 3) supporting industry efficiency
- creating 46 economic zones with low tax rates may encourage FDI leading to increased AD and job creation to tackle high youth unemployment (paragraph 2)
- creation of economic zones likely to increase manufacturing and industrialization encouraging a shift away from low income agricultural jobs to higher income manufacturing jobs thereby tackling the large percentage of the population living on less than US$2.50 per day (paragraph 2)
- potential for increased government revenue to repay debt by privatizing state-owned enterprises (paragraph 2)
- export-led growth and the attraction of FDI (paragraph 8) - Sri Lanka is actively encouraging FDI so trade and investment are likely to increase, thus increasing AD, and/or LRAS, and possibly breaking the poverty trap
- easier for businesses to register (paragraph 9)
- improving access to credit for small companies and increasing long-run potential output – creates jobs (paragraph 9).
Possible negative effects:
- increased unemployment
- privatizations of utilities could result in higher utility prices thus harming low income households
- possible negative externalities created by the opening of the economic zones
- possibility of increased income inequality in the distribution of income
- privatized firms may have monopoly power
- FDI may lead to more outflows of incomes on the current account
- liberalization of currency markets (paragraph 4) may lead to capital flight (outflows on financial account).
Any reasonable discussion.
