In the aftermath of World War II, Taiwan and Sri Lanka both faced daunting economic challenges. Hyperinflation, external shocks, and political instability plagued these nations, yet their trajectories diverged dramatically. Taiwan emerged as an East Asian economic miracle, a global export powerhouse. Sri Lanka, despite repeated attempts at liberalization, remained trapped in cycles of inflation, debt, and instability. The difference lies not in capacity or intent but in policy choices, particularly regarding monetary stability and trade strategy.
The Post-War Crisis and Taiwan’s Monetary Chaos
When the Kuomintang (KMT) fled communist China in 1949, they established their base in Taiwan. At the time, the island was reeling from the effects of Japanese occupation, wartime inflation, and economic mismanagement. Prices, especially for staples like rice, had skyrocketed—in 1947 alone, rice prices rose 400 times.
The currency in circulation, issued by the Bank of Taiwan (which also functioned as a commercial bank), was rapidly losing value. In response, a stabilization program was launched, introducing the New Taiwan Dollar at an exchange rate of 40,000 old dollars to one new unit. Still, despite U.S. aid, inflation persisted, mirroring the post-war chaos in Japan before Joseph Dodge—a German-trained economist—was deployed to stabilize the yen.
Taiwan had become a classic case of “lost generation economics,” with multiple parallel exchange rates, import controls, and widespread black market activity. Foreign exchange was rationed, and exporters were discouraged due to unfair conversion rates, while importers with licenses reaped enormous profits.
Enter S.C. Tsiang: Hayek’s Student Rewrites Taiwan’s Future
Sho-Chieh Tsiang, a Chinese-American economist trained under Friedrich Hayek at the London School of Economics, was the architect of Taiwan’s transformation. Working with economist Ta-Chung Liu and influential bureaucrat K.Y. Yin, he advocated a bold reform agenda: unify exchange rates, eliminate import controls, and move toward export-oriented industrialization.
Though initially met with resistance, these reforms gained momentum as economic conditions worsened. Following Yin’s exoneration from a scandal, liberalization resumed, culminating in the devaluation and fixing of the Taiwan dollar at 40 to the U.S. dollar. Interest rates were raised, the Bank of Taiwan’s commercial functions were curtailed, and the peg became credible.
Free Trade Zones and Export-Led Growth
To solve the persistent issue of import taxes crippling exporters, tax rebates were introduced. A visionary scientist and economic strategist, K.T. Li, pushed for export processing zones (EPZs). After studying Trieste’s free port model, Li led the establishment of Taiwan’s first EPZ in Kaohsiung in 1965. This move allowed inputs for exports to enter duty-free, significantly boosting competitiveness.
This policy mirrored what Singapore had done around the same time, though Hong Kong had always enjoyed monetary stability and free trade without central bank interference.
Sound Money as the Bedrock
Taiwan maintained its fixed exchange rate policy well into the 1970s. When the U.S. dollar depreciated due to its own inflation, Taiwan responded by appreciating its currency, unlike many nations that resorted to devaluation. In February 1973, the Taiwan dollar was appreciated from 40 to 38 per U.S. dollar.
The central bank sold certificates of deposit to soak up excess liquidity, a move applauded by economists like Robert Emery of the U.S. Federal Reserve. These policies ensured monetary discipline, enabled long-term investments, and provided predictability for businesses.
Trade Liberalization and the Export Boom
With the stabilization of the currency, Taiwan embarked on large-scale trade liberalization. Import duties were slashed, the tariff structure was rationalized, and export volumes soared. Economist Douglas Irwin quoted K.T. Li as saying the initial reforms were not ideologically motivated but were pragmatic solutions to real problems. “How to solve the problem efficiently and thoroughly in the practical circumstances,” was Li’s mantra.
In contrast, Sri Lanka devalued its currency similarly in 1978 under J.R. Jayewardene, but failed to follow through with tight monetary policy. Continued money printing, driven by the belief that depreciation fosters growth, led to recurring balance of payments crises and inflation.
The Currency Divide: Taiwan vs. Sri Lanka
The Taiwanese dollar, devalued to 40 per U.S. dollar in the 1960s, now trades at around 32. Sri Lanka’s rupee, once at 5.7 per U.S. dollar, has plunged to over 300. This stark contrast highlights the long-term benefits of monetary stability. Stable exchange rates signal to investors and the public that the government has a credible economic plan.
Meanwhile, Sri Lanka continued to reject classical economic principles. Despite advice from Singapore’s Goh Keng Swee to stop money printing and inflationary policies, Sri Lanka’s macroeconomists clung to Keynesian and mercantilist views.
Misguided Economic Thinking
The knowledge of how balance of payments functioned under fixed exchange rates—once well understood by classical economists like Hume, Ricardo, and Smith—was largely lost in the English-speaking world by the 1950s. The Monetary Approach to the Balance of Payments, as explained by Tsiang and others, had its roots in classical economics but was overshadowed by the Keynesian consensus.
Tsiang observed, “The monetary approach to the balance of payments really began with Hume’s price specie flow mechanism,” yet this wisdom was forgotten.
Whereas Taiwan embraced classical thinking and allowed interest rates to rise when needed, Sri Lanka subsidized inflation. The result: investors fled, capital was destroyed, and the poor suffered.
Taiwan, Singapore, and the East Asian Miracle
Like Singapore and Hong Kong, Taiwan maintained sound money. Even amid global inflation, it resisted monetary activism. This commitment helped Taiwan build a robust industrial base, attract foreign investment, and maintain social stability.
Singapore went a step further by aggressively appreciating its currency to combat imported inflation. Policymakers reduced employer contributions to social security funds to support exporters, a pragmatic balancing act Sri Lanka failed to replicate.
Lessons for Sri Lanka
Sri Lanka does not lack talent or vision. Its leaders have proposed bold economic reforms, and its people are entrepreneurial and resilient. But unsound money sabotages good policy. Inflation is not a growth strategy; it is a poison that undermines stability, erodes savings, and drives out capital.
Even now, Sri Lanka can change course. By restoring monetary stability, eliminating discretionary money printing, and anchoring the currency, the country can attract investment, reduce poverty, and stop the brain drain.
The past is not merely a story; it is a mirror. Taiwan’s transformation holds vital lessons for Sri Lanka—lessons of discipline, pragmatism, and the enduring power of sound money.
