Low economic freedom limits trade and prosperity

Sri Lanka’s complex trade policies affect economic freedom and growth

Trade freedom has advanced growth and efficiencies within several emerging and developed countries. It is a composite measure of the absence of tariff and non-tariff barriers that affect the import and export of goods and services. Sri Lanka is ranked 135th for Freedom to Trade internationally according to the Economic Freedom of the World report published by The Fraser Institute, a public policy think tank based in Canada. This indicates that trade freedom in Sri Lanka was ranked in the bottom 30 countries globally. The report was published based on data collected from 159 countries in 2015.

Sri Lanka is separated from the rest of the world through visible and invisible trade barriers, says Fraser Institute Resident Fellow Fred McMahon.

Along with freedom to trade internationally, other dimensions like the size of the government; the legal system and property rights; sound money; and regulation of credit, labour and business are used to measure the degree of economic freedom. Countries with higher levels of economic freedom correlated with various positive measures such as economic growth, higher income, gender equality and life expectancy. McMahon spoke with Echelon about Sri Lanka’s trade outlook and the performance of the Economic Freedom Index.

Excerpts from the interview are as follows:

Economic freedom is a new debate in Sri Lanka. Why is this important?
● Everyone needs to enjoy civil, political and economic freedom. The government should not decide who you vote for, what you say or how to manage your economy. It’s the most intrinsic freedom, as our lives mainly revolve around living and working materially. Government interference on where one works, what one does for a living or whether one can start a business affects individual rights and reduces overall freedom. There was a lack of concrete measure of economic freedom when the project was initiated. The relationship between economic freedom and prosperity, along with other desirable social outcomes, were unknown at that time. Since then, over 600 studies have proved economic freedom as a growth generator.

How has Asia performed in terms of economic freedom?
● Asia is a whole spectrum of nations with varying degrees of economic freedom. Hong Kong and Singapore rank the highest. Myanmar and Vietnam display low levels of economic freedom, while Malaysia lies midway. Unfortunately, Sri Lanka hasn’t ranked well.

What are the factors responsible for Sri Lanka’s poor ranking in economic freedom?
● Sri Lanka is stagnating with the outlook for trade worsening. A country with a relatively small population absolutely needs trade freedom to prosper.

Economic research undisputedly claims freedom to trade as a key driver of growth and prosperity, particularly for poor and small nations. Sri Lanka ranking 135th for Freedom to Trade internationally is an unfavourable condition, because any country that ranks 73rd is considered an indication of a disastrous situation. The government’s decision to cut off Sri Lanka from the rest of the world through several visible and invisible trade barriers is unreasonable.

Sri Lanka also has a poor score in all facets of trade. Standard deviation of the tariff rate is the difference between certain tariffs. If you have one tariff rate at 1% and another at 70%, that shows a variation. A huge amount of variation in Sri Lanka’s tariffs indicates that the government is trying to manage the economy and growth sectors. High tariffs levied by the domestic government create an unfair playing field that benefits those with political power.

In addition, non-tariff barriers to trade restrict the exchange of goods and services. The list goes on with various barriers to trade in the form of compliance costs and regulatory barriers. Sri Lanka limits trade just about in every way a nation can limit trade. Sri Lanka scored poorly on sound money as well. Protection of property is the cornerstone of economic freedom. You can’t have economic freedom if someone comes and takes your properties away. Inflation does that to your properties. The government causes the money to shrink by printing and spending people’s money; that’s where inflation comes in and restrains economic freedom.

Do you see any trends holding other Asian countries back in a similar way?
● Asia is a diverse region, and it is difficult to generalize trends. What goes around in Japan contrasts with the circumstances in Myanmar, or Sri Lanka for that matter. Prosperity in South Korea, Taiwan and Japan has certainly been built on trade. The stars of Asia are more open to trade than most others within the region. The differences are very clear. Taiwan, Hong Kong and Singapore, the rich nations, have open trade policies. Whereas, Malaysia and Indonesia have a relatively less open policy and are moving into middle-income strata. Nations similar to Sri Lanka with closed borders have trapped themselves within the lower-middle income level.

A large portion of Sri Lanka’s population is employed within the agricultural sector, which indicates the need for protective measures. Does this set the context for policy in trade?
● Sri Lanka’s massive potential lies in agriculture. Harnessing the agricultural potential will unlock powerful economic growth and development. The country should sell large amounts of agricultural goods to the rest of the world.

New Zealand had an agricultural industry similar to that in Sri Lanka. In the midst of a financial crisis, during the mid-1980s, New Zealand decided to scrap all farm subsidies and price supports overnight. Thereafter, the country transformed from being a small agricultural exporter to a power house. Meanwhile, Sri Lanka is preventing its own growth by throttling the agricultural sector.

Freedom to trade is a key driver of growth and prosperity, particularly for poor and small nations. The government’s decision to cut off Sri Lanka from the rest of the world through several visible and invisible trade barriers is unreasonable

Do you think it’s possible for a nation to prosper within a lagging region? Are there any examples?
● I will highlight two case studies from different regions. Chile was one of the poorest nations within the South American region. Chile moved into a free market system and undertook economic reforms. Subsequently, Chile’s economy skyrocketed from being the poorest to the richest Latin American nation.

On the reverse trend, Venezuela transformed from being the wealthiest nation in South America to the brink of financial collapse. The wealth was primarily not due to oil wealth, as a barrel was sold for $6 compared to $20 a barrel in today’s term. I fear what happened in Venezuela is happening in Sri Lanka, with crony capitalists taking control of industries inside closed borders. Venezuela is now an economic disaster, where food and medicine are scarce.

Another example from the Sub-Saharan African region would be Botswana. During the 1960s, Botswana was poorer than the average African nation. However, following the adoption of policies for economic freedom and rule of law, Botswana is growing at a faster rate than the so-called Asian tiger.

What are your observations regarding rule of law in Sri Lanka?
● Rule of law is fundamental for the economic freedom of all members of society, including the poor and weak. Rule of law needs to operate impersonally to protect the whole society. Sri Lanka ranked 135th is a huge disappointment. I have spoken to lawyers here, and they tell me Sri Lanka had a strong and impartial rule of law back in the 1980s. It’s essential to rebuild the rule of law rather than allow it to deteriorate further.

How has Sri Lanka fared in terms of labour regulations?
● Labour regulations are essential to create quality jobs within the private sector. The public needs to be encouraged to seek employment within the private sector rather than in the government. A weak private sector would affect taxes levied by the government to fund welfare and public services. A robust and competitive market is essential to create quality jobs that provide employment and market opportunities for the poor.

Rule of law is fundamental for the economic freedom of all members of society, including the poor and weak. Rule of law needs to operate impersonally to protect the whole society

However, labour regulations inhibit growth in Sri Lanka. Employers are reluctant to fire redundant staff due to the high compensation necessary to do so. As a result of problematic laws, employers are saving jobs rather than creating new jobs.

What are the consequences of a large government?
● An expanding government is detrimental to economic growth. There are a number of negative consequences associated with the civil service expanding in Sri Lanka. Bloating the size of the government is usually done to politicize civil services. When there are too many people doing the work of one person, everyone tries to be busy and tortures the public with excessive regulations, red tape and paperwork. A large population performing unproductive work affects efficiency and the work ethic, resulting in the spread of patronage and corruption, as individuals holding powerful civil service jobs would develop a patronage network and reward their relatives with employment in the civil service.