Market Economy at 40

Does low economic growth poison politics or are toxic politics the cause of anaemic growth?

Parched rice fields and lush cash crops on mountain slopes, the rich and the poor, altruistic and selfish, ancient and modern: Sri Lanka is a land of contrasts. Now, Sri Lanka has a new one: As Asia leaps forward towards openness, Sri Lanka remains dithering and closed.

Politics of the UNP – the Sri Lankan political party now controlling the government and setting policy in a coalition – have been pivotal, and led the change during the last 70 years. From leading Sri Lanka to independence, facilitating major irrigation to expand agriculture and introducing mega hydro projects to generate electricity, the UNP’s achievements in the socio-economic sphere have been outstanding.

Sri Lanka’s economy was in a perilous way when, in July 1977, the center-right UNP government led by J R Jayewardene was swept into power in a landslide election win. Soon after, the new government started dismantling the economic controls that had dissuaded private investment, obstructed free markets and isolated the island from the world.

During a period when East Asia’s most vibrant economies were beginning to benefit from market reforms in the 1970s, Sri Lanka resolutely introduced burdensome business regulations, high taxes and enterprise sapping controls.

Ceylon, as Sri Lanka was then known, was — at the turn of the 20th century — in the league of Asia’s richest economies, together with Japan, Hong Kong and Singapore (then a part of the Federated Malay States). In the early decades, Ceylon was viewed as a land of opportunity, attracting fortune-seeking immigrants and investment. European immigrants arriving here started trading ventures and employed other Europeans to plant vast acreages of coffee and tea.

At the turn of the 20th century, much of Colombo’s population was foreign-born. Ceylon was also among the wealthiest nations in Asia because of its agricultural success, infrastructure and links with the outside world, according to the most comprehensive global per head GDP data compiled by Angus Maddison.

In 1900, Ceylon’s GDP per head (in 1990 US dollars/international dollars) was $1,234 compared to Japan’s $1,180, Singapore’s $1,339 and Hong Kong’s $1,279 (in 1930, the first estimate of Hong Hong’s GDP). All other Asian states, and most of the rest of the world, were much poorer. People here were twice as rich as the average in Asia.

Although there have been periods of relatively fast growth and its people remain wealthy, Sri Lanka’s standing as one of Asia’s most vibrant economies is a distant memory

Although there have been periods of relatively fast growth over the last century – and since the nearly 30-year conflict ended eight years ago – and its people remain wealthier than their South Asian neighbours, Sri Lanka’s standing as one of Asia’s most vibrant economies is a distant memory.

Today, Sri Lanka’s per person GDP is only a quarter of Japan’s, 18% of Singapore’s and 17% of Hong Kong’s. Meanwhile, at the turn of the 20th century, laggards like Malaysia, Taiwan, Thailand, South Korea and China all now have far higher per person GDP than Sri Lanka. (see infographic on page 56)

Comparing the GDP product of different economies is fraught with challenge. It’s usually done by compiling estimates based on best judgments of what’s called ‘purchasing power parity’, which enables the comparison of incomes of various countries. Despite the PPP’s lack of precision and the same challenge associated with population estimates used to calculate per person GDP, they nonetheless pinpoint the trends.

However, what the data does show is that Sri Lanka’s relative decline accelerated during the 1970s because of its own regressive polices, while Asia’s most forward economies experienced high growth.

UNP government-introduced market reforms included abolishing a dual exchange rate system that swapped foreign exchange exporter income for rupees at a disadvantageous rate, while financing imports of essential items at a similarly artificial exchange rate. The financial services sector was liberalised, and many controls on trade were dropped overnight. The results were gratifying, with GDP growth topping 8.2% in 1978 and 6.3% in 1979. Since those years, Sri Lanka’s economic growth has averaged around 4% annually, a disappointingly low rate for a country with its potential.

This happened due to the government’s profligate ways catching up with it. The government funding three important projects at the same time – the Mahavali Scheme, the Greater Colombo Economic Commission (successor to the Board of Investment) and the Urban Development – was stretching the budget.

Government spending rose from Rs2.7 billion in 1977 to Rs8.2 billion three years later. However, the profligacy soon caught up, despite assistance from the IMF and loans from the World Bank.

Construction costs rose 50% in 1979 alone, a weaker currency resulted in costlier imports and inflation was soon out of control.

Singapore’s bright young technocrat and first Deputy Prime Minister Dr Goh Keng Swee pointed out the still-dominant role of the state and low private sector investment when he was invited here by President J R Jayewardene in 1980 for an independent view of the economy. By this time, Sri Lanka’s foreign aid in per capita terms, at $35 per head of the population, was the highest in the world. Dr Goh Keng Swee, in his report, recommended a 25% cut on government spending on non-donor funded projects in 1981 to stabilise the now-runaway inflation. By 1980, 65% of government investment was funded by aid, and for these projects to continue, the government had to provide its share of funding (counterpart funding).

He suggested that welfare spending also required trimming. “These (food stamps) are meant to help the very poor, yet are available to half the population. No doubt there is poverty in Sri Lanka, but it is not of the kind seen in many third-world countries were people live on the border of starvation,” he said in a 27-page report.

Dr Swee suggested that the government could save Rs850 million by reducing food subsidies to a quarter of the population instead of half of the people it was supplying these to.

“Drastic measures… nothing less would suffice to bring the budget into balance,” he warned. “I may mention that I encountered widespread scepticism among some of your ministerial colleagues and their senior officials that the proposed cuts can be effected. If they are right, inflation cannot be subdued and your party will face the next general election in a vulnerable position.”

Instead of a general election, a referendum extended the parliament’s term and maintained the UNP’s five-sixths majority in the legislature. Jayewardene won a second presidential term in a separate election in 1983.

Inflation was unabated, driven by a deprecating currency, limited local production and financing a massive budget deficit by printing money.

Concerns about the state of Sri Lanka’s economy have lingered. Many have hidden their wealth, accumulated by breaking  the rules, overseas. No government has genuinely attempted to fashion an economic agenda without publicly funded sweetheart deals for friends and family.

Globalisation has been a wonderful thing in general. Millions have been lifted out of poverty because they now have industrial or service sector jobs linked to supplying demand from overseas. These people are more self-confident and optimistic about the future.

However, a privileged set claiming a disproportionate share of the gains erodes wider confidence in open markets. They are well connected and have no qualms about bending the system to their advantage.

Sri Lanka’s toxic politics of blaming globalisation for the ills of laziness, incompetence and thievery have beleaguered the country’s rise since its bold market reforms in the seventies

Many of Sri Lanka’s free market era presidencies have bungled or been outright disasters. The pioneer Jayewardene allowed ethnic tensions to boil over to an armed rebellion. His successor, Ranasinghe Premadasa, led a murderous regime. Left of centre Chandrika Kumaratunga served two excruciatingly unremarkable presidential terms, and Mahinda Rajapaksa, despite the outstanding military defeat of the LTTE, was intolerant, nepotistic and threatened to stay in office for a long time. Sri Lanka’s industrial competitiveness has declined in the last one and a half decades, with exports as a share of the economy falling two and a half times to the equivalent of 12% of the economy, from 33%. Its agriculture production has fared even worse. However, services exports have outdone the manufacturing performance, growing to a global share of trade of 0.08% by 2013 from a 0.06% share in 1990.

When the benefits of globalisation don’t reach everybody, it poisons the politics: it’s a struggle over who gets what. Sri Lanka’s toxic politics of blaming globalisation for the ills of laziness, incompetence and thievery have beleaguered the country’s rise since its bold market reforms in the seventies.

This creates two challenges for advancing a liberal economic policy: an increase in inequality and opposition to immigration.

Inequality due to a privileged set exploiting the system has given liberal economic policy a bad name everywhere. Unless talented poor countries like Sri Lanka are prepared to accept economic migrants, they will struggle to build globally competitive businesses and industries.

The first two waves of the globalisation of goods and services, and ideas, have been exploited by now. Its third wave is the movement of people. Sri Lanka still has an opportunity to make a mark here