By W.A. Wijewardena –
Aseni, a whiz kid in economics, has learned of a statement made by some leading economists numbering 182 demanding that Sri Lanka’s foreign debt be cancelled instead of restructuring as insisted by IMF and the Western countries that back IMF. The statement has been reproduced by the UK based charity Debt Justice in its website. This statement has been viral on social media and has been the top news by all the media houses in the country. Aseni wanted to know about this statement and asked her grandfather, Sarath Mahatthaya, a former official of the Ministry of Finance to guide her. The following is the conversation between the two of them.
Aseni: Grandpa, did you see the statement made by 182 leading academics, including some from Sri Lanka as well, urging the creditors to cancel the debt they have granted to Sri Lanka? This has gone viral on social media and widely quoted by local media. Is there any justification for this demand?
Sarath: Yes, I read it. It is a galaxy of academics belonging to the social sciences field. In addition to several economists, this group consisted of those in the academic fields of sociology, law, anthropology, geography, women’s studies, microfinance, history, world affairs, and what not? The only exception was that there were not any scientists from natural sciences. However, these academics have proven diverse expertise. Therefore, it is a multi-disciplinary group excepting the contributions by natural scientists, and their opinion should not be ignored. As such, it need be critically appraised because, if accepted for Sri Lanka, it in fact provides a blueprint for a new world economic order.
This is specifically important because the group consisted of such giants in economics like Dani Rodrik who was sympathetic toward right type of reforms and markets underlying Washington Consensus in late 1990s but later critical of its achievements and Thomas Piketty who was in the opposite camp challenging the capitalist system of economic development. Dani Rodrik was later a member of a team of reputed global economists who met in in 2004 in Barcelona, Spain, to modify Washington Consensus and propose a new global governance now known as Barcelona Consensus. To bring these people together into a single platform would have been an enormous challenge. This statement is not specifically an address for Sri Lanka’s problems. It is a message delivered to the world community at large and more specifically a critique of the economic model being propagated by the old proponents of the Washington Consensus, namely, IMF, World Bank, and US Treasury.
Aseni: I have read this statement but could not figure out its main message. It is only a one and a half page, but behind it, I think there are thousands of pages of detailed economic matters that we should connect to understand it properly. Grandpa, can you help me understand it?
Sarath: True, it is brief and that is its beauty. But it is a fine critique of the current world economic order. The world economic order is how the world economy functions with its interconnectedness and interdependencies by engaging countries, their governments, local and multinational institutions, and above all, markets. After the collapse of the Soviet Union in early 1990s, the world economic order centred on free markets and their ability to create a prosperous world for everyone. However, this goal was an elusive one, and, instead of reaching equality in prosperity in the globe, the gap between those who are prosperous and those who are not has further widened. It is natural that those who have failed finding fault with those who have advocated it. The two chief architects of this failed order, namely IMF and the World Bank, have been the main target of attack.
In addition, the side supporters of these two architects like the World Trade Organization which is also unsuccessfully fighting for the elusive goal of global free trade and the international financial system that has facilitated the movement of global funds have also been at the receiving end. The statement of 182 academics is a summary of this attack. Hence, to understand it, you must know how the global economy works.
Aseni: I know a little about it. But how does it work?
Sarath: The global economy is also like the local economy. It is interdependent and interconnected. What this means is that rich countries depend on poor countries and poor countries on rich countries. They are also interconnected meaning that without this connection, they cannot function properly. This is like the human body. One part of the body is dependent on and connected to all other parts of the body. That is why when you have a pain in a very small part of the body, say, like a nail, it is felt by all other parts of the body. They also become either less performing or even non-performing. So, if you break this connectedness, the whole body become non-functional. In the same way, if we remove the rich countries in the world, the poor countries will also be removed. Similarly, if we remove the poor countries, the rich countries will also be removed. Hence, both are necessary for each other’s sustenance.
But the reality has been different. Poor countries feel that rich countries are hostile toward them and bent on robbing their resources. Rich countries feel that poor countries are beggars and seek to live a lazy life out of the resources transferred to them. The statement issued by 182 academics is a testimony to this ground reality from the point of poor countries. Therefore, it is only half-complete. To make it complete, the position of the rich countries should also have to be incorporated into it. In other words, a fair statement should have contained the appreciation of each other’s problems and recognition of the role being played by each one of them.
Aseni: Oh, I see. What does the statement then contain?
Sarath: The statement has three parts. First, the symptoms of the ailment which Sri Lanka is suffering. Then, the diagnosis and finally, the prescription. But as I mentioned, it has been done from the point of poor countries and has failed to present a balanced view.
Aseni: What are the symptoms it has identified?
Sarath: Those are the symptoms of a general disequilibrium in the macroeconomy of a country. First, Sri Lanka has been vulnerable to external and internal factors, normally known as shocks. Shocks are happening always, and some are expected, and some are unexpected. If the expected shocks happen, a country can pre-design the corrective measures to keep the adverse impacts at a minimum, if not able to eliminate them altogether. But if the shocks are unexpected, there is no way to preplan the safety measures. So, the country involved should necessarily go through the shock and suffer from its adverse impacts. However, if the systems of the country are flexible or it has sufficient space to come out of it, we say that the country has resilience.
For instance, suppose that there is a Tsunami which is an unexpected external shock. But if the country has a surplus workforce that can be mobilised quickly to remove the debris, and if it has adequate finances to rebuild the damaged infrastructure, and it can provide quick relief to people who have been affected by it, then, that country is resilient. So, shocks are not a matter for fearing if the country is resilient.
The other symptoms are rising food and energy prices together with interest rates. The depletion of foreign reserves and mounting balance of payments problems have forced Sri Lanka to suspend the repayment of some selected foreign debt. There are many more important symptoms that have not been identified. One is the continuously slowing real economic growth which has now become negative and will remain so in the next few years as well. Another is a stagnant export growth in a background of high imports leading to a stubborn trade deficit. On human capital side of which this group is highly concerned, there is this increased migration of technically qualified professionals in search of a new life outside the country because they have no opportunities back at home. This is a serious lapse in the statement of the academic group.
Aseni: That is interesting, but what is the diagnosis which the academic group has made?
Sarath: The diagnosis is not in a single place. It can be found throughout the statement. It cites policy mismanagement as one of the causes of the ailment. This mismanagement is not what the mainstream macroeconomists normally refer to as erroneous fiscal, exchange rate, and monetary policies that have compounded the goal of attaining a stable high growth. Instead, according to the academics, mismanagement specifically refer to deregulation and openness encouraging irresponsible borrowing, enabling illicit financial outflows, and leading to political corruption. However, in the case of Sri Lanka, both deregulation and openness of the economy are just myths. Neither the economy has been deregulated nor has it been open as it had been in East Asian countries. Sri Lanka’s capital account is still closed, and the private sector cannot enter the market without the approval of authorities.
And those approvals have been only a few dozen cases based on the merit of each case. If you are interested in learning of the state of Sri Lanka’s deregulation, just examine its ranking in the Ease of Doing Business Index compiled by the World Bank. In 2020, the country was ranked at 99 out of 190 countries in this index scoring only 62 points out of 100 (available at: https://www.doingbusiness.org/content/dam/doingBusiness/country/s/sri-lanka/LKA.pdf).
Hence, it has to go a long way to deregulate the economy. But these restrictions are not applicable to the Government which can always waive these restrictions when it decides to go to international markets for loans. Hence, the allegation by the academics that deregulation and openness had encouraged irresponsible borrowing applies only to the Government. The other charge that illicit financial outflows that are alleged to have taken place are not due to deregulation and openness but due to regulation and opacity in the economy. It seems that the learned academics have misdiagnosed it.
The charge that the successive governments have gone for irresponsible borrowing in commercial markets by issuing international sovereign bonds or ISBs is substantiated by the available evidence. When ISBs are issued, a prospectus guiding the prospective investors should be issued by the Government. In all these prospectuses issued since 2007, the Government has falsely claimed that the proceeds are used for development projects. But these proceeds go into a kitty from which general government expenditure is being met. Since Sri Lanka governments have run a deficit in their revenue accounts, these proceeds may have been used for the general consumption expenditure as well. By any standard, this represents irresponsible borrowing misguiding the prospective investors. I do not have to tell you, that when you borrow and consume, you will eventually run into difficulties.
Aseni: It is now clear to me. I believe that the prescription they have recommended is that these external creditors should cancel their loans to Sri Lanka instead of attempting at restructuring. Isn’t it a good thing for Sri Lanka?
Sarath: Any borrower will love if his borrowing is cancelled by creditors. But it can be extended only to a few selected borrowers and not universally to all the borrowers. If loans are cancelled for all the borrowers, creditors will be bankrupt, and the globe will lose an important recycling of the global savings. In this sense, the recommendation by the academics is outrageous. It also ignores the working of the global financial architecture today. In this architecture, people save by curtailing their consumption and make available those savings to those who are without adequate savings relative to their requirement. Sri Lanka is one such country.
It saves about 25% of its income as a whole and is required to invest about 35% of income to realise a growth rate of about 8% needed for becoming a rich country. This gap is known as the savings-investment gap, and it should be filled by using the savings made by people in other countries. If the loans are cancelled wholesale, those savers will lose and will not make any saving by cutting their consumption. Without these savings for filling the gap, it is the Sri Lankans who will suffer in the future. The available option in the absence of those foreign savings is for Sri Lankans to cut their consumption drastically, which we call tightening of the belt, and make available those savings for investment just like the Singaporeans did in 1960s and 70s and the Chinese are doing today. This is a bitter medicine and strangely the academics have not talked about this bitter option.
Aseni: But there are some positive sentiments expressed by these academics, aren’t they?
Sarath: Yes. They have warned the bilateral lenders not to play geopolitical games with Sri Lanka. This specifically applies to China, India, and the West. If these countries are genuinely interested in helping Sri Lanka, they should set aside the geopolitical ambitions without using Sri Lanka as a pawn.
*The writer, a former Deputy Governor of the Central Bank of Sri Lanka, can be reached at email@example.com