13 April, 2024


Child’s Guide To Ranilnomics: Economic Reforms Unproductive Unless Extractive Institutions Are Halted

By W.A. Wijewardena

Dr. W.A Wijewardena

Economics whiz kid Aseni and her grandfather Sarath Mahatthaya of the Ministry of Finance fame are continuing their dialogue on the economics of President Ranil Wickremesinghe, dubbed as Ranilnomics. Ranil proclaimed earlier that he took over presidency to give a life to the moribund economy and therefore, his economic policies need close examination by the citizenry. Previously, they had looked at how he should market his liberal ideology to political partners in Parliament who hold a contrarian view, the folly temporarily suspending the import of a large number of imports, how he should frame his governance system based on Lichchavi principles which he admires, the colossal debt restructuring issue he is facing, the need for implementing a program wider than what is stipulated by IMF bailout, and why he should prune government expenditure while implementing his proposed tax hikes. 

Today, they discuss another important aspect he should not ignore while introducing the economic reform program. That is the need for creating a just society free from the clutches of extractive institutions. 

Aseni: President Wickremesinghe is planning to implement a wide range of economic reforms. Among them, there are some prominent ones. One is the increase in the tax rates while expanding the tax net to catch those who are evading tax payments. Another is to introduce a pricing formula for products of which the prices are controlled by the government to reflect the cost of production. A third is to reform the state-owned enterprises including the state banks where he plans to sell 20% of shares to employees and depositors. He is also planning to make the central bank independent, a promise which he failed to deliver on two previous occasions, one in 2004 and the other in 2019. All these reforms are in addition to restructuring some selected Sri Lanka’s foreign debt as a precondition for a bailout package from IMF and some bridging financing from ADB and the World Bank. His Cabinet has also approved of requesting the International Development Association, a subsidiary of the World Bank that provides concessional loans to poor countries, to allow Sri Lanka to have access to such loans ignoring that the country is ranked by the World Bank as a lower middle-income country. Will these reforms work, Grandpa?

Sarath: These reforms are necessary for Sri Lanka to move forward economically. But there is another essential requirement which he should implement if he is to reap the full benefit of these reforms. Without it, these reforms are like pouring water to a pot with holes underneath. Whatever the water that you pour into the pot, it will soon leak out. That requirement is to establish a strong governance system in Sri Lankan society to put a stop to what is now known as extractive institutions. Instead, the institutional system in the country should be inclusive. 

Aseni: Institutions that you talk about are not clear to me. What are they? Are they the organisations like government departments, companies, and voluntary bodies that we find in a society?

Sarath: That is the general view that we have about institutions. In economics, institutions are not only the organisations that we have in a society. The best explanation is given by two American economists, Daron Acemoglu and James A Robinson who published in 2012 a pathbreaking book under the title Why Nations Fail. Its subtitle is the more revealing one. It says The Origin of Power, Prosperity, and Poverty. They say that some countries are prosperous because they have deliberately established inclusive institutions. The other countries have failed and remained poor because they have permitted the operation of extractive institutions. If you have extractive institutions, they siphon off the resources of society which should be used for developing prosperity for people. As a result, the country may have the best resources. But it cannot ensure prosperity for people and therefore remains in poverty. 

Coming back to your question about institutions, Nobel laureate in economics Douglass C North has defined it as constraints that have been devised by people for interaction with each other politically, socially, and economically. They are of two types. One is the informal ones that take the form of sanctions, taboos, customs, traditions, and codes of conduct. The other represents formal rules, like constitutions, laws, and property rights. We can therefore say that institutions are simply values, ethos, and ethics which a society upholds to conduct interactions or exchanges amicably and without conflicts. It is the incentive structure that we have in the system. Therefore, in economics, institutions are a wider concept than formal organisations. In fact, formal organisations are all based on these values, ethos, and codes of ethics. That is because they are created by people for use by people. 

Aseni: I now understand that institutions in economics are simply a value system. I can apply this to Sri Lanka’s present systems. Motorists on Sri Lanka’s roads firmly believe that all other motorists should permit them to pass through. That is why they continuously use the horn to keep others out of their way. This value system is particularly applicable to those in power. They believe that the road should be preserved for their exclusive use. When they overtake another vehicle, they gain an immense pleasure by being a winner for the time being, ignoring that it is only a small gain. Similarly jumping a queue that has been established for distributing something orderly is also considered a win. But you talk about inclusive institutions and extractive institutions. What are they?

Sarath: You are correct that in Sri Lanka the value system is to go for small gains. This is particularly observable in the case of the top politicians. They keep on relishing small gains seemingly believing that winning battles is a sure way to win the big war. A good example is that top politicians often proclaim, with a short timeline, that they want to make Sri Lanka a rich country. That is the big war they should win and after the proclamation, they entirely forget about it and keep on making small gains. As a result, that target, proclaimed again and again, has been an elusive goal for Sri Lankans. That value system when analysed from the point of institutions can be called a weak institutional structure. 

The proper establishment of institutions will help political leaders to win the war and not the isolated battles that deliver small gains for them. But as I have mentioned earlier, they should seek to establish inclusive institutions and not extractive ones. What we mean by inclusive institutions is the social value system that would ensure just distribution of the fruits of the economy among all the members. A good example is the distribution of meat of hunted animals by tribal leaders in Papua New Guinea. It is equally shared among all members of the tribe according to a strictly followed protocol, an inclusive institutional structure according to economists. You can find it here if you are interested:

The high social elite in the tribal society does not get a bigger share. As a result, everybody has the incentive to go for hunting and bring back the animals hunted by them as a team for distributing among all equally. 

One problem in such a system is the issue of the free rider who does not make the contribution he should make but seek to get a share. If this happens there are social norms in the form of ‘naming, shaming, and isolating’ such members. No one risks getting that bad name for himself. Those norms are also a part of the inclusive institutional structure they have set up. 

Aseni: Then, what are the extractive institutions?

Sarath: Extractive institutions are those social value systems that legalize or permit some people to get more than what he deserves. In other words, they are exploitative in nature. Most of the modern states, governed by rulers who are inclined to support extractive institutions, have given birth to such an institutional structure. This is in line with how the German sociologist Max Weber has defined the state. He has said that the state is nothing but a monopoly of legitimate violence. When the members of society feels that the state is creating social ethos that permit some group in society to get an unequally high share of the national product, they naturally rise against it. But the ruling class in the state will suppress them by unleashing the power to use violence on citizens. The government as a body of the state should use this power not to harm citizens but to protect them. But what actually happens is that all administrative, judicial, and law-enforcement systems are bent to suppress such agitations brutally.

Acemoglu and Robinson in their book titled Why Nations Fail have clearly documented that societies which have such extractive institutions do not attain a sustained development. In the initial period, there is some economic growth. But after the citizens realise that they have been duped to accepting an unfair deal, the incentive system to work hard and make a contribution to society is taken out. They respond by choosing a course involving ‘fight’ or ‘flight’. Sri Lanka’s present case is a very good demonstration of this. People who agitate against the presence of extractive institutions in society are brutally suppressed. When this suppression goes on uninhibited, they take the other available option, namely, flight. 

The repercussions of this unhealthy development are numerous. First, the country loses the workers who are in the prime age. Second, the continued agitations lead to instability of political as well as economic systems. Third, the loss of human capital of prime age is a deathblow to an already aging population. Fourth, the rising dependency ratio will make it burdensome for society to look after the old people in the absence of a viable social security system. Fifth, the loss of young brain power also reduces the country’s ability to introduce new inventions and innovations. Sixth, the remaining people will be just digital natives who are proficient in ICT but lacking a proper world outlook. The needed global citizens have already left the country. It seems that the ruling class in Sri Lanka is totally unmindful of these adverse repercussions because they are paying a blind eye to the growing issue. 

Aseni: Very relevant Grandpa. It is reported that many young people who are holding the most critical technical positions are leaving the country. The healthcare system, banking system, educational system, and the administrative system are some of the fields that have been very adversely affected. What should be done to address the situation?

Sarath: The young people are leaving the country because they cannot stand the extractive system that is ruling the country. The bribery and corruption are rampant, and people believe that there is no proper method to halt it. Even the United Nations’ Human Rights Council had for the first time in its as well as Sri Lanka’s history talked about the need for taking action against economic crimes committed in Sri Lanka in the past few years. The top leaders of the government, instead of taking the message positively, appeared on TV and questioned the mandate which UNHRC had got to make such allegations against a sovereign government. They have mistaken the sovereign nation for the government which is simply an arm of that nation. 

Even the US Senate Committee on Foreign Relations had remarked that Sri Lanka’s ability to get an IMF bailout will depend, among others, on curbing bribery and corruption. These two events which are interconnected have taken place at a time when the international community has observed that even the limited cases brought before justice have been dismissed by courts due to technical errors. These are serious indictments by the international community which the present administration cannot ignore. When these are happening, it is quite natural for young people to get into either a fighting mood or a flighting mood. The suppression of those who have come to the streets against these extractive institutions by using outdated police powers is unproductive. 

Nothing can be done at this stage about the young people who are leaving. But their contribution can be obtained for the development of the country on a future date by creating the right conditions in society that will attract them back to Sri Lanka. This is called reverse migration. It has happened in Vietnam when the boat people who had fled that country in 1980s returning to the country with maturity, experience, and financial capital to take it to the next stage of development. Similarly, those IT specialists who had left India long ago have returned to create the Asian Silicone Valley in Bangalore. Sri Lanka too should create the right conditions for those leaving the country today to return with experience and capital to make them partners of economic progress. 

Those who agitate against the government in the streets are being hunted by the government. As I mention earlier, it is totally counterproductive. Instead, they should be won over by meeting the demand they have placed before the politicians who matter. They are demanding a systemic change and it must be delivered by those in power promptly. 

Aseni: Thanks Grandpa. I think President Ranil Wickremesinghe should not ignore these issues anymore. He should remove incentives for extractive institutions to siphon off the nation’s resources for their private use. That can be done by implementing the bribery and corruption laws promptly. 

*The writer, a former Deputy Governor of the Central Bank of Sri Lanka, can be reached at waw1949@gmail.com      

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    “They are demanding a systemic change and it must be delivered by those in power promptly.”
    First of all, President Ranil should take initiative that what system changes he thinks that is good for this country . Then he should put forward it to all the 225 Members of Parliament. He is not an elected President. He is not elected by his political party. There is no point in waste his time if majority of those 225 members of paliament are against to his proposal for system change. If the fails to get their support, then he should put forward it to people and ask the people who is willing to his or her full contribution to that system changes. The question is whether the President is capable to bring the system changes. For example, the head of Government (President/Prime Minister) should not have in this position not more than two times or have an age limit of not more than 70 years.

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