By W.A Wijewardena –
Economic Policy Statement of Yahapalana Government: Building concrete plans for implementation out of the skeleton is needed:Part 1
An economic policy statement at last
Prime Minister Ranil Wickremesinghe outlined the economic policy to be pursued by his Government in the next five-year period in Parliament last week. In a sense it is belated. That is because a Government conscious of the limited time available to it in delivering its promises to people would have acted faster. Many analysts expected the Government to come up with its economic policy plan not later than one week after the formation of the new National Government in August 2015.
The market was hanging in suspense for need of a clear policy direction
Until the economic policy plan was out, the market was eagerly waiting in suspense. Certainty and clarity in economic policy is what the market wants. When the country is hanging in suspense, no long-term investments would take place, both by locals and foreigners. A country that needs such investments in massive volumes cannot afford to lose them.
There was another reason why such a policy statement was needed. That was because the ruling party had pronounced in its election manifesto that once it came to power, it would establish a “knowledge based competitive social market economy” in the country. Since this ideology was not clear to many, including those in the private sector, there was the necessity for clarifying what underlay the new ideology being proposed. In this sense, the market welcomed the policy statement by the Prime Minister, even though it was done belatedly.
The policy statement is a mere synopsis which needs to be developed into a detailed concrete plan
The policy statement is a skeleton – a kind of a synopsis synthesising the vast policy framework which the Government is planning to implement. Hence, every word, every sentence in it has to be developed into a separate action plan if it is to be properly understood by those who are to implement it.
On the side of the Government’s administrative machinery, such understanding is necessary to avoid contradictions and inconsistencies that may creep in and cripple its implementation. Even some independent analysts have been treated to harbouring certain misgivings about policy proposals pronounced by the Prime Minister. This was evident in a television discussion on the state of the economy and the Government’s economic policy statement on MTV channel recently.
Need for clarifying what underlie the policy goals
This article as well as a few others that are to follow will analyse in detail what the Prime Minister has synthesised as goals of the Government’s economic policy statement. They will also serve as the guidance for policy designers as to how they should design the detailed policy plans.
The economic policy statement contains a three-pronged analysis. The first segment is a stock taking of the state of the current economy inherited by the new Government from the previous administration. The second segment looks at why there is a need for changing the economic policy direction in the country. The third is the segment that really matters. It gives a synopsis of what the Government is planning to introduce in order to attain its goals.
The thrust of the policy is to create prosperity through trade
The thrust of the policy, based on the Government’s ideology of fostering a “knowledge based social market economy”, is to connect Sri Lanka to the rest of the world through enhanced international trade.
The statement has drawn to the fact that Sri Lanka had had created prosperity in ancient times through trade. Particular reference has been made to the reign of King Parakramabahu, the Great of the Polonnaruwa era. During that period, the country had created prosperity through the export of diverse products in demand at that time, including elephants. Sri Lanka has thus functioned as a key export-import hub, which economists today call ‘Entrepot Trading’, a strategy which Singapore had adopted in its early period of development.
The statement has expressed the desire to bring that prosperous era back to the country by using modern technology, trading opportunities and techniques. In summary, it is an export-led growth strategy which the Government is planning to adopt for achieving prosperity and growth.
Previous Government’s policy was to domesticate the economic growth
Is this the policy strategy which Sri Lanka should adopt today to bring prosperity to the nation? This question begs further analysis. In the previous administration, the policy thrust was the opposite where growth was to be generated by developing a strong ‘domestic economy based system.
This policy thrust was critically reviewed by this writer in a previous article under this series titled ‘Domesticating Economic Growth: Can the puny middle class make it sustainable?’.
The article has pointed out that Mahinda Chinthana, the policy ideology of the Government at that time, had called for developing a self-supporting economy in which everything would be produced within the country. This was followed to the letter by the Ministry of Finance which had highlighted in its Annual Report for 2011 that the country would strive to “build a domestic economy and add value to domestic resources”.
There has been a long list of strategies which the Ministry of Finance had said would be followed by the Government to attain the goal of adding value to domestic resources. However, that list of strategies did not refer to any specific strategy for promoting exports. Exports had been mentioned only as a side reference in the strategy for modernising the country’s industry. The result was the failure of the export sector to grow at least at the same pace of the growth in the domesticated economy.
As a result, exports, which amounted to a third of GDP in 2000, fell to less than 15% in 2014. The situation in 2015 would be worse since exports are to record a decline even in absolute terms.
India followed a successful export-led growth while Sri Lanka domesticated the growth
The article had stressed that though Sri Lanka had followed a domesticated economic policy, the neighbouring India had followed the opposite. India had oriented its economy to the rest of the world as the source of economic prosperity.
This was shown in the phenomenal growth of exports as a share of the country’s gross domestic product or GDP. Accordingly, in 1990, India’s exports amounted to 6% of GDP. By 2000, this ratio doubled to 12% of GDP. Since then, the ratio of exports to GDP continued to grow phenomenally doubling it once again to 25% of GDP by 2012.
Along with the growth of exports in both relative and absolute terms, the high tech component of exports too increased continuously. Between 2007 and 2009, India has increased its high tech exports by two and half times from $ 4 billion in 2007 and $ 10 billion in 2009, according to World Bank data.
Over this period, India has maintained on average an economic growth rate of over 7% for most of the period. But that economic growth has been created mainly by foreigners by purchasing a large quantity of its manufactured products and services like engineering, healthcare and software services. Hence, India, instead of relying solely on domestic consumers, has used foreign consumers to generate and sustain high economic growth.
Virtues of a domesticated economic policy
Strategically, there is nothing wrong in relying on domestic consumers to generate continued economic growth in a country provided that the country involved has a substantially large domestic consumer base.
Such a policy helps a country to avoid ‘ups and downs’ in economic activities due to similar ‘ups and downs’ in economic activities in countries that principally buy its products. For instance, if a country earns its living mainly by selling its products to foreigners, an economic boom in buying countries will create a similar economic boom in the home country as well. In the opposite, if there is an economic recession in the buying countries, it generates a corresponding economic slowdown in the home country.
Thus, the home country economy does well or badly in the same way the buying country economies would do well or badly. Economists call this phenomenon ‘external shocks’ and relying on the domestic consumers to generate economic growth will help a country to avoid being hit by such costly external shocks.
Domesticated economic policy needs a big enough middle class
But there is a prime requirement which has to be put in place if a country is to rely mainly on its domestic consumers for continued economic growth. That is, the domestic consumer base in the country should be large enough to buy its products in increasing numbers.
In this connection, there are two factors that will determine the capacity of domestic consumers to continue to buy the products of their respective home countries in increasing quantities: the number of domestic consumers and their buying power. The number is determined by the availability of a large consumer base which is mainly made up of the country’s ‘middle class’ that has a high proneness to consume. Those in the poor class do not have a sufficient income base to make a significant impact on the country’s total demand for domestic goods.
Similarly, those in the rich class, going for better taste and higher quality, will basically consume goods produced in other countries. Thus, in any country, the buying capacity of consumers is basically determined by the average income level of those in the middle class.
Hence, even if a country has a large population, it does not necessarily guarantee a large domestic consumer base within the country. Of that large population, a significantly large percentage should be middle class consumers and those middle class consumers should have a high enough income level to buy those products in increasing quantities.
Pitfalls of governments trying to substitute the middle class
In many developing countries where there is no a sufficiently large middle class to buy goods produced within the country, the governments have filled the gaps by being the largest single buyers in the respective economies. The rationale for the governments’ intervention in the economy in this manner is that if the private people do not consume enough, let the government using its powers create a demand for the country’s output, a proposition made by the British economist John Maynard Keynes in the early part of the last century and followed by almost all the countries in the world since then.
Sri Lanka is a case in point whose Government has been consuming about a quarter of the country’s total output throughout its post-independence history. However, for a Government to do so, it has to grab resources from the private sector by way of taxation or print money and inflate the economy or borrow from domestic and foreign sources or resort to any combination or to all of them.
Though a Government can make a marginal contribution to economic growth by participating in the economy in this manner, it is not without long term economic costs. The experience in both developing and developed countries has been that the governments’ buying goods through their budgetary operations have led to an unhealthy expansion of the government sectors, proliferation of unproductive capital projects financed by governments, loss-making public enterprises that eat up the country’s scarce resources and accumulation of unsustainable public debt levels that have hindered long term economic growth. Sri Lanka is a classic example for this unsavoury development making it difficult for the government to generate domestically driven economic growth any more.
Long term policy is to connect Sri Lanka to the rest of the world
The policy statement has thus correctly identified that the future prosperity of the country depends heavily on its ability to export. Sri Lanka’s middle class is puny and therefore cannot buy everything that the country would produce.
In this connection, the policy statement has laid down two strategies, one short-term and the other long term. The short term strategy has recognised the unfavourable global economic environment that has been ruling the global economy since 2013. Since Sri Lanka is unlikely to benefit from such an environment, the economic policy statement has proposed to strengthen the local economy and growth in the immediate future. In the long run, it is the promotion of exports since Sri Lanka’s domestic market is tiny and not able to absorb everything that it produces. The statement has therefore emphasised on the need for having a bigger market for its products than the small domestic market. In doing so, the statement reiterates, the policy thrust is to increase the high tech component of exports rather than continuing with exporting low tech products. This is a view which this writer has continuously emphasised in previous articles in this series.
Adopt complex technology to become a winner in the global market
In an article titled ‘Sri Lanka’s Future: Convert the simple economy to high-tech based complex economy’, this writer has argued as follows: “The competition out there is fierce, cannot be avoided and should be faced with a matching strategy. That matching strategy, based on a world view that things around us are not soothing or comfortable at all times, makes it necessary for us to change from a simple production process to a complex production process. Why a complex production process? Because, that is the way to keep our competitors away from us at a safe distance, so that, they cannot grab a big chunk of our markets.”
Inventions and innovations are a must
The policy statement has emphasised on the need for introducing innovations and measures for productive growth to attain the goal of converting the economy to a high-tech product economy.
While creating a market bigger than the local market, it has proposed the strategy of linking Sri Lanka to the global supply chain and introducing a ‘digitised economy’. The relevant high technology is to be acquired by encouraging global giants to enter the domestic market.
The thrust of the policy statement is to create wealth and prosperity by increasing the country’s exports which have recorded a decline in relative terms in the past ten years. That strategy needs sound planning and the next article in this series will examine the issues and the way forward for the country to reach that goal.
*W.A. Wijewardena, a former Deputy Governor of the Central Bank of Sri Lanka, can be reached at email@example.com