By Uditha Devapriya –

Uditha Devapriya

This time last year, the global economy was on the path to recovery. Commodity prices were picking up, particularly in the emerging economies, investor confidence was growing, financing conditions were rapidly improving, and the prediction was that the momentum would be carried forward to the next year, even decade. But bigger growth did not mean bigger potential growth, and the momentum, which investors and economists had banked on, collapsed within less than a year. The reasons adduced for this collapse are almost always the same: total factor productivity has weakened, and the rise of commodity prices and exports has decelerated.

That was not the bigger picture, however. The tariffs between the US and China, which had an impact on about 2.5% of global trade (a significant amount), the interest rate hikes in the US (against the wishes of no less a figure than the President), and the capital flight from emerging and developing economies that led to steep depreciations of their currencies (a trend that has slowed down now, and, according to financial publications like Forbes Magazine, might slow down even more from the second half of this year) were factors that obviously loomed over if not trivialised the problem of weakening factor productivity.

Investors are scaling back on the kind of investments they are making. As of early December last year, the S&P 500 fell by more than 8% and this despite the usual positivity associated with the festive season (in December 2017 it grew by almost 1% and in December in the previous year it grew by almost 2%). Investors were obviously hoping for sunny skies throughout 2018, which was at one level an year of false hopes. In this scheme of things, people are thinking twice about risk, and they are moving away from high risk investments to safer assets.

A survey conducted by BlackRock Inc indicates this shift quite clearly: while participants said they would increase their share of real assets, private equity, and real estate by 54%, 47% , and 40% respectively, they said they would reduce their share of equities and fixed income by 51% and 27% respectively. The shift is to safer and more short-term investments, a trend that, if unchecked, might lead to recession in the form of inverted bond yields (higher short-term yields over long-term bond yields). While an inversion is nowhere around the corner, the gap between 10-year Treasury bonds and 2-year bonds has been falling steadily since 2017. This, naturally, is seen as a cause for concern, since “major downturns” in the US and other advanced economies have been preceded by around six to 24 months by a bond yield inversion.

Overly optimistic expectations from “high-flying” stocks in Facebook and Amazon quickly soured owing to the scandals these companies faced, from Cambridge Analytica to minimum wage fiascos. With slowing growth rates in China (6% this year as opposed to the 10% witnessed more than five years ago), budget crises in Italy, and a never-ending Brexit, the skies haven’t just darkened; they’re growing darker. Trade disputes, budget crises, and conflicts between national and regional politics are not, to be sure, permanent. But the overall result is depressing: growth for 2019 is expected to be a mere 2.9%.

At least, according to the World Bank, whose Global Economic Prospects Report for January 2019 has been titled “Darkening Skies.” Not that the Bank saw blue skies before: its Report one year ago (January 2018) was titled “Broad-based upturn, but for how long?” As noted in the latter document, while major regions of the world experienced higher growth, investment and total factor productivity growth has been declining over the last few years. As is typical of World Bank rhetoric, the solution is to turn away from cyclical policies aimed at bringing up aggregate demand to structural policies aimed, apparently, at boosting living standards.

This, of course, has been the prescribed medicine ever since the Bank was founded. While one may disagree with it, however, one can’t escape the fact that a solution – cohesive, broad-based, and free of political partisanship – needs to be looked into. At the same time, though, the Bank singles out Trump for the problems of the economy, forgetting that the decision to raise interest rates – which led to massive capital outflows from emerging economies and facilitated an equally massive appreciation of the dollar – was implemented against his desire to lower them. (Trump’s tweets against the Federal Reserve – “I’m not happy with the Fed” – seem to have been missed by commentators who attribute the upward pressures in the US economy – which grew by 3.5% last year – to the man at the top and his tax cuts.)

According to Professor Howard Nicholas, Senior Lecturer in Economics at the University of Rotterdam, the problem isn’t one of cyclical pressures: it has to do with a “gigantic financial bubble” caused by banks from seven or eight of the world’s advanced economies printing vast sums of money and injecting them to the markets in such a way as to drive up property prices and equities “to unprecedented levels.” This has led to the edge of a precipice: almost certainly, “there will be financial fallout” to the tune of steep falls in the stock market.

In Nicholas’s view, the recession that the stock market situation should normally have resulted in by now has been delayed inexorably by the decision of the Federal Reserve to print more money and that of banks in certain other advanced economies to expand their quantitative easing. The pressure this has exerted on the global economy will, because of this, become so unstable that, for Nicholas at least, it will lead to a new growth process that will “no longer be centred on the advanced economies.” The focus, presumably and as always, will turn to China. 

When America sneezes, the whole world catches cold – except, perhaps, China and Russia and, to a lesser extent, the emerging economies like Brazil and India. Even the latter have witnessed a sharp downturn, although prospects for 2019, according to the World Bank, seem better. Not so much for developing economies, however: low income countries, as per the Report, have seen their government debt levels rise from 30% to 50% of GDP. The debate over this continues to be fanned by unfounded reports of a sell-out of economies in South Asia and Africa to China, with US Vice President Mike Pence predicting that Sri Lanka, the subject of a controversial piece last year in the New York Times on Chinese debts accumulated during the Rajapaksa regime, will soon become a “forward military base China’s growing blue-water navy.”

But then, all is not gloom and doom. With regard to the advanced economies, the solution is clear: move from high risk to low risk investments in a way that does not facilitate a bond yield inversion. With regard to emerging economies, the solution is as clear: ensure that investments in education and health services are in tune with the needs of a well performing economy. Solutions for economies like ours are not so clear-cut, but even here there’s no reason to fret: while all major credit rating agencies have downgraded Sri Lanka, for instance, strides and improvements have made in such spheres as the rule of law. The world isn’t going down, and even the least developed regions are improving in crucial economic and social indicators.

Sri Lanka presents an interesting conundrum, however. Politics and economics have never come together here, at least not in the post-independence era. The previous year was tumultuous for all the obvious and wrong reasons, in that regard: lopsided policies aimed at curtailing expenditure which were founded on rather disjointed premises (such as a Minister’s plea for people to think twice about “that trip to Alaska” when the vast majority couldn’t afford to even think of leisurely activities like that) were propounded as gospel truths, leading to electoral discontent against what was perceived to be the indifference of the government.

The voter backlash against in the form of the local government election results was, in that sense, inevitable, and it indicated quite clearly that the proposed programs for the upliftment of the economy, though laudable in terms of envisioned outcomes, did not interest the people. The constitutional coup in October was, outside the parameters of legality, a sequel of sorts to the voter backlash of February. While it had everything to do with politics, economics figured in as well: depreciating exchange rates, depleting foreign reserves, and huge investment outflows to the tune of USD 640 million in the first 10 months of 2018 alone.

The main problem shedding away the political infighting remains the same as ever, in the meantime: the lack of a proper manufacturing base, a problem economists seem to have missed. While economists like former Deputy Governor of the Central Bank W. A. Wijewardena do contend that Sri Lanka is spending heavily on imports, these diagnoses fail to touch the heart of the matter: we don’t have a manufacturing sector despite, or because of, our dependence on the garment sector (where we don’t produce a single needle), worker remittances (which are seeing a contraction at present), and manual labour (a shortage of which has ailed all our industries). It’s a paradox at one level – structural unemployment levels of up to 30% on the one hand and major shortages of labour in the industrial sector on the other – and it stems from one major cause: the apathy of the State towards the revival of what were once promising sectors, from textiles to chemicals to refrigeration technology.

This is essentially the point that has been made by the economists you don’t read about in your textbooks, most prominently, perhaps, S. B. D. de Silva, whose classic work on this theme, The Political Economy of Underdevelopment, explores in detail what has been pointed out in an interview with Professor Howard Nicholas as “the underdevelopment of the peasant sector.” Lack of industrialisation has been a problem ever since independence, so much so that barring the first decade in the post-independence era our balance of payments has consistently recorded a deficit owing to our national tendency to spend more than what we as a collective earn.

Professor Nicholas, of course, is in full agreement with the thinking of what he calls the “older Marxists”, of whom de Silva was one. In that aforementioned interview for instance, he implores Sri Lankans to “industrialise and go for manufacturing.” Contrary to the thinking of the pundits who prescribe fiscal consolidation, privatisation, and extensive liberalisation in the State sector (useless in the context of an economy in a recession), Nicholas contends that if the country goes after an aggressive industrialisation strategy and uses its connections with China, it can achieve massive growth. Otherwise, we as a country will be doomed to pursue strategies that promote extraction of primary products on the one hand and manufacture of certain cosmetic industrial products on the other in the name of specialisation, a strategy advocated by many development economists from here and abroad.

Certainly, it’s not all gloom and doom. Provided that political tussles don’t marginalise economic imperatives, the Fed Reserve’s current policy on interest rate hikes changes at least somewhat in the near future, inflation continues to be contained here and elsewhere, and exports pick up after a lacklustre year of deficits and discontent, Sri Lanka can move ahead with the rest of the world. The darkening skies may brighten, even if, as Wijewardena points out, the country will require a sustained annual growth rate of 9% in the next 15 years to beat that other major problem of the economy, the middle income trap. All is not well, but all is not down in the well either.

Uditha Devapriya is a freelance writer who can be reached at udakdev1@gmail.com