Business perspectives on free markets

Thirty years after the liberalization of the Sri Lankan economy, there is mixed reaction and much debate from the business community on the accomplishments, the mistakes that have been made along the way and the sweeping changes that still have to be implemented in order to call it a true success. Sri Lanka has not only had to confront the challenges nations face when opening up their market but has had to deal with the problems in the context of a civil war.

Then : Children in bread queues

Patrick Amarasinghe, a former Chairman of the Federation of Chambers of Commerce and Industry in Sri Lanka (FFCISL) said Sri Lanka rushed into a free market system a little too fast. "We went into an extreme end. In 1977, we should have liberalized the productive side," he said, explaining that raw material and machinery in the country as well as factories were not geared to international standards.

Amarasinghe said a consequence from the rush to liberalize made Sri Lanka a dumping ground for inferior goods with no quality. Local industry also fell victim to the increasing profitability of importing cheap goods from places such as India and China where the cost of production is far less than in Sri Lanka . "Our local people found it difficult to compete," Amarasinghe said. The products coming into the country had lower standards and ruined local industry to a fair extent. "Importing was less cumbersome and cheaper and trade became more profitable."

If not for the war, he believes Sri Lanka would have progressed much more. "If the war ends, things would be settled," he said. The country should also try and correct certain policies. Foreign investment is not coming in as expected but it is essential to ensure that existing local entrepreneurs will not collapse. "Lots of competition and labour is coming from India. We have a serious problem and labour shortages in every sector." He said government ministers must stop urging skilled locals to go overseas. In the context of regional development, Amarasinghe holds up India as having done it correctly. He also added that there is a greater feeling of nationalism in India as opposed to Sri Lanka.

Former Ceylon Chamber of Commerce Chairman Chandra Jayaratne said the free market has succeeded in the global and regional context but the way it has been implemented and supported, in particular the policy framework development is not the right one. "There is contradictory policy and implementation and as long as you have such things, a free market doesn't succeed," he said. "You need a set of policy and guidelines for the long term and changes of regime are disruptive."

Now:Shops stocked with food

Jayaratne said possible gains from a free market have been hampered by a lack of political stability and political consensus on national policies that could advance Sri Lanka and its people.

He said Sri Lanka should focus on infrastructure and a policy regime targeting comparative advantages in the region, especially capturing value from the Indian subcontinent in financial and service areas such as shipping, aviation, tourism and skills export.

Undoubtedly, the ongoing conflict has affected Sri Lanka 's growth and development but Jayaratne said the war is not the only reason. "If we had war along with the right statesman running the country, good governance, justice and correct values in society, I think Sri Lanka would certainly have been a real financial and trading hub as well as tourism and in the movement of people such as aviation and ports."

Jayaratne said local industry has not been as affected by the free market as shown and talked of by the private sector. As seen in India, a gradual opening of the economy accompanied by best practice and technology transfers would have helped local industries and even services areas to enhance competitiveness driven by comparative advantage. Jayaratne also said the private sector has not been responsive to liberalization. "Even though we asked for it, we don't like liberalization." He added that the private sector wants to make easy money on trading, are not good risk takers and have not implemented the changes that were requested to make the system work.

FCCISL Chairman Nawaz Rajabdeen said the free trade agreements with India and Pakistan were initially met with skepticism and fear that Sri Lanka would becoming a dumping ground for their exports but in fact, Sri Lanka's exports to India have increased more than thirty fold. "With the free trade agreements, Sri Lanka has more to benefit than India." The same is true of Pakistan. Rajabdeen said expatriate remittances are sustaining the Sri Lankan economy. "With the current free trade agreements with India and Pakistan, we have some breathing room."

Industrial development is vital to Sri Lanka. Rajabdeen said the FCCISL is keen on sustainable, regional development as opposed to big time investment. "We don't want big time investments. We want to go to the districts like Anuradhapura, Batticaloa, Vavuniya and Hambatota." Rajabdeen also said that peace is hinged on development, particularly development in the North and East. "Northern and Eastern development is essential or the war will go on for the next three to four decades."

Priority has not been given to cultivation. "We really have to address the agro base industry rather than giving subsidies to farmers for fertilizers. Then, I'm sure we will be ahead of other countries."

Chairman of the Ceylon Chamber of Commerce Mahen Dayananda said despite Sri Lanka being the first country in the region to liberalize, it has clearly not succeeded to the extent it should have. The failure to resolve the ethnic conflict has retarded economic progress. He calls it a 'managed liberalization' because certain controls such as the capital account were not liberalized.

Dayananda said corruption exists in most of the world and Sri Lanka is no exception. "Perhaps, post 1977 with liberalization and the unprecedented growth of the economy, the extent of corruption may have appeared to be of a higher order and far more obvious."

Extracts of a Parliamentary speech by Finance Minister Ronnie De Mel, some months after the UNP’s 1977 victory.

The local industry has had to make adjustments to the changes. Dayananda said there were several monopoly state corporations such as the Steel Corporation which had to adjust to market realities.

Liberalization forced enterprises to change and adjust to the new global economic order. There was a degree of protection which Dayananda said continued to be extended to local industries, giving them much needed time to adjust to the new order. "It hurt inefficient industries, some of which were wiped out but overall, it created the urgency for change and adjustment which are positive." He warned against liberalizing blindly as there are several countries that preach liberalization but protect vital parts of their own economies, either directly or indirectly.

K.C. Vignarajah, former Chairman of the Ceylon National Chamber of Industries (CNCI) said the results from opening up the market are mixed. "It was definitely a welcome move but the matter of operations initially and subsequently could have been handled much better." Initially, there wasn't sufficient time for readjustment of certain industries to make them competitive. In later years, there were too many macro economic factors which were within the control of the government but not attended to and the private sector suffered considerably.

He said some local industries have been hurt through liberalization of the economy, mainly due to a lack of complementary policies. In the current context, exporters are undergoing grave hardships because of the macro economic factors. The inflation rate having touched 20%, interest rates ranging from 20 to 35%, the electricity rates, transportation costs, etc. being far higher than our competition, the infrastructure being woefully inadequate are factors beyond the control of exporters. He said unlike Sri Lanka any successful exporting country has a competitive rate of exchange to support the exporters. Various types of restrictions and licensing schemes only help racketeers and fuels corruption.

Vignarajah said interference by the politicians was a sad feature that flowed out of the same government which also introduced the free market. "We have such a beautiful island with unparalleled talent for the size of this country. The sad feature is we have driven them away and are continuing to drive them away and not capitalizing on what we have. That is the tragedy." (NG)

High budget deficits affected private sector development

While agreeing that the open economy was the best option for the country, Dr Saman Kelegama, Executive Director, Institute of Policy Studies saw three issues that prevented Sri Lanka from achieving the ‘great dream’ to become another Singapore.

“While liberalising the economy, we always struggled to create the macro-economic environment to support the open economy. We had very high budget deficits which could not support the private sector led activities to the extent as we would have liked to,” he pointed out. He explained that when deficits are large, the crowding out phenomenon happens where the governments have to borrow funds and the funds for the private sector utilisation are constrained. “In economics, crowding out theoretically occurs when the government expands its borrowing to finance increased expenditure, crowding out private sector investment by way of higher interest rates. If increased borrowing leads to higher interest rates by creating a greater demand for money and loanable funds and hence a higher ‘price’, the private sector, which is sensitive to interest rates will likely reduce investment due to a lower rate of return. This is the investment that is crowded out,” he clarified.

“Also the escalation of the Eelam war has shaken the economy. Firstly it created an uncertain environment for the investors to the extent that they went for short- term and less risky projects rather than long-term projects which posed more risks,” he said. He noted that the war absorbed a lot of government expenditure which could have been easily divided for physical and social infrastructure development such as health, education and transport. “War expense stands at 3.5 percent of the gross domestic product (GDP), but it was as much as six percent in the late ‘90s” Dr. Kelegama said, adding that ideally in a country like Sri Lanka war expenditure should stand at two percent of GDP.

He pointed out the slow implementation of economic reforms as the third factor which stumped the country’s economy. “The attention was diverted to the war and the macro-economic management was neglected instead since the late 90s, the attention was diverted to political coalition management such as accommodating crossovers,” he said.

“We would have had a smoother ride had these three things not happened,” he reiterated.

Responding to a question if Sri Lanka has gone too fast into economic liberalisation, Dr. Kelegama said that it had to be done at the time. “ In 1977, the economy was stagnant and the first opening up was fine,” he said, but insisted that before it was further opened up after 1977, there was a need to develop the country’s domestic capabilities such as regulatory, managerial, entrepreneurial and technological.

Dr. Kelegama pointed out that most investors have factored in the war situation in their investment decisions and business activities. “This is the main reason why our economy is resilient,” he said. He added that the North and the East contribute only seven to eight percent of the GDP in the country, explaining that the balance is by the other areas with the western province contributing the most. “Both these factors have helped the Sri Lankan economy growth to average around five percent,” he said, pointing out that if not for the war, Sri Lanka could have reached the eight percent growth path, because there would have been more foreign direct investment (FDI), more exports and more tourists in the country.

He reiterated that the capital account should not be liberalised at present. “The domestic house should be in order before further opening up, because if this account is liberalised now, there will be capital repatriation and chaos with regard to the macro-economic management,” he said.

He noted that prior to ‘77, the closed economy had vested interests who benefited from the ‘Licensing Raj’. “There were handloom industries and such who would have never let the government open up the economy ‘gradually’. So, the opening up in ’77 was correct,” he said.

Dr Harsha de Silva, Lead Economist, LirneAsia (Pvt) Ltd said President J. R. Jayewardena had the foresight to liberalise trade, industry and investment in 1977, in a bid to make the three areas work in tandem, thereby contributing to the growth of the country. “When trade was liberalised, almost overnight we saw food, shoes, clothes and everything else that we were deprived of. A dramatic change in the scenery was the Delica vans, Datsons Sunnys and the Mitsubishi Lancers on the road,” he reminisced, adding that the negatives of this process were that the rupee was devalued and interest rates increased. “The pent up demand pre ‘77 was overflowing and many things come into the country, but nothing went out,” he added.

Dr. de Silva said that the Greater Colombo Economic Commission (GCEC), which is now the Board of Investment was set up in a bid to liberalise investments. “Then JRJ liberalized the industries and gave an opportunity to both local and foreign private entrepreneur,” he explained. He said that leading up to 1977, the private sector investments were below 10 percent, by 1980 it went up to over 25 percent.

“Therefore it is clear that the investment came from the private sector and this proves that the liberalization of trade, investment and industries worked together,” he added.

Responding to a question, whether the ’77 liberalisation was too soon, he said, “There was no other way to liberalise and at the same time there is no consensus amongst the economist fraternity whether this type of opening up was good or not,” he said. When asked whether Sri Lanka had gone too fast with the open economy, he said, “We have not gone fast enough. We should have quickly liberalised other areas such as education, the financial sector and the factor markets. We had a flash in the pan, but we had to keep the momentum, and sustain the change we saw by opening up the factor markets, which we did not.”
He explained that opening up of the economy and selling state assets are two different things and reiterated that liberalisation as according to some political parties was not selling off public assets, but creating efficiencies in the market.

“After 1977, without state protection, the state enterprises were not able to compete and they closed down. Ceylon Leather Corporation, which was producing shoes which opened up at the seams after two weeks of wearing, was one such state owned enterprise that closed down,” he said.

Dr. de Silva agreed that the political instability and the war took away the steam and drained the power from the engine which is the open economy. “The extremists in both the North and the South the LTTE and JVP flare ups killed the country’s progress,” he said.

“Unlike today, there was no private sector or institutional capacity. As a result after 1977, the budget deficits soared, inflation went through the roof and interest rate hikes were rampant,” he explained.

When asked why the economy is resilient, despite all the setbacks during the last 30 years, Dr. de Silva said this resilience comes from the private sector’s ability to weather the storms and somehow do their thing.

“There is never going to be a crash in the economy. It will continue and we will always have a five to six percent growth rate,” he said, reiterating that a five to six percent growth rate has nothing to do with any policy or whoever is in power. “What we need is a government that can achieve 10 percent growth rate. Growing by five percent will not root out poverty in this country,” he added.

Professor S. S. Colombage, Professor of Social Sciences, Open University and a retired Central Bank economist, said that Sri Lanka could not achieve the status it set out to in 1977, because of ethnic problems, political instability and macroeconomic instability all combined together.

He said liberalisation is essential, but highlighted that the government should play a key role in the economy. “Liberalisation is questioned by many economists, because they believe that the government has a role to play in regulating the economy, especially in infrastructure development, education and health. “Export growth is necessary to foster economic growth, which is explained in the ‘bi-directional rational’ and there is no question that an economy should be liberalised,” he explained.

However, he said that the way the economy was opened in 1977, was not very prudent. ‘We opened the floodgates, but South Korea, Malaysia and even Japan opened it up step by step. We had a ‘stop –go’ policy. There should be policy, consistency,” he said. Professor Colombage said that the country has lost about two percent of GDP growth because of the war. “This is the cost of the war and also the lack of fiscal discipline contributed to not achieving higher growth rates over the years,” he added.

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