Seizing the moment through third Generation Economic Reforms
The Third Generation of Economic Reforms (TGER) announced in the recent budget is intended to “improve and enhance the living standards of the people”. At last the well-being of the people has been emphasised after various unachievable and flamboyant goals like creating the ‘Wonder of Asia’.The objectives of the TGER are (a) creating one million job opportunities within the next five years and (b) development of rural economies and (c)creating a wide and strong middle class”.Strategies for the achievement of the above goals and objectives are the establishment of a social market economy including macroeconomic stability, higher investment, improved global competitiveness, a massive rural economic development programme and digitisation of the entire economy.
President Sirisena with Prime Minister Wickremesinghe seen in Parliament at the reading of the 2016 Budget
Social Market Economy
What is planned is the creation of Social Market Economic Policies (SMP) that was a response to the criticism levelled by the likes of Joseph Stieglitz and Paul Krugman against Neoliberal Policies (NB), the latter lies midway between classical or capitalist neoliberal policies and socialist planning. Criticism by these economists was that it cannot protect property rights mainly because of the principle of business secrecy, stands for privatisation, deregulation, reduction of government spending, free trade, etc. In effect therefore SMP believes in basic regulation of an economy, protection of property rights by providing law and order, social democratic reforms and free market policies under the guidance of a strong state (See Neoliberalism, Wikipedia, 2015).
Macro -economic stability
A major strategy of the government appears to be “sustaining financial stability through reducing” the budget deficiency to 3.5 per cent of GDP by 2020.The Government would have to exploit every opportunity to get out of the extremely tight fiscal bind of budget and trade deficits inherited by them. However the budget deficit in 2016 does not appear to have been contained significantly being 5.9 per cent of GDP compared to a deficit of 6 per cent of GDP in 2015. Government debt was at an unmanageable level of 75.5 per cent of GDP out of which foreign debt was at 31.8 per cent of GDP in 2014. The budget 2016 speech, however, does not refer clearly to plans for “reducing the burden of loans” except to say that “monies generated through listings of non-strategic (state-owned enterprises) will be used to retire the debts accumulated by the previous regime”. One wonders how successful this would be and whether Sri Lanka’s (SL) own resources will actually be available for servicing of foreign debts. In addition the budget 2016 reveals that it has decided to move in the opposite direction of the TGER wish of adjusting to 40 per cent direct to 60 per cent indirect taxation. The budget 16 reduces revenue from income tax while increasing it on goods and services as well as on external trade, substantially.
In the light of the above predicament it is also surprising that the TGER has decided to “establish a State Holding Corporation Ltd (SHCL), an organisation that will provide state entrepreneurship built along the lines of the famous Temasek Holdings of Singapore. This can do it because of its highly efficient and well paid public officials. SL on the other hand does not have such a public service. SHCL therefore could fail and worsen the budget deficit. It is therefore necessary to focus on “paying attention to state –private partnerships” as stated in the TGER and appoint carefully selected professional managers as CEOs and not kith and kin ‘enjoying the confidence of politicians’ even under this government. Fortunately the budget refers at least to ‘exiting partially and fully from non-strategic investments’.
As for monetary policy “enabling them (the Central Bank) to engage in their work in a more independent manner” is in line with the practice elsewhere in the world to manage the finances of the state in a non-political and professional manner. So is the proposal to establish a Central Procurement Secretariat for procurement and awarding of government contracts and “handling all state purchases” on the basis of “accepted tender processes”. This provision along with the proposed “methodology that can evaluate projects” on the basis of their technical and financial feasibility as intended by the TGER and the setting up of Independent Commissions under the 19th Amendment might help to reduce rampant public sector corruption that burdens the state treasury although this is not specifically mentioned in the TGER. Opposition Parliamentarian Vasudeva Nanayakkara said some time back that it siphons away about 45 per cent of budgetary allocations!
Investment
The main development strategy should be investment obviously because there is a serious inadequacy of goods and services especially for export. The words used in the TGER are “encouraging investment” especially by “focusing on foreign direct investment” (FDI). The latter is needed because there is a resource gap between the investment of about 35 per cent of GDP for the economy to grow at about 8-10 per cent per annum and a low domestic savings rate (21.1 per cent of GDP in 2014). SL however has not performed well in attracting FDI with inflows into SL in 2014 being US$944.2 million according to the World Bank as against US$ 1.7 billion quoted in the budget.
Investors/FDI would be taking decisions on the feasibility of the projects and other determinants like political/macroeconomic stability, the ability to protect investor/property rights, affording physical and personal security, respecting the sanctity of contracts as well as ensuring the predictability of laws and policies by the host country, etc. The TGER however does not spell out the details of the Enabling Environment (EE) required to attract investments consisting of changes to the Constitution including the resolution of the ethnic conflict that drove away investors/FDI. The budget speech, fortunately, has a statement that “the government is determined to augment the capacities of the enabling environment so as to connect with local and global investors” and talks about good governance. The TGER in addition emphasizes on (a) achieving stability, (b) maintaining law and order, (c) the review of the state take-over of certain enterprises under the Underutilised Assets Act, (d) an assurance that the government will not take over private enterprises, (e) give local and global investors the freedom to engage in business, (f) put in place an Investment Bill, (g) remove impediments facing such ventures, (h) bring in laws that will provide ownership of land to registered businesses, (i) help them to enhance their productivity levels and develop competitiveness and provide them with tax benefits, (j) a committee to review the formation of SME, (k) a strong sense of social protection, (l) trade agreements with Indian and China and (m) addressing the Trans Pacific Partnership Agreement (TPPA) – a rather comprehensive set of proposals.
The proposal to “address” the TPPA to encourage FDI seems to be attractive as developed countries like the USA and Japan are members of it and also because such preferential international investment agreements are far superior to the 28 or so Bilateral Investment Agreements signed so far by SL. There is provision in them for embedding most of the above mentioned determinants of such inflows into the laws and policies of the host country and may even overlook the small market size of SL. Another determinant of investment would be availability of technical and soft skills such as creativity, ability to work as a team to achieve targets and communication particularly in English. In the case of SL there is an acute scarcity of such skills. This cannot be overcome in the near term although the TGER provides for vocational training, the teaching of English and “sweeping changes” to the system of education with the generous funding allocated by the budget. Therefore it is suggested that investors be allowed to employ expatriates for a specified period where SL candidates are not available, subject to training of local personnel. Simplification of the labour market complexities arising from more than 45 laws particularly the Termination of Employment Act as well as the numerous labour regulations is also not mentioned either in the TGER or the budget speech. These areas as well as the numerous Ease of Doing Business constraints could seriously influence investment especially foreign investment flows, though there is a general statement in the TGER about removal of impediments.
Global Competitiveness
The TGER proposals on an export-led strategy includes making “Sri Lanka the most open and competitive economy in South Asia”. This is to be achieved by “adopting a competitive foreign exchange policy and providing tax free concessions for all earnings outside Sri Lanka” while paying “attention to competitiveness and enhancing productivity” as well as innovation, the reason for this being the decline of exports “from 30 per cent of GDP in 2000 to 15 per cent of GDP in 2014”. In addition to investments to produce goods and services for export the other important requirement is being “most competitive”. This can be ensured mainly by trade liberalisation or lowering of import tariffs that will reduce protection and increase competition among firms which would pressurise them to adopt innovative measures to add value or differentiate their products and services to meet the needs of top end customers willing to pay a premium price.
Trade liberalisation however is not mentioned in the TGER. As mentioned earlier there is a doubt in the budget as to whether the previous anti-export bias will be removed, as import levies such as Customs duties (the latter to 15 per cent and 30 per cent) have been increased. It is made worse by the imposition of higher taxation on exports from the earlier 12 per cent to 15 per cent. Global competitiveness cannot be achieved by following a flexible exchange rate policy alone as stated in the TGER. There needs to be a heavy emphasis on improvement of productivity all round.
The reforms include the development of export services as well since the country earned a mere $2 billion in 2014 from them. The programmes proposed for this purpose in the TGER and the budget include the establishment of a Megapolis/Financial Hub on the lines of Dubai and Singapore as well as the setting up of “tourism zones, transforming of the various cultural triangle sites” and other infrastructure development.
Finally, there is a very logical proposal to set up a single International Trade Agency by “restructuring the Board of Investment, Export Development Board and the Tourism Authority” in the TGER for expansion of exports since at present the functions of export development are scattered over a number of ministries/agencies, weakening the effort.
Rural Economic Development
The TGER envisages “development of rural economies by empowering 3 million citizens (mostly SMEs) in the rural and estate sectors to become land and house owners,” since “there is a considerable disparity between the economic development of Colombo, the areas close to it and the rest of the country”. This is a historic decision. No government has attempted this since independence and now the emphasis has at last been rightly placed on farmer wellbeing and rural agricultural productivity in SL which is very low. If implemented fully, it will help to set in motion a process that could alleviate poverty especially in the rural and neglected estate areas as well as a domestic demand driven economic growth path parallel to the trickle-down process undertaken so far.
However, the implementation of this programme is full of pitfalls. Most of the subsistence farmers (roughly 50 per cent) will start selling them hopefully to the holders of larger lots leading to consolidation as expected. However, a number of questions will arise. Will the “2500 state rural development centres” to be established for setting up of industries and services as well as the manufacturing enterprises to be attracted into the country, be able to absorb the excess employment (a high of 28.5 per cent of total employment in 2014) in the agriculture sector?
Will the programme disrupt the social fabric in the villages? Will this be professionally undertaken i.e after carrying out a Land Utilisation Plan to determine the soil types, the crops which could be grown on a large scale for further processing and for export, after re-plotting of holdings to help mechanisation, etc? Thus this is a massive and difficult undertaking which needs to be handled with great care, perhaps under the guidance of a committee of relevant experts like economists, sociologists, soil scientists, biologists, farmer settlement planners, etc.
Conclusion
At last SL has been gifted a mid-term policy that will if implemented efficiently carry the country along the path undertaken by the high performing East Asian economies to higher real incomes, alleviation of poverty and reduction of inequality .Its success will depend on the rectification of shortcomings mentioned earlier and above all on the ‘guidance of a strong state’ as indicated in the definition of a Social Market Economy at the beginning. Success would also depend on effective and consistent monitoring of performance in view of the low quality of the public service and the multiplicity of ministries and agencies. Could the (bickering) politicians, the people and the bureaucracy be motivated to undertake this practical economic development exercise? (The writer is an economist who writes regularly on economic and development issues. He could be reached at felixya37@gmail.com)