Next decade: Revival and beyond
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Is there any reason for us to remember the year 1977, which we passed through, or rather passed by, 43 years ago? One common answer would be that it was the year of the introduction of our “open economy” model in Sri Lanka. However, I am not referring to the introduction of the open economy, which was anyway a “half-done agenda ignoring some fundamentals”.
The policy reforms aimed at an open economy in 1977 were dramatic, not necessarily because of their own substance. They were dramatic compared to what we had earlier. However, many essential elements such as public sector reforms, public enterprise reforms, capital market reforms, and labour market reforms were not in that policy package. What was in the package was import liberalisation, exchange rate reform and some level of withdrawal from the market by the government. The very foundation of an open economy is the “law and order” that consists of both law-enforcement and law-impartiality. Smooth functioning of the open economy model requires the “discipline” set by the rule of law. This essential element did not appear to be in the foundation on which the shaky open economy was built. What the country experienced after that has also led many to conclude that all evils are by-products of the open economy.
Crisis in 1977
Apparently, it is a valid answer to the question I raised at the outset, but the answer I was looking for is the “economic crisis”. We should remember 1977 for the unparalleled economic crisis that brought the economy to a dead end. And why is it important to raise this question again after more than four decades later? Because, it was this economic crisis which prepared the way for the overnight change of the country’s policy regime from a closed economy to an open economy. If it was not for that crisis, the enabling environment for a radical policy change towards an open economy would not have been so “uncommon” as it was.
The crisis can be understood by looking at either the numbers of the economy or the people’s hardship with domestic supply shortages. There might be differences in opinion, but the numbers tell us the truth. The average rate of real GDP growth remained as low as 2.9 per cent during 1971-77, and around 20 per cent of the workforce didn’t have jobs. Someone could argue that the country achieved a current account surplus of 3.5 per cent of GDP after 20 years, thanks to the stringent import controls and the world tea price hike in 1977. Basic needs, including essential foodstuff, were in severe shortages justifying widespread price controls and regulations. The government decided even what people should eat and when they should eat such food.
As per available evidence, Sri Lanka never had such a severe crisis so far during its post-independence history. It was the severity of that crisis which provided the opportunities for the complete turnaround in economic policy. Whether that opportunity was fully exploited or not is a different issue, but it is a fact that there was the opportunity.
The second parallel
Why did I bring the 1977 crisis into our discussion today? It is because, we are again faced with a second parallel to an economic crisis today and unprecedented opportunities emerging out of that crisis too. Even though the present crisis was led by the global COVID-19 pandemic issue, perhaps for Sri Lanka it came during a worst time of the history. Due to the economic fallout that has taken place for a long period of time, at the point that the COVID-19 pandemic issue hit the economy, the country had exhausted much of its economic strength required to face it.
File picture of work at the Colombo Port City which will transform the capital in the next decade.
The rate of economic growth slowed down steadily letting the country to slip from upper-middle income category to lower-middle income category. In consistent with the slow growth of the economy, private investment and export growth didn’t perform well enough for a long period of time. A much deeper issue could be attributed to the inadequate investment in the areas of research and development as well as in higher levels of human resource development.
While many countries around the world were allocating significant amounts of resources for fiscal stimulus to support the affected people and businesses, Sri Lanka had to suffer from the lack of adequate resources. Faced with a weak financial strength, even the smaller amounts of cash allocated for financial assistance was dependent on the Central Bank’s lending to the government. This was in addition to the Central Bank’s own monetary policy stimulus provided through the banking system.
There was neither multilateral donor assistance extended to Sri Lanka, although it was available to many other countries in the region. In fact, it was early last year that the IMF review showed the deteriorated macroeconomic conditions of the country and extended one more year to show the performance in order to release the final tranche of its Extended Fund Facility. And the country failed to show any improvement by the time of the outbreak of the pandemic.
In the absence of multilateral support and the depleting tax revenue, much of the stimuli depended on Central Bank’s lending and money pumping under stringent import controls. It should be understood that in a desperate economy, import controls are the last resort that should come in for facing a problem irrespective of its detrimental consequences over people and the economy. This may be justified by some owing to the lessening foreign exchange inflows in the absence of a strong export base. However despite the dismal status of the economy, over 80 per cent of our imports consist of intermediate goods and investment goods which determine the country’s production and exports.
Beyond economic revival
There will be time sooner or later for the post-COVID global economic revival, but Sri Lanka needs to put the economy on track to go beyond revival. From the Sri Lankan point of view, revival means restoring the economy back to its sluggish performance level with unresolved macroeconomic problems. There is no justification for the country to stop there, as the nation requires much more than that – higher economic growth, better investment drive, and strong export expansion.
Two important factors will be critically important for Sri Lanka to bring the economy to a take-off stage that it missed even in 1977. The first is the fact that to which extent the potential investors can trust the political sphere of the country so that without fear and hassle they can bring their money and invest here. The second is the fact that to which extent can the country embark upon the “third wave” of policy reforms.
For two reasons, the required policy reform at this point of time in Sri Lanka is much more intense than what they would have been in 1977 or in 1989 – the two waves of policy reforms. The first reason is that we have not undertaken reforms for nearly 30 years so that the negative effect of the long lapse is much deeper than we can comprehend. Secondly, the world is different today than it was then, as there is severe competition among the markets and among the nations to offer attractive economic and political environment for businesses. As far as the ease of doing business is concerned, we should not forget that there are 99 countries in the world already performing better than Sri Lanka. These two factors point to the need of the country for an overhaul reform package.
The next question is when do we undertake it? The best timing is the crisis time because the opportunities that have emerged out of a crisis would not be seen again. .
(The writer is a Professor of Economics at the University of Colombo and can be reached at sirimal@econ.cmb.ac.lk and follow on Twitter @SirimalAshoka).