It’s the same pit!
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Tea was the main export in our economy in the 1950s-70s.
About two decades ago, Professor Chandra Rodrigo and I were working as Sri Lankan partners on what was called a Global Research Project. It was a world-wide research project explaining half a century of growth experience of developing countries in the world from 1950-2000. As the global research project was divided into a number of regional components, we together with a group of economists from our region were working on its South Asian component. Our research outcome was published as chapters of a book titled “Explaining growth in South Asia” edited by an Indian economist, Kirith Parikh (2006).
By this time, I had a fairly good knowledge about the post-independent development experience of Sri Lanka. As the above research project was, however, exclusively on “economic growth” over 50 years, it provided me with an invaluable opportunity to dig further and deeper into the growth trajectory of Sri Lanka.
We spent a few years in the research work exploring the facts and figures, meeting our counterparts often in Delhi, and discussing the progress and issues of the project. This gave another opportunity to compare and contrast the Sri Lankan case with growth experience of other countries in our neighbourhood – Bangladesh, India, Nepal and Pakistan.
Through this experience, what I realised was that the Sri Lankan growth experience is unique among our neighbouring countries in South Asia. While we had better initial conditions conducive to achieve fast economic growth than all other South Asian countries, Sri Lanka did not have poverty and other social issues compared to what others had.
But all that good start with superior socioeconomic status appeared to have gone wasted. After all, halfway through the 50-year period Sri Lanka had opened its economy in 1977, while all other South Asian countries commenced opening their economies only after 1990. This means that, all these countries did not have much to write about their growth performance under the open economy which was less than 10 years old by that time.
Need for protection
I thought of touching upon one crucial issue that struck my mind when I was working in the above research project: As far back as the mid-1960s, Sri Lanka had already realised that its economy would not move forward without exports and foreign investment; the question I had was that “why did it fail” in spite of knowing both the problem and the solution.
Recently, this crucial issue propped up in my mind from time to time, when I heard over and over the argument that “Sri Lanka needs to protect our domestic production with import controls” and that “it’s the open economy which destroyed our domestic production”. Well, I think by now, we have had enough with import controls to understand all that and we clearly know its outcome as well.
It was the same argument that was promoted since the late 1950s in order to achieve two objectives; to save foreign exchange and to promote domestic production! The closing up of the Sri Lankan economy began in the late 1950s and, this move was strengthened after 1960.
As the country’s trade surpluses had turned to deficits causing foreign exchange shortages, import controls were intended to save some foreign exchange.
The same import controls were intended to protect domestic production from competing imports. The new policies received a wider political support nationally and internationally as anti-Western and pro-nationalist sentiments were sweeping across developing countries at the time.
The decade of 1960s started with increased tariffs and quota restrictions on imports and controls over foreign exchange, which were designed to meet the growing foreign exchange crisis. Non-essential imports were classified in order to apply selective controls.
With import controls and foreign exchange restrictions, import expenditure was cut down from 30 per cent of GDP to 18 per cent during the first half of the 1960s. The irony is that, however, the policy outcome was far from being a solution to the foreign exchange shortage which continued to get worse.
New exports and FDI
The new government that came to office in 1965 had a new idea to promote exports and, for that matter even to attract foreign investment (FDI), while allowing for cautious liberalisation in the midst of the prevailing import substitution policy framework. It’s exactly the same argument that we hear even today, a half a century later: We need import controls to support domestic production; however, without distorting that policy, exports can be promoted and FDI can be allowed!
The new export strategy since 1965 was identified as promotion of “non-traditional” exports – minor export crops, gem and jewellery, petroleum products and, some manufactured exports. The government introduced a Bonus Voucher Scheme (BVS) in 1966 as an implicit export subsidy scheme. The exchange rate was devalued by 20 per cent against the British pound in 1967, while a dual exchange rate system was introduced in 1968 under the Foreign Exchange Entitlement Certificate (FEEC) scheme in 1968. An attractive incentive package was offered to export-oriented FDI in 1966 in a White Paper on foreign investment.
The government took all the above policy measures to promote exports, but it was reluctant to make a drastic change in the existing import substitution policy framework. In a nutshell, the period of 1965-70 was marked by a partial deviation from the previous “closed economy” model, which was known as a period of a “mini-liberalisation” programme.
Despite all of the efforts to promote exports, the policy outcome of the mini-liberalisation period was dismal. Although the rate of economic growth increased temporarily in 1967 and 1968, exports as a percentage of GDP continued to fall from 24 per cent in 1965 to 15 per cent in 1970. It was, anyway, not a strange policy outcome. The question was that, even though the government believed in the role of export promotion for development, why was it reluctant to adopt a policy shift towards an export regime?
Policy dilemma
The UNP government of 1965-70, appeared to have suffered from the lack of strength and confidence for a full-scale change from an import substitution policy to an export promotion policy mainly for two reasons.
First, although liberalisation was consistent with the government’s own ideological position, the world development thinking in favour of import substitution at the time was, actually, against it.
Unlike today, there was not even a single country to provide an example of an open economy! If the government had initiated a full-scale liberalisation programme in 1965, it would have been a radical and risky exercise at a time when world development thinking and practice were moving in the opposite direction.
Secondly, the local potential political resistance that it would have produced otherwise weakened the political will and the capacity of the government for liberalisation.
Apparently, the potential political opposition as such would have been fully backed by the political opponents including the left-wing parties of which the ideological lines were in favour of a regulated economy. In fact, it was already a weak government that was formed by a coalition of seven political parties.
It would have been most likely that the government expected that the positive outcome of export promotion together with the then agricultural development would have paved the way for a gradual move towards an “open economy” by averting its short-term cost of adjustment. However, this expectation didn’t materialise, due to unsatisfactory export growth and worsened foreign exchange shortage; why?
From a policy point of view, it was a policy regime with a “bias against exports” so that marginal and sporadic policy incentives favouring export promotion would not be successful. Before we talk about import protection and export promotion as half-and-half policy, we need to remember our own 50-year old lesson from the 1960s.
(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).
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