Achieving economic goals in the midst of global challenges: Views of independent economists

The Sri Lanka Economic Association or SLEA, the long-standing professional body of economists of Sri Lanka, has published some selected papers presented at its Annual Sessions in October 2011 in a volume titled ‘Achieving Economic Goals in the Midst of Global Challenges,’ the theme of the sessions.

The volume, edited by two veteran economists – Professor A.D.V. de S. Indraratna and Sarath Vidanagama – contains 6 papers written by a number of independent economists and the Presidential Address delivered by Professor Indraratna as SLEA’s incumbent President. The address of Professor Indraratna was reviewed in a previous My View published in this paper on 2 July 2012 under the title ‘Sri Lanka as Emerging Wonder of Asia: Suitable ground conditions to realise the goal are a must’ (available at: http://www.ft.lk/2012/07/02/sri-lanka-as-emerging-wonder-of-asia-suitable-ground-conditions-to-realise-the-goal-are-a-must/).

Since the other papers in the volume are valuable readings on the current status of Sri Lanka’s economy from the eyes of independent economists, this ‘My View’ is devoted to offering a critical review of those papers to readers.

Sri Lanka cannot do without the global economy

The theme selected for the Annual Sessions of 2011 is appropriate for two reasons.

First, it recognises that Sri Lanka has to operate within the global economy nourishing it on the one side, while being nourished by it on the other in the process. This is an open view taken by SLEA as against the popular belief held by many that Sri Lanka can do without the global economy.

Sri Lanka is a small economy without natural resources of worth to mention and has to sell a significant part of its surplus output to foreigners while buying essential consumer and investment goods from them. Hence, Sri Lanka cannot be oblivious to what is happening outside its borders and has to reorient its economic policy to face the emerging global challenges successfully.

Second, after the end of the disastrous ethnic war in 2009, Sri Lanka has now to work tirelessly to open the economic opportunities which it had lost in the past. This takes the form of steering Sri Lanka along a high economic growth trajectory so as to bring prosperity to its entire population. To attain this objective, Sri Lanka has set itself high economic goals to be realised in the next few years, but its success would largely depend not only on the domestic policies pursued but also on how favourable the global economy would be for the sustenance of such policies.

The papers in the volume have shed some lights as to how Sri Lanka should overcome the challenges posed by this emerging global environment which is not favourable at all to the country in the present juncture.

Impartial and objective views of independent economists

The volume also demonstrates the independent and impartial view taken by the contributors on different aspects of the economy. The analyses in the papers, while appreciating the recent economic measures taken by the authorities, have highlighted the critical risks which the country is facing and the need for introducing policy reforms on a priority basis.

This is quite contrary to the official analytical sources which have painted a very good picture on the country’s economy always highlighting it as a success story which can be emulated by other nations. Such a view taken by the official economists makes them slaves of their own arguments closing the door for critical review of policies and preventing them from taking corrective action in time if things go wrong.

It is not a satisfactory state at all since the global economy to which Sri Lanka is now highly connected throws new challenges, making Sri Lanka’s path toward prosperity within a few years, as planned by the country’s authorities, almost impossible. In this sense, the papers contained in the volume are eye – openers for all.

Commodity prices and inflation

C.P.A. Karunatilake, Superintendent of Currency of the Central Bank, has in a paper titled ‘Commodity Prices and Inflation’ tried to establish the relationship between these variables as applicable to Sri Lanka. Karunatilake has identified two sources for the continuous change in the general price level of a country leading to high inflation, the aggregate demand shocks and the aggregate supply shocks.

Central banks in their monetary policy actions concentrate wholly on aggregate demand shocks emanating from increases in money supply boosted by high deficits in both the government and private sectors of a country. For central banks, the way to tackle inflation is to control the source by raising interest rates to discourage private consumption and raise savings and using moral suasion to put good sense to the governmental authorities to go for austerity measures. However, Karunatilake has found a positive relationship between the changes in commodity prices and the consumer price index in Sri Lanka thereby implicitly suggesting that the Central Bank has become irrelevant and redundant.

By using Vector Auto Regressive or VAR techniques to establish the underlying relationship, Karunatilake has found an immediate significant positive impact exerted by imported foods, oil prices, and domestic paddy prices on the consumer price index but gradually tapering off the initial impact over a 60 month period.

He has found the same relationship, somewhat in a weak form, between these prices and the wholesale price index meaning that consumer prices will increase after a given period of time when goods on wholesale trade are released to the market. He has thus concluded that the commodity prices have a strong impact on domestic prices at consumer price level but a weak relationship at the wholesale price level. The latter is only an indicator for the Central Bank to take appropriate monetary policy in advance to avoid an impending crisis.

These findings are naturally to be expected since commodity prices are a sub set of the general prices and if they go up, they will do so by elevating the general prices as well. However, the importance of his findings is the cumulative impact which commodity price increases have inflicted on general prices with their cascading effect on the price system. This too is to start to fizzle out after 10 months, according to Karunatilake.

Thus, if a government is interested in controlling the consumer price index, it could do so by controlling commodity prices either by direct controls or by giving a subsidy to the consumers. Both are inflationary in the long run due to distortion of relative prices in the first case and having to run excessive budget deficits in the second case.

Sri Lanka had a very bad experience in the first case prior to 1977 with a stagnant economy. It is experiencing a similarly bad experience at present in the second case with mounting losses in key public enterprises by compelling them to sell their products below the costs.

Taxing exports through appreciated exchange rates

Dr. Saman Kelegama, Executive Director of the Institute of Policy Studies, has discussed the impact of trade imbalances in the context of contemporary trade policies and agreements. According to the data presented by Kelegama, Sri Lanka’s macroeconomic policies have favoured imports and discriminated against exports in the last decade. The share of Sri Lanka’s exports in both the global exports and the country’s GDP has recorded a decline over this period. Accordingly, Sri Lanka’s exports accounted for 0.09 per cent in 2000. This share fell to 0.05 per cent in 2008.

Similarly, Sri Lanka had exported about 33 per cent of its GDP in 2000. By 2010, according to Kelegama, its share has fallen to 16 per cent. The fall in exports while imports have remained more or less a constant share of GDP over this period has augmented Sri Lanka’s trade deficit reducing its ability to maintain the stability in the exchange rate without resorting to borrowing from abroad.

Even then, when the external shocks have been too severe, it had to allow its external reserves to decline fast driving the country to a critical level. In the meantime, Sri Lanka’s rupee has appreciated in real terms as demonstrated by the appreciation of the real effective exchange rate index calculated by the Central Bank with respect to 23 major trade partners. Hence, Kelegama has found fault with the country’s macroeconomic policy authorities for not allowing the rupee to adjust appropriately till the end of 2011. Economists call this a policy of taxing exports and subsidising imports.

Given this scenario, Kelegama has recommended that Sri Lanka does not have an option but to promote regional trade agreements, especially with neighbouring India and Pakistan.

Want to promote exports? Trust the private sector

Sarath Rajapatirana, former economic advisor to the World Bank, has taken Kelegama’s study forward in his paper on ‘Further Thoughts on Trade Policies and Agreements’. While agreeing with Kelegama that Sri Lanka’s past trade policies have favoured imports and discriminated against exports, Rajapatirana has argued that Sri Lanka should trust markets for promoting exports instead of trying to fine-tune export policies. The market system will allocate resources among competing ends efficiently while targeting of exports has been a failure in Sri Lanka in the past.

Rajapatirana mentions the example of Sri Lanka’s attempt at promoting non-traditional exports in 1970s at the expense of traditional exports through targeted export policies. This policy did not help Sri Lanka to diversify its exports in that era mainly because such industries were manned by inefficient governmental authorities.

After 1977, the diversification took place to some extent through the market system. Hence, even to promote trade with East Asian markets, Rajapatirana recommends that it should be done with the private sector which would promote exports to those countries driven by profit motive. Rajapatirana concludes his paper by suggesting that the trade imbalances should be corrected by adjusting exchange rates and not by resorting to tariffs and subsidies, a position endorsed by Kelegama too.

FDI flows are a plenty, but Sri Lanka is starved

Professor Anoma S.P. Abhayaratne and Thushari Vidanage – Abhayaratne being the Dean of Arts Faculty at University of Peradeniya and Vidanage a lecturer at the same university – have discussed the challenges faced by Sri Lanka with respect to the attraction of foreign direct investments and portfolio flows in the context of global developments in these flows in the recent past.

Abhayaratne and Vidanage have found that FDI flows to many developing countries have been prompted by the need for seeking markets and resources rather than for harnessing economies of scale present in those countries. Sri Lanka is not an exception in this regard. However, developed countries still attract the lion’s share of global FDI flows because of the presence of salutary factors for businesses to flourish in those countries. It is only in 2010 that developing countries have been able to match the FDI flows to developed countries.

According to the two authors, Sri Lanka’s FDI flows have improved from less than one per cent of GDP in 1978-93 to 1.5 per cent in 2005-2009. However, compared with flows that had been attracted by China, Brazil and India, Sri Lanka’s FDI flows amounting to an average of $ 502 million are still negligible. If Sri Lanka is to raise its economic growth to above 10 per cent, FDI flows should rise to at least eight to 10 per cent of GDP in the coming years.

They have also identified several pre-conditions that should be put in place for Sri Lanka to attract significantly high FDI flows in the future. Of them, creating a better investment climate in Sri Lanka through appropriate government policies and macroeconomic and political stability plays an important role.

Want inclusive growth? Then, go for micro interventions

Nilakshi de Silva, Gayathri Lokuge and Arunika Meedeniya of the Colombo-based Centre for Poverty Analysis and Ramini Gunatilaka of Monash University have in a joint paper attempted to identify the drivers of inclusive growth in Sri Lanka by using both quantitative and qualitative methods.

While Sri Lanka is pursuing the goal of doubling its per capita GDP over the six year period from 2010 to 2016, inclusive growth issues have to be understood in order to make that economic growth accessible to all the people of the country. The authors have used the national data available in the Household Income and Expenditure Surveys conducted by the Census Department in 2002 and 2006/7 to identify the drivers of inclusive growth in their quantitative study and have found that access to infrastructure, education and skill development have contributed to inclusive growth.

In the qualitative analysis done in Puttalam District, access to technology, credit and work related experience have been important drivers of inclusive growth. Hence, the authors conclude that economic growth alone will not guarantee inclusive growth and more micro interventions are needed for a society to attain the same.

Pro-poor policy has not reduced income gap

Dr. R.M.K. Ratnayake, presently consultant to the Ministry of Higher Education, has in a paper titled ‘Economic and Social Equity’ tried to examine the qualitative aspects of economic development from an equity point of view.

It is argued by many that in a globalised world, when global shocks hit poor countries, the poor are disadvantaged to a greater extent. Hence, it is worthwhile for Ratnayake to examine the equity issues in Sri Lanka. Since Sri Lanka has followed an ‘equity now and growth later policy’, the data should show a move toward greater equity in the country. However, according to the data presented by Ratnayake, this has not happened till 1978 as demonstrated by all the equity criteria of the country.

Even after adopting pro-poor policies in 2000s, there has not been a marked reduction in inequity in the country. For instance, Gini Coefficient still remained at 0.49 in 2009/10, the level it had been in 1953. During 2006/7 to 2009/10, per capita GDP in Sri Lanka increased by 13.7 per cent. But the income of the poorest 40 per cent increased only by 0.6 per cent meaning that the bulk of economic growth has been shared by the well to do in the country. Hence, instead of moving toward economic and social equity, Sri Lanka has been aloof to that goal throughout.

SLEA publication a must read

Overall, it is the view of this writer that the volume released by SLEA recently containing seven scholarly papers is a must read by every student and professional practitioner of economics in order to understand the strategies which Sri Lanka should adopt in order to overcome the challenges which have been posed to it by the emerging adverse global developments.

(W.A. Wijewardena can be reached at [email protected].)