Part 5: Social Market Economy – Go for complex production system, facilitate entrepreneurship

Inventions and innovations go hand in hand

Part 4 of the article in this series argued that Sri Lanka should create an ‘innovation economy’, and not just a knowledge economy, by using the research think-tanks at universities and research institutions if it is to deliver sustained prosperity to its people (available at: http://www.ft.lk/article/478857/Part-4--Social-Market-Economy--Universities--research-institutions-as-catalysts-of-an-innovation-economy). 

Knowledge creates inventions but inventions alone will not help a nation unless they are used for producing commercially viable goods and services for use by people at home and abroad. That process, it was pointed out, is being completed by entrepreneurs who function as innovators. Hence, inventions and innovations should go hand in hand if the process is to deliver success. What this means is that knowledge without practice is fruitless. 

 

Knowledge without practiceis fruitless

This was a wisdom known even in ancient times. For instance, the Chinese philosopher, Lao Tsu who lived in the 5th century BCE is said to have emphasised the importance of practice when he said that ‘knowledge is a treasure, but practice is the key to it’. Similarly, the 4th century BCE Indian Guru, Chanakya, also known as Kautilya, said in Chanakya Neethi or Ethics of Chanakya that ‘there is no use of knowledge confined to books only’ meaning that knowledge, for its proper benefit, has to be applied in practice.

In modern times, this was emphasised by London University’s Education Professor Alison Wolf when she asked the question aloud ‘Does Education Matter?’ in her 2002 book under the same title. The subtitle of the book, namely ‘Myths about education and economic growth’ gives a clue to the answer to the question she has raised. According to her, education matters only if it is relevant education and there are conditions conducive for the application of that education in practice. 

 

Government’s job is to make education relevant and applicable

Making education relevant and creating conditions conducive for practical application of knowledge built through education are matters for governments to deliver by having appropriate public policies. That involves a shift in government policy in two areas. That is, increasing the country’s expenditure on research and developments or R&D progressively over the next decade and creating conditions for private entrepreneurs to use that new knowledge in the production of goods and services. 

 

Countries that have moved into complex production systems have been winners

Advanced economies in North America, Europe and East Asia have transformed their economies from simple production systems to complex production systems in order to keep them afloat in the ever competitive global economy. The example set by them has been followed by newly advanced economies in South East Asia such as Singapore, Taiwan, Hong Kong and South Korea.

Through deliberate government policy, these countries have transformed their economies from simple production systems to innovative and creative economies. In the meantime, poor countries in Asia, Africa and Latin America have been concentrating on continuing with producing goods for the world market by adhering to simple technology that can be copied by anyone easily. This has led to the creation of a new type of divide between advanced economies and poor countries, namely, a ‘technological divide’ between them. Sri Lanka is in the latter category but it need not remain in that category forever.

 

Sri Lanka is ranked low in economic complexity index

The Economic Complexity Index compiled by Harvard University and Massachusetts Institute of Technology jointly ranks Sri Lanka at 84th place in terms of economic complexity in 2013 among 124 world nations though it was an improvement of its position at 98 in 1995 (available at: http://atlas.cid.harvard.edu/rankings/country/2013/). However, in the recent past, Sri Lanka’s position has gradually deteriorated from 82 in 2011 and 83 in 2012 in the same index. Figure 1 and Figure 2 show the Sri Lanka’s product map in 1995 and 2013 as compiled by the Harvard-MIT Economic Complexity Atlas Compilers.

 

The dismal performance of Sri Lanka’s exports

The two maps show that there has not been any noticeable change in the product mix of the visible exports made by Sri Lanka during the 17 year period under consideration. In the Atlas, what is shown in light blue are the complex products which Sri Lanka has exported to the rest of the world. In both years, that segment has remained less than 5% of the total exports of the country. Accordingly, 95% of the products which Sri Lanka produces and exports at present have been simple products for which there is a fierce competition from other likely countries which can easily copy them from Sri Lanka. This is evident in the case of apparels, tea and other plantation crops, fish products and raw materials which Sri Lanka exports to the rest of the world. 

As a result, Sri Lanka’s exports have declined as a percent of both its GDP and world exports over the years. With respect to GDP, Sri Lanka’s exports have declined from 33% in 2000 to less than 15% in 2014. As a share of the global exports, Sri Lanka’s exports have declined from 0.9% in 2000 to 0.5% in 2013. Obviously, this trend has to be arrested and reversed if the country is to create sustained prosperity for its people. The way to do so lies in Sri Lanka’s ability convert itself from the current simple economy to a complex economy.

 

Losses and mismanagement in public enterprises have caused government to spend less on R&D

What this means is that Sri Lanka needs to invest a higher percentage of its income continuously in research and developments or R&D. Sri Lanka’s R&D expenditure stood at 0.2% of GDP in 2013 when the world on average had spent 1.7% and countries like Israel had spent more than 4%. Many attribute Sri Lanka’s low investments in this vital contributor to economic growth to its low income but it is not the case. The reason has been the failure of economic policy governance to eliminate waste, losses and misuse of scarce public funds on one hand and decide on proper priorities of the nation on the other. 

A classic example about the losses is the wrong economic policy decision taken by the Government in 2008 to renationalise SriLankan Airlines and set up another State-owned budget airline named Mihin Air. SriLankan Airlines partly owned fully managed by Emirates Airline was financially very badly hit when the Katunayake Airport came under a terrorist attack in 2001. In this attack, SriLankan Airlines was the biggest casualty. However, with a prudent restructuring program implemented by Emirates, SriLankan Airlines was able to make a turnaround within two years and become profitable once again without a single subsidy from the government. It in fact started paying dividends to the Treasury as from 2003 according to the Annual Report of the Ministry of Finance for 2008. Thus, during 2003-2006, the total dividends paid to the Treasury amounted to Rs. 1.7 billion.

 

The sad story of SriLankan Airlines and Mihin Air

However, as from the Government’s takeover of SriLankan Airlines and the commencement of Mihin Air, they started to incur losses even at operational levels requiring the government to bail them out from time to time by recouping the losses by way of capital infusion. During 2009 to 2014, the total operating losses of SriLankan Airlines amounted to Rs. 116 billion while that of Mihin Air amounted to Rs. 4 billion, making it altogether Rs. 120 billion from a single sector. 

In comparison, the annual recurrent and capital expenditure of an average university in Sri Lanka had been about Rs. 2 billion. Had these two undertakings been private companies, they would have been closed down long time ago on account of the negative capital base and consequently not being ‘going-concerns’. But what the Treasury did was even without getting Parliamentary approval, replenished the losses from time to time. If Sri Lanka government had practised proper economic policy governance, such continuing losses would have been avoided and money would have been used for augmenting R&D expenditure. 

 

Closing Mihin Air is better for Sri Lankans

Thus, what the present Government should do in order to find money for increasing R&D expenditure is to implement a comprehensive restructuring program in public enterprises. The government has announced that it would reform Mihin Air but there is no case for doing it. How Mihin Air is operating today is by hanging on to the profitable routes operated by SriLankan Airlines and not running an independent business. Accordingly, the losses of Mihin Air too are rubbing on SriLankan Airlines. As such, instead of attempting at reforming Mihin Air, it is worthwhile for the Government to close down the undertaking altogether and divert the resources so saved to increase its R&D expenditure.

 

Anti-entrepreneurship sentiments

With respect to entrepreneurship, Sri Lanka has failed to develop an entrepreneurial class with its anti-private sector and anti-entrepreneur policies in the past. Traditionally, it has inculcated in the people a value system which is anti-private sector and anti-profit making. Even in schools, when students celebrate their annual commerce day, short dramas are staged by them depicting the middleman as an exploiter ignoring his service as an agent to reduce the transaction costs to be incurred by both the consumer and the producer. Such themes played in dramas by students demonstrate that, contrary to the objective of commerce, they are harbouring in them a value system that downgrades their own future career as practitioners of commerce.

 

Killing of entrepreneurship in the private sector by the government

The government policy too has been anti-private sector and anti-businessmen. Whenever a local entrepreneur of worth emerged from the dusts at the ground level, Sri Lanka had killed him either by expropriating his business under the pretext of serving the common man or bringing him within a strict governmental regulatory regime to prevent him from, as the country’s leaders had argued, harming the people. Hence, in the whole of the post-independence period, leading industries were started and managed by the government by employing bureaucrats who had no knowledge of running businesses in a competitive environment or handing such industries to political supporters whose only interest in the industry was to serve their political masters.

Even the trader type entrepreneurs who got nourished in the system could not work on their own and had to seek comfort of the country’s rulers to win numerous business favours from them. Thus, creativity and innovativeness, the two pillars on which a true entrepreneur would stand high in society, were alien to Sri Lanka’s entrepreneurial class. They were, for all practical purposes, shrewd businessmen who took advantage of the prevailing regulatory and protective regime of the country. Hence, in an environment where there is free competition in the market, they would find it difficult to survive unless the government comes to their rescue.

 

Protect the property rights

An important policy change that should be made by the government to build an innovating entrepreneurial class has been the protection of property rights. Property rights are the right of a person to hold property – both human and physical – that generates an income stream to its holder. The person concerned must have the right to dispose of his property in the market in a voluntary exchange. There should not be possibilities for any private party or the government to grab it from him without his consent and without compensating him properly.

To protect the property rights, the government should observe the Rule of Law and maintain law and order. To ensure both these pre-conditions, there should be a judiciary which is independent and free from influences of the government and the politicians who make up the government. In addition, the law enforcement agencies, namely, the Attorney General and his staff and the Police, should also be able to conduct their affairs freely and independently.

It is not sufficient to introduce constitutional provisions safeguarding their independence since the government in power can always abuse its powers by exercising its majority power in Parliament. To keep a proper check on these agencies as well as the government and its politicians, it is necessary to empower civic society institutions which will function as watchdogs protecting the rights of the people. A society which does not uphold the rights of these civic society institutions is unlikely to protect the property rights of the people. When property rights are violated, there is no entrepreneurship too in such a society.

 

Lay a firm foundation 

Hence, Sri Lanka today should lay foundations to build several strong pillars in its economy. First, it should take measures to convert the simple product economy to a complex product economy. Second, to do so, it should promote R&D activities by its universities and research organisations. 

Third, it should give a proper value to private businesses. Fourth, to enable the private businesses to function as innovators, it should protect the property rights by observing the Rule of Law, maintaining law and order and upholding the independence of the law enforcement agencies.

(W.A. Wijewardena, a former Deputy Governor of the Central Bank of Sri Lanka, can be reached at [email protected].)