Reality behind potential output: A response

Thursday, 27 March 2014 00:00 -     - {{hitsCtrl.values.hits}}

By Practical Economist I am pleased that W.A. Wijewardena has welcomed my response to his article. Whilst thanking him for his comments, I also wish to offer a few additional thoughts so that your readers could benefit even more through this interesting debate. Wijewardena argues that the accelerated Mahaweli development program in the late 1970s and early 1980s overheated the economy, resulting in very high inflation, and that later, some damage control measures by the Central Bank stabilised the economy. On that basis, he concludes that the current rapid infrastructure development could also lead to such unfavourable developments. Here, there are two arguments that arise from his conclusion. First, if the Central Bank in the 1980s was proactive and took the measures before inflation went out of control, the economy would not have suffered from overheating. Perhaps as a result of learning from past experience, the Central Bank of today has taken the proactive measures to prevent such overheating, since the recent massive infrastructure development and other activities of the private sector have not caused any overheating, but rather expanded the capacity of the country to grow faster in the medium term. That position is further explained by the fact that large scale infrastructure investments have been made by both public and private sectors while single digit inflation has been continuously maintained for five years. Ironically, the current five-year single digit inflation period coincides almost exactly with the period since Wijewardena’s retirement from the position of being the Deputy Governor in charge of price stability! Second, time and space is needed to assess the medium to long term benefits of any mega infrastructure development programme, such as the accelerated Mahaweli program of the past or the present infrastructure development program. In my view, the enhanced agriculture output which was generated through the Mahaweli development program over the last few decades, and the huge savings that the Mahaweli hydropower generated in terms of less fuel imports every year, has amply justified the total cost of the Mahaweli project. In much the same way, even though some persons may be critical of the vast infrastructure developments of today, it is likely that they will realise the benefits of the ongoing infrastructure developments in due course. In that background, it is fortunate that Wijewardana was not an advisor to President J.R. Jayewardene in the 1970s and 1980s, because had President Jayewardene been guided by Wijewardena, Sri Lanka may have been highly vulnerable to the world energy prices and also perhaps facing a severe food crisis today. Wijewardena’s response also attempts to give the impression that my previous note suggested that I believe only physical infrastructure and a higher investment to GDP ratio could increase capacity. However, it would be noted that in my note, I have mentioned that both economic and social infrastructure could increase the capacity of an economy. Social infrastructure relates to the human capital that is needed to take advantage of the enhanced capacity arising through the physical infrastructure development. In my view, the reforms in social infrastructure are already in effect, although it was not specifically discussed since there was no debate in this area in Wijewardena’s original article. In fact, Wijewardena himself is actively supporting this social infrastructure development effort through his involvement in a private institution which is training youth with the necessary skills for emerging sectors. That factor itself could therefore be cited as an important example as to how reforms have helped generate the necessary social infrastructure as well. Let me conclude by stating that I appreciate Wijewardena’s reiteration that his analyses are based on conclusions which are uncertain due to limitations in his research studies, while the arguments made by the ‘Practical Economist’ are based on robust evidence. That assertion reflects his humility and modesty, a trait that is rarely seen in today’s world. At the same time, it may also be the right time now for Wijewardena to honestly admit that he is a politically-biased writer who is espousing the economic view point of the Opposition party, and stop hiding behind a screen of a technical ‘Economist,’ reputed or otherwise.