Reply to Lalith De Mel – Why globalisation is the way forward by R.M.B Senanayake

Lalith De Mel has raised the question whether globalisation meaning openness to trade with the world sans tariff barriers and import controls, is desirable for Sri Lanka. His answer is in the negative. He says the key drivers of growth are agriculture.

But Agriculture accounts for only `12% of the GDP and its average contribution to annual growth rate is even less than that figure depending on the weather which determines the harvests to a large extent. Industry accounts for about 30 per cent of the GDP and its contribution to growth is over 30 per cent. Our growth is propelled really by the Service sector which accounts for 60 per cent of the GDP. He says the private sector is largely based in the rural areas – about 75 per cent he says perhaps by counting all the farmers- a declining ratio in the total work force.  Our Service sector contributes to growth. These include the port related activities, banking and insurance, telecommunications, tourism and other miscellaneous services.

He asks the question whether globalisation will alleviate poverty. He says we need both growth and poverty alleviation and says globalisation will not do either. The gains from trade are well documented. They include the benefits of greater market size and enhanced competition. Other sources include technological improvements through increased contact with foreigners and their alternative production styles. Such contact can come, for example, from direct investment by foreign firms with proprietary knowledge, or by the exposure to imported goods that embody technologies developed abroad. Each of these elements of trade and other international interactions has the effect of promoting growth in the domestic economy. But openness to trade and its effect on growth have to be empirically verified and this has been done by several econometric studies,

Fortunately, economists have undertaken statistical tests of the determinants of countries’ growth rates. Investment in physical capital and education are the two factors that emerge the most strongly. But other determinants matter as well. There is a correlation of growth with openness, measured for example as the sum of exports and imports as a share of GDP. David Romer and Jeffrey Frankel [in a 1999 article] looked at a cross-section of 100 countries during the period since 1960. They sought to address a major concern regarding simultaneous causality between growth   and trade: Does openness lead to growth, or does growth lead to openness? They removed the complication of simultaneous causality and determined the effect of openness on growth. They found that the estimate of the effect of openness on income per capita varies, but is in the order of 0.3 over the span of 30 years (and perhaps four times that in the truly long run).

That estimate means that when trade increases by one percentage point of GDP, income

increases by about 0.3 per cent over 30 years. By way of illustration, the increase in US

openness since the 1950s has been 12 percentage points. The numbers imply that

increased integration has had an effect of about 4 per cent on US income. More

dramatic is the case of Burma and Singapore. Burma had a trade ratio close to zero, versus Singapore, with a ratio close to 200 per cent. The estimated coefficient of 0.3 implies that as a result of its openness Singapore’s income is 60 per cent higher than Burma’s over a 30-year period, or 120 per cent higher in the very long run. Their approach studied the growth benefits only from geographically induced trade and did not extend to the effects of policy-induced trade.

But the benefits of one impetus to trade will not different from those of another. In any case, critics of globalisation like De Mel seem to think that increased international trade is the problem, regardless of whether it comes from technological progress or market-opening negotiations. Globalisation clearly increases per capita incomes. Trade has been a major component of the growth that has lifted India and East Asia including China out of poverty over the last 40 years.

Agriculture

Of course our agriculture requires some special attention before opening up. The productivity of our agriculture particularly paddy farming is low both in terms of the productivity of land as well as of labour. The traditional economic remedy is to release the surplus labour in peasant agriculture to urban manufacturing and to allow consolidation of small uneconomic plots to larger units which can give a reasonable income to the remaining paddy farmers. But this requires giving outright ownership to the farmers particularly on land allotted under the Land Development Ordinance and a free market in agricultural land. Lalith De Mel is right when he says that if we remove tariffs a large part of our agriculture will be killed and farmers will be unemployed. For the last fifty years we have mismanaged our economy by running budget deficits and printing money to fund them. As a result the prices in our country are far above those of the rest of the world. Developed countries have low inflation of 2-3 % for several decades while our average inflation was 11% over the same period. But there is a remedy. We can correct our price disparities through depreciation of the Rupee and giving up deficit financing. We have to adopt modern technology in agriculture and this requires capital which the peasant farmers lack. But large investors can bring in as CIC has done in recent years. But I think there is scope for a regional marketing network for agricultural products where our farmers’ produce can be sold freely to South Asian countries on a duty free basis. This will help to avoid the seasonal gluts which depress prices for our farmers. A Commodity Exchange may perhaps be necessary where foreigners can buy and sell such produce. This requires freedom to export not import and it will require negotiations with SAARC countries.

Industry

De Mel says, “The problem is that due to the lack of economies of scale we will never be competitive globally in a number of industries”. True indeed. That is why there is a case for entering into CEPA. The East Asian countries including China and Japan are integrating their production into Regional Production Networks where each country produces not the whole product but only a part or parts of it where they have a competitive advantage. India has woken up to this regional movement rather late in the day. But she is now trying to catch up lost ground and is in discussion with several countries in ASEAN, South Korea and Japan. Our historical fears and animosities should not   stand in the way of CEPA just as France and Germany which had fought two wars did not, when they agreed to set up the European Union – a free trade area with free movement of goods, people and capital. Mr. De Mel has forgotten the Law of Comparative Advantage. It doesn’t matter if India can produce every good cheaper than Sri Lanka; there is still a case for free trade between them as Adam Smith pointed out about Britain giving up then production of wine in Scotland  and importing French wines instead. As Adam Smith said, “Man is an animal that makes bargains; no other animal does this – one dog does not change a bone with another.” Just because we enter into CEPA it doesn’t mean every enterprise in our country in industry will be killed. What happens will be through mutual bargaining. True some firms will be sold to Indians like the Glass Company which our local entrepreneurs couldn’t run and had to sell out to Piramal Glass. Have our people suffered as a result of this sale to Piramal? Not even the former owners who would otherwise have lost their sunken capital have suffered. The enterprise was sold only because they could not run it profitably. The change in ownership has enabled us to develop the industry and earn foreign exchange which belongs to the country as a whole. De Mel says the Indians will erect barriers to our entry into Indian market. Haven’t our business groups like John Keells and Aitken Spence entered the hotel sector in India. What about Damro and even Munchee. According to De Mel’s argument only countries of the same size and at the same level of development should enter into trade. This runs counter to the entire body of economics which forms part of International Trade Theory based on the Law of Comparative Costs. It points out that even if we can produce all the goods we require, it would yet be advantageous to a country to specialise in the production of those goods where it has a comparative ( not absolute) advantage.

If Indian goods are cheaper it is because Indian wages are lower than ours.  Why are Indian wages lower than ours (apart from the fact of our higher inflation caused by deficit budgeting and owing to which trade unions have forced employers here to compensate them). If we separate the inflation differentials, it is only because Indian workers are less productive than ours. In 1996 essay ‘Ricardo’s Difficult Idea’, Dr. Paul Krugman, Nobel Prize winning economist pointed out that wages are determined by worker productivity. Therefore, low wages reflect low productivity. This fact, once grasped, reveals that low-wage countries have no general competitive advantage over high-wage countries. (Quoted in Bordereaux in Myths and Fallacies: Trade in Café Hayek)

In any case under CEPA unlike under the earlier SAFTA there is greater liberalisation.