Disrupt the economy creatively or perish should be the slogan to be followed by the new Government Pic by Shehan Gunasekara
For good results, disrupt the existing systems
It was a cakewalk for Sri Lanka Podujana Peramuna or SLPP, headed by President Gotabaya Rajapaksa, to seize power in Parliament. Within a matter of a few months of its formation as a political force, it has kept a record by rising to the pinnacle of the countrys power cathedral. In the process, it has disrupted the two oldest political powers in Sri Lanka, namely, the United National Party or UNP and the Sri Lanka Freedom Party or SLFP. The emergence of a disruptor, though the name sounds something frightening, is a welcome development in any society. This is because it is disruptors, and not conventionalists, who have created a new world for the betterment of humankind.
Relating to economics, this was first presented by the 19th century French economist and statesman, Frdric Bastiat when he said that breaking of windows even in acts of vandalism was to be welcome. That was because it enabled the world to go for new generation windows sustaining the window industry, on one side, and creating a new output for society, on the other.
In the early part of the 20th century, Bastiats views were more formally and cogently presented in a positive way by two economists. One was the Russian economist Nikolai Kondratieff. The other was the Austrian-American economist, Joseph Schumpeter. I have covered their views in a previous article in this series that can be accessed at http://www.ft.lk/columns/Long-waves-in-global-business-cycles-versus-Sri-Lanka-s-disastrous-short-waves/4-701288.
Kondratieff: Inventions should be commercially produced
Kondratieff had discovered through empirical research that capitalist societies had repeatedly undergone ups and downs in their economies known as business cycles but had managed to recover to a new position every time they had suffered from an economic downturn. Such business cycles had typically been experienced by Western economies for long periods of about 50 to 60 years which he designated long-waves of business cycles.
The reason for the recovery of a dying economy was the commercial adoption of scientific and engineering inventions by businessmen thereby taking an economy to a higher wave. Schumpeter, quite independently of Kondratieff, said that any new technology that was to replace the old ones, though feared by people, was a creative destruction.
Joseph Schumpeter: Generate creative destructions
Countering the Marxian view of the self-destruction of capitalist societies from internal conflicts, Schumpeter presented the contrarian view that capitalist societies continued to sustain and prosper through the introduction of a series of new technologies to replace the worn-out old ones. Expanding his conception of creative destruction, he identified four basic developments that should take place in an economic system enabling it to rise to a new height in development. His concept agrees with the Kondratieff long-wave formation in an economic system through scientific and engineering inventions that are commercially adopted by businessmen. But this commercial adoption was called innovation by Schumpeter. Taking it forward, he identified two further developments that should be followed for an economy to sustain its prosperity. One was the diffusion of knowledge among as many businessmen as possible. The other was the imitation of new technologies by prospective entrepreneurs.
Inheriting a sick economy by SLPP
Why should SLPP be a creative disruptor of Sri Lankas economy? That is because it has inherited an economy sick with a multitude of ailments. Sri Lankas economy had infected itself with some of these ailments right from the independence of the country. Some are later infections by governments that had introduced disastrous viruses to its body from time to time. However, with no proper medication administered at the appropriate time, these ailments have grown within the body of the economy like a silent cancer that grows without demonstrating any symptoms.
As I have indicated in a previous article (available at: http://www.ft.lk/columns/C-19-economic-recovery-Most-probably-it-will-be-a-flattened-U-shaped-one/4-703372), political leaders have been playing a blame game accusing each other for the maladies from which the economy has been suffering. That was an exhibition of complacence on the part of politicians coupled with the desire to evade responsibility.
The behaviour so demonstrated by them was similar to the man falling from the 20th floor of a building shouting at a man at the window of the 10th floor that he was alright so far and there was nothing to be worried. It was simply acting on self-delusion quite oblivious of the empty space below him through which he was falling to a fatal end. In Sri Lanka, this has been repeated ad infinitum at every general election. The one that was concluded last week is not an exception.
Sri Lankas manifesting sickness from all sides
Sri Lankas economy began to demonstrate signs of serious sickness from around 2013 when the growth rate began to decelerate. Immediately after the end of the war in 2009, the economy showed all signs of recovery to a high growth path recording growth rates of above 8% in the three succeeding years. These growth rates were attained basically by investing in capital infrastructure which could sustain the growth rate only for a limited number of years. That was because in the absence of the needed reforms in the capital markets, labour markets and the public sector, the rigidity of the economy could not be softened. Such growth has been designated by Nobel Laureate Paul Krugman as ones that are attained through perspiration and not inspiration. Hence, as expected, growth rate began to fizzle out as from 2013. Along with the falling growth rates, the symptoms of other ailments from which the economy was suffering also became manifest.
Such ailments had taken the form of rising budget deficits, unmanageable public debt, rising inflation, deficits in the trade, services and the current accounts of the balance of payments or BOP. Since adequate capital flows could not be harnessed to meet the deficit in the current account, there were deficits in the overall balance of BOP too. It led to the peculiar situation in which foreign reserves had to be built only by making further borrowings. It led to two other basic ailments. One was the pressure for the exchange rate to depreciate in the market in the absence of adequate foreign exchange flows to the country. The other, arising from the inadequate foreign reserves, was the accumulation of debt by the government beyond manageable levels. As a result, repaying the maturing public debt has become a serious challenge for the new government.
No rosy picture about the economy in the next few years
Certainly, the new government has to worry about the frightening economic conditions in 2020 and in the next few years. It is facing an economy that has been virtually incapacitated by the disastrous economic fallout of COVID-19 pandemic towards the end of the first quarter of 2020. As a result, the first quarter of 2020, the size of the real economy, pulled down by a negative growth in agriculture and industry and a slow growth in services, became smaller by 1.6% in rupee terms. Its contraction was sharper in dollar terms at 5% because of the fall in the value of the rupee against the dollar from Rs. 176 to Rs. 190 per dollar in the period.
In the next three quarters, the decline in the economy would be sharper due to a completely underperforming services sector. Unless an effective vaccine against the coronavirus is found soon, this negative economic performance is to linger into the next few years too. Such an adverse development would make Sri Lankans poorer and poorer year after year. This is what the new government should avoid and for that purpose, it has to creatively disrupt the economy too.
Dont fear disruptions
A disruption is simply a forced change of how people think, act, produce, distribute and consume. Taken together, they can be called the behavioural pattern of human beings. These behavioural patterns are represented by culture and culture is subject to a natural evolution over the time. Such cultural evolutions take their own pace to complete a full cycle but when they are shocked by an external agent an opinion maker, new technology or new product the evolutionary process is quickened.
A good example is the smart mobile phone. Five years ago, except those in young age categories, no one knew how to use the data processing power of a smart mobile phone. But today, hit by the social and economic restrictions of COVID-19 pandemic, everyone has trained himself to using smart phones and their versatile applications. As a result, practically everyone today is conversant with using popular Apps like WhatsApp or Zoom to communicate with others or disseminate information. This they do on a real time basis building networks of people and assembling them together. Thus, the smart mobile phone was a shock-agent and that agent has disrupted the traditional communicating agents like newspapers, radios, TVs or even land-based telephones. This was evident when people used smart mobile phones to learn of results, quick and fast, of the general election held last week.
An aggravated fiscal crisis by a generous tax offer
Sri Lankas present economic crisis has been aggravated by a fiscal crisis, debt crisis and a foreign exchange crisis. In the case of the fiscal sector, the crisis took the form of an unwieldy budget. The government revenue in relation to GDP was falling, consumption expenditure rising, savings of the government becoming negative, having to borrow to finance both the consumption and capital expenditures on one side and pay interest and repay the maturing debt on the other. This resulted in an unwarranted rise in the public debt stock and by the time the new government came to power at end-2019, it was as high as 87% of GDP, up from 72% five years ago.
This frightening fiscal scenario was worsened by a generous tax cut offered by the new government to income tax and VAT payers. It resulted an estimated revenue loss of some Rs. 600 billion per annum. This was an unaffordable and unwarranted comfort which the new government had given to some section of the people in the country. The consequential rise in the gap in the government budget had to be financed by the government by borrowing from both the central bank and commercial banks. During the first six months of 2020, the government had borrowed, on a net basis, a staggering Rs. 1.22 trillion from this source.
This is money printing which people in the street often talk about. Its inflationary pressure will have to be borne especially the low-income people. Hence, it is an iniquitous public policy since it favours the middle class and the high-income people, while passing the burden called incidence of tax-financing versus inflation-financing on to low-income groups. Hence, it is of utmost importance that the government revert to the tax system that prevailed prior to 2020 and save its budget. But it will be a shock-agent disrupting the comfortable life which the countrys taxpayers have been enjoying ever since the new President was voted to power. But that disruption is a sine qua non today.
To resolve the debt crisis, resolve the fiscal crisis first
Sri Lankas debt crisis is an off-shoot of its fiscal crisis. Hence, the way to resolve that crisis is to resolve the fiscal crisis first. Sri Lankas government has to borrow and raise the debt levels because its revenue is inadequate relative to expenditure programs. One reform it can do in this context is to generate savings in the budget by placing the governments consumption expenditure those expenses involving the day to day running of the government below its revenue levels. To attain this target, another shock-agent of disruption has to be employed by the new government. While going back to the old tax regime, the government should economise its expenses from top to the bottom.
The curtailment of the benefits which many are enjoying today is a real disruption. This applies at the top to the Cabinet ministers who enjoy an array of benefits not counted in the budget as direct payments to them. Like in Singapore, the number of ministerial posts should be restricted, while paying them a decent salary and getting them to meet all their requirements out of those emoluments. In todays context, the direct salary of a Cabinet Minister is less than Rs. 100,000, a salary lower than the total pay package of a minor employee of a state bank. But cost to the taxpayers by way of providing houses and their maintenance, vehicles and all associated costs, security officers, etc. which are recorded in different heads in the budget is enormous.
Taking into account the current economic crisis in the country, they should go for a voluntary disruption. All other unnecessary expenses of the government should be cut, savings in the revenue account generated and those savings used for vital capital programs. In selecting those programs, those that would help the government to get more taxes in the future should receive priority. In this way, borrowings are directly linked to extension of welfare to people and gaining capacity to repay them on time.
External sector crisis needs reforms in all sectors
The crisis in Sri Lankas external sector has been manifested by a need for borrowing for repaying the external debt and meeting the stubbornly high deficit in the current account of the balance of payments. The cause of the current account deficit has been the inadequate foreign exchange earnings by way of export of goods and services and remittances by Sri Lankans working abroad relative to the high import bill of goods and services and interest payments.
The government has recently clamped import controls on what it has termed inessential imports but the savings it could make through this measure is insignificant since the total such expenses are also a small fraction of the total bill. Sri Lanka spends massive amounts import crude oil, raw materials for industries, medicines and capital equipment. Any growing economy cannot curtail these items without compromising growth rates.
Hence, the way forward for the new government is to earn more foreign exchange in the medium to long run by increasing exports and attracting non-debt sources of foreign exchange such as foreign direct investments. To boost both these sources of earning, an essential requirement will be to introduce reforms to enable exporters to export more and attract more foreign direct investments into priority areas. Already, some of the reforms have been introduced to the goods market. But the labour, capital and land markets still remain untouched. It is necessary to shock these three markets through disruptive changes. Sri Lankas archaic labour laws dating back to the colonial times need be revised protecting both the workers and producers.
Singapores experience in reforming the labour sector
This was what Singapore did as a priority in 1960s because the growing trade union militancy supported by Chinese communists kept the foreign investors away from the country. As S R Nathan, an Ex-President of Singapore, has narrated in his autobiography, An Unexpected Journey, a special Labour Research Unit or LRU was set up at the instance of Singapores first Finance Minister, Goh Keng Swee, with the responsibility for ensuring a fair deal for workers through training, empowerment and recognition of workers rights.
Nathan who joined LRU as a researcher initially became its head later. His reading of the behaviour of trade union leaders in 1960s perfectly matches those in Sri Lanka today. Nathan has observed that those trade union leaders were full of hate, delusion and bias and poor of facts and understanding. LRU therefore initiated programs to help them overcome those deficiencies. Sri Lankas trade union leaders who shout at the microphones posed to them by media display that they still live in the world in which Singapores trade unionists lived in 1960s. The new government should as a priority engage trade union leaders in productive negotiations and for that purpose, as a herald, should serve them with a shock-agent of disruption first.
Hence, disrupt the economy creatively or perish should be the slogan to be followed by the new government.
(The writer, a former Deputy Governor of the Central Bank of Sri Lanka, can be reached at email@example.com.)
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