Budget 2021: A reversion to J.R. Jayewardene policies of 1940s?

Gota’s Budget, presented some seven decades later, has followed JR’s ideology on budgeting, State expansion and the use of Central Bank money to finance the budget deficit. Given the current gloomy economic situation, he has no choice

Development budgets that do not deliver development

Budget 2021, presented to Parliament by Prime Minister and Finance Minister Mahinda Rajapaksa last week, has been hailed as a ‘prosperity budget’, ‘development budget’ or ‘growth budget’ by many. All Chambers, including the 181-year-old Ceylon Chamber of Commerce or CCC, welcomed it as an attempt at taking Sri Lanka to the next level of development. 

CCC specifically called it ‘business-friendly, production-oriented and demonstrative of policy continuity’. This policy continuity appellation given to the budget 2021 is disputable since it is a complete departure from the policy package adopted by the previous Government that relied on a more liberal, open, and globalised economic policy package. Hence, the acclaimed policy continuity will start from 2021 and go on as long as the present administration will be in power. 

JR’s ghost in budgeting too

But the examination of the vision, mission and content of the budget 2021 reveals that it is not different from what the first Finance Minister J.R. Jayewardene, popularly known as JR, recommended to Ceylon National Congress in 1939 as suitable economic policies to be adopted after independence and what he actually implemented through the first six budgets of independent Ceylon as its Minister of Finance. 

Budgets to give something for everyone

However, the preparation of a budget is not an easy task since it has to satisfy diverse interest groups. Recognising this difficulty, State Minister Ajith Nivard Cabraal in a recent webinar on the budget expressed his satisfaction that it is an ‘evenly-poised budget’. I am inclined to agree with him since the budget 2021 has something for everyone. But the budgets presented by JR too possessed the same qualities.

JR, the fan of Keynes

JR had been influenced by the 20th century’s most influential economist John Maynard Keynes, according to his biographers, KM de Silva and Howard Wriggins. Keynes published his main thesis on economic policy in 1936 under the title ‘General Theory of Employment, Interest and Money’ which is commonly known as General Theory. According to the two biographers, JR had read General Theory immediately after it was published and become instantly a fan of Keynes. This has happened before the development and spread of the body of economics now known as ‘Keynesian Economics’. 

Keynes had diagnosed that developed countries go into temporary recessions because the whole output produced is not consumed by people. Hence, the economic system goes down generating unemployment and finally economic recession. To overcome this, Keynes suggested that government can create a demand for the output by having budget deficits, most often funded out of newly printed money. The new demand will lead to the production of output over the time in amounts greater than the original amount of financing by the government, called the multiplier effect on the output. 

Keynes proposed his theory for a developed economy with no foreign transactions. Those economies had an installed capacity and therefore could produce new output at short notice when the new demand was created by the government. Since there were no foreign transactions, there was no possibility for the money to leak out from the economy. 

But what was propagated and what JR too had understood was that it was the easy and quick way for an undeveloped country to become a developed country. In this model, the state control of the economy at every level was the pre-requirement. And JR had absorbed that into his system faithfully.

JR’s policy package in 1939

This was evident from a policy package proposed by a Policy Committee of which JR was the author and key intellectual to Ceylon National Congress in 1939 for adoption when Ceylon would gain independence from Britain. What was proposed in the policy package and the vision, mission, and the content of Gota’s budget 2021 are more or less the same. 

JR in 1939: Everything should be in the hands of the State

The JR package had proposed that in the future social development of Ceylon, protection should be given to the ‘indigenous population’ as against foreigners. 

He had proposed to ensure food security by increasing food production by implementing five measures. They were extensive farming by opening new areas for food production, intensive farming by adopting scientific methods for cultivation, granting subsidies to farmers, protecting farmers by controlling imports via tariffs, total prohibition of the import of specified food items that can be cultivated in Sri Lanka. This was to be strengthened by the State control of the production and distribution of agricultural produce. This is exactly what Gota’s Budget 2021 also has suggested. 

JR: Land should be acquired by the State

JR’s land policy in the policy package is similar to what the present government is also following. He had suggested that land should be acquired for public use from private individuals by paying compensation. Then, to prevent the fragmentation of land, alienation of private lands below a certain extent should be prohibited. When land above a specified extent is being sold in the open market, he had suggested that the State should buy it for public use. 

With respect to industry, it had been suggested that all key industries should be state-owned. What this meant was that heavy industries like iron and steel, chemicals, fertilisers, etc. should be operated by the State. The private sector can do bakery industry or soap industry. 

A further suggestion had been for the State to take over the business of importing essential commodities. All public transport services, namely, railway, omnibus, air and by sea, should also be state-owned. 

JR: No foreign workers

Regarding the use of foreign workers, JR had suggested that it should be completely prohibited. This is something which even the professionals are agitating today and accepted by the present Government as a policy. Adding to the list of state-owned activities, JR had suggested that all elementary adult, industrial and vocational education should be provided by the State.

Practicing Keynesianism 

What this meant was that JR was a state-led growth maniac in his early political career due to the influence of Keynes. To provide all these services, revenue should be generated through taxation. The policy of colonial rulers was to keep the expenditure within revenue so that the system was that of balanced budgeting. Therefore, there was no room for deficit budgets in the colonial era. JR criticised this policy when he presented his first budget in 1947. 

His criticism was that when the country had adopted balanced budgeting, all programs for social and economic development have to be abandoned if there were no funding sources. It was unfair by an emerging newly independent nation which had a lot aspirations to become a nation of worth. Therefore, there was nothing wrong in going for deficit budgeting and it was also in line with Keynesian thinking. That was the birth of deficit budgeting in Sri Lanka which had been followed by all successive Finance Ministers, except M.D.H. Jayawardena in 1954 and 1955. These deficit budgets were justified on the ground that they were intended to serve the poor and create a more harmonious and prosperous society.

A full employment and development budget that failed to deliver either one

In the same way Gota’s Government has branded budget 2021 as a ‘budget of prosperity and splendour’, JR also designated all his budgets starting from 1947 as ‘full-employment and development’ budgets. The goal to attain full-employment was taken from post-war Britain that had followed full-employment as a goal though the UK was at full-employment level in 1946 with an unemployment rate of only 2%. But JR’s Ceylon did not have reliable data for the unemployment rate since the census conducted in 1946 did not enumerate that number. 

However, going by the number of people seeking jobs by registering themselves in the Employment Exchange, a mechanism to divert the job seekers to potential employers, the rate happened to be only 1% of the labour force. Hence, both the UK and JR had this full-employment target as a vision to be followed by successive governments. The UK, to its credit, maintained the full-employment target till 1974 by keeping the unemployment rate below 4% of the labour force. But the successive governments in Ceylon were not so fortunate because within years, the unemployment rate had accelerated to a level above the threshold of full employment at 4%. By 1963, the rate increased to 8% and remained above the threshold of full employment throughout except in 2012 when it receded to 4% only for one year. Thus, JR’s wish of having full employment in the Sri Lankan economy had only been a dream unrealised. Since full employment is an important criterion of assessing the quality of development, ex post, none of the budgets in the past had qualified to be called ‘development-oriented budgets’ though they had been hailed to be so ex ante by many. 

JR: State must control prices, interest rates and investments

Armed with Keynesian ideology to the teeth, JR did not trust the operation of the free market system for generating social welfare for all. Therefore, in his budget for 1947, he emphasised the need for expanding the state into many areas of the economy claiming that it is the responsibility of the state to ‘ensure high and stable level of employment’. 

What he meant was that there are economic fluctuations from time to time which the free market economy could not avoid. When the economy moved down, many workers lost their jobs and along with it, their livelihood too. The solution was to invest a larger part of the present income to enable the workers in the future to earn their wages at a stable level. According to his budget, that is another responsibility of the state. This can be achieved only by expanding the Government activity in the economy. 

Hence, he suggested in the same budget that ‘the state must control prices and interest rates, and if necessary, it should influence private investment as well as the capital expenditure of local authorities’. Gota’s Government is doing exactly what JR had proposed in 1947 by controlling prices, interest rates and influencing private investments into areas which it believes to be the priority areas. The whole gamut of supply side incentives Gota’s budget 2021 has proposed by way of subsidies, tax holidays and direct support from state institutions has been in line with this JR philosophy of state role in the economy. 

Expansion of the State sector by borrowing

As promised in his budgets, JR expanded the Government expenditure by borrowing from the market. In the colonial period from 1939 to 1946, the average annual current expenditure was just Rs. 237 million. In the seven years during which JR was the Finance Minister from 1947 to 1953, the current annual expenditure on average shot up to Rs. 742 million. So, the State sector and the budget was expanded following the Keynesian prescription. All successive Finance Ministers had followed JR and just done it in ever-increasing amounts. 

How did JR did this? By increasing borrowings. During the colonial time from 1939 to 1946, the average annual borrowings amounted to Rs. 24 million. But JR set a record by increasing average borrowings by more than six times to Rs. 153 million. He had borrowed a total of Rs. 698 million during this period. But close to a half of those borrowings amounting Rs. 310 million had been made from the newly established Central Bank on a net basis. The narrowly defined money supply had increased from end-1949 to end-1953 by Rs 178 million. The slow growth in money supply has been due to the decline in the net foreign assets of the banking system during this period by Rs. 301 million. But the Government by borrowing huge amounts from the central bank had become the main expansionary factor of money supply. So, Keynesian economics had really worked on JR and all other Finance Ministers since then. 

When markets behave oddly, no solution from Keynesianism

But JR had to face reality at the end. Though he managed to expand the state sector by borrowing, principally from the Central Bank, the promised economic development and full employment slipped through his fingers. Economic growth which amounted to 6.2% in 1951 fell to 1.9% in 1953. The economy and the budget went into trouble when tea prices fell and rice prices rocketed causing a severe bleeding of foreign reserves. JR was forced to propose to Cabinet the abolition of the rice subsidy that had been established during the war times to ensure food security. There was no Keynesian remedy when an economy was hit by such a real shock. 

His attempt at getting $ 50 million from US government as an emergency funding line was unsuccessful. The only solution lied in belt-tightening, a policy that went against Keynesian economics and was in sympathy with what is now known as neoliberalism. But it got itself into a political turmoil forcing both the Prime Minister and JR to resign from the respective portfolios.

Gota being guided by modern monetary theory

Gota’s budget, presented some seven decades later, has followed JR’s ideology on budgeting, state expansion and the use of Central Bank money to finance the budget deficit. Given the current gloomy economic situation, he has no choice. For him, resources are scarce relative to mounting expenses. Because of the economic slump caused by the prolonged COVID-19 pandemic, the space available for raising taxes is also limited. The only way out is to get the Central Bank to finance it as was done by JR in late 1940s and early 1950s. 

But this time, the ideology is provided not by Keynesian economics but by a new version of it called modern monetary theory or MMT. The advocates of MMT argue that people will not die even if the inflation rate is at a high level, say at around 15%. But if the Government does not spend money into their hands, they would certainly die. Since human life is more important than low inflation, governments should get the central banks to print money and finance the required expenditure programs to enable the country to wade through difficult period. 

The present situation faced by the country is certainly a qualifier for it, the advocates argue. But it conflicts with the monetary theory or MT being followed by central banks. This is specifically so with the flexible inflation targeting being adopted by the Central Bank of Sri Lanka as its monetary policy framework. Under this framework, inflation would be maintained at a predetermined single digit level but the advocates of MMT want the Central Bank to abandon it. Voicing this aloud, Budget 2021 has announced that ‘the Central Bank should have a new perspective on the monetary policy regarding money and liquidity management’.

Failure of development budgets

All budgets presented in the past had been called development budgets by their authors. Others, specifically Chambers, had joined them in endorsing that claim. But there had not been any attempt at appraising whether they really delivered development to the country. To the contrary, those so-called development budgets had failed to generate the minimum growth of 8% on a sustained basis to enable Sri Lanka to become a rich country within a generation. Where had these budgets gone wrong? They had failed to put a cap on consumption, divert resources to needy and relevant investments and finally, create a business-friendly environment to enable private initiatives to take root and deliver growth. But they had been good at giving something to everyone. 

JR’s ghost in politics as well as in economics

The 20th Amendment to the Constitution enacted recently is being criticised on the ground that it is a reversion to JR era of all-powerful executive presidency. But the budget 2021 also demonstrates that a similar reversion has taken place in the budgetary policy as well.

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