A pathway to alleviate poverty and gain prosperity

The long-term path to alleviate widespread poverty and for achieving prosperity for Sri Lanka includes the adoption of a number of major strategies such as realising socio political stability plus macroeconomic stability, good governance, long term social market liberal policies, ease of doing business, improvement of productivity, particularly of the rural agricultural sector and of course higher global competitiveness – Pic by Shehan Gunasekara 

This article is about the manner in which the economy of Sri Lanka should be rebuilt, mainly to alleviate poverty worsened by the devastating effect of the COVID-19 pandemic. But it goes beyond the short term to the long term as the economy was already very sick when the pandemic hit the country, due to problems which have not been solved for several decades. 

Apart from the visible effects of a lockdown, it may be right for us to believe that poverty and inequality of incomes in the country would have reached a new high level as one finds that the beggar population including even young boys has increased several fold. 

Widespread poverty

Official records indicate that poverty in the country based on a so-called ‘poverty line’ of Rs. 4,166 per person per month to be spent on food alone was 4.1 % of the total population. It is a thoroughly inaccurate figure of poverty in the country. 

A recent UN working paper, however, reveals that before the crisis, 74% of families survived on less than Rs. 613 per day. It adds that the incomes of these families would fall by about 27% due to the pandemic; in addition it notes that so far Samurdhi social protection payments have been made to 42% of families in the country while 58% of needy households have been excluded from such payments and that 38% of the families in the middle income group have also been ignored from current social protection programmes since such payments are based on poverty. It concludes by stating that 86% of the population may now need to be supported with social protection (Tackling the COVID-19 Economic Crisis in Sri Lanka, Working Paper, United Nations, June 2020). 

So the poverty situation in the country is much worse than what has been revealed by the other criteria used so far. In addition there appears to be widespread starvation – sometimes many surviving on one meal day. The situation could become still worse with the expected decline in food production after the ban on the import of chemical fertilisers and associated chemicals. The danger is nutritional standards will drop, particularly of children, and productivity of workers could drop drastically.

The effects of the pandemic need to be dealt with two types of plans i.e. short term and long term. The former could seek to solve the immediate problems such as the health issues, the supply breakdowns and the extension of relief to the worst affected. The enormous increase in poverty mentioned above needs a well-thought-out, long-term plan. 

Main objective 

Certainly alleviation of this high level of poverty needs to be the main objective of any long-term economic development plan. Achievement of prosperity for the country is the other side of this objective. 

Main strategy – Improvement of macroeconomic stability

The main strategy that needs to be implemented for this purpose is the improvement of the macroeconomic management processes in the country that appear to be in a complete disarray.

Economic growth declined sharply by 3.6% in 2020 after registering a slow growth rate of 2.3% in 2019. Government debt rose to 101 % of GDP in 2019. The main causes of the contraction of economic growth were low Government revenue, a serious balance of payments crisis due to a decline in export trade compared to the high expenditure on imports and low inflows of Foreign Direct Investments (FDI). 

Government revenue was 12.4% while expenditure was 18.6%, creating another budget deficit in a long history of such deficits. Cancellation and reduction of several taxes in 2020 to broaden the revenue payment base did not help. This has led to high rates of inflation currently while the prevailing interest rates are low discouraging savings that can be used for investment, though it may have helped to increase production of supplies that had declined due to the pandemic. 

The total annual debt repayment by the Government was more than its revenue. Foreign debt rose to a massive $ 56 billion (Central Bank of SL, 2019). Meanwhile, it is reported that SL’s foreign reserves in 2021 could drop to less than $ 4 billion. 

The crisis was worsened by the resort to borrowing of foreign loans on commercial terms. They rose to 56% of foreign loans in 2019. The average annual interest rate of such loans was about 6% and had to be repaid in five to 10 years compared to the long-term concessionary loans from the IMF bearing very low interest rates. With Fitch and other ratings having come down to a low CCC level, even borrowing on commercial terms could be near impossible. Actually the rank of macroeconomic stability in SL started to worsen in the 1970s; see the 2019 position in item 2 in the table. 

Thus the macroeconomic situation has definitely to be improved especially by increasing Government revenue collection particularly by increasing direct taxation (e.g. income tax, property and wealth taxes, etc.) and lowering its expenditure drastically. The best way to solve the ‘dollar crisis’ in the meantime would be to go immediately for a debt restructuring programme with the International Monetary Fund (IMF).

Attraction of investment 

The other main strategy that needs to be adopted is to attract a massive inflow of Foreign Direct Investment (FDI) into the private sector to create jobs for the increased number of persons without jobs and to expand the capacity for exports mainly to deal with the very heavy foreign debt of $ 56 billion.

It is estimated that if the economy were to grow at 8% per annum the country has to invest about 35-40% of the Gross Domestic Product (GDP) every year. But SL does not save enough for the purpose; for example the average domestic savings for the last five years was about 25% of GDP. Therefore SL needs to attract FDI. 

The other reasons for this are SL does not have the modern technologies required and an adequate knowledge of global markets for export of goods and services produced here. The FDI could provide these. But the fact is SL has failed miserably to attract sufficient FDI. 

For instance by 2019 the country has been able to attract a stock of only about $ 13 billion, apparently in gross terms, while Singapore has been able to attract a stock of about $ 1.7 trillion! One of the first things to do when preparing a future development plan is to find out why this has happened and studiously rectify the problems.

Why – Absence of socio-political stability 

FDI normally go in search of large markets like China and India for their products. Otherwise they look for countries with political stability (probability that a country/government will be destabilised by unconstitutional or violent means such as terrorist activities), for a long period of time of about 30 years with predictability. 

Item 1 in the table above shows the low level of political stability in SL, compared with those of Singapore and Malaysia. These figures show that SL does not enjoy such stability currently. Actually the country has not enjoyed political stability since 1956 and that is why it has not been able to attract the large and well-known foreign investors like those listed in the Fortune magazine referred to as ‘the Fortune 500’.

Main reason for political instability – Ethnic problem 

The main reason for the absence of social and political stability and of course inadequate investments particularly FDI in the country could be the inability of the leaders of the past and present to solve the so called ethnic problem which has given rise to terrorism and frequent clashes (aroused by majority community extremists) among the different racial and religious groups in the country since 1956, the last of which was on Easter Sunday last year. Foreign investors apparently fear that such clashes may continue.

Solution – Change the Constitution

This surely needs a consensus among all political and religio-communal groups to solve the problem once and for all by amending the Constitution suitably. The excellent recommendations of the Lessons Learnt and Reconciliation Committee of 2011 could be used as the basis of such change. 

Improvement of governance

Another serious problem that SL faces is the absence of good governance and ineffectiveness of Government; see items 3 and 4 in the table above. This along with the absence of social and political stability prevents the attraction of investments as investors for instance fear that the prevailing system may not allow them to take effective legal action in the case of a dispute in the absence of a proper judicial system or that policies may change from time to time on the whims and fancies of the leaders of a country. 

The absence of good governance is mainly due to the many weaknesses in the various constitutions that have been installed in SL particularly since 1972. One of them is the grant of special powers to the president of the republic as in the case of the amendments of the constitution of SL in 1978, 2010 and 2020; in such cases the Parliament elected by the people to rule the country becomes a mere tool to be used by the President of the Republic as he or she wishes and not of those of the members of parliament. 

What is good governance?

Good governance includes: a) participation or freedom of speech and association by the people, b) rule of law by an impartial body, c) responsiveness or dedication of Members of Parliament (MPs) to serve the needs of the people, d) consensus or agreement by MPs on basic principles and policies to serve the needs of the people, e) equity or equal rights for all irrespective of race, religion and caste, f) effectiveness and efficiency of Government and public institutions, g) accountability or indication of who is responsible for what and their actual performance and h) predictability or consistent application of policies.

If there is no such positive enabling environment consisting of political stability along with an absence of good governance, it would be difficult to attract the required FDI or even local investments to set up especially manufacturing industries to solve the problems of severe poverty plus low growth and heavy indebtedness to the rest of the world. 

Solution – Change the Constitution

Therefore, it is recommended that the Constitution be changed suitably to bring about good governance to the country. Promotion of good governance could provide a positive enabling environment for the economy to take off especially with new investments (Economic Effects of Constitutions, Torsten Persson and Guedo Tabellini, 2003). 

If political stability and good governance are not ensured it will not only be difficult for the country to attract FDI, but also will make it difficult to become prosperous and enable the country to take its place in the world as a respectable global citizen; SL then may also not qualify for the Generalised Scheme of Preferences of the European Union: in that case exports will suffer.  

The right kind of policies

Another major problem SL has faced is the inconsistency of policies adopted by successive governments. The right kind of policies, such as social market liberalism (a mix of socialism and liberal policies including open markets) with the private sector as the ‘engine of growth,’ have been adopted successfully by about 100 countries including the high performing East Asian Economies (HPEAE).It should be noted that these countries have given up pure liberalism. 

In SL, however, every five years governments move to the right (social market liberalism) one time and move to the left (socialism and import substitution) another time. Import substitution with high import tariff protection will also fail since a small country like SL with a small internal market cannot induce the setting up of large projects that generate exports to earn the required foreign exchange. 

The World Bank says: ‘The present import regime is one of the most complex and protectionist in the world’ (World Bank, 2016). In fact SL’s rankings in respect of trade (import) tariff barriers and non-tariff barriers are high: see items 11 and 12. By the way such tariff protection creates an anti-export bias as well. These indirect taxes have to be lowered gradually not only to open markets but also because they fall heavily on the poor masses in the country by way of high prices of essentials. 

Other strategies 

Other strategies that need to be implement in addition to those mentioned above include improving the ease of doing business with a single institution taking decisions regarding approvals of investments, for instance, productivity particularly of the rural agricultural sector and global competitiveness; these are negative in respect to SL; see items 10, 13 and 14 in the table.

The productivity of the rural agricultural sector is extremely low in SL (e.g. value added per worker in SL was about $ 2,800 vs. $ 91,600 in Israel (World Bank 2018)! The remedy is to carefully introduce land reform (as done by Japan, South Korea, China, etc. very successfully) and abandoning the expensive and simplistic present land policy, to consolidate land holdings by the farmers to enable them to earn better returns with lower unit costs, while providing the very small farmers who would drop out in the process with jobs in manufacturing projects.

Conclusion 

Thus the long-term path to alleviate widespread poverty and for achieving prosperity for SL includes the adoption of a number of major strategies such as realising socio political stability plus macroeconomic stability, good governance, long term social market liberal policies, ease of doing business, improvement of productivity, particularly of the rural agricultural sector and of course higher global competitiveness. Protection of local production plus services to become self-sufficient will definitely fail to alleviate poverty and achieve prosperity. 

A more detailed version of this article will appear in the forthcoming issue of the SL Economic Association Journal.

(The writer is a Development Economist)