Good governance and economic development – Part III

The absence of a proper governance system has been the main reason for Sri Lanka to get into a state of bankruptcy today 

The individual policies are in the hands of the economists working under political authorities. If they fail to assess the outcome of a policy as it pertains to today as well as in the future, the overall impact of the policy, whether it is wholly extractive, wholly inclusive or a mixture of both, is not considered. This is the working of the bad economist referred to by Bastiat1. The result is a net loss to society. To prevent such a net loss, economic policy making should be handed to a group of technically qualified individuals instead of leaving in the hand of a single official or a single politician or a group of politicians. Such group assessment will prevent the implementation of policies that do not bring in overall economic benefits to society

In the previous two parts, we discussed the essential features which a good governance system should contain to serve its purpose as identified by the World Bank in its Worldwide Governance Indicators or WGI. They are the voice and accountability, political stability and absence of violence and terrorism, government effectiveness, regulatory quality, rule of law, and control of corruption. These are what is lacking in Sri Lanka today and the Government should concentrate on establishing the same. 

However, in ancient India, the absolute monarchies should have practices what was called the 10 principles of royal qualities. They were gifting, sacrifice, virtue, austerity, uprightness, softness, non-harmfulness, having non-ill will, forbearance, and non-conflict. The governance issue has come to focus today because of the insistence by IMF that there should be a diagnostic study done on the governance system in Sri Lanka which includes the existing anti-corruption machinery as well. 

This study is to be completed by September 2023 and if there are deficiencies in the governance structure in the country, the Government is required to take the necessary corrective measures. IMF now brings the governance structure as a pre-condition for lending after it had had a bad experience with Russia in early 1990s. In this instance, the moneys lent to the newly formed Russian Federation were siphoned off because of the defective governance structure.

In countries where the governance system is defective, there is the proliferation of the extractive or predatory institutions that get the blessings of the ruling class. These institutions not only rob the wealth of the people, but also legalise plundering by using the political powers they possess. The result is the creation of a society which believes in robbing the wealth of others is an ethical activity. Hence, any government that kills the salutary institutional setup retards the process of economic development. The Buddha highlighted this in the Pattakamma Sutra in the Angutthara Nikaya that one should protect the wealth one has earned through just enterprises from kings who are inclined to rob such wealth. 

Sri Lanka’s post-conflict situation has thrown an enormous challenge at the country’s political leadership. That is, through good governance measures, to establish ethnic, racial and religious harmony among diverse groups living in the country. Such harmony is needed to avoid the repeat of a costly experience which the country had to undergo during the past three and a half decades. It requires on the part of the political leaders to act with a foresight. Good governance principles require that foresight to treat all ethnic groups in the country as shared partners of a common destiny rather than considering one group as conquerors and others as defeated subjects

North Korea drives youth to despondency

Teenagers in North Korea are beset by a common institutional structure: growing up in poverty without entrepreneurial initiative, creativity or adequate education that equips them for skilled work. The accepted value system is that even if one works hard, one is not able to enjoy its fruits since it is immediately appropriated by the state. It forces some of them to get into illegal economic activities which are high cost and high risky. For others, it is a life of despondency. But in the South, the youth have prospect of growing up into success through good education and excellence in chosen vocations. They are aware from early in life that if they are successful as entrepreneurs or workers, they can enjoy the fruits of their hard labour. They have the prospect of improving their standard of living. 

The institutional structure in North Korea is extractive while that in South Korea is inclusive. In extractive institutional systems, the state plunders the fruits of hard work by its population through various devices and apportions them among those who support or are made up of the top echelon of the Government. Say Acemoglu and Robinson: They are “extractive because such institutions are designed to extract incomes and wealth from one subset of society to benefit a different subset”. In contrast, “inclusive economic institutions create inclusive markets which not only give people freedom to pursue the vocations in life that best suit their talents but also provide a level playing field that gives them the opportunity to do so”.

Facilitating politicians to prosper through extracting economic institutions

Acemoglu and Robinson say that extractive economic institutions are prospered by the type of political setup prevailing in a country. If the political parties or those who lead political parties wield exclusive political power, that is, only they could engage in illegal acts with impunity and not others, the whole economic system is converted to an institutional system that preys on others to sustain itself. Extracting resources from others is considered a normal and moral activity by politicians and those who are around them. The values that are implanted into the psyche of all those in society have only one element. That is, robbing from society, either through Government or through the market by means of franchises bought from politicians, is a normal legitimate activity. 

In such a system, misusing State property for private gains is considered an innocent activity which should not be an offence to be handled by law enforcement authorities or an immoral act to be discussed publicly by civil society. Thus, all institutions in Government or in civil society are converted to instruments supportive of extraction. An example was the recent downplaying, by the former President as a very trivial act, of using some 20 odd vehicles belonging to the State for private commercial gain by a top politician in Sri Lanka. Such intolerance of the acts of extraction supported by its justification in public leads to the establishment of a value and belief system endorsing what extractive economic institutions do in society.

Wholly inclusive economic institutions are the best

Economic policies can create either extractive institutions or inclusive institutions or a mixture of both. Extractive institutions will plunder resources from beginning to the end. Inclusive institutions will prosper resources and allow citizens to enjoy the fruits of their labour. The mixture of both extractive and inclusive will provide a better deal to society depending on the relative importance of the extractive side or inclusive side in the whole institutional structure. If the extractive side is preponderant, then, it is as bad as extractive institutional setup created by the first type; in a setup where inclusive type is preponderant, it is still acceptable though it is not the ideal setup which a society should aspire to have. That is because it does not allow a society to have the best for its future.

Dismiss extractive institutions

So, what is to be dismissed by a society is a structure in which institutions are wholly extractive or preponderantly extractive. What is to be aspired is a wholly inclusive institutional structure; a structure where inclusive aspects are preponderant maybe accepted as a temporary arrangement until a society moves to a wholly inclusive institutional structure. 

Acemoglu and Robinson say that extractive economic institutions are prospered by the type of political setup prevailing in a country. If the political parties or those who lead political parties wield exclusive political power, that is, only they could engage in illegal acts with impunity and not others, the whole economic system is converted to an institutional system that preys on others to sustain itself. Extracting resources from others is considered a normal and moral activity by politicians and those who are around them. The values that are implanted into the psyche of all those in society have only one element. That is, robbing from society, either through Government or through the market by means of franchises bought from politicians, is a normal legitimate activity

Economic policies should not promote extractive institutions

So, what is the responsibility cast on economic policymakers? They should avoid policies that lead to wholly extractive or preponderantly extractive institutional structures. If any policy leads to a structure where inclusive side is preponderant, they should have that policy under continuous surveillance so that they could adopt measures to change into wholly inclusive institutional structures as the final goal of policy.

Contributors to extractive institutions

How could an extractive or preponderantly extractive institutional structure be established in society? There are two contributors. One is the general policy being implemented by the state favouring or promoting economic extraction. The other is the individual policies that permit one setup of society to extract economic resources from another setup. In both cases, the property rights of people are violated. Such violations in the form of extracting real resources from those who have hard-earned them, will lead to the development of extractive institutions. The presence of those institutions in society are the biggest stumbling block for sustained economic advancement. Sri Lanka is in this state today. 

Governments’ failure will generate extractive institutions 

In the first case, governments’ failure to uphold three good governance requirements will change the entire value and belief system in society. They are the non-observance of the rule of law, violation of property rights and toleration of bribery and corruption in society. When these bad elements are supported by the prevailing exclusive political setup, the nation descends to a perilous state. The program to introduce constitutional reforms in Sri Lanka after the Presidential election in January 2015 sought to address this issue. The implementation of the program only halfway through so far has denied society the benefit which it sought to bring in. Hence, the system of governance in Sri Lanka today is not different from that prevailed prior to Presidential election in January 2015. As such, the country has the same risk with respect to economic policy governance.

So, what is the responsibility cast on economic policymakers? They should avoid policies that lead to wholly extractive or preponderantly extractive institutional structures. If any policy leads to a structure where inclusive side is preponderant, they should have that policy under continuous surveillance so that they could adopt measures to change into wholly inclusive institutional structures as the final goal of policy

Economic policies should be made by technically qualified experts and not by politicians

The individual policies are in the hands of the economists working under political authorities. If they fail to assess the outcome of a policy as it pertains to today as well as in the future, the overall impact of the policy, whether it is wholly extractive, wholly inclusive or a mixture of both, is not considered. This is the working of the bad economist referred to by Bastiat1. The result is a net loss to society. To prevent such a net loss, economic policy making should be handed to a group of technically qualified individuals instead of leaving in the hand of a single official or a single politician or a group of politicians. Such group assessment will prevent the implementation of policies that do not bring in overall economic benefits to society. Hence, economic policymakers should be made accountable even after they leave office if the policies which they have implemented have brought a net loss to society by allowing one group of people to extract resources from another group of people.

These are important requirements which must be put in place to satisfy economic policy governance. Since it is unlikely that politicians would implement them on their own, it is important to empower civil society so that an effective voice could be made whenever there are deviations from the accepted policy.

Economic policies can create either extractive institutions or inclusive institutions or a mixture of both. Extractive institutions will plunder resources from beginning to the end. Inclusive institutions will prosper resources and allow citizens to enjoy the fruits of their labour. The mixture of both extractive and inclusive will provide a better deal to society depending on the relative importance of the extractive side or inclusive side in the whole institutional structure

Conclusions

Governance in both political and economic spheres has been an important element in ensuring sustainable development of a society. However, issues relating to governance arise due to two interconnected reasons: Principal-Agent problem and selfish behaviour of individuals. In ancient times, kings or rulers were required to observe 10 royal qualities of government obviating the necessity for enforcing governance requirements from outside. In modern times, such self-discipline cannot be expected of rulers and therefore it has become necessary for societies to enforce governance codes as explicit requirements.

Sri Lanka’s post-conflict situation has thrown an enormous challenge at the country’s political leadership. That is, through good governance measures, to establish ethnic, racial and religious harmony among diverse groups living in the country. Such harmony is needed to avoid the repeat of a costly experience which the country had to undergo during the past three and a half decades. It requires on the part of the political leaders to act with a foresight. Good governance principles require that foresight to treat all ethnic groups in the country as shared partners of a common destiny rather than considering one group as conquerors and others as defeated subjects. 

The absence of a proper governance system has been the main reason for Sri Lanka to get into a state of bankruptcy today. There was not the observance of the economic policy governance by ruling classes in the country. Hence, damaging, and disastrous economic policies were adopted by rulers without conducting a proper analysis of the short-term and long-term effects of the policy. A good example is the policy pursued by the Gotabaya Rajapaksa administration to covert Sri Lanka’s agriculture to organic farming overnight by banning the importation of chemical fertilisers and pesticide. Despite the warning given by experts and technocrats, the administration continued with its policy to find that the country’s agricultural production, both subsistence and commercial, has declined by about 30%. But at that point, it was too late to reverse the policy package and free the economy from its influence. 

This negative trend continued in 2022 with a negative economic growth of nearly 8% and agriculture sector shrinking by about 5%. The agriculture sector did not fully recover even in 2023. In the first quarter of 2023, the agriculture sector grew only by 0.8%, a non-growth for all practical purposes. The economy shrank in this quarter by 11.5%, caused by a faster decline in manufacturing and a mild decline in services. This indicates the importance of economic policy governance in national as well as local decision-making processes in Sri Lanka. 

It is therefore necessary for Sri Lanka to follow the principles of good governance as a prerequisite to sustained economic advancement of which the goal has been to make Sri Lanka a rich country by 2048. 

Footnote:

1Bastiat, http://dev.econlib.org/library/Bastiat/basEssNotes.html (accessed on 10.1.2019)

(Concluded.)

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

Part I and II of this article can be seen at https://www.ft.lk/columns/Good-governance-and-economic-development-Part-I/4-749375 and https://www.ft.lk/columns/Good-governance-and-economic-development-Part-II/4-749633