The loud voice of economists: Reform or perish

Professor Buddhadasa Hewavitharana felicitated

The legendary Economics Guru of Peradeniya vintage for more than four decades, Emeritus Professor of Economics Buddhadasa Hewavitharana, was felicitated last week by the country’s top policy think-tank, Institute of Policy Studies or IPS and the Department of Economics and Statistics of the University of Peradeniya by releasing simultaneously two felicitation volumes containing 44 papers by his students, peers and well-wishers numbering 54 in all.

The theme of the felicitation volume was “Economic and social Development under a Market Economy Regime in Sri Lanka” covering the policy regime brought into existence after 1977 and still being continued with minor variations. IPS chose to pay tribute to this great economist for the yeoman services he had rendered to the country’s policy studying think-tank as a founder member of its Board of Governors from 1990 to 2006 and later as its Chairman from 2006 to 2010. The Department of Economics and Statistics owed a bigger debt to Professor Hewavitharana which it had to repay in a fitting manner: for 43 long years, he was on its academic staff rising from assistant lecturer to full professor and head of department, steering the department’s academic programmes and producing thousands of economists and many hundreds of academics in the subject over this period.

The two volumes, edited by Saman Kelegama of IPS and Dileni Gunewardena of Peradeniya University, were launched before a gathering of an array of dignitaries in Colombo last week. The Senior Minister Dr Sarath Amunugama who delivered the keynote address paid a fitting tribute to Professor Hewavitharana recalling his long association with him from early Peradeniya days. In the words of the Senior Minister, Hewa, as he called him, was a rebel of a different kind, being ever ready to critically look at any proposition that would have seemed normal to many others. Professor Wiswa Warnapala, another colleague of Professor Hewavitharana in his Peradeniya days, presented the gathering with a profile, rich in diversity, of the great guru being felicitated. According to Professor Warnapala, Hewa’s involvements in his long professional career have not been confined only to teaching economics at Peradeniya. He had been to active leftist politics, policy advising to the Government and many international bodies, university administration and of late to the promotion of Buddhist economics worldwide.

The two volumes were reviewed at the launch by four reviewers. The Volume One by the present writer and the Volume Two by Dr Indrajth Coomaraswamy, Professor Sirimal Abeyratne and Professor J.B Dissanayake.

The following is an appraisal of the key messages in the Volume One and the learning outcome arising from them for the guidance of Sri Lanka’s future policy framework.

Seeking advice from visiting ‘Keynesians’

The first paper by Sarath Rajapatirana, a former World Bank economist and presently the Vice President of the Washington based Institute of Economic and International Development, was an evaluation of the policy advice given to the Government of Ceylon during 1957-58 by seven eminent economists who had studied Ceylon’s economic conditions and recommended the way forward strategies on the invitation of the Government. Their recommendations, published under a series titled Papers by Visiting Economists, were to be incorporated into a ten year master development plan being formulated by Ceylon at that time.

The economists who had been invited by the Government were all eminent personalities in the field. They were John Hicks, Ursula Hicks, Gunnar Myrdal, John Robinson, Nicholas Kaldor, Oskar Lange and John Kenneth Galbraith. Rajapatirana had the benefit of hindsight to evaluate their policy papers after more than 50 years.

Almost all these economists had been followers of the British economist John Maynard Keynes who came out with an economic philosophy in 1930s that advocated Governments’ running budget deficits and spending through Government expenditure programmes to overcome economic recessions in advanced economies. The followers of this economic philosophy were known as Keynesians and hence it was like asking Keynesians to propose ways for solving Ceylon’s economic problems.  

Rajapatirana’s paper has laid a firm foundation for any review to be made on the economy which Sri Lanka had after 1977. It is indeed the story of hopes which the country had harboured in late 1950s and the disappointments from which it has suffered thereafter. Rajapatirana, having listed the views of the visiting economists under several key sub topics, has used both the benefit of hindsight and the hard economic wisdom that had prevailed around and prior to that time to make a critical evaluation of the same. According to Rajapatirana, many of the recommendations made by the visiting economists had not materialised. They had feared about a growth impeding population explosion in Ceylon, but the actual realisation has been in the opposite. They had recommended import substitution industries which later proved to be costly and had to be abandoned after 1977. They had recommended either the nationalisation of key industries or the expansion of the public sector to lead the economy. Sri Lanka followed both and later found itself to be in an economic mess that had brought in inefficiency, burden to tax payers and waste of scarce resources. Their recommendation on planning did not succeed in Sri Lanka. The first ten year plan of 1959 which drew on their recommendations was never implemented and the Five Year Plan of 1971 was a failure due to lack of resources. Thus, Rajapatirana has identified three deficiencies in the collective recommendations of visiting economists: failure to reckon the political economy aspects of policy making, non-visualisation of the brewing ethnic issue and non-recognition of the political manipulation of the expanded public sector. All these issues are to come to prominence as key problems of economic development in what has been called the market economy regime.

Reform or get caught in a ‘Middle Income Trap’

IPS’s Deputy Director and reputed macroeconomic analyst Dushni Weerakoon in her paper titled “Role of the Market Regime in Transformation from Developing to Middle Income Country: What Next?” has evaluated Sri Lanka’s economic transformation in the post 1977 period. In this period, there have been first generation policy reforms like cutting tariffs, scrapping exchange controls and abolishing administrative red tapes that helped Sri Lanka to create a certain growth momentum in the country. But that should have been followed by a series of second generation reforms to eliminate the still existing growth impeding policies, regulations and institutions. The failure to do so, according to Dushni Weerakoon, has prevented Sri Lanka from harnessing its full potential of economic growth during that period. Hence, it practically took two and a half decades for Sri Lanka to move up from a developing economy to a lower middle income economy. Within such a span of time, countries like Singapore and South Korea succeeded in joining the high income country league. So, what is next for Sri Lanka? Dushni Weerakoon has concluded that without broad based reforms, the construction based economic boom which the country is experiencing at present would be short-lived leaving behind macroeconomic instability in the wake. Hence, Dushni Weerakoon has warned that Sri Lanka faces the threat of getting caught in a ‘middle income trap’ as Malaysia and some of the Latin American countries have at present been caught, unless these second generation policy reforms are implemented.

Bribe both losers and winners

The policy reforms needed to make the state sector efficient have been identified by Malathy Knight-John, Head of IPS’s Industry, Public Enterprise Reform and Regulatory Policy Unit, in her paper on the evolving role of the state with emphasis on privatisation, competition and regulatory governance. Sri Lanka’s policy today has shifted toward a state run economy as presented in Mahinda Chinthana, the policy document of the present Government. Yet one cannot ignore the inefficiencies in the state owned enterprises which impede rapid and sustainable economic growth. Quoting Machiavelli, Knight-John has said that those who benefit from the old system tend to oppose changes and those who are to benefit from the new system offer only a lacklustre support for the change. As a result, a wider public support for a policy reform programme is unlikely to be realised. Hence, according to Knight-John, there should be a mechanism to ‘buy-in’ those lacklustre winners to defend the policy changes and ‘compensate’ the losers so as to win public support for policy changes. This has become critical today as the financial crisis in key state owned enterprises has reached intolerable proportions and it cannot be allowed to continue any further in that perilous state. She concludes that the opportunity for change should not be missed by Sri Lanka once again and the policy authorities should have a hard political will to go along with an unpalatable policy reform programme since it is the only way out for the country.

Two-legged policy needed

W.D Lakshman, former Vice Chancellor of the University of Colombo and currently Chairman of IPS, in his paper on participatory development has discussed its rationale, methodology and the underlying limitations. According to Lakshman, such a development methodology is needed because the market economy based economic development leaves some of the participants behind the development process. To capture them and bring them to the mainstream economic life, it is necessary to have a “Two-legged Economic Policy”, one leg playing the dominant role in reforming the macroeconomy and the other leg, somewhat a weaker one, attempting to alleviate the adverse social consequences of the first one. Having taken the readers through a number of such programmes being implemented in Sri Lanka, Lakshman, while not rejecting the need for macroeconomy based policy reforms advocated by other writers, concludes that the economic imbalances created by such policies could be corrected by approaching development from below and targeting the vulnerable groups. Such a two legged policy approach to development will certainly help Sri Lanka to overcome social, political and ethnic tensions that hinder future economic growth.

Money supply is outside Central Bank’s control

The former central banker and now a leading academic in the country’s university system, S.S. Colombage, writing on endogenous money supply, has argued that the Sri Lanka’s Central Bank’s monetary policy based on the assumption that it can control the supply of the quantity of money at its discretion is somewhat ineffective, since the empirical evidence suggests that the money supply is determined from within the economic system and not outside it by the central bank. Colombage in his paper has ventured into a theoretical debate over which there is not yet a final winner. The central banks throughout the globe have based their monetary policy on an economic model, drawn basically from monetarists, that posits money supply as exogenous to the determination of income and price level. Hence, it is believed that central banks can control money supply to control inflation. If, as argued by Colombage, money supply is determined from within the system, that is, if money supply changes when income and prices change, the Central Bank cannot control inflation by controlling money supply, because its goal post is continuously shifting. As a result, when it takes the ball to the goal post, it may find the goal post located somewhere else. In my view, this is a good academic contribution to knowledge and based on Colombage’s findings, central banks have to search for new policy measures to control inflation. However, it implies that the Central Bank has become irrelevant since it cannot control money supply to control inflation.

Inflation: Demand driven or supply shocked?

Danny Atapattu, Professor of Economics at the University of Ruhuna, has argued in his paper that Sri Lanka’s aggregate price level during the post 1977 period has basically been determined by both internal and external factors. Based on the old and now abandoned Colombo Consumers’ Price Index with a base year in 1952, Atapattu has identified changes in the domestic food production and administered prices of key consumer items as internal factors. The external factors are the changes in the import prices. All these factors relate to the changes in the supply conditions in the market. But the prices are changed not by changes in supply only, but by changes in both demand and supply. The demand side of the equation comes from changes in money supply and that has not been considered in the paper. But the paper by the former Eastern University’s Vice Chancellor M.S Mookiah under the title “Liberalisation of the Economy and its Impact with Special Reference to the Eastern Province” has argued that the inflation in this period in Sri Lanka has been caused by money supply changes arising from high budget deficits financed from borrowing from the banking sector. If one goes by both Colombage and Atapattu who imply that the central bank is irrelevant, one could not disagree with both Milton Friedman and Friedrich Hayek who have eloquently proposed that societies are better served if their central banks are closed down due to the failure of their missions.

Discipline the budget

Of the three papers on fiscal policy, two have argued that the fiscal policy in Sri Lanka is still fraught with massive problems, while the third has tried to answer that allegation. The paper by free-lance economic consultant Martin Brownbridge and World Bank’s lead economist Sudharshan Canagarajah on “Towards a More Growth Oriented Fiscal Policy” has identified several key areas in the priorities for fiscal reform in Sri Lanka. According to them, cutting the fiscal deficit, tax reforms and rationalising the expenditures are the main issues threatening the country’s fiscal stability. In the case of rationalising expenditures, they have pointed out the need for generating a surplus in the Government’s revenue account by curtailing its recurrent expenditure. They have concluded that in many respects, fiscal policy reforms in Sri Lanka have lagged behind other areas of policy reform thereby impeding fiscal policy’s contribution to growth.

J.M Ananda Jayawickrama of the University of Peradeniya, in his paper on “Post-Reform Public Finance Management: Problems and Prospects”, has identified several key fiscal issues facing Sri Lanka today. Jayawickrama has noted that the political will to attain the needed budget discipline has been lacking and the deterioration in the revenue collection and overshooting of recurrent expenditure continue to be a serious problem in public finance management. He also has questioned the effectiveness of the public finance reform policies because of the failure to reduce the size of the Government sector markedly.

PBJ: Fiscal reforms are needed

The veteran economist cum top policy authority, P.B. Jayasundera, while confirming these charges, has tried to answer them in his paper on “Fiscal Policy Issues in the Post-Reform Economy: Macro Fiscal Perspectives”. He has pointed that fiscal policy reforms have been continued during the whole post reform period but the benefits of reforms have been overshadowed by the negative developments brought about by the 25 year long war against terrorism. But he has noted several key issues in public finance still facing the country. The stubborn revenue account deficit and its negative impact on the overall domestic savings of the country, the still high public debt and the need for refinancing the maturing debt and payment of interest, shifting of the revenue base from external trade to domestic income and value addition, the legacy of a large public sector and non-preparedness to negative external shocks have been some of the issues still lingering in the fiscal arena. With the election of the incumbent President to office in 2005, there has been a need for re-engineering fiscal policy space in the country. He has argued that with the policy changes effected under Mahinda Chinthana – 10 Year Development Horizon, these issues are gradually being sorted now. His final message as the top policy authority in the country is well revealing: Have a surplus in the revenue account and use that surplus for financing the large scale investments. For that, it is necessary to implement effective reforms in taxation, state enterprises and in public expenditure management so as to continue with an undiminished public investment programme.

Reform or perish

What are the key messages which the eminent economists have delivered in their papers? There are many but all relate to the need for continuing with appropriate reforms. It should go for second generation reforms and after that perhaps for third generation reforms. It should discipline its budget, generate a surplus in the revenue account, divert resources from consumption to investment and convert loss making state owned enterprises to efficient profit makers. If Sri Lanka is to win its future, these are the essential minimums to be implemented.

Hence, the loud voice of the top economists contributing to the Professor Buddhadasa Hewavitharana Felicitation Volume One is clear: Reform or perish.

(W.A. Wijewardena can be reached at [email protected] )