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Having authored the best seller ‘Breakout Nations: In Pursuit of the Next Economic Miracles’ published in 2012, Sharma said although Sri Lanka didn’t fulfil the criteria to be listed in the book, it had to be put down since he was highly impressed with the country.
“The book covers 20 emerging markets but I had to make some space for Sri Lanka even though in terms of economic size basis it was not justified. I always had a sweet spot for Sri Lanka. Ever since I came here in1997, I obviously fell in love with the raw beauty and charm of the country,” he said.
“I have has a positive feel for this country for the past few years. It has done a remarkable job coming out of the civil war. Typically when you look at these types of conflicts, the country loses about 30% of economic output over 15 years’ time. Remarkable what Sri Lanka had done is that even in that difficult period the economy kept growing at 4% or so. After the conflict ended, the potential is a lot more,” added Sharma to justify the incorporation of Sri Lanka in his latest publication.
Setting the stage for his lecture, Sharma explained he would be speaking about the country based on the ‘15 rules of the road’ as to him numbers and long term forecasts have very little meaning. “What I notice is that Excel spread sheets and numbers don’t allow one to properly understand the country since the data tends to be backward looking. A trend that has become popular in the past decade is to make long term forecast. These forecasts are made so far out in the future that neither you nor I am going to be around when changes happen,” he told the audience.
Sharma opined that the best forecast period is from three to five years, or at maximum a decade as according to him what happens after that is not very relevant. “This is my job. To select a time horizon that is pragmatic that all of us can relate to. For this I have made the ‘rules of the road’.”
Although Sharma had conceptualised 15 rules of the road, due to a limited timeframe given for the lecture, he was able to explore only a few. He stressed it is important to note that no one rule can be considered in isolation. “All the factors should be taken into account to come up with how a country might do over a period of five years,” he clarified before presenting the innovate set of rules.
Growth is not easy
When looking at the history of economic development he said one will find sustaining economic success is rather difficult.
Although countries such as China, Korean, and Taiwan have challenged this notion, Sharma said statistics reveal that for any particular decade for the last 50 years about one-third of all countries in the world have been able to grow at 5% fold on average. The sustaining of this growth for the second decade fell to one-fourth, whereas for the third decade it fell to one-tenth.
He pointed out that only six countries have been able to grow at 5% average every year for four decades in a row and only two have done so for five decades, which are Korea and Taiwan. “If a country does well for one decade, the odds are that it will start faulting in the second or third decade,” noted Sharma.
Stuck in the circle of life
Opining that most nations are stuck in this circle of life, he said the primary reason for this is because countries fail to impose reforms to sustain the achieved economic growth.
What first takes place is a boom which leads to an excess in the economy. Soon after, the country moves into a crisis and reforms typically takes place in this period, he said. “Very few countries reform when they are in good times and that is a key take. What normally happens is that by going through this cycle many countries lose out on time and are unable to make progress. That is what many emerging markets tend to follow,” elaborated Sharma.
He observed that out of the 120 odd economies the IMF tracks, only 25 are listed as developed and everyone else are emerging. For that group it is noted that countries such as Mexico and Brazil are emerging forever. To break this cycle Sharma recommended countries to have a systematic reform plan every five years or so to ensure that some productivity is in place to maintain the growth.
Extrapolation: A safe mode
“This is where many countries draw a straight line to their growth. They show good growth for a decade and just after that period they start extending their growth lines,” he explained.
Sharma opined that by doing so countries forget the mantra of reforms and end up facing many economic problems. Typical examples he said were India, Russia, and Brazil.
Reform momentum
Speaking on Sri Lanka on this regard he said the country’s economic growth over the last few years has picked up sharply compared to other emerging markets and also compared to its own history. However, Sharma questioned if this growth will be taken for granted.
“The attitude of where else will the money go should not take shape at any given time. These are dangerous words that affected India,” he said, while sharing with the audience the mistake made by India in 2010 which according to him was taking for granted the 8% growth and the recession in the West.
Leadership cycle
“The best time for economic reforms for any country is in the first term of a new Government,” opined Sharma. The reason for this is because it is when a Government has fresh ideas and energy, resulting in maximum output especially at a time when the country is coming out of an economic crisis. “Having a new leader and looking forward to change, the people of the nation are prepared to support the measures that are needed to get the economy back on track. But this is usually for the first decade,” he noted.
Taking the Philippines as an example, Sharma said although the country had a large English speaking population and a per capita income second to Japan in the 1960s, because of “messed-up” political leadership it performed poorly and many countries in South Asia surpassed it. “It is common that when a leader stays in power for a decade or more, the outcomes are diminishing returns to power.”
Taking the recent situation of Russia to add relevance to this rule he said that when President Putin came to power in 2000 he was highly focused on economic reform since the country was smarting with the troubled decade that they had in the 1990s. However, it was observed that the attitude shifted overtime.
“Political leaders also have a life cycle, and it is the best in the first term. Up to a decade it is fine, but after that it is difficult for is to evaluate the country,” he stressed.
On this rule according to him Sri Lanka is doing “fine” so far. “The current President has been very decisive and is taking important measures to ensure reforms take place. However, if a leader wants to protect his legacy, he should not be in power for more than a decade since after that will be diminishing returns of power,” asserted Sharma.
Government spending
While not all Government spending is bad, Sharma said when more is spent on subsidies than on economic structures; the behaviour is not a good indicator. He pointed out that in the 1960s, Sri Lanka’s very high government spending and socialism creeping into the decision making process were few reasons that can be attributed to the down fall of the economy at the time.
Stating that China is the ideal country to follow with this regard, being a mixed economy it has a very low Government spending in relation to its GDP where an average of 10% is allocated to physical infrastructure. On the other hand, Brazil, which has the highest Government spending in the world, only 2% of the GDP is spent on infrastructure development. In economic terms it means that a lot is going towards unproductive spending.
“In Sri Lanka I like the fact that the Government spending is getting back to shape although there is a lot more to be done,” he said, while commending the country for having 30% of investment in relation to GDP, which according to him is an ideal rate for an emerging economy.
Inequality
With inequality being a common global problem, he said it is important to put this in perspective. Typically when an economy is opening up and is liberalising, inequality tends to increase and the important factor to note here is if poverty is reducing or not. “In countries where the per capita income levels are below US$ 5,000, inequality levels begin to drop. When it doesn’t, it is a problem,” asserted Sharma.
Pointing out that the lower inequality were the reasons for success in Korea and Taiwan, when looking at the Billionaires index he said sparked differences were observed between Korea and Russia. “In Russia, billionaires control 20% of the GDP whereas in Korea it is only about 4-5%. It is therefore imperative to see how wealth is created and distributed in economies,” he added.
Corruption
In any emerging market first to be highlighted is corruption. The common trend is that when a country grows richer the corruption levels tend to come down. “In poorer countries corruption is just a way of life. If corruption is increasing as the country is getting richer, then that indicates a problem,” he said.
Although corruption is an issue in Sri Lanka, he said the country is doing fine in this regard since when taking into account the Transparency International Index, the country ranks better comparing to other nations having a per capita of US$ 3,000 or so.
Inflation
Although high inflation was interpreted by the Indian Prime Minister as the ‘price of prosperity,’ Sharma said economic history points out just the opposite.
“Typically, investment booms are the ones that sustain growth. When investments rise sharply, there are no reasons for inflation to go up sharply as well. High inflation means that not much investment is taking place,” he said.
“It is good in Sri Lanka that there is talk on maintaining inflation at mid-single digit as that is where the country has to be in this stage of economic development,” stated Sharma, commending the country on this regard.
Inexpensive currency
This should be felt when setting foot to a country, the feel that the currency is cheap. “This is problem that was taking place in countries like Brazil, where at one point it became highly expensive. Nevertheless they are now taking measures to correct it. Many East Asian economies were able to keep exchange rate competitive which is good for the economy,” highlighted Sharma.
Using the ‘Four Seasons Index’ to measure this he said that in Philippines it costs only US$ 200 per night at a luxury hotel, but in Brazil the same would cost US$ 1,000 or so. The fault line according to him for Brazil is that it began to run huge current account deficits even in midst of the commodity boom. “It is absolutely necessary for exchange rates to remain competitive and it should remain undervalued in emerging markets,” he advised.
Second city
Calling this a fun rule, he said Governments should ensure that economic development is not concentrated in one area or city. Picking Thailand as an example to provide better insight in this regard, he said: “The reason for political unrest in Thailand in the entire decade was because the entire wealth creation was taking place in Bangkok, which is 40% of the economy. This led to the attitude of Bangkok being against the rest of the country. The typical population of the top tier and second tier cities should be 2:2:1 or 3:2:1.”
Commending Sri Lanka once again for the measures it has taken in this regard, he said the interconnectivity will help ensure that the country will have its population distributed to the smaller cities as well.
Cluster
A big problem in South Asia according to Sharma is that intraregional trade is the lowest comparing to any other region in the world where the only other region that is comparable is Africa.
“More trade should take place within the region. The best economic stories take place in clusters and not individually. That is how a nation should take advantage of the geography, which is to have a good ecosystem built around to have good growth,” he professed.
Credit growth
When a country has exceeds credit growth that increases excessively for five years, no matter what the starting point, that country always will end up in economic trouble, according to Sharma. “When a country tries to grow by spending money very quickly, it is bound to run into trouble because it acquires lot of bad loan in the system,” he said.
Commenting on Sri Lanka he said that although excessive credit growth was observed for a few years, the situation has reined in very well in the recent past. “Monitoring how it fares with the GDP is quite important as it shouldn’t go beyond GDP,” cautioned Sharma.
Having presented his rules of the road, Sharma said in the broader spectrum, Sri Lanka scores relatively well. “Investment as a share of GDP is good here but manufacturing should be brought to 25% from 18% to achieve an economic growth of 9% for the decade or so. It is good to note that a number of Free Trade Agreements (FTAs) are coming up. Sri Lanka certainly has a lot of scope in terms of growth and what people forget is that the higher the per capita income, he more difficult it is to progress,” he said.
Although he painted a rather positive picture for Sri Lanka with regard to its economic performance, Sharma cautioned before concluding his speech that there is a 40% probability for countries that have had civil unrest to return to this position after a decade of peace. “In is important that Sri Lanka considers this. Although the situation is handled well here and the chances of returning to unrest are less, the 40% probability should be kept in mind,” emphasised Sharma.
Pix by Upul Abayasekara
