Top priority of the new Finance Minister

Deadweight losses

The inconvenience experienced by people when they do business, called transaction costs by economists, is a killer of an economy. That is because it imposes a cost on people but no one else within the system gains out of those costs. 

For instance, when we buy a loaf of bread from a seller, the price we pay is a cost to us. But we gain because we get a loaf of bread. On the other side of the coin, the seller loses his bread. But he gains because he gets money for the bread. Since one person’s loss is a gain of another in the economy, such losses are cancelled out by the gains of others. Hence, they do not act as deterrents to do business. 

But this is different when we have to stand in a queue to get the bread or have to make a long search for a bread seller or pay a commission to get the right to buy the bread. There, we lose our time, money, and energy. But only we incur those losses and no one else in the economy gains. Such losses are called ‘deadweight losses’. The role of the Government is to eliminate these losses or keep them at a minimum if their total elimination is not possible. The presence of such deadweight losses makes all the three main economic activities, namely, production, distribution, and consumption, inefficient activities. 

What is measured as the ease of doing business by the World Bank or the degree of competitiveness in the Global Competitiveness Report by the World Economic Forum is this inconvenience to do business. Sri Lanka ranks in both indexes on the low side. In the Ease of Doing Business Index, it ranked at 99 out of 190 countries in 2020. In the case of the global competitiveness index, Sri Lanka ranks at 84 out of 141 countries. Both rankings are medium to low and need quick addressing by policymakers.

Mission was to eliminate deadweight losses 

President Gotabaya Rajapaksa was required to address these issues on a priority basis to put the economy on a sound growth path. But many policy actions taken by his administration, instead of reducing inconvenience, have added to them. In this connection, some glaring policy actions that have contributed to inconvenience are as follows.

Palm oil folly

Within months of coming to power, his administration decided to put a stop to oil palm cultivation, and through that action, killed the fledgling oil palm industry in the country. The reason adduced to this hasty policy action was the belief that oil palm trees cause a depletion of underground water resources and hence, the elimination of other competitive plants in the area. But by this time, many low country plantation companies located in the Southern Province had started diversifying their plantation crops by moving into oil palm cultivation. Since oil palm seeds had to be processed within a few hours of being harvested, several oil extracting factories had also been started close to those plantations. 

This was in accord with the experiences of both Malaysia and Indonesia which had moved to the oil palm industry in early 1970s. The reason was palm oil was both an edible and an industrial oil and hence, commanded a secured global market. In 2020, Indonesia had accounted for 57% of the global palm oil market, while Malaysia had accounted for 27% earning $ 18 billion and $ 16 billion, respectively. The main buyer of palm oil has been Sri Lanka’s neighbour to the North, India. If a viable oil palm industry had been established in Sri Lanka, this giant market close to its borders could have been easily tapped.

Palm oil: An essential input in bakery and soap industries 

Following the banning of oil palm cultivation and oil palm industry, an import ban of palm oil too was introduced. In Sri Lanka, palm oil is used as an important ingredient in the bakery industry and soap manufacturing industry. The banning of imports had, therefore, delivered a policy-initiated shock to these industries. When there were agitations, instead of reversing the import ban, arrangements were made for the Ministry of Finance to issue licences to those industrialists to import limited quantities of palm oil for their use. 

This is where the inconvenience was brought in. The Treasury officials who are paid by taxpayers had to devote their time to process applications and issue licences. This is an unnecessary waste of taxpayers’ money. Those in the bakery and soap manufacturing industries had to employ additional staff to follow up with their applications for licenses. This is also an unnecessarily added expenditure and an inconvenience imposed on businesses. 

Chemical fertiliser fiasco

The next policy action has been the flash banning of the importation of the chemical fertilisers and herbicides. The declared intention of this policy action had been, like the banning of oil palm cultivation and oil palm industry, to preserve environment, provide the nation with toxin-free foods and convert Sri Lanka to an organic farming country, the first to acquire that title in the world. The implication of this policy measure was discussed by me in a series of previous articles in this series. 

In an article published on 24 May 2021, I argued that shocking the agriculture by banning chemical fertilisers and pesticides was not Sri Lanka’s top priority at a time the country had been economically devastated by the breakout of the COVID-19 pandemic (available at: https://www.ft.lk/w-a-wijewardena-columns/Shocking-agriculture-by-denying-chemical-fertilisers-and-pesticides-not-highest-priority-today/885-718291). 

In this article, I argued: “It seems that the Government has taken a calculated risk when it decided to ban the importation of chemical fertilisers and pesticides. Today farmers are cultivating hybrid varieties which depend on the use of chemical fertilisers and pesticides to sustain the output levels. Hence, when these two inputs are denied to farmers, a sudden drop in the output is unavoidable. It seriously threatens the food security, on one side, and causes losses to farmers, on the other. This is fertile ground for food riots and farmer agitations. Both are toxic and will cause piercing of the normal social fabric. Hence, to keep people from starving, Sri Lanka will have to spend foreign exchange for importing food items. As a result, it is unlikely that Sri Lanka will have an immediate net gain of the ban.”

Failing to listen to experts

Since Sri Lanka’s paddy yield at around 4,000 kg per Ha has been low compared to other rice producing countries, I argued what is needed by the country is not a banning of the use of chemical fertilisers and pesticides, but the efficient use of them in a second green revolution that relies mainly on these inputs. Then, the scientific community made a plea to the Government that the agriculture sector should not be denied these essential inputs overnight and the country’s transition to organic farming should be done gradually over a period. 

The Government did not listen to this expert advice and continued to stand by its earlier decision to ban chemical fertilisers and pesticides in preference for organic fertilisers. In a subsequent article published on 21 June 2021 I argued that the Government should listen to the advice offered by the experts (available at: https://www.ft.lk/w-a-wijewardena-columns/Fertiliser-fiasco-Shouldn-t-the-Government-listen-to-expert-advice/885-719438). 

The scientists, most of them from the Government-owned outfits, had given a dismal picture about the immediate impact of the measure on Sri Lanka’s agriculture that includes both food crops and commercial crops. I presented their view as follows: “About the food security and the impact of the flash banning of chemical fertilisers and pesticides on food production and export crops, the 30 scientists had given some estimates of the loss of output to President Rajapaksa. Drawing on the estimates of the relevant state-owned research institutions, they had said that tea would lose up to 50%, paddy 30-35%, maize 50%, potato 30-50%, sugarcane 30-40%, cinnamon 25%, betel 20%, upcountry vegetables 30-50%, floriculture/foliage plants environment almost 100%, and controlled environment agriculture/hydroponics almost 100%. They are alarming numbers, and no sensible policymaker can ignore them.”

Organic tea and reality

Sri Lanka’s tea sector has been one of the casualties of this decision. I discussed the risks involved in seeking to convert the country’s entire tea sector to organic in an article published on 28 June 2021 (available at: https://www.ft.lk/w-a-wijewardena-columns/Composting-tea-cultivations-The-Good-the-Bad-and-the-Ugly/885-719702). The associated risks were the high costs of organic fertilisers, non-availability of quality assured products, increase in the labour deployment to handle the job and manual weeding of perilous herbs, and the risk of having fungus attacks on tea bushes. 

Thus, though organic tea fetches a higher price, the high costs involved have cancelled out the benefit from these high prices. Hence, organic has to be tried out only as a pilot project and not as a project covering the entire tea industry. 

Multiple inconveniences to farmers

As a result of banning chemical fertilisers and pesticides, their prices in the open market rose by about three times. At the same time, they were not freely available in the market. Thus, a single decision of the Government had subjected the farmers to a double whammy. In agriculture, unless fertilisers are applied on the due dates, farmers stand to lose the best output. Most of the farmers who had stood in a queue in front of the Government’s fertiliser distribution centres had to go back empty-handed. 

Even those who were lucky to get them at a higher price could not get the entire requirements. Hence, they were subject to multiple inconveniences. That inconvenience, representing the transaction costs, was a doom for Sri Lanka’s agriculture. As a result, farmers have been agitating continuously for the supply of quality fertilises to enable them to sustain their crops. 

Manipulating forex market

Another set of inconveniences to which the Government has subjected its citizens is the current foreign exchange fiasco. When the Government had realised that the country’s balance of payments was in serious trouble, it would have sought a facility from the International Monetary Fund, known in its abbreviated form as IMF. Instead, the Government went for import and exchange controls, exchange rate controls and interest rate controls. Import controls could not rescue the country from the current malaise. Despite these controls, the country could not maintain a healthy stock of foreign exchange. 

When the Central Bank could no longer support the market by supplying dollars to prospective demanders, the dollar liquidity in the market got evaporated The Central Bank continued to publish on its website a market clearing exchange rate Rs. 202 to a dollar. But when importers went to banks to open letters of Credit or LCs, they were abruptly told by bankers that they had to wait a few days to secure the required foreign currencies. The result was the emergence of a black market for foreign currencies. In the black market, the rate shot up to Rs. 236 per dollar marking a margin of some Rs. 34 per dollar. 

This gloomy situation was discussed by me in an article published on 5 July 2021 (available at: https://www.ft.lk/w-a-wijewardena-columns/Forex-crisis-plea-for-calmness-in-national-interest-and-need-for-getting-IMF-driven-bailout/885-719992). In this article, I warned the Monetary Board of the Central Bank not to shirk its responsibility and go for an IMF type bailout of the economy: “It is the responsibility of the Monetary Board to protect the rupee domestically and internationally. On previous occasions, the Board stood valiantly to perform this duty by being flexible in its stance. As I have reported above, even the Treasury secretaries who are Government officials supported these prudent policies fully. There are three independent board members who represent people and not the Government. They have a duty by the nation to perform. If they fail, there is an irrecoverable loss to Sri Lanka rupee.” 

Domestic impor t substitution industries are doomed

Now manufacturers who produce goods for both the domestic and international markets have to wait a few days to open LCs to meet their import requirements. They have been forced to employ full-time people called searchers and pushers to find out which bank has foreign exchange and when. This is an unnecessary cost that could have been avoided had Sri Lanka gone for a facility from IMF immediately after the present Government was sworn in. 

Break the Deadweight Loss Raj

An economy filled with such inconveniences or transaction costs is called a ‘Deadweight Loss Raj’. The top priority of the new Finance Minister, Basil Rajapaksa, should be to take action to destroy this undesirable Raj and empower people.

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