Sri Lanka’s emerging fiscal cliff: Are we to fall off or fly over it?

Dr. Jayasundera: Large Government is not a problem

Sri Lanka’s top most policy administrator, Dr P.B Jayasundera, Secretary to the Treasury and Secretary to the Ministry of Economic Development, has for the first time admitted in public the daunting challenges he faces when balancing the purse of the country’s Government.

Addressing the 30th Annual General Meeting of the Sri Lanka Administrative Service Association in Colombo last Tuesday, he is reported to have said that he does not believe in the pitfalls of a large government which, according to him, has not been proven by empirical economic evidence, but only the pitfalls of a complex administrative system that prevents the bureaucracy from delivering what it should deliver to the people efficiently and effectively.

Two days after this, delivering the prestigious Sujatha Jayawardena Memorial Oration again in Colombo, Dr. Jayasundera is reported to have said that the 2013 Budget is being prepared by the Government under trying conditions because there have been adverse local and global developments that stifle the nation’s high growth momentum and, despite that, many want the Government to give them more and more concessions presuming that the Government has access to an enormous pool of resources.

A large Government should be paid by the citizens

Ironically, these two views expressed by the veteran economist appear to be contradicting each other. A large government is a large government despite its adherence to simple procedures demanding the lion’s share of a nation’s resources and those resources used by the government are a loss to the rest of the nation. In economics, what is lost by one has to produce more in the hands of its gainer if it is to justify its transfer from the first party to the other. Hence, a large government that does not produce more cannot justify its existence to society.

As this writer has argued in the previous articles under this series, the tendency of the bureaucracy is to multiply itself because of certain inherent weaknesses in the relationship between the bureaucracy and the citizens. In a democracy, citizens’ interests are to be looked after by elected representatives but when there is poor governance in the system, the citizens are hit by double jeopardy, in the first instance by elected representatives and then by bureaucrats who will collude to work for their own benefits ignoring those of their principals. However, at the end of the day, the bill on account of the enlarged government and the enlarged bureaucracy has to be paid by the citizens.

Small government multiplies by itself

That weakness, known as ‘the Principal-Agent Problem’ in economics simply says that the agent, namely the bureaucracy, has all the incentives to maximise his welfare and not the welfare of his principal who in this case are the citizens. This was developed into an economic theory of bureaucracy by the US economist William A. Niskanen in early 1970s. This theory and the associated principal-agent problem were discussed by this writer in an article titled ‘The Perilous State of Sri Lanka’s Higher Education: Cooperation and not Confrontation is the need of the day’ published in this series on 27 August 2012 (available at: http://www.ft.lk/2012/08/27/perilous-state-of-higher-education-cooperation-not-confrontation-need-of-the-day/#more-106155).

What this means is that a bureaucracy which is very small now and efficient can grow into a huge monster in time to come because there is an inherent tendency in the government to multiply itself. There is empirical evidence throughout globe including Sri Lanka about public institutions growing large over time and becoming inefficient and unwieldy. At that stage, the authorities have to reduce them to correct size by offering handsome early retirement schemes at a great lump sum cost to the citizens of the country. But, after reducing the staff, unless its growth is checked continuously, it starts growing again needing another round of an early retirement scheme at a larger cost than before. Good examples are the Mahaweli Authority, Ports Authority and the Central Bank of Sri Lanka where after the initial down-sizing of the respective institution, another series of recruitments was made by the subsequent managements thereby reversing the original cost-cutting reforms.

Sri Lanka’s Government has multiplied itself

Sri Lanka’s public sector has multiplied in this manner throughout its post-independence history. Jobs in the public sector have been used by all successive governments to appease the youth who cannot get employed because there is no adequate growth in the private sector to offer them job opportunities. When the problem becomes critical, thousands of youth are recruited to the public sector without making an appropriate assessment of the need and how the citizens could bear the cost over the span of the life of those recruited to the public sector. The result is the multiplication of the bureaucracy and the Government.

According to the Central Bank data, in 1969, for example, Sri Lanka had 218615 public servants or 17 public servants for every 1000 people of population. These two numbers have started to go up rapidly since then: in 1977, 422647 and 30, in 1983, 489472 and 32, in 1992, 653959 and 38, in 2000, 856665 and 46. But these numbers slightly declined to 785756 and 41 in 2003 due to the austerity measures followed by the government in power during that period. Since then, they went up again to record 986386 and 47 as at the end of 2011. The increase is more noticeable since 2006 when the Government pursued a policy of relying mainly on the Government sector for all services to be rendered to the public.

Expanding bureaucracy does not tally with automation

This increase in the public servants is justified on the ground that there had been vacancies in the service which had not been filled in the past and they should now be filled to provide a better service to the public. This argument does not go well with the increased automation of the public services in the country which would in fact have enabled the government to provide a bigger and a more voluminous service to the public with a lesser number of public servants.

For instance, in the issue of annual revenue licences to vehicle owners in district secretariats, about 10 people had to be employed earlier to accept applications, register them in manually maintained registers, check the accuracy of documents, issue and deliver the revenue licence, accept payments, keep accounts and prepare final accounting statements and so forth. Today, with full automation of the work with on-line connection to the Motor Traffic Department, two officers, one to issue the licence and the other to receive payments could issue more licences than before.

Accounts are automatically kept through the automated accounting systems. In fact, the issue of a licence which took hours earlier is being done within less than five minutes now. The automation is therefore to improve efficiency, cut costs and provide an improved service to the members of the public. Despite this fact, along with automation, the current trend has been to fill the public service with more and more people. Though it satisfies the goal of providing jobs to unemployed people, it also increases the cost of running the government.

Citizens are the ultimate payers of large governments

This is the pitfall of having a big government. A private sector enterprise which has over-expanded cannot survive if it does not earn enough at the end of the year. Hence, a private businessman is more cautious when he has to make a choice about expanding into an unproductive area. A government can continue to survive despite its growing into unproductive areas because it can finance its expenditure by resorting to three types of means: taxation, money-printing or borrowing.

Each one of these tactics has its own pitfalls. Taxation is a compulsory transfer of resources from the private sector and the private sector loses resources for its use when the government makes the transfer. Money printing when done excessively leads to inflation eventually reducing the true value of the wealth and the income of the people; hence, it is akin to imposing an inflation tax on the private sector. Borrowings will increase the government’s debt levels requiring the future generations to set aside their own wealth for the payment of interest on debt and repayment of the principal. If the interest payment and the repayment of the principal are done by issuing further debt, known as rolling over of debt, the total public debt continues to increase reaching levels that can no longer be afforded by the economy.

USA’s approach to ‘fiscal cliff’

Prudent fiscal measures require governments to avoid these pitfalls. The US which had expanded its government into many unproductive areas has now been caught up in these pitfalls which they have termed ‘fiscal cliff’.

In fact, the term ‘fiscal cliff’ has been coined by Ben Bernanke, Chairman of the US Federal Reserve System, its Central Bank, early this year when he gave evidence before the US House Financial Services Committee. He is reported to have said that there will be a massive fiscal cliff of tax increases and expenditure cuts on 1 January 2013.

 The reference to this particular date has been drawn from the US Budget Control Act of 2011 under which the US Congress has to go for a massive automatic tax increases and expenditure cuts in order to reduce its untameable budget deficit. In other words, the US has now reached the fiscal cliff and their choice is to fall off the cliff to their destruction if they do not take action to improve government finances that have gone haywire or fly over it by taking the measures prescribed in the Budget Control Act.

The reversal of USA’s good budgetary policy

In the last phase of Bill Clinton administration, the US managed to cut expenditure, increase revenue and generate a surplus of about 2 per cent of GDP in the budget. However, this attainment was reversed during George Bush administration when US went into war in Afghanistan and with Iraq. The deficit was at historic high at closer to 10 per cent of GDP when Barack Obama took office and consequently he had to take measures to bring order back to US budgetary system.

The problem was compounded when the US public debt rose from 40 per cent of GDP in 2000 to 80 per cent of GDP in 2010. Accordingly, massive budget reforms are to be implemented by the US in the remaining period with a view to bringing down the deficit to about 2 per cent of GDP and debt ratio to about 60 per cent by 2022. If these measures are not taken, the deficit would remain at about 6 per cent and debt ratio would rise to 100 per cent causing the US dollar to fall in the global markets, bringing the US economy to a sudden halt and making it lose the economic and political supremacy it has been enjoying in the world.

Cutting budget deficit is a hard economic and political choice which the US has to make, but considering the future of the country, it has not been left with any other choice either.

David Cameron of Britain: Early action a must

David Cameron, new conservative Prime Minister of Britain, despite his heading a coalition government, took early action to correct the emerging budgetary imbalance before it reached the level of fiscal cliff.

On assuming office in 2010, his government announced an expenditure cut of £ 6.2 billion before the end of the year in order to reduce the growth of the UK public debt which, according to his Chancellor of Exchequer – the equivalent of Finance Minister in Sri Lanka – was rising at the rate of £ 3 billion a week.

A massive civil service and welfare reform programme was also introduced by the government to support this move. The whole reform programme has been intended for future prosperity and sustainability at the expense of the current economic growth which has turned out to be an economic recession for Britain.

Sri Lanka’s choice: Pacify people or sustain the economy

What Dr. Jayasundera has implied by ‘preparing a budget in trying conditions’ is Sri Lanka’s approach toward this worrisome fiscal cliff. Like USA and the UK, Sri Lanka too is faced with a hard choice today: Whether to keep on pacifying people with enlarged budgets or taking early action to avert the impending crisis in the country’s tax state. It can certainly continue for some time by borrowing abroad and printing money, but when the country is hit by the crisis, it will have to sacrifice all the good attainments which it has made in the past. This writer has drawn the attention of the Government to this possibility in a previous article published in this series on July 9, 2012 (available at: http://www.ft.lk/2012/07/09/brewing-crisis-of-the-tax-state-stimulus-for-prosperity-or-austerity-for-sustainability/#more-96874).

Since the publication of the article under reference, more recent data are now available on the emerging fiscal crisis in the country.

Sri Lanka’s fiscal crisis is looming

According to the data published by the Central Bank, during the first seven months of 2012, Government revenue has increased by seven per cent to Rs 556 billion compared with the revenue raised during the first seven months of 2011. However, as against the budgetary targets, this is an underperformance of revenue by 14 per cent. The consumption expenditure during this period amounting to Rs. 695 billion has been in excess of the budget targets by eight per cent. Accordingly the deficit in the Government’s consumption over revenue during this period which had been targeted at zero level in the budget has ballooned to Rs. 139 billion or 1.85 per cent of GDP.

While the capital expenditure has performed as targeted in the budget, the overall deficit has increased to Rs. 417 billion or 5.56 per cent of GDP. The deficit for the whole year as per the budget has been 6.2 per cent of GDP. Since the financing of the deficit has been done by resorting to borrowing at a higher rate than the growth in GDP, debt to GDP ratio is to increase from 82 per cent that prevailed in 2011 to a significantly higher level by the end of 2012.

So, Sri Lanka faces a fiscal cliff and unless early action is taken to correct the emerging fiscal crisis, it may fall off the cliff. Or it can make hard choices and fly over the cliff to the other side. The philosophy underlying the Budget of 2013 should necessarily be in line with the latter option.



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