ISSN: 1391 - 0531
Sunday, January 21, 2007
Vol. 41 - No 34
Columns - The Sunday Times Economic Analysis

Growth statistics mask deepening economic crisis

By the Economist

Pronouncements about the high rate of economic growth in 2006 and predictions of even a higher growth rate for 2007 confuse most people. The realities they face do not indicate an improvement in their living conditions.

In fact they are facing one of the severest erosions in their incomes at the same time they listen to the assertion of a high economic growth. Some may well ask ‘what is the use of economic growth if it does not benefit us?’ Others may well ask who benefits from this growth.’ Still others may say, ‘statistics statistics and more statistics- damn lies’.

Economists, who do not like to displease the powers that be for whatever reasons, even explain the twin phenomenon of a high growth rate and a high rate of inflation as being not inconsistent. They cite the experience in the 1980’s when the economy reached the all time record growth of just over 8 per cent with a rate of inflation of 20 per cent as evidence of this. The implication of citing that evidence is that we are going through an economic growth experience of a similar sort. and that inflation should be endured in the interests of economic growth. Plainly they imply that inflation has been generated by the growth momentum. Nothing could be further from the truth.

The comparison of the growth cum inflation experience in the 1980’s with that of today is unwarranted. Paradoxically it is useful in understanding the underlying factors determining growth and inflation during the two periods. The comparison is misleading, as they are contrasting scenarios and causes for a similar result. In 1983 the economy grew at over 8 per cent, while inflation rose to 20 per cent for the same year. One economist pointed out at that time that the rate of inflation during this period was understated by the indices used and demonstrated that in fact inflation was around 26 per cent in 1983 rather that the official count. He demonstrated that basic items such as food and medicines were among those whose prices increased highest and therefore by implication inflation hit the poor worst. This is the current experience as well.

The causes for the high rate of inflation then and now are however widely different. In the 1980’s inflation was caused by what economists call “overheating” of the economy. There was a huge thrust in investment, particularly in infrastructure, that would yield returns in the long run rather than produce results immediately. Such large expenditure was inflationary in the short run. They were justified in the long-run interests of the economy though some economists, such as those of the IMF, argued that stabilisation measures were needed to ensure that long term growth was not adversely affected. The large investments were mostly financed through foreign funds though there was large counterpart funding as well. The inflow of foreign funds that are converted to rupees, as well as the deficit financing of the government, led to huge increases in the money supply that fuelled inflation. Therefore one might say that what was a good development for the economy in the long run had rather distressing effects in the short run and particularly on the sections of the middle classes, fixed wage earners and the poor that were particularly hard hit.

The current situation and developments are qualitatively very different. The causes for inflation are the high prices for oil, large subsidies to corporations, increased expenditure on salaries and the huge cost of the war. The trade deficit and the consequent strain on the balance of payments is depreciating the rupee and thereby increasing the cost of imports. In summary both the fiscal deficit and the trade deficit are having an inflationary impact though in different ways. There are also other proximate factors that account for high prices of food, an important component of the cost of living. These are the rains, floods and landslides that have reduced production, as well as disrupted transport of produce. These are to some extent temporary though there is a tendency when prices rise, they do not come down to the earlier levels when the immediate causes are removed. This “hatchet” effect will be further buttressed by the general inflationary pressures as well.

The salient contrast in the two experiences of growth and inflation in the 1980’s and now is that the former was brought about by mainly large productive investments that overheated the economy, while the current inflation has been brought about by high oil prices, large subsidies, war expenditure and the depreciating currency. These expenditures are generally described as “unproductive”, even though some are inevitable.

This column has repeatedly pointed out that the growth statistic itself is misleading. The 6 to 7 per cent growth includes a high proportion of growth that is the resultant of increased government expenditure on services such as defence, increased expenditure on security services, increased employment in the public services and increased salaries and welfare expenditures. The convention in the compilation of national accounts is such that the value of output of these services is computed as being the value of the expenditure on them. Additionally, there is a growing scepticism about the veracity of the GDP statistics. Are the figures massaged to give a higher growth figure? The nature of the Sri Lankan economy and the manner in which the statistics are compiled permit a high degree of kneading production statistics. It is known to have been done before. Is it being done now?

There are many reasons why the commonsense view that all is not well with the economy is buttressed by hard statistics. The large fiscal deficit reaching double digit proportions, even the official price statistics indicating a 19 per cent rate of current inflation, a trade deficit that is likely to be the highest ever of over US$ 3000 million and the continuing depreciation of the currency are clear indicators of a deepening crisis. Hiding behind a dubious high rate of economic growth is indeed a dangerous course for the country.

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