Business Times

Economic development -- In search of consensus

By Milinda Moragoda, Leader of the Sri Lanka National Congress, Minister of Justice and Law Reform
The re-election of President Mahinda Rajapaksa with a historic mandate accounting for nearly 58% of the total votes cast presents a unique moment for Sri Lanka to capture the many opportunities for economic development which we have missed since Independence. This overwhelming victory should serve as a wake-up call for our political establishment across all party lines to stop squabbling on parochial and personality-based issues and to unite and work together on matters of national importance. The electorate has clearly demonstrated that they desire stability and continuity.

Southern Expressway

During the past four years, President Rajapaksa has been laying the foundation for a growth-based development agenda through an ambitious island-wide infrastructure development programme.
The President has said that, during his second term, he intends to pursue national reconciliation, nation-building and economic development with the same single-minded determination that he prosecuted the war and delivered peace during his first term in office. It is very clear that uniting a nation that is deeply divided on race, class, caste, religious and party lines remains one of the major obstacles to progress. One hopes that all political parties will have the maturity and statesmanship to put an end to the culture of manipulation and brinkmanship. However, in this article I will focus primarily on the issues connected with economic development.

With the successful conclusion of the war, the recently concluded Presidential election and with the upcoming General Elections, an opportunity presents itself to review Sri Lanka’s overall development strategy. It is timely, therefore, for us to have a national discussion about the “vision” that should drive our development strategy and the policies and programmes that would bring lasting benefits for all our people.

This discussion should be open-minded and pragmatic, not narrow-minded and grounded on false and unrealistic ideology. Unthinking and chauvinistic populism should give way to rational analysis focused on identifying what works in practice. Short-term political expedience should give way to a long-term perspective based on a rigorous assessment of Sri Lanka’s dynamic comparative advantage in the global economy. For years, partisan politics have driven economic policy-making. The current historical conjuncture presents the country with a unique opportunity to move away from “business as usual” that has given us two youth insurrections in the South and a separatist war in the North. The time is ripe to build a consensus around a long-term strategy for developing the country.

The need of the hour is a national discussion conducted without rancour, which focuses on policy and practice rather than personalities. President Rajapaksa’s pledge at the launch of his Manifesto to end the “politics of promises” and to begin an era of politics based on policies, is a step in the right direction.
The intention of this article is to initiate this discussion. I will begin by presenting my thoughts on a “vision” for achieving sustained development of the country. I will then propose to set out some policies that, in my view, are necessary to achieve this “vision”. This article is intended to stimulate debate, which I hope will eventually yield a national consensus.

The “vision” for Sri Lanka’s development must be based on:

  • Accelerating the growth trajectory of the economy.
  • Maintaining macro-economic stability based on a predictable and transparent policy framework.
  • Implementing structural reforms that improve the competitiveness of the economy, including micro-economic measures.
  • Ensuring that growth is inclusive by maximising its employment intensity.
  • Striving for both regional and urban/rural balance.
  • Developing a targeted social safety-net that affords protection to the poor and vulnerable, as well as those who are affected by the adjustment costs of reforms.
  • Achieving sustainability by reducing the carbon intensity of the economy.
  • Fostering international relations that support the country’s commercial/trading interests.

A sustained reduction in poverty and increased prosperity cannot be achieved without “growing the cake”. Moving the economy to a higher growth trajectory requires a significant increase in the overall productivity of the economy. This involves enhancing both the quantity and quality of investment. Increasing productivity through strengthening investment performance is at the core of sustained development.

Investment as a percentage of GDP averaged 25% over the last decade. This resulted in growth averaging 5% during the same period. Our objective must be to achieve 8-10% growth per annum. This is well within our grasp, particularly as for the first time in three decades the whole country is in a position to contribute to accelerated growth. Investment will have to rise to the 30-32% range to achieve this. For this to happen, savings must be increased and the efficiency of capital allocation and utilisation enhanced. National savings averaged 21% of GDP during the last decade and external flows 4% of GDP. Total savings need to rise to the 26% range to achieve 8-10% growth. Addressing this saving/investment gap will be crucial to achieve the growth objectives.

This cannot be achieved without addressing the structural budget deficit. The government’s fiscal performance is a source of instability in the economy. The current account deficit in the budget has averaged 2.8% over the last 10 years. This deficit must be converted into a surplus which contributes to public investment (capital expenditure).

During these past 10 years domestic savings averaged 16% of GDP, and national savings were higher at 23.8%. This is attributable to the impressive levels of remittances from Sri Lankans working abroad.
The overall policy framework should incentivise the increase of all forms of savings to bridge the savings-investment gap identified above. The savings performance in the economy cannot be improved without achieving macro-economic stability. The policy framework must be stable, predictable and transparent. It must create the conditions for low inflation and balance of payments viability. We need to get away from the stop –go policies that have characterised our post independence economic history. We need to create an economy that is efficient enough not to overheat (rising inflation and balance of payments pressure) when we achieve 5-6% of growth.

We cannot achieve macro-economic stability without fiscal consolidation. High budget deficits exert pressure on key prices, such as the exchange and interest rates which are important determinants of savings and investment decisions. Unsustainable budget deficits result in higher interest rates, which increase the cost of funds in the economy. This leads to lower growth, employment and incomes. In addition, large deficits would exert pressure on the exchange rate by increasing the inflation differential between Sri Lanka and its major competitors and trading partners. An uncompetitive exchange rate encourages imports by making them relatively cheaper and this discourages savings and investment by reducing the competitiveness of the domestic economy.

I would also like to reiterate that inflation fuelled by an unsustainable budget deficit is an implicit regressive tax on the poor, who do not have the compensating benefits of appreciating asset values. A rigorous public expenditure review, based on clear national priorities drawn from the elements of the “vision” set out above, would be central for meaningful fiscal consolidation. Improving tax administration and the efficiency and buoyancy of the tax system is also important. President Rajapaksa has established a Tax Reform Commission, which I expect will present us with concrete recommendations to achieve this.

Stable macroeconomic policies must be supported by structural reforms which improve the efficiency, and therefore the competitiveness, of the economy. There are two large pools of low productivity in the economy: the public service and paddy production. These sectors absorb considerable resources yet yield low returns. Policies need to be developed, which not only shift resources to other more productive sectors but also use the resources that remain more efficiently. The challenge is to achieve these objectives while minimising adjustment costs in terms of lost livelihoods and incomes. There is a debate to be had on the pace and sequencing of reforms in these sectors. There is, however, a strong case for arguing that “the pain in the short-run will ultimately yield gains in terms of more employment and incomes in the longer-term”. We need a national debate on the difficult issues surrounding the reform of these politically sensitive sectors. This debate should take place in the knowledge that much will be foregone in terms of future prosperity if we continue to adopt soft options as we have done in the past.

There are a number of other structural issues that need to be addressed. The financial system is the lifeblood of any economy. The recent crisis has demonstrated the importance of sound institutions operating in a well regulated sector. We need to ensure that the Sri Lankan financial system is fit for purpose in the coming decades of the 21st century. The recent actions taken by the Central Bank to reduce spreads are positive for business. However, we need to adopt a holistic approach in reducing the cost of intermediation in the economy. This has to be supported by measures that seek to make credit available to profitable businesses in all sectors.

In recent years, considerable progress has been made in developing infrastructure, particularly power generation and roads. There is a great deal more to be achieved to reduce the transaction costs in the economy, not least the uncompetitive prices of utilities in the economy. There must also be a pragmatic debate on how best Sri Lanka can take advantage of public-private partnerships to accelerate infrastructure development. Organisations such as the CPC and CEB also need to be reformed.
The global economy places a high premium on competitiveness. A skilled labour force with high levels of productivity is an important element of the competitiveness strategy for any country. Our education system, vocational training and overall skills development should be aligned to labour market dynamics. These in turn must be linked to Sri Lanka’s dynamic comparative advantage in a highly competitive global economy. The focus of policy in this area must be on raising the opportunities available to people in all parts of the country. The controversial area of labour market reforms is another subject that requires a pragmatic debate and effective action. We need to ensure that we have the right balance between the interest of labour and investors.

Sri Lanka possesses the most attractive investment climate in the South Asia region. However, there is much to be done if we are to be more competitive in the overall Asian region and the global economy more generally. Transaction costs must be reduced and “doing business” should be facilitated by reducing red tape and bureaucracy. A significant amount has been done in this respect but we now need to move to the next generation of reforms. These need to be formulated in collaboration with the private sector. However, the private sector, for its part, needs to move beyond narrow self-interest and contribute to constructive thinking on improving the overall business environment.

Employment generation is the best transmission mechanism for sharing the fruits of growth. Interest rates and exchange rate policies as well as the tax system must be geared to support inclusive growth. Priority must also be attached to providing the labour force with the opportunity to acquire marketable skills.

Much has already been done to address regional disparities. This has been a priority for President Rajapaksa. However, more needs to be done. We need to explore how best to develop growth poles in various parts of the country. Rural/urban imbalances are less pronounced in Sri Lanka than in many other developing countries. However, the performance of the rural sector is heavily influenced by the low productivity of the paddy sector.

Large scale resources are allocated to this sector through public expenditure on irrigation, the fertiliser subsidy, extension services and the guaranteed price scheme. Paddy and rice are an integral part of our culture and heritage and as such this cannot be viewed through an economic lens alone. However, we have to find ways to modernize and be competitive, perhaps drawing upon the experiences of other rice-centric cultures such as Japan, Thailand, etc. Another debate to be had and consensus to be developed is related to the structure of the agricultural sector in the country. Crop diversification and the balance between small-holder and commercial agriculture are issues that need careful and balanced consideration. We also need to explore what measures can be taken to promote agro-industry.

istorically, the country’s performance in this area has been disappointing. Priority needs to be attached to realising the potential of this sector. As a humane society, we must provide social protection to the poor and vulnerable. However, such support should be carefully targeted, monitored and kept to the absolute essentials so that resources are not diverted from productive activity. We need a conversation among ourselves on whether there is an “entitlement culture” that is constraining Sri Lanka’s development. Do we need to move from an entitlement to a more entrepreneurial culture, which will create the conditions necessary to bring about a rapid transformation of the life prospects of our people.
Well designed compensation schemes to mitigate adjustment costs are an important element of any ambitious reform programme. Any such scheme must also support retraining for workers displaced by implementation of the structural reforms necessary to place the country on a higher trajectory of growth, employment and incomes.

Despite the disappointing outcome at the Copenhagen Summit, it is inevitable that all countries will eventually have to reduce the carbon intensity of their economies. A concerted plan is needed to promote energy efficiency and the development of renewabe energy sources. Any future vision for Sri Lanka must also take account of the need to adapt to climate change.

Sri Lanka cannot afford isolationist and inward looking policies. Our international relations need to be conducted in a manner that enables us to take advantage of all commercial opportunities. Our policies should be such that we have good relations with both the East and the West. The global economic centre of gravity is shifting to the East. We need to be alive to the opportunities arising from this qualitative change in the landscape. At the same time, it would be unwise not to nurture the relations that we have developed over the years with the West and multilateral organisations, such as the World Bank, Asian Development Bank and the International Monetary Fund.

Arguably the most critical determinant of the country’s future prospects is going to be our ability to capitalise on India’s emergence as a global power – both economic and geopolitical. The four southern states of India (Andra Pradesh, Karnataka, Kerala ad Tamil Nadu) are all experiencing rapid growth. The Indian economy was growing at 8% before the global economic crisis. There is confidence that such levels of growth will be restored in the coming years. If the country is recording an overall growth rate of 8%, the four southern states must be enjoying double digit expansion as the overall performance of the Indian economy is being dragged down by lagging states with large populations, such as Uttar Pradesh and Bihar (though performance in the latter has improved recently).

Our efforts need to be focused on how to tap into the rapid progress and rising disposable incomes in India, particularly in the four southern states which are in close proximity to Sri Lanka. We need to have a rational conversation on how best to take forward the Comprehensive Economic Partnership Agreement with India. Sri Lanka is faced with a unique opportunity for transformative change. We need to grasp this opportunity with both hands. We must not be held back by petty-mindedness and a lack of ambition.
We must set aside our insecurities and look forward to the future with boldness. There are risks that need to be managed but we should be confident that we can do this and secure a much more prosperous future for all the people of Sri Lanka.

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