The current political developments have overshadowed economic concerns. The presidential election is the focus of attention for the rest of the year and into the early months of next year. Such distraction from the economy is an inevitable cost of a vibrant democracy: an accepted disadvantage of democratic politics. One can only hope that law [...]


Poll overshadows economic imperatives: Whither reforms?


The current political developments have overshadowed economic concerns. The presidential election is the focus of attention for the rest of the year and into the early months of next year. Such distraction from the economy is an inevitable cost of a vibrant democracy: an accepted disadvantage of democratic politics.

One can only hope that law and order is maintained during these maddening days, that no blood is shed in the coming months and that the democratic process is worked out without much disruption of the economy. The shorter and peaceful the electoral manoeuvres the better. Since an economy must operate within the framework of a political process, we hope that once the elections are over, that the needed reforms discussed below are implemented to accelerate economic growth.

Fundamental weaknesses
Sustaining the economic growth momentum has been a concern among economists owing to fundamental macroeconomic weaknesses, lack of economic reforms, poor governance, uncertainty in economic policies and inadequate investment in technical and scientific education. These and other concerns have been brought out in the State of the Economy 2014 report of the Institute of Policy Studies (IPS). It has pointed out that without reforms and efforts to achieve macroeconomic stability, the country may be caught up in a “Middle Income Trap”.

While many countries have been trapped on reaching middle incomes, those countries that have undertaken reforms and policies to ensure that their macroeconomic fundamentals are sound, have moved on to higher levels of economic achievement.

The IPS State of the Economy report argues that to sustain continued economic prosperity, Sri Lanka must introduce reforms that will lead to the reallocation factors of production across sectors of different productivity and move towards a higher average total factor productivity growth. Here, the quality of a country’s institutions matter. Incentives built into institutional structures determine whether they act more in public interest or as rent seeking entities favouring one group over another.

The IPS makes the significant point that: “Institutions influence the allocation of resources, including physical and human capital. Weak institutional structures also lead to administrative confusion and entrench privileges of the political elite over time. In contrast, institutions, based on transparent rules and governance structures will help instil confidence in investors and businesses to undertake productive investments rather than in rent-seeking.”

This emphasis on institutional development is timely and important as the weakening capacity of institutions has been a conspicuous adverse development of recent years and a serious constraint to economic development.

Fiscal consolidation
The IPS also emphasises that fiscal consolidation is vital for ensuring macroeconomic stability. A higher proportion of GDP as revenue, reduction of losses in state enterprises and the reduction of debt and debt servicing costs are vital to achieve a manageable fiscal deficit as targeted by the government. These cannot be achieved without significant reforms.
In the words of the IPS, “the headline numbers mask some troubling developments that suggest the lack of a serious attempt at reform. The most telling is fiscal reform, not least to increase revenues sufficiently to reverse a low and weakening revenue ratio. Fiscal constraints have been overcome by resorting to foreign borrowing to finance Sri Lanka’s public infrastructure investment programme, exposing the country to a hefty external debt repayment schedule in the medium to long-term.” The massive foreign debt burden and its servicing cost must be addressed immediately. The Central Bank too highlighted the serious dimensions of this problem recently.

No reforms
The government’s inertia to reform has been emphasised in the IPS report. “Central government fiscal consolidation efforts have also largely by-passed attempts to reform the state sector. Loss making State-Owned Enterprises are haemorrhaging funds, with spillover effects on other state entities, such as banks, impinging on productivity across the economy. Reforming the state sector is by no means an easy task. But it is all the more important for Sri Lanka as government efforts to stimulate the economy through infrastructure investment bring elements of greater state activity in the economy.”

The report cites the instance of state banks raising development finance from abroad, and facilitating government directed lending. “If the absorption of resources by the state — be it in terms of workers or finance — is not matched by revenue mobilization,” the IPS cautions, “Sri Lanka will not have the fiscal manoeuvrability to address other critical areas necessary for sustained rapid growth.”

Increased investments on education and reforms that change the content and quality of education are vital imperatives for the country escaping the “Middle Income Trap”. The report points out that while some countries in Asia, such as Malaysia, Korea and Singapore, were not trapped owing to their development of education to cope with higher levels of productivity and technological advancement, others have failed owing to their technological incapacity. “Skills upgrading is a necessary prerequisite if Sri Lanka is to see a transformational change in the structure of its economy. Growth boosting infrastructure spending is skewing economic activity towards non-tradable sectors such as construction, mining, utilities and in services sectors such as tourism and retail trade.”

The IPS points out that “In Sri Lanka’s case, non-agriculture job creation has not been sufficient to decrease its overall share of employment in the economy which still stands at over 30 per cent. More such workers will have to be moved into more productive jobs over time, especially as the country’s labour force growth slows.”

Other prerequisites
There are other important prerequisites besides those discussed above to ensure economic growth and development. These include, law and order, rule of law and security of property rights, certainty and predictability of economic policies, good governance and economic management. Fiscal space for priority expenditure and strict accountability of public finances are essential. New directions in agricultural development strategies and effective social interventions to protect the vulnerable, the poor, handicapped and the elderly, are needed to ensure growth with equity.

Once the elections are over, it is essential that the powers that be, whoever they are, once again focus on these economic issues to ensure the acceleration of economic growth. For the present, and hopefully for a brief period, these issues will be dormant.

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