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Serving Sri Lanka

This web log is a news and views blog. The primary aim is to provide an avenue for the expression and collection of ideas on sustainable, fair, and just, grassroot level development. Some of the topics that the blog will specifically address are: poverty reduction, rural development, educational issues, social empowerment, post-Tsunami relief and reconstruction, livelihood development, environmental conservation and bio-diversity. 

Monday, May 23, 2005

Increase Public Investment for a Stronger Infrastructure and Pro-Poor Growth

Sunday Island: 22/05/2005" By Kanes

The IMF constantly advise developing countries which come to her for help to emasculate the public sector, to prune government activities, cut government expenditure and hand over government enterprises to the private sector. The state, it is argued, cannot manage business ventures and therefore they should be left in the hands of private enterprise. Private enterprise, it is further stated needs a free environment to operate efficiently and consequently the state should remove obstacles and hindrances by deregulation, decontrol, liberalization and downsizing the state. The recipe for success, it is repeated is downsizing the sate and upsizing the private sector. Both the previous governments — SLFP and UNP — followed these policies: they had to, in order to borrow funds from the IMF. The result was downsizing the state’s role in economic development in the form of cutting government’s capital expenditure from 10-15 per cent of GDP in the period 1978-1989 to below 5.0 per cent of GDP in 2002-2003 as shown in Table 1.

The reduction of capital expenditure was felt mainly in the economic services where it was cut from an average of 7.5-12.00 per cent of GDP in 1978-1989 to 3.3 per cent of GDP in 2002 and 2003. It is significant that the lowest ratio of capital expenditure to GDP was in 2002-2003, the two years of the previous government. The present government at the beginning said it wanted to pursue an independent economic policy without being dictated to by the IMF, but it is under great pressure to toe the IMF line: the IMF is withholding funds until the government adopts IMF’s liberalization reforms. Whether it will yield to this pressure is yet to be seen.

The crucial importance of public investment in a developing country like Sri Lanka cannot be overemphasized. Sri Lanka like other developing countries lack modern and efficient infrastructural facilities, which are an essential prerequisite for any economic development. It is beyond dispute that the country needs more and better roads and railways, harbours and airports, irrigation schemes, power supplies, water supplies, and communications to accelerate growth, and more and better hospitals, schools, and higher educational institutions to provide health, knowledge and skills to people to engage in productive work. It is the responsibility of the state to provide these infrastructural facilities which in turn involves higher capital investment. Thus, by reducing public investment the state has failed to build and improve the country’s infrastructure and provide an environment conducive to higher investment and growth.

Investment in the infrastructure alone is not enough to promote rapid growth where the private sector is young and afraid to take risks. In such situations, the state has no alternative but to invest directly in productive enterprises such as banks and large-scale factories. Some privatized ventures have been neglected by the private owners — like Kantalai Sugar Factory — and the state needs to take them over and operate them efficiently. Public ownership is also necessary where public interests need to be protected such as water supplies and electricity. Leaving vital necessities to the tender mercies of the market is too risky especially when private firms like Enron can vanish overnight. When there is much public opposition to the privatization of petroleum, railways, electricity and banks, it is necessary for the government to find a suitable formula to restructure them and win over the people in the same way cluster bus companies are to be revitalized.

Private Investment Facilitated by Public Investment

There will be little private investment without effective infrastructural facilities. Expectation of private profits is as much related to infrastructural facilities, as they are to tax and other incentives. A major reason for three-quarters of the world’s foreign direct investment (FDI) to flow into developed countries is the superior infrastructure of these countries. Africa receives only 0.1 per cent of world FDI mainly because of its poor infrastructure while Latin America receives 10.5 per cent and Asia 12.2 per cent by virtue of their better infrastructure. Public investment does not as some say crowd out private investment. Public investment on the contrary, stimulates private investment by involving private firms through contracts in the creation and improvement of infrastructural assets and providing them with new business through orders for machines and equipment required in infrastructural investment. In Sri Lanka, private firms are selected on a tender basis to build or improve roads, airports, seaports, irrigation and hydro-electricity dams and to construct buildings for schools, hospitals, administration and public housing. In addition, the equipment and materials needed by the government for these physical assets, machinery, spare parts, motor vehicles, ships, aeroplanes, railway engines, generators and other machines are purchased from private firms on the basis of public tenders. So expanding public investment results in expanding private investment in a symbiotic relationship.

It is relevant to note that the reduction in public investment in 2002-2003 failed to stimulate private investment to a significant extent as expected by the policy-makers. Public investment was at its lowest in 2002 — 4.6 per cent of GDP and 5.3 per cent in 2003; it had declined from over 6.0 per cent of GDP in 1999, and 2000 and 5.6 per cent in 2001. Private investment, which was over 20.00 per cent of GDP in both 1999 and 2000 and 16.2 per cent in 2001, rose marginally to 16.7 per cent of GDP in 2002 and to 17.0 per cent in 2003 — hardly anything to crow about.

Public Investment larger in Developed Countries

The developed countries have large public sectors although the developing countries are being advised to have small ones. Government spending as a percentage of GDP is 52 in Sweden, 50 in Denmark and France, between 40 and 50 per cent in Japan, Belgium, Italy, Germany, Netherlands and Canada, between 30 and 40 per cent in UK, Spain, Australia and 29 per cent in USA. Strangely, Sri Lanka’s government expenditure in 2000 was 27 per cent of GDP, even lower than that of USA and yet we are asked to emasculate the public sector. Public spending on such a large-scale is financed by high taxation. Total tax revenue exceeds 50 per cent of GDP in Sweden, varies between 40 and 50 per cent in Denmark, Finland, Belgium, France, Italy, Netherlands and Norway, between 30 and 40 per cent in Germany, Britain, Canada, and Switzerland and 20 to 30 per cent in US and Japan. In Sri Lanka tax revenue in 2000 was only about 15 per cent of GDP — much lower than in the developed countries. Corporate tax rate is 40 per cent or more in Canada, Japan, Italy, Belgium and US and 39 per cent in Germany more than in Sri Lanka where it is 35 per cent. Top income tax rate is 60 per cent in Netherlands, 50-60 per cent in Denmark, Finland, Sweden, Belgium, France and Germany and between 40 and 50 per cent in Spain, Italy and Britain as compared to 35 per cent in Sri Lanka. There is a strong case of revising our corporate and income tax rates upwards. Higher taxes have not discouraged private investment in the developed countries and there is no reason why it should in Sri Lanka.

The Need for an Efficient Public Sector

The private sector cannot provide such services as national security, food security, preservation of the environment and biodiversity and regulations and controls necessary to prevent business malpractices and to ensure competition. It is sometimes forgotten that in developing countries, there are several problems which cannot be solved by the private sector alone such as poverty, inequality in the distribution of benefits, unemployment and underemployment which if not solved, would tend to make things difficult for private enterprise and to free market to operate. Many policy-makers and economists today are obsessed by high economic growth. Economic growth is necessary but insufficient for human development and the quality of growth not just its quantity is crucial for human well being. This quality can be ensured only by the state. Growth can be jobless rather than job creating — as an oil refinery — ruthless rather than poverty reducing — liberal imports killing domestic agriculture and industry — voiceless rather than participatory — no liaison with workers or farmers — rootless rather than culturally enshrined — unrestricted foreign films, TV and music — and futureless rather than environmentally friendly — gemming, river sand mining, cutting of forests for timber and killing animals for tusks or fur. Growth that is jobless, ruthless, voiceless, rootless and futureless is not conducive to human development. It is the responsibility of the state to ensure that growth promotes human development.

The stat cannot entrust the task of economic development to the market forces and wait patiently for the free market to deliver the goods. In a developing country like Sri Lanka, where private enterprise is generally underdeveloped, the state has a responsibility to regulate the market to prevent abuses and to undertake directly a good part of economic development. High growth and equitable distribution of opportunities and benefits require a dynamic public sector playing a leading participatory as well as interventionist role in the economy: without it, economic growth cannot be pro-people, can never provide them with the opportunities for economic and social achievement, can never safeguard the interests of future generations. We have to be conscious of the fact that markets have no conscience and do not promote social justice: it is only the state, which can ensure it. This may sound as heresy to those believing in the Washington Consensus, but Joseph Stiglitz and others have pointed out that the most successful developing countries are those which have not followed the precepts of the Washington Consensus.

The government should have no hesitation increasing public investment to achieve high economic growth.

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