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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. 

Tuesday, May 31, 2005

Will the UPFA’s "New Development Strategy" Work?

Sunday Island: 29/05/2005" By Mahoshada

Follow the Yellow Brick Road...

At the recent Development Forum the UPFA government rolled out its New Development Strategy. (It is available on-line at www.erd.gov.lk.) This document says many of the right things and is full of the essential buzz words. This is not surprising because the primary audience of this document is the donor community and the government knows well what these agencies want to hear. But it is the country that presumably has to live with the proposals being put forward. And it is the country that should be asking: Is it new? Does it actually amount to a strategy for development? Will it work?

Accelerating Economic Growth

The document begins with what is now an over-used clich`E9, the assertion that economic growth alone is not sufficient to ensure reduced poverty, that what is needed is "pro-poor" growth. There is however at least the implicit recognition that increased economic growth is necessary for reducing poverty; that the job cannot be done through redistribution alone.

To this end, the UPFA "targets" growth rates of 6 to 8 percent over the next five years. This is the linchpin of their strategy. But it is a simple matter to "target" a goal of higher growth — anyone can do that. It is quite a different matter to put in place the appropriate policies and programs to reach such a target. And it is fair to say that if this growth target is unlikely to be achieved, none of their other professed goals aimed at reducing poverty should be taken very seriously. We can go a long way towards judging the credibility of this document by what its proposals suggest about the prospects for increased economic growth.

What is needed for higher rates of economic growth? This question can be answered simply. To increase incomes the human and physical resources within the country have to be used more productively — to produce goods and services of greater value. To make this a bit more concrete, think of the country as a business enterprise which has available workers, buildings and machines and financial capital. This enterprise can grow in several ways. It can increase the total value of what it produces by shifting workers from producing low value goods to higher value goods. It can adopt more effective management techniques or gain access to new technologies, so that it becomes possible to produce more output with the same workers and equipment. Or it can grow by increasing additional resources beyond what it has currently at its disposal — by attracting new investment from other enterprises (countries) abroad. Like this enterprise, the country’s economy will grow only through some combination of a better allocation of resources, technological advances and increased investment.

Role of Government in Increasing Growth

Given that these are the means by which economic growth can be increased, it is worth considering what role the government can usefully play to this end. The government has the potential to influence how the private sector utilizes the resources it has available. If it chooses to do so the government can pick winners and losers and divert resources where it wishes. But does anyone honestly believe that the government has the expertise and capacity required to determine how resources throughout the economy can be most productively employed; what technological and management approaches would be most effective; or how to best attract substantially increased foreign investment? Of course not; past experience has made that clear. But this is one of the main pillars on which the UPFA’s New Development Strategy rests.

But the concerns about government’s role go beyond its lack of capacity to effectively manage the employment of non-government resources. The government is directly responsible for the utilization of nearly one quarter of the country’s total available productive resources, (i.e., 23.5 percent of GDP in 2004), including employment of over one million people.

By most accounts, virtually all government departments and state owned enterprises are burdened with two to three times the number of employees actually required. This means that as many as one-half million people or more could be shifted to work elsewhere in the economy without any loss of value in the output of government. The additional output produced by those people re-employed outside of the public sector would directly increase the country’s real income and add to real economic growth. Yet nowhere in the UPFA’s New Development Strategy are there any substantive proposals to significantly improve the efficiency of the public sector and/or to reduce the large numbers of under-employed workers and the extensive resources it now absorbs to more productive endeavors.

Cost of Living, Taxes and Fiscal Policies

There is probably no proposition that would get more widespread support by economists than maintaining stable prices and sound fiscal conditions are essential prerequisites for sustained economic growth. One of the reasons why the growth rate has declined since the 2004 election has been the reversal of the fiscal and monetary policies that had earlier led to reduced inflation and increased growth.

The UPFA’s strategy document says that it recognizes the importance of "implementing a sound monetary policy to contain inflation and encourage investment and domestic savings", (page 16). Does this mean that after one year in office they have come to see the error of their ways and now aim to follow a more sensible policy direction? Perhaps.

The unrelenting rise in the cost of living since April 2004, abating only momentarily in March as it does nearly every year, has been fueled by the excessive government spending and expansionary monetary policies ("printing money") adopted by the UPFA. The argument that this has all been a result of high international oil prices can be easily dismissed. Virtually all countries have faced the same rise in oil prices, but Sri Lanka has been nearly alone in seeing the advent of runaway inflation.

As an indication that the government intends to mend its ways, the strategy document indicates that the growth in the money supply will be cut by more than a quarter (i.e., from 20.9 percent in 2004 to 15.0 percent in 2005). This would require sharp increases in interest rates and amount to a remarkable change in course were it actually to take place. However, already nearly half way through this year there is little sign of such fundamental changes. Interest rates continue to be negative, well below the prevailing rate of inflation.

The fiscal policies reflected in the strategy document suggest substantial increases in taxes yet continued very high budget deficits for the next several years. Total taxes (revenues) would be increased by more than 25 percent over the next four years while expenditures would increase somewhat. As a result, the government is targeting its budget deficit to remain over 8 percent of GDP for the next two years and fall modestly to 6.7 percent in 2007. It is easy to forget that budget deficits of this magnitude are extremely high by international standards and are clearly not sustainable year after year.

However, experience suggests that such targets are never hit. Revenues are unlikely to grow this much this quickly. (There would be considerable adverse political fallout were it to happen.) And as usual, the deficit will likely exceed targeted levels.

But if the UPFA government were actually to be successful in diverting substantially larger shares of the country’s resources to the public sector, there can be little doubt that there would be negative impacts on economic growth. The public sector already absorbs too large a share of resources and is enormously unproductive in how these are employed. And the prospect of continued high budget deficits ensures not only that the country’s public debt will continue to grow well beyond manageable limits, but that the more productive private sector will find it difficult to get the resources needed to support increased economic growth.

A New Development Strategy?

Is there anything fundamentally new in this UPFA document? If there is anything genuinely new, it is not apparent. One can equally ask is there anything much different from the policies pursued by the earlier PA government? Other than the professed unwillingness to consider privatizing state owned enterprises there is almost nothing new. These are the policies that have been economic policies of the country for nine of the last eleven years with results that can be readily seen.

Does the UPFA’s New Development Strategy actually amount to an effective development strategy? We can get at the answer to this question by looking at what this strategy is likely to mean for economic growth. The strategy document itself makes clear that while increased growth may not be sufficient to reduce poverty, it is certainly necessary. As a result, the New Development Strategy targets economic growth of 6 to 8 percent; well above the average achieved over the last two decades. But increased economic growth requires employing the country’s resources in more productive ways, including shifting them to more productive activities; improving productivity through more efficient technologies and/or management practices; and/or attracting additional resources through increased investment. And unfortunately, there is little or nothing in this strategy that would lead one to expect these sorts of reforms that would support improvements in national productivity. Indeed, there is much that will almost certainly undermine productivity and with it economic growth, including the further expansion of the public sector.

So this document is neither new nor a development strategy that is going to lead to reduced poverty. Should we be surprised? Not really. This is a document whose primary function is to convince donors to continue lending money to the government, rolled out in time for the recent Development Forum. It is not a serious attempt to overcome the country’s economic challenges and will no doubt be forgotten once its purpose has been served. (Mahoshada@gmail.com)

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