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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. 

Thursday, April 06, 2006

Facing Increasingly Difficult Economic Conditions: The Need to Get Back to Economic Fundamentals

Sunday Island: 19/03/2006" By Mahoshada

"While average growth has remained about 5 percent, this has not been adequate for significantly reducing poverty beyond urban areas. There are vast differences among regions and sectors, and between the rich and the poor — inequality has risen sharply. Macroeconomic performance weakened in 2004 and the fiscal situation remains under severe stress. Needed reforms have proven elusive in the face of the political instability and the challenge of recovering from the tsunami. Economic performance continues below the potential and the reform agenda remains on the back burner." The World Bank, "Country Assistance Strategy Progress Report", February 2006.

This is the rather dismal assessment by the World Bank of the economic climate prevailing in Sri Lanka today. And as much as the government might wish to dismiss or deflect this criticism, they cannot avoid the conclusion that it has been their own poor management of the economy that has been a major factor causing the increasingly difficult economic conditions now facing the country. Unfortunately, there seems to be little prospect for any substantial improvement in the foreseeable future unless there are major changes.

The World Bank’s assessment makes clear that economic growth at current rates will do little to reduce poverty, especially in rural areas or in substantially reducing overall inequality in incomes. Addressing the disparities in economic progress between the Western Province and the rest of the country was one of the central economic issues raised by the UPFA in the 2004 general election. The World Bank’s statement makes clear that under current circumstances, little if any progress can be expected in fulfilling this promise and closing the gap between Colombo and the rural economy despite the rhetoric.

During the recent presidential election both of the main party candidates accepted the inescapable fact that substantially higher sustained rates of economic growth are going to be required if poverty is to be significantly reduced. President Rajapaksa made a commitment to reach 8 percent growth while his opponent Ranil Wickremesinghe promised to aim for 10 percent. In light of this unusual convergence of views on the overriding importance of substantially increasing the country’s economic growth rate, the voters might have expected that steps would be taken to fulfill this commitment. It looks as though once again, the public will be disappointed with the lack of economic progress.

Other Signs of Difficulty

One does not have to take the word of the World Bank to realize that the country is facing increasingly difficult economic conditions — despite the continual assurances of politicians and officials to the contrary. One only has to look around, go to the market or read the newspapers. There are more negative signs than positive.

The cost of living continues to rise rapidly, making the struggle to make ends meet ever more difficult. Every year around this time the prices of key commodities, especially rice, tend to come down as domestic supplies from farmers generally increase leading to falling prices in the market. But despite this brief seasonal relief for consumers, other prices have continued to rise. As a result, the underlying inflation rate has remained higher than should be the case. The most recent estimates, for February 2006, by the Central Bank of the average rate of increase in the prices of the goods that the average family buys are in the 8 to 10 percent range. One year ago, the same inflation indices were at about the same level, or even slightly lower.

It is true that there has been some progress in reducing the rate of inflation, following the very sharp increases after the UPFA assumed power in April. But this progress has been too little and too slow in coming and these are few signs that it will continue.

One of the consequences of the falling rice prices is that it puts pressure on farmers’ incomes. Recent reports suggest that farmers are selling paddy at Rs. 9 or 10 per kilo, well below the prices promised by the government — Rs. 17. It is good for consumers, but bad for farmers and bad for the rural economy. This situation typically results in the government trying to give the impression that it is doing something useful to resolve the problem, such as intervening in the paddy market by purchasing what are only marginal amounts of the available supply. This rarely if ever has much of an impact on prices. However, nearly every year, by April or May the price of rice will begin to rise again because the local supplies coming to the market will begin to decline. There may be some who are fooled into believing that this is the result of government actions, when it is simply the usual seasonal fluctuations in supply and demand.

The recent strike by public sector workers and threats of further such actions offers another sign of economic troubles ahead. There have also been increasing numbers of workers in the private sector striking or threatening strikes. While there is undoubtedly a political dimension to these actions, it is also a reflection of the growing desperation of workers arising from the increasing cost of living. There have been substantial annual increases in the salaries of public sector employees in recent years. Yet because of the rapid increases in prices, there has been little if any real improvement in the incomes of people working for the government. Now they are demanding a substantial 65 percent pay increase — an increase the government simply cannot afford.

There is no doubt that some in the public sector warrant higher salaries that better reflect their education and experience. But substantially higher salaries cannot be paid to the one million public sector employees without bankrupting the country, which would quickly lead to a national financial crisis that will affect everyone. Higher salaries can only be justified if there are real, sustainable increases in productivity and a significant reduction in the size of the public sector. Nevertheless, few politicians seem willing to address this problem directly, preferring to promise what they should know they cannot deliver.

In response to this weeks strike action, the President has named yet another salary commission, expected to make recommendations on public sector salary levels later this year. It remains to be seen whether it will follow the last salary commission appointed during the PA government, which recommended substantial cuts in the numbers of employees along with significant pay increases.

In other areas the current government continues to raise taxes in various ad hoc ways, including increases in customs duties which leads to even more pressure on the cost of living. And to try to make ends meet, the Treasury continues to increase the public sector debt, now relying much more on offshore borrowing. It has been the case for the a number of years that much of the government’s borrowing has been to fund day to day operating expenses and meeting the costs of subsidies rather than for investment in projects. There seems to be no sign that this approach to managing the public finances is going to change voluntarily. It is clear, however, that this sort of thing cannot continue indefinitely. Sooner or later there will come a point where the government will have to face the difficult financial reality that it cannot spend more than it can take in revenues. Unfortunately, it will be the poor and middle class that will eventually have to pay the price for fiscal indiscipline.

Economic Fundamentals

Why is the country seemingly unable to achieve the much stronger economic results that most economists believe are attainable? One of the chief reasons is the unchecked ability of politicians to get away with making promises during election campaigns that make no economic sense. Time after time, candidates promise the sun and the moon to voters, with no pain or sacrifice required. And time after time, they are rewarded at the ballot box.

It would be foolish to expect politicians to give up something that is working well for them. This will only begin to change when voters demonstrate that they are unwilling to swallow whole some of the unrealistic promises being offered. And for this to happen, there needs to be a much wider and more vigorous debate of economic issues in the public press and media. In this writer’s opinion, the central focus of this debate ought to be on the economic fundamentals underlying growth and development. This should include discussions on how best to meet the government’s revenue requirements and how this burden should be shared. This debate should also pay much more attention to how the government spends the money collected from the people. Right now, most of the budget is devoted to servicing the enormous public debt and paying public employees salaries and pensions. Finally, this debate ought to raise public understanding of the dire implications of a government continuing to live far beyond its means.

Only if the public comes to appreciate the economic fundamentals that govern all countries can we expect to see the stronger sustained economic performance that is possible. Only then will the ambitious targets of 8 to 10 percent growth be attainable. Mahoshada@gmail.com — comments and earlier articles can be obtained at www.mahoshada.com)

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