Common Sense Solutions to Sri Lanka’s Crisis

Not too long ago, the Sri Lankan government declared a food emergency. The nation’s foreign exchange reserves have plummeted by nearly $5 billion since November 2019, while Fitch, S&P and Moody’s have all downgraded Sri Lanka’s credit ratings. Moreover, since the record economic contraction of 3.6% in 2020, the Sri Lankan rupee has depreciated nearly 20% against the US dollar. Now, with the depletion of foreign exchange to finance imports, the government has empowered the military to seize and ration essential food items under mandated prices. Additionally, the importation of fertilizer has already been banned, and the Minister of Energy is urging people to use fuel economically so there could be enough foreign exchange to purchase vaccines and drugs.

Is COVID the Culprit?

That Sri Lanka is in dire straits is evident. While the COVID-induced lockdown has no doubt dealt a severe blow to the economy, the pandemic is not the sole cause of the present crisis. Underlying problems of governance and policy are largely responsible for the island’s economic woes. Since 2005, Sri Lanka has been borrowing billions from China for lavish infrastructure projects. However, Colombo has not done a good job of repaying them. For instance, after failing to service the $1.4 billion debt used to build the strategic Hambantota port, the government had to relinquish it via a 99-year lease to a Chinese company. Time would only worsen this trend. The national debt last year, for example, would mark a record 101% of the GDP [from 86.8% in 2019]. While the enormity of more recent numbers can hardly escape notice, Sri Lanka’s pathological borrowing is not a novel phenomenon.

Big Government = Big Problems

For nearly seventy years since Sri Lanka’s independence, its government has been operating with a fiscal deficit, and financing its spending addictions with foreign debt. Meanwhile, it has intruded almost every sphere of economic life and stifled private initiative. Granted, between 1977 and the early 1990s, the island experienced an invigorating respite from this bureaucratic tyranny. However, for the most part, Keynesian[1] quick fixes of deficit spending and the bankrupting model of Modern Monetary Theory[MMT][2] have dictated Sri Lanka’s policymaking. Therefore, any lasting solution must necessarily restrict the state’s role in the economy, reduce government waste, strengthen private property rights, and permit free enterprise to thrive. Thus, in what follows, I propose several common sense recommendations which can alleviate Sri Lanka’s economic woes and put the island on the path to prosperity.

Privatize State-Owned Enterprises[SOEs]

‘Public funding’ for most SOEs is merely an elegant euphemism for squandering tax money. Sri Lankan Airlines, for instance, had been consistently generating profits under the management of Emirates. Soon after the government seized it in 2008 however, it began racking up mammoth losses which, by March 2015, would stand at Rs.123.26 billion. To put the number in context, this is more than twice what is allocated to Samurdhi aid each year. Sri Lankan Airlines, nonetheless, is hardly an exception. The Sri Lanka State Plantation Corporation[SLSPC] and the Janatha Estates Development Board[JEDB] have failed to procure any profits for at least 5 years, while Mihin Lanka has barely earned any profits since its inception. According to the recent available performance reports [from 2014][3], 55 SOEs [out of 245 SOEs], were receiving Rs.126 billion from the government budget, Rs.47.6 billion in treasury guarantees and Rs. 471.2 billion in bank borrowings. While the budget allocation mostly represents tax money, the borrowings and guarantees reflect what more efficient private enterprises could have procured for their expansion during this period.[4]

Dismantle Monopolies

Even when SOEs are apparently profitable, they often operate as monopolies [e.g., the Sri Lanka Ports Authority, the Ceylon Electricity Board etc.]. This drives out potential competitors who can provide higher-quality products at lower prices. Conversely, breaking monopolies would simultaneously reduce prices for consumers and permit more businesses. This would likely raise employment opportunities as well. The drastic decrease of telecommunication prices ensuing the dismantling of the telecom monopoly is a fine example. Monopolies obviously extend beyond SOEs. Licensure-based private monopolies over bus routes is one such case that deserves market-oriented reformation.

Stop Favoritism

Furthermore, governments tend to create an uneven-playing field in favor of SOEs. The exemption of LakSathosa from the NBT and the VAT is a striking example. Other supermarkets consequently must compete for consumers against a government-sponsored entity which might fair better based on favoritism rather than merit. This conceals an inefficient allocation of resources as well as hidden subsidies whose cost is ultimately borne by the taxpayers. Moreover, because SOEs can keep operating despite waste and inefficiencies, they can easily breed nepotism and corruption.

Remove Price Controls

Price controlling schemes are often inspired by noble intentions. But the outcomes they seek are to be more ardently wished for than seriously anticipated. Basic economics teaches that while price ceilings may yield immediate benefits to some consumers, their secondary consequences can devastate economies.[5] Producers and sellers, who often bear the initial burden of such policies, would likely switch to more profitable avenues of income, provide low-quality products, or engage in illegal trade. Eventually, consumers themselves would suffer from shortages, low-quality products or black-market pricing. Amidst Sri Lanka’s present crisis, government mandated prices would likely impoverish rural farmers, urban suppliers [because alternative avenues of income are scarce] and low-income earning consumers. Granted, the removal of price controls, by itself, would not immediately solve a food shortage. Therefore, it should be accompanied by a reduction of food taxes.

Reduce Food Taxes

Sri Lanka’s taxation of staples amounts to legalized plunder. As the rupee continues to depreciate in kerb markets, such levies would pillage many fixed income earners. However, if the Sri Lankan government decreases some food taxes, such as the CESS and the Special Commodity Levy [SCL], consumer prices would fall substantially. This recommendation is not impractical.[6] The annual government revenue from the SCL has been around Rs. 55.8 billion while the annual budget allocation for SOEs has been likely exceeding Rs. 126 billion. Thus, if the government privatizes at least a few wasteful SOEs [such as Sri Lankan Airlines], this food tax could be reduced to zero. This would provide much relief to many poor families with starving children.

Invite Foreign Investments

While domestic investments from domestic savings are not insignificant, the Sri Lankan economy needs more capital to thrive over the long haul and prosper as a nation. Medical research, technological innovation and electronics manufacture cannot occur without substantial capital expenditure. However, this is best accomplished not by borrowing loans from the Chinese Communist Party but by attracting direct investments from foreign enterprises. Singapore’s meteoric ascent from rags to riches, in this regard, constitutes a paradigm that merits analysis.

A Model for Emulation

The newly independent Singapore of the 1960s was a poverty-stricken fishing village plagued with social strife. 50% of Singaporeans were illiterate, 14% were unemployed, and 65% were occupying slums and squatter settlements. However, today it has an annual GDP of over $300 billion [higher than 75% of the world] and the world’s 4th highest per capita GDP at $65,233 [from $428 in the 1960s]. Singapore’s current sources of income range from entrepot trade and medical technology to oil refining and culinary tourism. What is important to note is that, presently, over 3,000 multinational corporations[MNCs] account for more than 65% of Singapore’s manufacturing output and direct export sales. In other words, foreign investments explain much of Singapore’s prosperity. However, Singapore did not arrive here overnight.

In the 1960s, amidst imminent economic collapse, Lee Kuan Yew’s government embarked on an ambitious project of labor-intensive industrialization. Realizing the desperate need for more capital, the Singaporean government, thus, initiated reforms to create a low-tax, safe and corruption-free country capable of attracting MNCs. Soon, Singapore saw double-digit annual GDP growth, and by 1972, foreign and joint-venture firms, largely funded by Japanese and American investors, constituted about 25% of Singapore’s manufacturing. International companies, moreover, began training unskilled workers in electronics, petrochemicals and information technology. Thanks to the education of the labor force by MNCs [with little cost to the government], Singapore would move from exporting garments, textiles and basic electronics in the 1970s to eventually engaging in integrated circuit design, biotech research, pharmaceuticals, aerospace engineering, wafer fabrication and logistics.

Right for Sri Lanka?

Indeed, Sri Lanka’s path to prosperity must suit Sri Lanka’s unique circumstances. However, no government can borrow its way to wealth or spend its way to prosperity. A developing nation such as Sri Lanka, therefore, is unlikely to experience rapid and sustainable economic growth without substantial foreign direct investments. While such investments do not impose the burdens associated with debt, they do require a lean, disciplined and efficient government to play a vital role in society.

The Role of Government[7]

The proper responsibility of any government is to protect private property rights, enforce private contracts, maintain law and order, and provide for a strong military. While voluntary associations and religious organizations can more effectively care for the vulnerable, a government should provide a basic social safety net for those who fall through the cracks. It bears noting however, that a basic safety net is fundamentally different from a welfare state feeding on high taxation; high taxation repels investments and discourages entrepreneurship.[8] Additionally, attracting and sustaining foreign investments require sound monetary policy,[9] and a predictable and clear legal system that ensures political stability. Only under such circumstances would Sri Lanka’s economic conditions be conducive to rapid economic growth.

A New Approach

When politicians campaigning for office promise new goodies, let’s remember that no government can give to its people what it has not already taken from its people, because, as Margaret Thatcher noted, “there is no such thing as public money; there is only taxpayers’ money.” Granted, transition is seldom easy and change rarely comfortable. However, salvaging and growing Sri Lanka’s economy require tough choices. Sri Lanka cannot afford to delay further, and now is the time for Sri Lankans to choose free enterprise, entrepreneurship and innovation over bureaucratic waste and government handouts sponsored by high taxation and foreign debt.

Written by Ayesh Perera on behalf of the Policy and Governance Committee of the Centenary Movement.

[1] see Shostak, Frank [2020]. “Why Keynes Was Wrong about Consumer Spending,” Mises Wire. https://mises.org/wire/why-keynes-was-wrong-about-consumer-spending

[2] see Rothbard, Murray N. [1990]. “What Has Government Done to Our Money?” https://nakamotoinstitute.org/static/docs/what-has-government-done-to-our-money.pdf ; for a shorter explanation see Shostak, Frank [2019]. “The Problem with Modern Monetary Theory,” Mises Wire. https://mises.org/wire/problem-modern-monetary-theory

[3] There is a disturbing dearth of transparency, and few SOEs periodically release proper performance reports; for more details see “The State of State Enterprises in Sri Lanka-2019,” Advocata. https://www.research.advocata.org/wp-content/uploads/2019/03/THE-STATE-OF-STATE-ENTERPRISES-IN-SRI-LANKA-PS-1.pdf

[4] see “Barriers to Micro and Small Enterprises in Sri Lanka,” Advocata. https://static1.squarespace.com/static/55697ab8e4b084f6ac0581ef/t/5e60b64ed2194734b1e3984f/1583396433574/Advocate+Barriers+to+Micro+%26+Small+Ent.+in+SL+.pdf

[5] see Sowell, Thomas [2015] “Basic Economics: A Common Sense Guide to the Economy,” Chapter 3: Price Controls. https://riosmauricio.com/wp-content/uploads/2020/07/Basic-Economics-5th-Edition-Thomas-Sowell.pdf ; see Hazlitt, Henry [1946] “Economics in One Lesson,” Chapter 17: Government Price-Fixing. https://www.liberalstudies.ca/wp-content/uploads/2014/11/Economics-in-One-Lesson_2.pdf

[6] see “Price Controls in Sri Lanka — Political Theatre,”Advocata. https://www.research.advocata.org/wp-content/uploads/2018/10/Price-Controls-in-Srilanka-Book.pdf

[7] The concurring testimony of history demonstrates that the expansion of government inevitably results in the restriction of liberty; see Friedman, Milton [1982]. “Capitalism and Freedom.” https://ctheory.sitehost.iu.edu/resources/fall2020/Friedman_Capitalism_and_Freedom.pdf; see Hayek, Friedrich A. [1945]. “The Road to Serfdom: with The Intellectuals and Socialism.” https://cdn.mises.org/Road%20to%20serfdom.pdf

[8] Ibid.

[9] The Central Bank should refrain from Quantitative Easing which penalizes saving, and eventually induces recessions; see von Mises, Ludwig [1912], The Theory of Money and Credit, Chapter 21; see von Mises, Ludwig et al [1996] “The Austrian Theory of the Trade Cycle and Other Essays.” https://cdn.mises.org/The%20Austrian%20Theory%20of%20the%20Trade%20Cycle%20and%20Other%20Essays_3.pdf

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