A common theme reiterated during the pre-budget discussion “Budget 2022: Sri Lanka’s Path to Economic Stability” held last Friday (22) was that the Budget 2022 must involve comprehensive economic reform for greater de-regulation and for the organisation of a more complete free market order.
University of Colombo Department of Economics Senior Professor in Economics Sirimal Abeyratne claimed that price controls do not work for a country, and that Sri Lanka’s long history of price controls have adversely affected Sri Lanka’s economy. “Not only have price controls failed to effectively address our supply shortages, but have also eliminated quality goods from the market and have not helped to alleviate poverty in the country.” He described price controls as a politically favourable feel-good policy which have failed to solve any of Sri Lanka’s basic economic problems related to poverty and commodity shortages.
However, he further claimed that the recent removal of price controls on selected commodities was also not the answer and that it should have been part of an overall reform package to be effective. Moreover, he noted that in the absence of such an effort, a piecemeal approach to a free market order as we have witnessed in Sri Lanka over the past couple of months is expected to have massive negative repercussions to low-income groups.
According to keynote speaker, Friedrich Naumann Foundation for Freedom Policy Advisor for Economic and Financial Affairs Justus Lenz, there is no one-size-fits-all process for the implementation of a free market order and is of the belief that each country must find its own path to organise its free market order.
Commenting on the Budget 2022, Lenz held that rules hindering entrepreneurship and foreign direct investment (FDI) must be addressed and that the justice system must be well funded to ensure the rule of law is upheld and the rights of investors are protected as promised.
On Sri Lanka’s public debt, which has reached 108% of the gross domestic product (GDP) as of 2020, Prof. Abeyratne pointed out how budgetary management in Sri Lanka has traditionally been ineffective and how, currently, government expenditure is twice the value of government income. Moreover, Prof. Abeyratne noted that around 70% of government revenue is reserved for debt payments annually.
Commenting further, he claimed that in 2020, when the world went into a recession, the link between money and inflation broke down, giving space for central banks to increase money supply/printing without causing inflation. However, by 2022, the world would have successfully moved out of the current pandemic situation, thereby limiting the ability of the Central Bank to finance the budget deficit by printing money. Therefore, in his opinion, the 2022 Budget will be quite challenging for the Government.
Explaining further, he provided that Sri Lanka’s current Budget-related problems are not pandemic related, and instead predate the pandemic. Unlike other countries, economic recovery for Sri Lanka doesn’t equate to getting out of the pandemic situation, as Sri Lanka has been on a downward trend prior to the pandemic. Therefore, he stated: “Budgetary management has to manage expenditure, cutting down all wasteful expenditure and targeting how to improve the government revenue.”
Sri Lanka has historically struggled to attract FDI with the highest yearly inflows recorded in 2018 at $ 1.8 billion, which accounted for 1.8% of our GDP and in 2019 due to the Easter attacks, FDI inflows fell to $ 760 million, which is around 0.9% of the GDP. According to the Ministry of Finance Annual Report for 2020 FDI inflows fell by a further 42% in 2020.
According to Board of Investment (BOI) Chairman Sanjaya Mohottala, FDI should not be looked at as a mechanism for filling the budget gap. Mohottala opined that what matters is not the quantity of FDI, but rather the quality of the FDI inflows. He claimed that not all FDI is created equal and that what we as a country must focus on is the economic multiplier of the FDI and not its dollar value.
In order to facilitate FDI inflows, he highlighted the need to ensure ease of doing business, which requires the development of the legal framework and legal reforms. This involves increasing capacity with regard to the number of judges, the development of infrastructure, the digitisation of the legal system, and the introduction of laws to streamline the litigation process. Therefore, he claimed that the Budget for 2022 must provide for the acceleration of such initiatives.
Mohottala further stated that the Budget 2022 must push for the deregulation policies being proposed in an aggressive manner.
Both Prof. Abeyratne and Mohottala commented on the need to improve Sri Lanka’s tax regime to bolster government revenue. Prof. Abeyratne claimed: “80% of Sri Lanka’s tax revenue comes from indirect taxes in the form of commodity taxes and only around 20% is derived from direct taxes, which is a sign of an underdeveloped country and not a middle-income country.”
Similarly, Mohottala claimed that as our economy advances, we must keep abreast with our tax collection, which Sri Lanka has failed to do. He further provided that tax or tax concessions must be used as a tool with regard to FDI as an equaliser to ensure Sri Lanka has a level playing field with others competing for FDI inflows. Moreover, he called for smart taxation which considers how the company is structured and taxes accordingly and also considers the social benefit from such FDI.
Lenz provided that there are lessons that Sri Lanka can learn from Germany’s experience in the introduction of economic reform towards a free market order.
Lenz claimed that by the summer of 1948 the German economy was in shambles, food rationing and fixed prices were in place to mitigate food shortages, and in response, liberal conservative politician Ludwig Erhard implemented economic reforms in West Germany which created the social market economy. Erhard abolished price controls and introduced stability-oriented currency.
In a social market economy, property rights and unregulated prices form the foundation of the free market and the role of the State is to not intervene in the market and ensure the enforcement of the rule of law and as well as the provision of infrastructure, education, and social policies.
He pointed out that the transition to a free market economy from a controlled economy was highly controversial at the time and there was very strong opposition to it in Germany and the fact that the positive effects of such reforms took time to be properly revealed, made such opposition worse. However, the recovery of the German economy was so successful following such reforms, that within 10 years, the biggest concern for the German economy was the lack of workers.
In contrast, East Germany under the Soviets moved in the opposite direction towards a planned economy which is centrally controlled. This dichotomy in Germany makes it, according to Lenz, a perfect real-life experiment to ascertain the efficacy of a free market economy.
East and West Germany both shared the same language, same culture, geographic location, and had emerged out of World War II in shambles.
While West Germany embraced free market order, entrepreneurial spirit, and open society, East Germany bet on central planning and top-down control. In the first two decades, the race to prosperity between the two parts of Germany was very close. However, with time, the long-term effects of a free market and a controlled economy became apparent.
By the time of the reunification of Germany in 1989, East Germany and its planned economy had failed; East Germany was bankrupt, its products were not competitive in the world market, and its people wanted change. In contrast, the social market economy of West Germany was thriving. According to Lenz, free markets, rule of law, and the resulting freedom for entrepreneurs were the key factors for Germany’s economic development.
He further provided: “Free market reforms need some time before the positive effects are widely felt. So, when we start on this road, it is very important to remember that it will take some time.”