Lonely island in globalising Asia
Last week, there was a seminar to commemorate the 117th birth anniversary of the late President J. R. Jayewardene, widely known as “JR”. The seminar was on the “Open Economy and JR” and was held at the Sri Lanka Foundation Institute (SLFI). Prof. Rohan Samarajiva and I delivered speeches, while it was attended by about 400 participants, including parliamentarians and political party representatives.
I elaborated in my speech, first, on how the pre-1977 United Front (UF) government prepared the country for policy reforms towards an open economy, which was seen at the time as an impossibility. Secondly, I described how and why the open economy deteriorated subsequently, in spite of its early success and potential future prosperity. Thirdly, I pointed out that how the reforms were abandoned, and that the open economy was reversed, driving the economy to the recent collapse. Fourthly, I concluded on how the country can recover and prosper in the coming years moving beyond its fragile and mediocre journey.
Dr. Swee’s main focus in the Report was to give an early warning about “an emerging economic crisis” in Sri Lanka and to propose remedial measures. The crisis that he talked about was the growing budget deficit and escalating inflation – in fact, it all came true in the subsequent years of the decade of 1980s.
For whichever the reason, the open economy policy reforms that were limited largely to ‘trade liberalisation’ appeared to be ‘incomplete’ too. It’s very foundational reforms were not in the policy package. They included, first the delayed state-owned enterprise (SOE) reforms. Sri Lanka has been still maintaining about 400-500 SOEs that were set up under the pre-1977 closed economy
Two historical reports
At this event, I met Pradip Jayewardene, grandson of JR. It was through him I received the soft copies of two invaluable historical documents. It seems to me that the two documents had been used personally by JR and read them attentively: I could see JR’s own pencil underlines and marks in margins. Pradip confirmed that they are JR’s own.
The first document is known as the Shenoy Report (1966) – a report by an Indian liberal economist, B.R. Shenoy, which had greatly influenced JR’s open economy policy reforms. I had come to know that JR had approached Shenoy for advice when he was a Cabinet Minister of 1960-1965 UNP government. Also, I had known that he was convinced that Sri Lanka should be an “open economy” and wanted to start such policy reforms much earlier, but the political backing that he required was not there.
By 1977, he was the leader of the UNP which received a landslide victory at the general elections. In fact, the previous UF government of 1970 formed by the SLFP and the then influential two Marxist parties (CP and LSSP), had prepared the way for JR’s open economy reform agenda.
The closed economy model of the UF government with stringent government controls had caused such a severe stress on the economy and hardship to the people. As a result, the people gave an undisputable sweeping victory to the UNP led by JR at the general elections in 1977. Out of the total 168 parliamentary seats, UNP won 140. While SLFP was able to save only eight seats, the CP and LSSP were wiped out completely once and for all from Sri Lankan politics.
Emerging crisis
The open economy was introduced by the UNP government in 1977, while its main policies were as follows: Import liberalisation, reduced foreign exchange restrictions, unified and flexible exchange rate, market-determined prices, and opening the room for private investment. Even prior to winning the elections, JR had already declared that he was aiming at making “Sri Lanka a Singapore”.
The second document, that I mentioned above is a report submitted to JR in 1980 by its author Dr. Goh Keng Swee, the First Deputy Prime Minister of Singapore. He has a PhD in Economics from the London School of Economics (LSE), and held a couple of ministerial posts, including the first Minister of Finance, in the Singaporean government prior to being the Deputy Prime Minister.
Dr. Swee commented on immediate results of the open economy during 19771980: First, it ended the country’s supply shortages, long queues, and black markets, while improving the living standards of people. Second, it promoted private investment opening opportunities for employment creation, income generation, and foreign exchange earnings. Third, it opened the doors for massive foreign aid flows which made Sri Lanka “the world’s highest per capita foreign aid recipient country”.
Nevertheless, Dr. Swee’s main focus in the Report was to give an early warning about “an emerging economic crisis” in Sri Lanka and to propose remedial measures. The crisis that he talked about was the growing budget deficit and escalating inflation – in fact, it all came true in the subsequent years of the decade of 1980s.
We are politicians!
One of the interesting contrasts that Dr. Swee had observed was the inadequate private investment in Sri Lanka against the massive public investment fueled by foreign aid. It caused rising budget deficit due to increased local counterpart funding. He observed that Sri Lanka’s private investment was only 15 per cent of the total, compared with 75 per cent of that in Singapore.
Dr. Swee recommended to slow down by curbing government’s massive spending on mega projects, housing, and food stamps, but said that “Mr President, it is a matter of personal regret that my report will bring no joy to you…” In referring to the uneasy balance between politics and economics, he also mentioned that after all “we are both politicians…!”
It appeared to me from the pencil marks throughout the report that JR had read the document attentively from the beginning to the end. But regrettably, just as Dr. Swee too anticipated he did not implement the recommendations – cutting down public expenditure and containing the rising inflation.
As the Report predicted, Sri Lanka had to face massive budget deficits and high inflation in the 1980s, creating policy inconsistencies and sabotaging the progress in the open economy. This macroeconomic issue has been analysed later in detail by Premachandra Athukorala and Sisira Jayasuriya in their joint publication “Macroeconomic Policies, Crises and Growth in Sri Lanka” (1994).
“Half-baked cake”
In addition to the expenditure crisis in the 1980s, another blow to the open economy came from the country’s political crisis. The outbreak of the Tamil separatist war in the north and the second JVP insurrection in the South multiplied the expenditure crisis on the one hand and hindered private investment expansion on the other hand.
For whichever the reason, the open economy policy reforms that were limited largely to ‘trade liberalisation’ appeared to be ‘incomplete’ too. It’s very foundational reforms were not in the policy package. They included, first the delayed stateowned enterprise (SOE) reforms. Sri Lanka has been still maintaining about 400-500 SOEs that were set up under the pre-1977 closed economy.
Secondly, the open economy was not supported by its much-needed public sector reforms and regulatory reforms, including revisions to the land and labour laws. Thirdly, there was no reforms aimed at the area of ‘rule of law’, including the related institutional reforms. As a result, finally, the flood gates were also open for massive ‘white-collar’ bribery and corruption. The Secretary to the Treasury at the time, Dr. W.M. Tillekeratne once said in a meeting that “we have now replaced our retail corruption with wholesale corruption”.
What is interesting is that, in spite of all these problems, the contemporary international literature on Asia predicted the future of Sri Lanka as a “newly industrialising country (NIC) of the 2nd generation”. The 1st generation NICs were Singapore, Hong Kong, South Korea and Taiwan.
Economy on “reverse gear”
After two rounds of major policy reforms in 1977 and in 1989, Sri Lanka never had a comprehensive and purposive policy reform process. Besides, since 2005, the country made a decisive policy reversal against the open economy and promoted economic activities even against export growth.
Today, despite rhetoric, Sri Lanka is no longer an “open economy” integrated with the rest of the world; it is ‘an isolated island in the midst of an integrated Asia’. The world’s largest free trade region is in Asia with ASEAN plus RCEP countries, including China and India. Apart from that most of the countries within this regional trading bloc have also signed FTAs with the world’s traditionally advanced countries, the US, the EU and the UK. In the midst of all that, Sri Lanka continued to remain isolated and eventually collapsed.
Sri Lanka’s current economic crisis is primarily a foreign exchange crisis – a consequence of reversing its open economy and getting isolated in a globalising world. Then, the way out of the crisis too lies on re-reversing the policy reforms and getting integrated with the globalising world. The growth process could be enhanced by addressing the essential reforms in a comprehensive manner pushing the fragile economy beyond its mediocre recovery.