Monday, April 07, 2008

The Myth of the Open Economy

The Sri Lankan left (and it's modern-day 'mainstream' apologists) often point to 1977, the year when Sri Lanka started liberalizing the economy to describe anything 'bad' to do with Sri Lanka, from moral degradation, the persistence of poverty and occasionally as the root cause of the war.

Recently, when I pointed out that the partial liberalization in '77 has in fact, increased per-person income levels of Sri Lankans, a reader (and my friend) Andy, left the this comment:
Ya, it has increased incomes. But This can be hardly called great development. Countries like Singapore, the Asian Tigers have grown much faster.

Open Economy in Sri Lanka has not worked well enough. Maybe it's the war.
Now, I don't like the phrase, "Open economy" for two reasons. one, it somehow gives this notion that being open or not open to international trade is the only concern in a modern economic system, which is clearly not true. Two, in Sri Lanka the term is used as a catch-all-phrase for market liberalization. I prefer the term a free-market economy, but Sri Lanka isn't much of a free-market either, nor is it all that 'open' under any sort of definition.

To answer Andy, if at all the "Open Economy" has not worked, it's because the economy hasn't been open enough or if you ask me, isn't free enough.

Sri Lanka still has a mediocre socialist attitude towards policy.

In recent times, policymakers proposed using (and have used) price-controls to tackle inflation, we have a string of failing state enterprises, and if that's not enough we start more disasters. Investing in Sri Lanka is made difficult, with excessive restrictions on capital transactions, so on. The Central bank has lost all credibility as an independent institution and comes up with absurd theories to justify 20+% inflation. The labor market is heavily regulated, wasteful subsidies and welfare schemes which are nothing but political support systems

Entrepreneurs in Sri Lanka face high taxes, all sorts of restrictive licensing requirements and bureaucratic red tape, which results in heavy corruption. The World Bank doing business report in 2008 ranks Sri Lanka 101 of 178 countries, down 1 place from last year. We are with the worst lot when it comes to ease of doing business and things are not getting better.

We have a bloated government, the largest cabinet of ministers in the world and possibly the largest bureaucracy in the world with over a million state-sector employees for a country with 21 million people - one bureaucrat for every 20 people. India, often thought of as the worst bureaucracy only has about a 1:54 ratio of bureaucrats to people. The government spends most of our taxes on paying salaries to keep this massive bureaucracy alive, not on infrastructure, education or health, and no, not even the war effort. We simply can't afford this.

So no, Sri Lanka isn't much of a free-market. Yes, there are things we have managed to right and It's great that Sri Lanka still manages to grow, despite the government and despite the war, but things can be so much better.

There are two indices which measure how "free" an economy is. One published by the Heritage Foundation/Wall Street Journal ranks Sri Lanka 90 out of 162 countries. They are kinder, whereas the report published by the Fraser Institute ranks Sri Lanka 101 out of 142 countries. (pdf link) . The two reports differ on approach with the Heritage foundation depends on a more subjective analysis using a group of experts while the Fraser Institute relies on purely statistical analysis to come up with the rankings.

In both cases, Sri Lanka's rating is nothing to write home about, and that should tell the story why we are still a poor country. Economic Freedom promotes economic growth and prosperity and if we can have that, we can still progress despite having a war, like Ireland and so many other countries have.


Sam said...

Well said.
I don’t know are Sri Lankans are really ready for a concept like Free Economy, even now. Come to think of it, we have been under strict caste system for past couple of centuries. Which, government tells us what to do and we do it like good sons and daughters. Entrepreneurship was not an important talent in that system, and I highly doubt, if that exists, until Arabs come here. We still continue the same relationship with the government. We can’t go to school without government, we can’t deliver a baby without the government or we can’t fertilize our fields without the government.

Sri Lankans need the thing call free economy or open economy or however you say it. If not that, we won’t have anything else to blame on for our tremendous failures, other than our own laziness. That could be a horrible thing.

sittingnut said...

a good post on the whole, but there are faults in your arguments
but first i am for more free market , less taxes , and less regulation, etc etc .

following concerns the way you make your argument only, not the main idea. and i like that fact that you are propagating the idea .

are we taxed more than others as you claim? i don't think so. and number certainly don't support that. why not come up with numbers to support your claim.

"singapore, the asian tigers have grown much faster." yes but weren't they less free, more government controlled , lot more regulated in some aspects? say what do you make of singapore housing market to take an example?
so what does that prove? that we got the specific regulations , taxes, etc wrong ?

same with capital flaws , there are restriction in those countries too . it all seem to depend on which specific ones

"recent times, policymakers depended on price-controls to tackle inflation"
is that for real or merely for pr? there is a difference. i mean i never see even any attempt to enforce price controls in any meaningful way except in monopoly items like wheat flour, gas etc (even that subject to specific contracts) ?
so do we really have price controls? i don't think so. most prices are in fact market determined in spite of politicians. that is the reality

"all sorts of restrictive licensing requirements and bureaucratic red tape,"
again how effective are they ? effective as road rules here imo . everyone ignore and government does not enforce.

"We have a bloated government... We simply can't afford this."
agreed . now you have to make the argument for cuts.
cut teachers? cut nurses? which will you cut and privatize? how?
if you are to make real world arguments for free market you have say that, instead of making broad generalizations. ( not "bureaucrats" but specific bureaucrat that make up the one million )

that is the main weakness (of not just you specifically, but all those who make the pro free market arguments ) they are reluctant to go to details.

"Heritage foundation depends on a more subjective analysis using a group of experts while the Fraser Institute relies on purely statistical analysis to come up with the rankings."
i am not sure i agree with that comparison between the reports after looking at them , but as you wish

Deane said...

Sam, Agreed in general. But there ARE some of us who go to school without the government, delivers babies and don't fertilize our fields. So I think it's very much possible to become more freer.

Sittingnut, I agree i haven't gone into details. guilty as charged. Intended this to be much shorter before i started rambling about over regulation. But I still pretty much stand by my general claims.

Here is a brief reply, I will incorporate some of it back to the post some time.

Taxes, the world bank doing business report ranks Sri Lanka 158 of 178. Now that's mostly due to difficulties in paying taxes, like having 60 procedure.s but generally speaking we have about 63% of profit taxed if the law is to be followed, which is much higher than say, the asian tigers, Singapore for example has 23% taxed with 6 procedures. Hongkong, South Korea, similarly low .

And the point about the apparent paradox with singapore and asian tigers is not accurate.

The asian Tigers are economically free, despite not being politically free. Singapore and hongkong are ranked the most free economies by both these reports. This doesn't mean of course you can't find counter examples like the housing in Singapore, but speaking as a whole, the economy lot freer than Sri Lanka or even the U.S.

The point about non-enforcement of regulation, true. But even what's enforced is too much, ask people in the import/export business. Similarly there are heavy restrictions on capital flows, Sri Lankans investing abroad for example. Other countries too might have some restricts, but here it's more.

Price controls, yes most prices are set by the market. But the market for these so called 'essential items' are heavily intervened, from setting prices for paddy, gas etc. and other controls like banning imports, which amounts to price fixing. Here's a great idea by Bandula

As for cutting down government, well cutting down everywhere, most govt. departments are over-staffed. Then looking at Privatising Railways, CEB, Mihin, state banks. might not be politically feasible, but at least someone has to talk about the possibility. then at least some bunch of unemployable graduates might not be given government jobs next time as an election promise.

The difference between the two reports were told to me by a prof. who help compile the fraser report. I'm willing to take his word.