Economic prosperity

To make the wishful thinking a reality

A Presidential Election is round the corner and the two main candidates are seeking a mandate from the people to rule the country for a six year period.
So far, the battle has centred on political and social issues: abolition of the Executive Presidency; restoration of democracy; protection of media freedom; upholding human rights and long lasting constitutional reforms.

The goal of presidential aspirants: Prosperity
The economic policies of the two candidates have not been laid down in detail, except a wish boldly expressed to brighten the lives of people with prosperity. Had Kautilya been among us today, he would have advised them that material well-being or Artha predominates the attainment of all other goals, political, social, religious or spiritual. Hence, the detailed plans for bringing prosperity to the nation should be clearly laid down and their wish should graduate to a concrete strategy from the status of wishful thinking.
Prosperity is simply the creation of wealth on a continuous basis, so that the total wealth of the society grows year after year. While the growth is an important factor, it is also important to allow people to share that wealth equitably according to their contribution, enterprise and ability.
In the Kautilyan economy that prevailed in the 4th century BC, wealth was created through three leading economic activities: agriculture, animal husbandry and trade. But today’s complex economies generate wealth from three main sources: agriculture, including animal husbandry, fisheries and forest developments, industry including mining and services that include trade as well.
In the parlance of economists, wealth creation is referred to as the production of numerous goods and services for use by people, called the real gross domestic product. The rate at which this domestic product grows annually is called the real economic growth rate and the amount of such product available on average to a single individual is called the per capita income.
Hence, the measurement of the success of the wealth creation by a country can be gauged by reference to two leading economic indicators: real growth rate and the level of the per capita income.

Lion’s rate of growth
During the three decades beginning from 1978, Sri Lanka’s economy had recorded, on average, an annual real growth of just 5 percent. With an annual population increase of just over 1 percent, this growth rate would have improved the prosperity of an average individual by slightly less than 4 percent.
A 5 percent economic growth or a 4 percent individual income growth is a dismal achievement when compared with the improvements recorded by some of Sri Lanka’s neighbours. Traditionally, when India had attained an average annual economic growth of just 3 percent, it was nicknamed ‘Hindu Rate of Growth’, because India could attain it without doing anything. Similarly, Sri Lanka’s 5 percent economic growth can be termed ‘Lion’s Rate of Growth’, because, even without doing anything, the country could attain that growth rate. Hence, any economic growth rate below 5 percent is a negative growth for Sri Lanka; any rate around 5 to 7 percent is an average growth rate and only growth rates above 8 percent are real economic achievements about which the country can be complacent.
The current average individual income level in Sri Lanka is just a little over 2000 US dollars. Since the value of the Dollar in the international markets has fallen by about 50 percent since 1999, the real prosperity which Sri Lanka’s average individual income level has brought to its citizens is just a basket of goods which they would have bought for1000 US dollars in 1999.

The wishful thinking of doubling per capita income
The wishful thinking of the politicians seeking a fresh mandate is to double this average individual income level to 4000 US dollars in the next decade. This is a laudable goal, but its realisation involves the implementation of proper policies and exacting unimaginably high sacrifices from people. Both the politicians and people should be ready to bear the burden.
The compound growth formula tells us that, to double the average individual income level in 10 years, the average income has to increase by about 7.2 percent per annum. Since the population grows by about 1.2 percent every year, this amounts to the maintenance of an average annual economic growth rate of about 8.5 percent consistently over the next decade. This is a high growth rate when compared with Sri Lanka’s ‘do – nothing’ growth rate of 5 percent per annum.

What causes growth?
Economic growth in the short run depends on two factors: the level of investments and the efficiency of converting those investments into goods and services.
Investments are those expenses incurred by both the government and the private individuals for acquiring machinery, vehicles and buildings and for building roads, ports, airports etc that will contribute to the production of goods and services. The total of such items is known as the capital stock of a country. The overall level of such annual expenditure expressed as a percentage of the total domestic product, known as the investment rate, should be sufficiently at a high level for a country to record a high growth rate.
The efficiency is simply the ability of a country to produce the largest quantity of goods and services by using the smallest capital stock. This is known as the ‘Incremental Capital Output Ratio’ (ICOR.) Sri Lanka uses capital inefficiently compared to developed countries and therefore, has a high ICOR of about 5, meaning that 5 units of capital has to be used by the country to produce 1 unit of output. In comparison, ICOR is about 2 and 2.5 in countries like USA, Japan or Australia.
The wide difference in ICOR between Sri Lanka and developed countries is understandable. Take, for example, a passenger bus that can carry 40 passengers. This bus will take about 90 minutes to make one trip from Kottawa to Colombo which has a distance of about 20 km. The same bus will make this trip in 30 minutes’ time in Melbourne, Australia. What is the secret for this apparent higher efficiency level in Melbourne? That is because Melbourne has better highways, improved management systems and effective rules for operating passenger buses compared to Sri Lanka. Therefore, in our example, the bus is the same, but it operates three times more efficiently in Melbourne than in Sri Lanka.
In the short run, a country cannot improve its ICOR and, therefore, has to take it as given and adjust other policies to attain a desired growth rate.

High savings to finance high investments

The growth rate which a country can attain is determined by the investment rate it maintains, divided by ICOR. Since Sri Lanka’s ICOR is about 5, for it to attain a growth rate of 8.5 percent, it has to maintain an investment rate of about 42.5 percent year after year.
To invest, a country has to use resources. Resources are generated domestically by consuming less than the income and thereby making savings. Sri Lanka’s government is a notorious dissaver, because it spends as day to day expenses more than it earns. Hence, its savings are negative to the extent of about 2 to 3 percent of the country’s total domestic product.
The country’s citizens are a little wiser, but understandably, they too are big consumers. On average, a Sri Lankan consumes about a four fifth of his income and saves only about a one fifth. This means that, with government’s dissavings, the country’s average savings rate is about 17 to 18 percent per annum.

Why foreign investments should be encouraged?
Hence, to maintain an investment rate of 42.5 percent, it has to fill a saving – investment gap of about 25 percent. To fill this gap, the country has to use a two – pronged approach: while increasing domestic savings, it has to attract the savings made by foreigners.
These two are the most difficult challenges which the new President will have to face after the election.
To attract foreign savings, the country should build confidence among the foreigners, because such foreign savings flows are voluntary and foreigners are no under obligation to give Sri Lanka their savings. To build confidence, the new government has to adopt consistent economic policies, uphold the rule of law, maintain the law and order, protect property rights and, above all, desist from making anti – foreign rhetoric. The danger of the rulers’ making anti – foreign rhetoric is that it inflames the minds of radical groups which may try to take law into their hands imbibed by the belief that they are being supported by the highest level of the government.

How to promote private savings?
To promote domestic savings by individuals, the most important requirement is to have a realistic interest rate policy and a realistic exchange rate policy. The adoption of a realistic interest rate policy requires the central bank to have the nominal interest rates determined above the inflation rate, so that the real interest rates are positive and contribute to improve the welfare of the citizens in real terms. A realistic exchange rate policy requires the central bank to allow the exchange rate to move up or down in terms of the demand for and the supply of foreign exchange, so that the citizens have no incentives to over – import and consume a larger portion of their income.

The government too should save
The government too should contribute to the domestic savings by curtailing its day to day expenses below the revenue and generating a surplus in its current transactions.
This is challenging in Sri Lanka, because about a half of the government revenue is spent on salaries and pensions paid to public servants and a further 42 percent on interest payments and subsidies. Both Presidential candidates should be mindful of this constraint and should not propose schemes that will worsen the existing anti – growth budgetary situation.

Draw wisdom from Kautilya
Kautilya, in his recommendation to the king, specifically mentioned that salaries to the king’s servants should be kept at one fourth of the total revenue of the king. This requires a deliberate policy of not expanding the public service and paying the public servants according to their contribution and hierarchical positions. He recommended that the salary payments should be de – compressed by paying double the salary of a worker to his supervisor and double that salary to supervisor’s supervisor and so forth.
Kautilya also admonished the king of having a lavish expenditure pattern and recommended that the receipts and expenditure should be properly looked after by the king, for otherwise the king will run into a financial calamity. When hit by a calamity, the king will lose his Treasury, and through that loss, his country, his fort and his army. It is, therefore, important for a king to maintain fiscal prudence at all costs.

What the presidential aspirants should not do
Hence, a presidential aspirant who is mindful of the future economic growth of the country should be absolutely concerned about the danger of expanding the public sector beyond its carrying capacity, increasing the public debt beyond its ability to bear the interest payments and repayment of the principal and thinking of offering new subsidy schemes to lure voters.
He might be tempted to print money and finance for his lavish promises. That is more dangerous, because it will create inflation, cause the exchange rate to fall further, raise interest rates making interest payments unaffordably bigger and, above all, dry up the needed foreign savings flows.
He might win the election by these attractive, but fiscally imprudent methods. But after the election, he will have to face the reality. The popular and imprudent policies may come as sweet honey before the election. But after winning, it will turn out to be a bitter poison.
(The writer can be reached on waw1949@gmail.com)