The Revised Budget for 2015 and the need for a market economy

by R.M.B Senanayake

The Minister of Finance presented a budget for 2015 revising the earlier budget of Mahinda Rajapaksa. He gave a plethora of tax reductions on commodities by removing or reducing the Special Commodity Levy imposed on them. There will naturally be a reduction of government revenue which the minister had to make up to keep to the same expenditure. The Revenue after these reductions is estimated at Rs 1,622 billion – a reduction of Rs 67 billion. The revised aggregate expenditure is Rs 2,121 billion – a reduction of Rs 89 billion. So the expected budget deficit is Rs 499 billion – down from Rs 521 billion. The financing arrangements have not changed except that the domestic financings have been reduced by Rs 22 billion to Rs 248 billion from the earlier Rs 270 billion. Of course the need for the Government to borrow to fund the foreign debt repayment is not reflected in our budgets. The Government will have to borrow from the Central Bank and the banking system to repay the foreign debt. Will the Government repay it within the period specified in the law?

The Primary Deficit has been reduced from Rs 96 billion to Rs 74 billion.  Any   deficit in the Primary Account means that the Public Debt will continue to increase when the least to be expected is to balance it and stabilize the Public Debt.

Public Investment is reduced by Rs. 176 billion from Rs. 696 billion to Rs. 520 billion. Is it prudent to do so if we want to maintain the existing growth rate? Global growth is slowing down. True that the budget deficit needs to be brought down to restore macro-economic equilibrium and reduce the current account deficit in the balance of payments. But it is still too risky to reduce the public investment since the private sector is not investing more. The government perhaps hopes the increase in domestic demand will sustain growth.  But there is then the risk of worsening the Current Account Deficit and our Foreign Reserves are not adequate to meet the debt repayments and also fund a larger deficit unless accompanied by depreciating the rupee which of course will raise prices. A country with a high public debt cannot take the risk of slower growth. We need to maintain the investment level and spur productivity growth. The minister has introduced some unusual taxes- one of which is the Mansions tax. This sort of retrospective taxation will not inspire confidence in the business community. There is criticism also of the reduction in tax on wheat flour because it might increase the consumption of bread when we need to reduce the consumption of imports.  But bread is consumed by the estate workers who are the poorest segment in our society.

We need however to increase domestic production which requires structural reforms.

Institutions need to be built

Rich countries are rich because they have good institutions. Poor countries are poor because they have bad institutions. That institutions matter is a consensus among economists. So the World Bank publishes a Doing Business Index that captures part of the importance of institutions. We should improve our position in that index whatever it takes to do so. It means functioning courts, functioning police, and predictable government departments. Only 4% of the criminals tried are convicted and that too takes such a long time that punishment ceases to be a deterrent. So a more powerful deterrent by way of re-introducing the death penalty is necessary. Our courts are run by the lawyers in their interests. The Judges don’t take control of the proceedings.

I once suggested to Mr. Walter Laduwahetty that lower court judges should be given a quota which they must complete or be penalized. He seemed outraged but I really can’t see anything wrong. How do you move from bad institutions to good institutions? England took hundreds of years. Japan took a US occupation. South Korea and Singapore took benevolent despots. But history provides ample evidence that left free of government meddling, a society with bourgeois values will generate enormous economic growth. The new Government must take a hard look at the procedures followed by our government departments. The late NUJ chaired a Committee (of which I too was a member) which examined all the departments connected with trade and made recommendations but none were implemented. All new ministers should ask their departments for suggestions to reduce regulations and cut down on red tape.

Structural Reform is needed

It will not do for the new Government merely to dole out public money through higher public sector wages and pensions while shunning structural reform. For example we could easily increase the GDP by reducing holidays. We could increase labor productivity by liberalizing the labor market. In a market economy a worker’s low wage reflects that worker’s low marginal productivity - that is, the wage reflects the low contribution of that worker to his or her employer’s bottom line.  The root cause therefore, is the worker’s low productivity; the low wage is merely a symptom of this illness.  So the only way to cure this illness is to raise that worker’s marginal productivity.  And while there are good and bad ways to raise that worker’s marginal productivity giving a pay hike without addressing, much less curing, the underlying illness will take us nowhere. Our teas estate workers produce much less than their counterparts in Kenya or even South India. Why? Excessive severance pay in the case of termination and difficult regulations regarding termination of employees undermines management control as managers are unable to check and punish workers who slack. Go to any company run workshop and see for yourself how workers waste time. It also discourages employers from hiring more workers. It has created a two tier labor market where wages in the informal sector are low and there are no incentives for SMEs to expand and join the formal sector. The whole economy should be made more market oriented by removing price and other controls.

Raising the incomes of the farmers

The producer protection by way of guaranteed prices is really not the answer. What is needed is to encourage a close relationship between the supermarkets and other large buyers with the farmers and eliminate the middlemen. This can be done if unnecessary restrictions and taxes on the former are removed. The government owns several large stores close to producer areas in the outstations. These should be given to large buyers to purchase and store the produce of the farmers. The farmers should be encouraged to enter into forward contracts and the government should underwrite them so that farmers will not default when market prices go against them. State buying organizations for paddy have failed over the years due to corruption.    It is better for the State to co-opt the private sector buying organizations.

Price ceilings (on, say, red onions ) cause the quantities of red onions that buyers want to buy to be higher than the quantities that sellers are willing to sell; the result is a shortage. Queues then form outside the CWE and street urchins stand in to buy for traders. Price controls spawn black markets and the black market prices are above not only the state-mandated maximum, but above what would be the high market price in the absence of price controls. Prices set on markets reflect underlying economic realities; price controls – such as price ceilings and minimum wages imposed statutorily – are government mandates that force prices to lie above underlying economic realities. Rather than lower the cost and increase the availability of goods, they actually raise the cost and decrease their availability by sending out false reports about the true state of the availability and value of the good subject to price control. Imposing a price ceiling on food doesn’t just make food cheaper.

Producer subsidies

Many people believe that locally produced goods should be protected from similar imported goods. But what does it mean? Apart from the case of dumping there is no case to stop or penalize imported goods which compete with local goods because the benefit is to the consumer for it raises his standard of living. We went through the import substitution phase in the 1960s and early 1970s.  J.R had to open the economy to bring down the cost of living in the 1970s.

There is still talk about producer subsidies. Government subsidies, of course, can enable some producers to remain in business by covering losses they incur when selling at prices low enough to compete with others including importers.  But subsidies do absolutely nothing to reduce the quantities of resources required as inputs.  Subsidies at best can only shift the burden of bearing many of these high costs from farmers and their customers to taxpayers. 

Marxist errors

Marxists are still popular in our society despite the manifest failure of Communism. Capitalism is supposed to impoverish the poor working class. Has it happened? Yet capitalism has been around for more than 200 years and the living standards of the masses have skyrocketed – arguably by more than the living standards of the rich.  Salvation from starvation and moving into dwellings with hard floors and solid roofs (rather than sleeping on straw and dirt beneath rat infested and highly inflammable thatched roofs) is a visible improvement in the living standards of our villagers. Let us teach modern liberal economics in our State universities to rescue the youth from false doctrines. The new Minister Rajva Wijesinha should get American professors to redraw the economics curriculum.
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