COVID-19: Policy Changes and Lessons | Daily News


 

COVID-19: Policy Changes and Lessons

The Colombo Port, the import-export lifeline.
The Colombo Port, the import-export lifeline.

Economic issues surfaced recently and aftermath of COVID-19 pandemic have now forced the Government to introduce import controls deviating from so far followed unrestricted trade policies. But many are not in favour of this policy change thinking that liberalized trade policies are superior to the earlier followed control policies.

However, past experience shows that the country has failed in achieving the expected performance in both policy eras mainly because of the shortcomings in policy executions. Therefore, in the Sri Lankan context, we cannot conclude that liberalized trade policies are conclusively better than control policies. However, at this present economic crisis, the Government has no alternative but to select import control policies to be followed at least the economy can get the balance of payments situation improved while trying to solve other major issues efficiently. In this background, what is needed is to formulate policy guidance by getting the experience we had from the beginning into consideration and effectively putting them into practice. Therefore, this article attempts to trace the history of introducing controls, evaluate the success of their implementation, reasons for replacing controlled policies with liberalized strategies and appraise the level of achievement of these latter policies.

Background

Many are of the opinion that the impact of COVID-19 on world economies is much more serious and prompter than that of great depression experienced from the late 1920s to the end of the 1930s, during which aggregate demand for goods and services in almost all the countries dropped, factories had to be closed down, unemployment increased even up to 25 percent of labour force. To get rid of these long felt issues, countries tried to restrict their imports as much as possible and promote exports competitively with each other, but in that, all countries failed in their efforts for a period more than a decade. This phenomenon directed to look questionably at liberal trade policies hitherto followed, and this forced economists to develop an alternative economic approach to get rid of the great depression.

In this background, John Maynard Keynes in Britain put forward an alternative economic approach known as General Theory or Keynesian Theory in 1936. This theory was emphasized to follow more Government involved economic activities rather than depending on market forces to adjust the economy in a situation like excessive depression. As such, in the subsequent years, many countries adopted the Keynesian Theory and started believing more on following fiscal policies (budgetary policies) or increasing Government expenditure in economic activities. This trend could be seen in Sri Lanka as well, especially after the mid-1950s which was further speeded up on account of emerging of increasing balance of payment difficulties and the past depletion of country’s foreign reserves by the late 1950s. In this setting, the Government started following a policy of restricting or completely prohibiting imports into the country and following an import substitution trade policy. Accordingly, 1957/1958 budget raised the duty rate by 100 percent on some consumer luxuries while reducing import duties on capital equipment and raw materials with the view to diversify the classical export economy by promoting industries which so far could not show a considerable growth.

Inward-looking Policy

In this setting, the Ten Year Plan (1959-1968) argued that if Ceylon were to pursue industrialization on a substantial scale there would appear to be no alternative but to initiate a serious and effective policy of protection. The Planning Secretariat (1957) showed that the local market was sufficiently large enough for industrialization via import replacement, and emphasized that such a policy of protection would have to go beyond the familiar ‘infant’ industry argument. For some commentators the developing strategy chosen in this manner to industrialize the economy was a ‘forced’ Import Substitution Industrial (ISI) Strategy, depending on the then prevalent ideological bias in developing economic thinking.

In the ensuing years, particularly from early 1960s to 1964, more rigorous steps were taken to curb imports in addition to imposing higher import duties. In this setting, the private sector producers responded well to the strong ‘sellers’ market created by these restrictions. The public sector industries too expanded in this era. However, a majority of these industries depended on imported raw materials and intermediate goods. But even importation of industrial raw materials and intermediary goods had to be drastically curtailed in the subsequent years on account of further increasing of balance of payments difficulties, leaving increasingly unused industrial capacity in already set up factories. As such supply side constraints highly restricted the capacity utilization of these IS Industries. As a result, Sri Lanka could not reach even the ‘easy import-substitution phase’ that required meeting at least domestic demand in textiles, footwear, food processing and producing other light- labour incentive products. Also, as expected, the ISI could not be geared to produce for exports (Athukorala, 1997).

Then, the new Government came to power in 1965; changed the trade policy to follow a partial liberalization with a view to enhancing the supply of raw materials and other inputs for industry from foreign sources which, to some extent, became successful and led to increase industrial output compared to that of earlier period. Afterward, showing that liberalization efforts carried out from 1965 to 1970 was a ‘wasteful’ experiment. The new Government which came to power in 1970 took actions to reverse the partial liberalization and returned to a stringent ISI strategy with greater direct Government involvements, and imposition of rigorous controls and establishing tariff and non-tariff barriers at higher levels than the 1960 - 1964 regime (Rajapathirana, 1988). However, decline in the manufacturing sector’s share in GDP from 16.7 percent in 1970 to 14.7 percent in 1977 proved the failure of IS industrialization in this period.

Shortcomings

Some researchers such as Patabendige (2006), Rajapatirana (2004), Authukorala and Jayasuriya (1996) and Karunatilake (1987) in their various documents on the areas of trade policies and industrialization, have identified a number of shortcomings appeared when following ISI policies before 1977, and some of them can be highlighted here as follows;

1. Within the pre 1977 ISI policy era, the Government did not have a carefully planned and clearly defined industrial approval policy. As such, import-substitution industries from the beginning in that era led to misdirection scarce resources and pushed the economy into a deeper crisis. Whereas one or two industrial units would have been sufficient to meet a certain requirement of the domestic market, several firms were given approval to produce those requirements, creating a ‘premature widening’ of its industrial structure with a larger number of small, relatively inefficient, high cost firms serving a small domestic market, which were unable to take the advantage of economies of scale.

2. One of the major objectives of adopting the ISI strategy was to lessen the foreign currency expenditure of the country and thereby solving the persistent deficit in balance of payments. But, in actual practice, ISI worsened the foreign reserve situation of the economy. Although, ISI reduced foreign exchange expenditure on final consumer goods significantly, it outweighed foreign exchange expenditure on import of raw materials, intermediate goods and capital goods.

3. Another key objective of ISI was lessening unemployment prevailed in the country at that time. But IS industries failed to do so as evidenced by the highest rate of unemployment being recorded during this period. Most of the Government budgets presented in this era were used to offer a large number of incentives to investors with a view to promote industrialization which included granting tax concessions, accelerated depreciation allowances, tax holidays, and charging no tariffs or lower level of tariffs for importation of machineries. Further, credit rationing at artificially low interest rates and having overvalued real exchange rates too encouraged choosing capital intensive technologies creating over capacities of many industries and underutilization of industrial capacities due to scarcity of foreign reserves to import raw materials and intermediate goods. All these trends restricted employment generation considerably. For instance, the rate of unemployment in the heyday of following this policy in such years as 1971 was 15.6percent while it was 24.0percent of labour force in 1973.

4. Moreover, strategies followed in this era such as high taxes, prohibition of repatriation of dividends, increasing uncertainty in the economy, imposing tuff labour laws Such as Termination of Employment of Workmen Act (TEWA) 1971 and the trend of increasing nationalization highly discouraged the inflow of foreign capital (FDI) during this period.

5. Even traditional exports such as tea, rubber and coconut too failed to earn a sufficient amount of foreign currency in this period. Also, a highly protected domestic market created in this period favoured producing for the local market than producing for exports. As a result, manufacturing products under ISI could not penetrate the export market in order to reduce the manufacturing sector’s dependence on the fortunes of structurally weak traditional export sector. As such, a limit was set on the growth of industry in Sri Lanka by the B/P difficulties well before the completion of the easy phase of ISI.

6. Small and medium enterprises sprang up in large numbers to produce various products to the local market as infant industries in this period. But their failure rate was also very high and they did not have a vision or ability to expand their businesses or going beyond infant status and remained continuously as toddler producers. But, no attention was paid to put them into correct path.

7. Also, import-substitution industrialists, particularly small scale producers very often produced inferior quality products. Products produced for the local market did not face effective competition since high quality foreign goods were totally banned. As such, in this era, producers enjoyed a sellers’ market where they could earn high profit by selling inferior and adulterated products. For example, jaggery was produced by mixing with termite mound clay, chili powder was produced by mixing with brick dust, and black paper was mixed with papaya seeds by some unscrupulous producers and sellers (Abeyratna, 2019).

8. Consumers’ queues were frequent at co-operative shops and selling outlets of Government factories whereas other traders did not have sufficient stocks to trade. Also, the black market exploited consumers.

An Outward Looking Policy

Many countries starting from the early 1950s practiced more controlled policies due to a number of reasons. For example, almost all the South-Asian countries followed such inward looking policies and tried to make their countries industrially developed by following import-substitution industrialization considering the public sector as the engine of growth. But, performance of these countries was weaker compared to that of some East Asian countries which followed outward-looking policies. Accordingly, during the first half of the 1970-decade average growth rate of Bangladesh was 3.6 per cent, Myanmar 2.5 per cent, India 2.5 per cent, in Pakistan, it was 4.5 per cent while Sri Lanka reported only 2.9 per cent of average growth (Kelegama, 1991). But East Asian economies such as South Korea, Taiwan, Singapore, and Hong Kong which were known as ‘Tigers’ at that time and also considered as Newly Industrialized Countries (NICs) experienced superior economic growth around 10 per cent for an extended period of time by following more outward and somewhat liberal trade policies and producing for foreign markets. Thus, on one hand, having realized the implication of controls and restrictions by following inward-looking policies, and on the other hand, having seen the spectacular development achieved by NICs through following more open economic policies, Sri Lanka too started implementing more liberalized economic policies from 1977 onwards. Thus, as pointed out by Kruger (1995) the outward-oriented trade strategy for these countries became a sine qua non to acquire a type of rapid growth commensurate to the growth experienced by East-Asian Economies.

According to Vidanapathirana (1991) the main objectives of the 1977 liberalization policy included

a) attaining a higher level of economic performance through channeling resources more towards the export sector,

b) gaining a progressive improvement in the balance of payments by diversifying the economy and

c) generating greater employment and income opportunities for growing population, and

d) ensuring a more equitable distribution of income and improving the physical quality of life of the people. To achieve these objectives a prominent place was given to the private sector by removing the monopoly powers hitherto enjoyed by the public sector organizations and as such, the private sector was considered as the engine of growth from 1977 until the Covid -19 pandemic surfaced suddenly and unexpectedly.

Under the open economic policies introduced after 1977 the country could acquire a higher growth especially in initial years up to early 1980s and subsequently it was tapering away to a somewhat lower rate. However, most of the years it was, about 5 percent GNP growth until 2015. In this era, employment generation also increased along with achieving some structural diversification. However, compared to the level of development achieved by other countries by following similar policies in the region Sri Lanka is noticeably lagging behind. The export structure could not be diversified as expected, and it is still dominated by export earnings of low value-added products. Although the unemployment problem was reduced over the years under this era anecdotal evidence shows that especially after 2015 onwards it has become more acute than indicated by the official data. The employment share of the formal economy (including the formal private sector as the major subdivision) has reduced while that of informal sector has increased showing a labour market deterioration (Patabendige. 2006). These results imply that even before the outbreak of Covid-19 the private sector led economy has failed to show the expected results in several aspects. These failures show the fact that what is important is putting whatever the selected trade policy into correct and efficient practice. The Cambridge University Professor Ha-Joon Chang shows that even now developed industrial countries started developing their industries imposing restrictions for competitors’ products not allowing to come to their countries and now these developed countries are preaching for others to follow free trade policies. According to Chang this is like kicking away the ladder for the other countries not to reach this top level. Also, East-Asian Four Tigers fist started their industrialization by following an import-substitution industrial strategy and very soon they became successful to convert their countries to produce high value added products for the export market although Sri Lanka is still mainly involved in exporting low value added products such as garments even after following more than four decades of open economic policies. As such what matters is how efficient a particular selected trade policy has been put into practice rather than favoring a particular one to be selected.

Pandemic and Way forward

The Covid-19 pandemic starting from March 2020 spread among all the countries within a few weeks forcing them virtually to lock down and stop all the activities including, production, transportation, trading, travelling, social interactions, engaging in employment, sending children to schools etc. while confining all persons to their homes.

In this background, the Sri Lankan Government has chosen to shift from following liberal trade policies to make the country self-sufficient by controlling unessential imports. This policy change has been advocated not only owing to the situation created by Covid-19 pandemic but also helping to ease the economic difficulties surfaced in the recent past. As such, now, it seems that the Government is going to implement import controls at least until the country can build up a stable level of foreign reserves, at least around US$15 billion (Cabraal, 2020).

Nevertheless, some economists and various commentators are not in favour of the country’s going back to embrace inward looking policies as indicated by some of the recently published newspaper articles under such headings as ‘Return to IS won’t deliver a rapid growth’, ‘The Myth; Self Sufficiency Guarantees Food Security’ etc. Accordingly, their policy recommendation is to follow outward looking policies practiced before the outbreak of the pandemic. However, in a situation of rapidly depleting foreign reserves of the country, breaking down of the export trade, collapsing of the tourist industry, dropping remittances from foreign workers and accumulating a huge foreign debt to be paid back immediately, the country is heading to face a severe balance of payments difficulty very soon. In such a setting, the Government has no alternative left other than restricting or stopping unessential imports turning to practice inward-looking policies to some extent although these policies have been already rejected by many countries.

Therefore, in this background, on one hand, it is prudent to examine strategies being currently followed by other similar countries, and on the other, to examine how we performed in both in the pre-1977 period and the post-reform period until the Covid-19 Pandemic surfaced. As such, policy makers should develop a comprehensive plan not only by looking at how other countries are trying to get rid of these current issues but also by looking at our past experience and how much we were efficient in implementation of our past trade strategies under both looking inwards and looking outward trade policies.

However, our normal practice is showing some interest in making plans, but not taking a considerable effort for implementation. This practice can be noticed starting from the first plan to the last one we had. For instance, in this respect, our first planning attempt was formulating the First 6 Year Plan (1947-53), then, The Six Year Investment Programme (1954-60), next, Ten Year Plan (1959-68), after that Five Year Plan (1972-76), Mahinda Chinthana and Vision 2025. But it seems that there were no effective operational efforts taken to implement these plans and as a result, now they have become only bygone policy documents. Therefore, at least now onwards, we should deviate from this bad practice. Anyhow, still we cannot see that our policymakers and planning authorities have developed such comprehensive thinking and policy formulation to face this problem. Instead, what is currently noticeable is that persons attached to some Government institutions and authorities talk of taking some actions to be consistent with the Government’s generally declared policy of import substitution which will not be sufficient enough.

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