Pathfinder Foundation response to Collective for Economic Democratisation
Daily Mirror
15 Jul 2015

The Pathfinder Foundation (PF) appreciates the Collective for Economic Democratisation’s (CED) response (Daily Mirror 2015-07-10) to its rejoinder (Daily Mirror 2015-06-30) in the spirit of welcoming a much-needed discussion on economic reforms. It also gives the PF an opportunity to provide further clarification on some important issues.

At the outset, the PF would like to emphasise, contrary to the CED assertions, that it supports social justice and consultative economic decision-making. However, this should be done in the context of market-friendly policies and ‘smart’ regulations. The state should address market failure and provide a robust social safety-net. Equality of opportunity should be created through a strong commitment to education, training and skills development and a meritocracy. In this regard, we would like to respond to what are, in our view, misrepresentations of some of our positions. To do this, we focus upon the themes addressed in the CED’s latest response.

Economic priorities and redistribution

The PF would like to reiterate that, despite the CED’s repeated claims, its blueprint for economic reform does not advocate a move away from universal provision of basic services, such as health and education. A distinction has to be made between basic services and the social safety-net. The PF has argued for the targeting of the latter. It contends that the existing scheme of subsidies and transfers needs to be better designed and targeted. Recent World Bank research has shown that these currently benefit the better-off disproportionately. There is no economic or social justification for a ‘universal safety-net.’ It needs to focus on those who need it. While there should be a strong commitment to universal basic services, a pragmatic approach should be adopted to public, private and mixed provision.

On taxation, the PF has consistently expressed concern about the government’s revenue performance and the regressive tax structure which is overly dependent on indirect taxes. Currently, revenue amounts to only 12 percent of gross domestic product (GDP), as highlighted by the CED. In its earlier writings, the PF has advocated that it should revert to the 20 percent of GDP attained in the past. A greater reliance on direct taxes, which are more progressive, should be a part of the efforts to improve revenue mobilization. As Nishan De Mel has pointed out in his constructive intervention, tax administration needs to be improved with a particular focus on addressing widespread tax avoidance.

On public expenditure, the PF has not at any point indicated that the overall level of public expenditure is too high. Instead, its focus has been on the unsustainable size of the budget deficit; the negative systemic effects of financing it; and the associated debt burden. If revenue reverts to 20 percent of GDP and the budget deficit is contained at a sustainable 3 percent - 4 percent of GDP, then public expenditure can be 23 percent - 24 percent of GDP. This would be higher than the figure recorded in 2014. So let us be clear that the PF is not advocating a reduction in the overall level of public expenditure as part of an ideological drive to reduce the size of government.

However, one must emphasise that it is not possible to get away from the ‘fiscal consolidation’ necessary to reduce the budget deficit to 3 percent - 4 percent of GDP in the medium-term. It was 6 percent in 2014 and is likely to be higher this year. There is a debate to be had on how one does this: the mix of revenue and expenditure measures. In the PF’s view, by advocating a greater reliance on direct taxes and a rigorous public expenditure review, based on clear priorities, it has been on the progressive side of this argument.

A move to a more progressive tax structure combined with a public expenditure review, which takes into account social objectives, serves to counter the CED claim that the PF has been advocating policies which are anti-poor. However, the PF is very much of the view that growth is crucial for generating the tax revenues necessary to fund basic services and the social safety-net. For instance, the Mahatma Gandhi National Rural Employment Guarantee Act and the Food Security Act could not have been implemented in India without accelerated growth a decade ago.

The CED’s point about the quality of public investment is well taken. The PF too has expressed concerns, in the past, about this and the rates of return on the investments undertaken. The public expenditure review should also address this. A robust system of screening projects on the basis of clear and transparent priorities is necessary.

Reform of labour laws

The CED has repeated its claim that the PF’s call for labour market reform constitutes an attack on the workers. This ignores the fact that the PF has sought to give a direct ‘voice for labour’ in the reform process by calling for a tripartite (business, labour and government) approach which balances the interests of both investors and workers. At present, there is the worst of all worlds: inflexible and archaic labour laws which disincentivise investment and good quality employment creation, as well as informal arrangements which reduce overall labour standards. The PF approach advocates a shift from a ‘de facto regime of flexibalisation’ (CED’s language) to more flexible labour laws (de jure) formulated through a consultative tripartite process. Buy-in from business, workers and government, through such a consultative process would also improve the prospects of implementation.

However, it is important to stress that there needs to be far greater awareness among all stakeholders of the nexus between wages, productivity and the business cycle. We live in a globalized world which places a high premium on competitiveness. In addition, Sri Lanka is a small country where autarchic policies yield disappointing outcomes, as we learnt in the 1970s. These are not facts that are going to change. In this context, wage increases, even good quality employment, are much more sustainable, if they are linked to productivity and a better understanding of the business cycle. The PF does not disregard the need for sharing the benefits of higher productivity between capital and labour. Responsible tripartite arrangements are needed to promote this and the development of a safety-net/re-training to protect workers affected by changes in market conditions. The whole culture of industrial relations needs to be more constructive. Germany provides an instructive template for achieving this. The current situation is unfavourable for both labour and capital. Labelling any attempt to improve the unsatisfactory status quo as an ‘assault’ on the workers, as CED does, is not helpful to those whose interests it seeks to promote.

The need to understand the central importance of increasing productivity has now become much more urgent for Sri Lanka. It has completed its ‘demographic transition’ (onset of ageing) before ‘economic transformation’. This is extremely unusual and makes things much more difficult for us. These pressures stem from the past failure to achieve a better balance between social development and wealth creation in our development process. Future growth will be far more dependent on productivity increases at a much earlier stage in the development process than is normal. As mentioned above, without growth and its positive impact on government revenue, it becomes much more difficult to finance basic services and the social safety-net.

Financialisation and crises

The PF reiterates that it has not called for capital account liberalisation. It is also for ‘smart regulation’.
The long-term debt (including mortgages) and pension markets can be developed without opening up to potentially destabilising short-term external portfolio flows. There should, however, be a role for more ‘sticky’ foreign direct investment (FDI).

The PF also believes that smart and robust regulatory capacity becomes even more important as financial and capital market development progresses. This serves to manage the risk/reward environment to reduce the risks of ‘financial shocks’. However, the PF reiterates its view that foregoing the benefits of capital and financial market development would result in lowering the potential growth in investment, employment and incomes. This would not be in the interest of those whose interests the CED seeks to promote. The debate should not be on whether or not capital and financial market development should take place. Instead, it should focus on what constitutes best practice in terms of smart regulation/safeguards needed for financial stability and consumer/small investor protection.

Need for new policies

The CED contends that the PF is advocating austerity policies which have failed elsewhere, notably in southern Europe. We have not been repeating the constant refrain of ‘living within our means’ from a blindly neo liberal perspective. Our view is that Sri Lanka needs to do this to create the enabling conditions (stable macroeconomic fundamentals) to maximise investment, create good quality employment and boost incomes for all the people of Sri Lanka.

Continued failure to do so would open the country up to domestic and external pressures which are detrimental to the poor and vulnerable, in particular. The eventual climb down of the Greek government is a good example of the pressures which can be applied on countries that lose control of public finances/debt. Sri Lanka should make every effort to avoid putting itself in such a position by learning to ‘live within its means’. This is a home truth which applies not just to countries but also to households and businesses.

Canada, in the 1990s, demonstrated that it is possible to have growth-oriented fiscal consolidation. It combined fiscal consolidation with an accommodating monetary policy (low interest rates), structural reforms to encourage private investment and depreciation of the currency to promote exports. The PF does not advocate a rigid adoption of these policies. However, the Canadian experience in the 1990s points to a framework which has relevance for Sri Lanka today. The actual policy mix should be customized to reflect specific domestic circumstances. The timing, pace and sequencing of reforms should be driven by the local context. However, it should not be forgotten that delay results in more painful austerity measures in the future. In this connection, one cannot get away from the need for greater fiscal discipline. A situation where over 90 percent of government revenue is absorbed by debt servicing (i.e. almost all other public expenditure, including health, education, welfare and public investment projects, is financed through borrowing) is fraught with danger.

The PF hopes that the focus will be on what it is actually advocating rather than on attempts to put it into one or other ‘ideological box’.