Colombo, Economy, Politics and Governance

The Dead-End Formula of Neo-Liberal Economics

Although I teach economics at the University of Peradeniya for my bread and butter, I have been quite distant from the discipline for sometime and my readings on the subject has been quite limited to the two courses I teach at the university. My principal research work is on conflicts. Hence, it was not strange for people to call me oftentimes as a teacher attached to the Department of Politics. However, in the last three four months, I had to re-enter this interesting area of work as I was invited to make comments on two books, one in Sinhala (Sri Lanka Arthikaya edited by O G Dayarathna Banda et al) and one in English (Development and Conflict by Kumar Rupesinghe). I had to refresh my knowledge and do some additional readings in the course of my preparation to make these two presentations. More I read on the subject, more I got convinced on the ineffectiveness and the incorrectness of the economic policies proposed by neo-cons and the international trios, the IMF, the World Bank and the WTO. All successive Sri Lankan governments since 1977 adopted those incorrect policies. When I say ‘incorrect’ I mean not some elements of the policy package but the policy package in toto and its underlying theoretical premises. The policy package includes inter alia the followings:

  1. The government should adopt free trade regime with lower tariff rates: Annual Report of the Central Bank of Sri Lanka 2007 boasted that ‘[t]he depth of openness continued to remain high as reflected in the low average tariff rate of 4. 1 per cent in 2007.’
  2. The government should maintain lower budget deficit (something like 5% of the GDP) since the inflation is the main evil: Annual Report of the Central Bank of Sri Lanka 2007 lamented that the government managed to reduce the budget deficit to 7. 7 per centin 2007 it was not able to do it adequately because of many constraint beyond the control of the government;
  3. The government should liberalize both current and capital transactions of the balance of payments;
  4. The government should close down inefficient state enterprises;
  5. State enterprises should be privatized;
  6. Interest rate should be maintained at higher level in order to discourage wasteful investments;
  7. Labor market imperfections should be corrected. 

Of course some of these measures taken separately make sense. For example, Cuba reduced its budget deficit 3. 8% in recent years in order to counter inflationary tendencies although inflation may not be attributed only to budgetary policies. Leon Trotsky commenting on development policies of the USSR in the late 1920s and 1930s emphasized the prime importence of maintaining stable currency for development. However, the policy prescription of neo-liberals in its totality is absolutely flawed. The policy package is based on three principles and those three principles characterize the neo-liberal economic theory. The followings are the three principles:

  1. Free trade enhances economic growth and all economic activities tend to reach equilibrium through the operation of market. This is I called the Smithian Principle as the neo-classical writers attribute this view to Adam Smith and to his book, The Wealth of Nations. Although Smith means by free trade the absence of monopolies, neo-classicists do not put much emphasis on private monopolies.
  2. The countries engage in free trade get benefits if they produce least ineffective goods or in other words goods with comparative advantage. This is I called the Ricardian Principle.
  3. The governments are ineffective and government’s intervention in the economy invariable creates disequilibrium and adverse effects. This is I called Friedmanian Principle since Milton Friedman revived this anti-state perspective.  

From development perspective, all these three principles are theoretically incorrect, and not substantiated by contemporary experience and/or supported by historical data. However, this flawed theory supports the needs of the industrially-developed economies and benefits the world capital markets. This theory works well when an industrially developed country interacts with an industrially undeveloped country and contributes working invariably in favor of the former and against the latter. None of the present day industrially developed countries (England, the USA, Germany, Japan, and Australia) however adopted economic policies based on these three principles when those countries were in their early phase of industrialization. The countries such as South Korea was able to break the trap of underdevelopment in the 1960s and 1970s by consciously adopting economic polices that countered these three principles. If the countries that are under-developed adopt these polices and base their economic thinking above-mentioned three pillars of neo-liberal theory, those countries will fail to break the vicious circle of underdevelopment.  

Capitalistic growth needs specific social relations and structures (Karl Marx) within which the operation of the principle of increasing returns, technological change and synergy and cluster effects (Schumpeter) are made possible. The presence of market and availability of capital do not provide adequate basis for capitalistic growth as these two conditions by in themselves do not provide the basis for capitalistic growth. A country can develop if and only if it produces more commodities that encompass these three elements, namely, increasing returns, technological change and synergy and cluster effects. Free market and lower tariff structure do not help but rather hampers production of such commodities. No country in the world has developed without tariff barriers and protection for its infant industries that were characterized by increasing returns, technological change and synergies. Economic policies of 1977 are flawed not because of those policies reactivated internal market mechanisms by eliminating restrictions imposed by the dirigisme regime but because of those policies were detrimental to industries that are characterized by increasing returns, technological change and synergies. The whole exercise has been trade-based not production-based. It favors merchant capital not the production capital.  

Take the Sri Lankan case and its principal export products. The production of tea by nature is subject to diminishing returns, and the production process does not require constant technological changes to reduce the unit cost. Moreover, it has a very few synergies or cluster effects. One may argue, it is different in the case of garments. Up to certain point, the production of garments involves increasing returns and technological change. Since there are backward and forward linkages, it can possibly link with other production processes. Therefore, it was not incorrect to build such an industry at the early phase of development. But we have to keep two things in mind. Garment production depends still on an extensive use of labor and the sectors that can be mechanized are limited. Still one person needs for one sewing machine. So, Sri Lanka entered garment production when advanced capitalist countries gave up that industry because of the fact that it reached technological saturation point. When an industry reaches its technological saturation point, its market competitiveness depends on the availability of cheap labor. Hence, we do not compete with other garment producing countries in the world on the basis of technology but on the basis of the cost of labor the advantage that we are losing at increasing rate. The second factor is that no important steps were taken to advance synergy and cluster effect element when the garment industry made a progress in the last three decades. Countries that began with garment and textiles have gradually moved to technologically more advanced sectors with more synergy effects by producing goods that are characterized by increasing returns. Those success stories showed that those countries gave reasonable protection to those ‘infant’ industries even refusing the advice given by international organizations. Flying geese model explaining East Asian industrialization is good example for such successes. We have followed in the last two decades or so what is known in development discourse as dead-end model. There is no fundamental difference now between tea industry and garment industry.

The whole debate on GSP+ today signifies the flawed economic policies adopted by all the successive governments including the present one since 1977. The principal issue discourse on GSP + should pose is: Will Sri Lanka continue to follow the dead-end formula of the IMF, World Bank and the WTO or adopt a new formula that brought development in today’s advanced countries in the world?

It is better to follow what the developed countries did in the past rather that what they tell us to do today.     

The writer teaches political economy at the University of Peradeniya. E-mail: sumane_l [at] yahoo [dot] com

  • Geethu

    Who do you have as examples of countries NOT following neo-liberal economics?

    Cuba, Burma, North Korea, Venezuela, Zimbabwe.

    Mahinda Chinthanaya is based on turning back from neo-liberal policies so your wish may soon come true.

  • Very insightful. I agree that tey are flawed in totality…but not outright. I think the development of South East Asia and East Asia in particular are good examples of nations that have been cautious in shaping their economies. Sri Lanka has often veered into polar ends of economic thought…instead of striking a balance.

    Trying to make Sri Lanka competitive in this day and age is a herculean feat given how we’ve slumped since Independence.

  • aj

    “However, the policy prescription of neo-liberals in its totality is absolutely flawed.”

    How can you say this with a straight face? Most countries that have democrazy, rule of law, low inflation, low poverty haved so-called ‘neo-liberal’ framework. Neo-liberal is a label given by fascist, large-state, promoters of government action that supress the individual freedoms and competition. This was clearly Sri Lanka’s experience since 2004.

    People who oppose free trade automatically support inefficient domestic producers (local enterprenures who get fat on the poor consumers) and the collection of taxes to run governments. Why should local enterprenuers be given preference? All ‘developed’ countries with low inflation and low poverty have low tarriffs in general, though domestic lobby groups always try to push the prices up through taxation in order to preserve their own businesses/jobs.


    Government deficits are bad. Deficits give the government to spend beyond their means on questionable projects. Individuals, – you, me, a private company – will not spend money except on something that gives us a good return and in turn the country. The government on the other hand will spend on things that give politicians votes. These include government recruitment, subsidies and other vote buying techniques. Deficits means governemtn is taxing people, and it is not enough and it is borrowing. These borrowings will have to be repaid out of the earnings of our children. Why should our children pay for political popularity through deficits?

    In Sri Lanka state enterprises run losses (financed by peoples taxes and inflation) and are run for the benefit of their workers rather than the people – their customers. Government workers get tax free salaries and pensions. They get inflation protected salaries. More than half the taxes are now spent on salaries. Government workers also get tax free cars. Politicians get tax free cars and pensions after five years. So do at least five of their lackeys (personal staff), usually a politicians wife is appointed to a position to get the benefit.

    This is not soviet or leftist justice. This is a feudal system of patronage and living off the taxes and inflation of the poor by the creation of super citizens. Government and its workers through a clever rhetoric that basterdizes individual hard work, private enterprise (no shame in private enterprise of ordinary citizens) who pay taxes, working in cohort with those elements of local enterprise who fear foreign competition (oppose free trade)and like to perpetuate fiefdoms created through barring foreign producers.

    Inflation is a result of deficit spending and controlling interest rates through central bank activity. Interest rates are controlled through printing money. This causes inflation to go up.

    Central banking manipulates interest rates through printing money and gets everyone in trouble. This is neither ‘capitalist’ nor neo liberal. This is the very opposite of what was said by people like Ricardo who has been criticized in the article. It never ceases to amaze me how poeple will put faith in politicians and governments against their own fellow citizens in productive sectors who work hard producing real goods and services.

    Modern governments run on taxes and inflation through money supply created by nothing other than treasury bills, taxing people, especially old peoples savings through low interests brought about by money printing.

    Such dastardly legalized crimes of the state are justified through the rhetoric against various percieved or otherwise labels, neo con or whatever. Why is this that politicians advocacy groups, and what goes for so-called leftists come up with these labels.

    Markets are practical reality. Market forces are the same. There is no emotion, good or bad. If governments manipulate markets invariably the poor will suffer. a governmetn that manipulate money and credit markets to create inflation and steal from the poorest of the poor and old peoples savings has no right to talk of social justice.

    that is why big governmetns are bad. Governmetns were established to give what ordinary free citizens could not properly deliver, public goods like roads, law and order which needs taxation and collective contribution.

    Ordinary people should be left to run their lives the way they want not at the behest of people who think they know what to tell us to do with their money, to the extent that they will tax foreign goods in a bid to force normal people to buy what they think is right.

    A governmetn that cannot deliver, roads, law and order and tries to control free trade and restrict the right of an ordinary tax or inflation paying citizen to buy a good made by the cheapest producer is an absurdity.

    It is an absurdity in governance and cannot be held as an example to support the dubious glory of state or politically or ideologically based action that against the so-called label of neo-liberalism and other labels that are brought from time to time to justify increased goverment actions against the rights and freedoms of ordinary citizens outside state patronage.

  • Amali

    Good opening!
    But haven’t we heard enough of these stories about how Sri Lanka became a ‘[t]ale of missed opportunities’, falling from grace? And can somebody tell me whether our policy makers have ever been really concerned about the principles behind policies they implement? I think they just be ‘liberal’, ‘socialist’ and ‘moderate’ to fit with the vogue.

    To drive policies which suit us, at our interest is difficult when big brothers try to discipline us and we’re demanded to be sensitive to others’ sensitivities. For example look at how India threatens. With the given circumstances (all these debts to the Twins, and to all the other places you can name) coupled with our short sighted policy makers whose knowledge is limited to form ‘flying ministers model’, I think there’s no other alternative than to continue with dead-end policies and go to hell!!!

  • Shocked

    Am I the only one who is shocked that someone who teaches economics at university level is, by his own admission, “distant from the discipline for sometime and my readings on the subject has been quite limited to the two courses I teach.”
    It shows.

  • Ekcol

    Why do you teach a subject in which you have no interest to contribute, review or expand your knowledge? You are short changing your students. But I admire your honesty which I am sure would spur you to learn more. I know many SL university teachers’s knowledge of their subject is as old as the date of their Ph.D. or less, but they puch in the clock and somehow become professors!

    Your observation that the tea industry and the “Garment Industry” are dead-end models is accurate. SL’s garment industry is really not a real garment industry. It is a tailor industry. They do not design garments or weave the clothes. All material inputs are imported and the product exported to countries that give quotas to keep the cheap production going.

    I remember Srimavo and her leftists who sold their souls to become Ministers banned and restricted imports of vehicles. Some clever entrepreneurs imported parts of whole cars and tried to assemble cars. Instead of encouraging assembling of vehicles, for which the talent was there then, and is there now, they banned the imports of parts for whole cars to restrict production of cars. This is well before South Korea or even India started exporting cars. If not for state interference, SL would now have a vehicle manufacturing industry, instead of Tailoring Industry.” Yes it was a missed opportunity.

  • disgusted

    What is the problem with the tailoring industry? Why should we pollute Sri Lanka with a manufacturing industry of textiles if we can import textiles and have better quality jobs higher up the value chain?

    Do you think the quality of life of a textile factory worker who is messing around with dangerous chemicals day in and day out is better than that of a machine operator or a cutter? Do you think a chinese factory worker gets a better salary than one of our garment factory girls, especially those who work the specialized machinery in a lingerie factory?

    Also do you think that it was better for village girls to come to Colombo and serve as domestic aides to people in Colombo at houses of thos who preach against liberal economics neo or other-wise? Village girls slaved 7 days a week in houses in colombo and elsewhere got up at the crack of dawn and went to sleep late at night after the ‘hamus’ who preach against private enterprise and well as those who engage in private enterprise went to bed.

    Sometimes the girls also had to go to bed with them. We have read enough in newspapers about such cases. And that must be the tip of the ice-berg.

    The so-called ‘tailoring industry’ changed the lifelstyles of the hundreds of thousands of young women rescued them from drudgery of ‘house-maiding’ and gave them a 9-5 job or overtime if not.

    They got a day (or two) off a week, a provindent fund, however imperfect it was, it was better than than the drudgery of being a domesic aide in Sri Lanka.

    Even now millions of girls are going out of the country to be housemaids abroads. If we had good jobs for them here even courtesy of “The Dead-End Formula of Neo-Liberal Economics” they would be here with their families.

    Assembling cars is just tax arbitrage. Knocked-down cars are taxed lightly vs fully constructed ones. It makes economic sense to assemble cars because the government taxes fully built cars heavily. Any profits the assembler makes is due to tax losses made by the government. It is just an arbitrage game.

    I am not blaming the assembler for making use of the opportunity.

    May be it it is not a bad thing if some hardworking chap gets a car at a cheaper price, even if the hated capitalist assembler makes millions off tax arbitraging and enjoying the protection of ‘non neo liberal economics’ government policy of heavy taxation of the citizenry.

    Are cars only a perk to be enjoyed by non-tax paying government workers who preach “The Dead-End Formula of Neo-Liberal Economics” and live off the taxes of the ordinary people who have to work hard and pay taxes and have no chance of enjoying the perks of tax free cars?

    Don’t make us laugh.

  • Shy

    Agree with Sumane to a certain extent, But I think we need to put things into perspective, more. How about politics? How about already prevalied clientelist state strucutre on which neo liberal economy was introduced. Works of Simona Piottoni ( clientalism) and Mirielle Grindle ( political economy)would be useful to understand the economic and social ( conflict) trajectories produced as a result of juxtaposing of neo liberal economic ethos and democracy deficit in Sri Lanka.

  • WTO

    I agree with Disgusted. The dearth of servants is a real problem. It is always difficult to find good ones but now finding any servant at all is a problem-because alternatives have opened up.

    Most girls see domestic service as low status and prefer to work in a factory or office, never mind the savings on board and lodging that go with domestic service. Now almost the only source of servants are the tea estates-tea plucking seems to be the only job lower in status (or perhaps it’s the easier work that attracts them) to domestic service.

    I personally know a friend who employs a servant – but they have to go through the pretence of employing her in his brother’s laundry business so that she can save face at the village.

    When there was no choice they were quite happy to accept domestic service and choice is what neo-liberal economics has brought these people.

    The whole edifice of Marxism is constructed on an unrealistic assumption of human nature – that men are naturally cooperative and will sacrifice personal gain for the betterment of the community. This is never explicitly stated anywhere but for Marxism to work in practice this is what is necessary. This is why it had to be imposed, by force through dictatorship in China, Eastern Europe and elsewhere. And this is also why it proved to be unsustainable. The remaining countries that practise it are all failures in one sense or another: North Korea, Cuba, etc.

    Trade happens only if it benefits both parties: otherwise it simply will not take place. If we did not trade each family would have to forage for its food, teach its young, heal its sick and bury its dead. Specialisation and trade is what allows it to be otherwise and international trade is no different from domestic trade.

    Marxism has lost its support in most areas because it is seen to be failure; however fine its ideals might be it cannot deliver. The only remaining proponents of this doctrine are to found in the guise of anti-globalisation groups, which trumpet the same agenda under a different name.