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:
- 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.’
- 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;
- The government should liberalize both current and capital transactions of the balance of payments;
- The government should close down inefficient state enterprises;
- State enterprises should be privatized;
- Interest rate should be maintained at higher level in order to discourage wasteful investments;
- Labor market imperfections should be corrected.Â
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:
- 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.
- 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.
- 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. Â
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. Â
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. Â
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. Â Â Â Â
The writer teaches political economy at the University of Peradeniya. E-mail: sumane_l [at] yahoo [dot] com