Economic Reforms Sri Lanka needs now

A view from independent economic development consultant

By Asita De Silva

The task ahead for Sri Lanka is to transform its economy from an inward-looking, public sector driven, debt dependent one into an export-driven, private sector-led economy that a broad share of the population can participate in and benefit from. A set of “structural” reforms based on global best practice can be undertaken unilaterally by Sri Lanka to begin to set its economy on this path without waiting for externally imposed “conditions”. Proactive steps in this direction can send strong positive signals to international creditors and development partners that Sri Lanka has a path to recovery, hasten the debt restructuring process, and unleash the potential of Sri Lanka’s economy to achieve rapid and sustainable economic growth that can improve the lives of all Sri Lankans.

At present, Sri Lanka’s economy is undermined and vulnerable to shocks from a range of underlying weaknesses, including limited growth potential due to its inward orientation; dependence on rolling over unsustainable levels of external debt; public expenditure dominated by debt service and maintenance of a unnecessarily large public sector that leaves inadequate room for investment in productive infrastructure and human capital; and suppressed potential of the private sector to create jobs and income-earning opportunities by unwarranted regulatory restrictions. As a result, Sri Lanka has seen continuous challenges in maintaining macroeconomic stability; is uncompetitive in the global economy; and has been unable to generate sufficient broad-based income-earning opportunities to substantially raise the living standards of all Sri Lankans. In the last few years, these weaknesses were aggravated by imprudent revenue and monetary policies that led to the current extreme crisis and hardships among the people. A basic reform agenda to address these underlying weaknesses and shift Sri Lanka to a sustainable economic growth path would comprise the following steps:Restore macroeconomic stability. Key measures would include (a) maintaining prudent monetary policies to contain inflation and ensure a stable, market-determined exchange rate; and (b) reducing the fiscal deficit and thereby the need for government borrowing by increasing government revenues through tax reform and reducing unnecessary government expenditures. Tax reform can involve broadening and simplifying the tax system rather than just increasing tax rates on a narrow tax base. Expenditures can be contained by reducing unnecessary or wasteful spending, such as on maintaining a large public sector or supporting loss-making state corporations, rather than by reducing essential expenditure on public infrastructure, health and education services, or the social safety net.

Remove unnecessary obstacles to private investment and business activity. A range of unnecessary rules, laws, licenses, permits, fees, documentation and other obstacles exist that inhibit private sector economic activity that can create employment and income earning opportunities. Steps are warranted to rationalize the regulatory environment so that it enables and encourages private sector investment and business activity while protecting core public interests. Increased private sector activity during the current crisis can help deliver basic goods and services; generate export earnings; maintain and increase employment; and expand income earning opportunities.

Enable market signals. A wide range of state directives distort market signals and mis-direct investment, including price controls, tariffs, subsidies, interest rate controls, and other state directions. Steps to remove these barriers to market signals are warranted in order to channel economic activity into the most efficient and competitive areas and thereby enhance the prospects of rapid, sustainable economic growth.Ensure a competitive environment. A range of sectors are dominated a single or a few public or private sector firms that undermine the benefits of a market-driven economy, such as lower prices, higher quality products, customer-orientation, and innovation. Efforts are warranted to ensure a competitive environment, dismantle monopolies, and identify and break up any cartel-like behavior.
Maintain and improve essential infrastructure to the extent possible. Within the constrained fiscal environment, priority may need to be placed on ensuring adequate basic infrastructure services that support increased economic activity, including reliable electricity, water, transport, and communication services. Some public infrastructure development can also serve as a safety net transfer measure through temporary employment generation.Ensure financial sector stability. Although the financial sector has been relatively well-performing to date, is likely to be under increasing stress in the current environment. Close monitoring and timely intervention may be warranted to avert major instability in the financial sector that can severe adverse implications for recovery of the economy.

Enhance the efficiency of the justice system to support economic activity. Continuing deficiencies exist in the capacity of the legal system to support strong private sector-led growth, including inefficient enforcement of contracts and resolution of insolvency. Steps are warranted to address these weaknesses and ensure that the legal system fully supports rapid growth in economic activities.Develop “smart” industrial policy. When markets are enabled, restrictions on private sector activity removed, and a level playing field established, then selective interventions to enable or encourage the development of specific industries might be considered. Such interventions need to have a clear rationale, be transparent, time-bound, and firm-specific rather than sector wide.
Enhance and target social safety net transfers. The current crisis requires a substantially enhanced safety net system to avert extreme deprivation among population. Given the need for prudent fiscal management, these transfers would need to be managed carefully. At present weaknesses exist in the safety net system, with benefits leaking to those not in need; many of those in need being left out; and the prevalence of untargeted measures such as subsidies and price controls that are inefficient and distort market signals. Use of modern technologies can improve the accuracy of targeting, reduce leakage, and reduce fraud. Steps to enhance the quality and efficiency of the safety net are therefore warranted, including through removal of indirect transfers such as untargeted subsidies and price controls in favor of direct cash transfers; and use modern technologies to identify, target, and transfer resources to the vulnerable population.

Begin reform of the higher education system. The higher education system represents a bottleneck to progress toward rapid economic growth. Limited opportunities deprive many young people of the ability to fulfill their potential and the commercial sector has little use for skills imparted by the system. Steps are warranted to broaden and expand access to higher education; enable private tertiary education provision; and improve the quality and relevance of tertiary education.

Begin reform the civil service to create a lean and dynamic public sector. As the current crisis has revealed, Sri Lanka cannot afford to maintain such a large public sector as the large wage bill increases the need for unsustainable government borrowing. Extensive public sector involvement in commercial activities and in regulating private sector activity also inhibits growth in private sector economic activity that can create employment and income earning opportunities. Steps are warranted to reduce the size of public sector and contain the wage bill; reorient the public sector toward objective-based management; and encourage a behavioral change in the public sector on enabling rather than obstructing private sector development and a market economy as best means to improve the lives of the people.
Inform the public of the costs they are bearing under the current economic structure to build a consensus on the direction of reforms. Reforms to change the structure of Sri Lanka’s economy offer the potential to create broad-based income-earning opportunities and improved living standards and are thereby in the best long term-interests of the people. The public can be informed of the costs and lost opportunities they are bearing under the current economic structure, including the costs of unnecessary regulations that benefit the few over the many; state directives that distort markets and suppress investment, exports, and job creation; and public funding of loss-making state enterprises that serve no essential public interest. Narrow vested interests in resisting change would also need to be systematically identified and overcome. Strategies would also need to be developed to systematically identify and overcome narrow vested interests in both the public and private sectors that will seek to resist and obstruct change.

The agenda above reflects global best practice in enabling a market economy to work to generate income earning opportunities for the population and supplementing this with public sector interventions to support human development and a social safety net. Proactive implementation of these measures will greatly enhance the prospects of a faster recovery and alleviation of the extreme hardships being endured by the people; support timely debt restructuring and access to international sources of finance; and set the country on the path to rapid, sustainable economic growth and improvement in the living standards of all Sri Lankans.
For further discussion of these issues, see: http://ardesilva.com/2022/06/07/slstrategy/Asita De Silva is an international development consultant, former staff member of the World Bank Group, and former executive at Hayley’s Group. The views expressed in this article are the writer’s own and do not reflect the views of any institution or agency.

The writer can be reached on asitadesilva11@gmail.com