When the government presents Parliament with its 2007 budget next month, it is likely that one of the main areas of focus will be on the very large regional disparities in incomes that persist between Colombo and the Western Province on one hand, and much of the rest of the country, especially in rural areas. It has long been recognized that major differences in terms of economic opportunities exist within the country. However, several years ago when the Central Bank and the Department of Census and Statistic quantified the extent of the gap the regional disparities in poverty and levels of income, the issue seems to have taken on a greater urgency.

Most people would agree that no country is likely to remain politically stable or to prosper economically while allowing excessively large differences in economic conditions to continue unchecked. Indeed, there are many who would argue that addressing these disparities is (or ought to be) the most pressing economic issue facing Sri Lanka. It is therefore the case that the government’s budget and their proposed economic policies and programs are going to be judged in large part by their expected impact on creating an environment where those areas still largely untouched by economic development are able to begin to catch up.

The Nature of the Problem

When presenting the current year’s (2006) budget, the government recognized the problem. Their approach was largely focused on "the development of provincial and community level infrastructure facilities" – as part of what was termed a pro-poor budgetary framework. The proposed regional development infrastructure expenditures included programs for improved provincial roads, rural electrification and irrigation. About one-third of the regional development budget was to be aimed at the tsunami affected areas. It is, however, not clear how much progress has been made in any of these areas during the course of this year.

Significantly improving infrastructure throughout the country is undoubtedly an essential part of any solution. But it is only one part. The fact is that the country’s investment in basic infrastructure, including necessary maintenance, has been inadequate for many years. Massive sustained investments over years are going to be required to build a foundation capable of sustaining high rates of economic growth throughout the country. This will require a major change in priorities and in the ways in which such projects are implemented as well as substantial additional resources, particularly from the international community.

But the economic challenge facing the country goes far beyond overcoming shortcomings in infrastructure. The enormous disparities in economic conditions have not arisen by accident. They are to a very great degree a result of policies that have been pursued for many years; policies that have facilitated the growth and development in the Western Province while leaving much of the rest of the country behind.

It has to be recognized, however, that in almost all countries and at almost all times, major cities tend to grow and develop more rapidly than rural areas. There are important economic forces that bring people and resources together in cities and that make urban centers more productive and economically dynamic than rural areas. The process of economic development is very much a process of economic opportunities spreading outward to surrounding regions from rapidly growing cities. As Jane Jacobs, the highly respected urban planner argued, cities, not nations are the primary sources of economic development; nations are in many respects only "political and military entities" comprised of a number of very different types of economies. This is a picture that reflects very well the situation that prevails in Sri Lanka today.

But it is also the case that the economic policies that have been followed for many years have done much to exacerbate the income disparities between the more prosperous Western Province and the rest of the country. A central thrust of these policies has been to encourage many types of commercial activities that can only operate in or around Colombo, with its major port and its large local market. Businesses must locate where they can minimize their costs of production if they are to remain profitable and survive.

When trade policies seek to encourage activities intended to replace imported consumer goods, the businesses that emerge almost always find it necessary to be located near to the port through which imported raw materials arrive. They also find it necessary to be located relatively close to their largest market if they are to adequately control their transportation costs. And it continues to be the case that infrastructure services, such as electricity and water, tend to be much more readily available and reliable in the greater Colombo area than in rural areas.

In contrast to the policies that have generally favoured the types of activities with strong commercial reasons for operating in the Western Province, the policies that have determined the economic environment in rural areas have done much to limit the growth and development of agriculture and related activities that can prosper in rural areas. While actively helping urban oriented activities, the government has actually done much to impede the growth of rural oriented activities.

Agriculture is the essential foundation on which rural economic growth and development needed to raise rural incomes will depend. For this sector to begin to prosper there must be much greater opportunities for it to use the resources that are available in these areas more productively and more profitably. This means that farmers need to have the ability to more freely choose to produce crops with higher real value. It also means that greater scope for forming larger, more commercially viable farms that can better meet the demands of both local and export markets.

Longstanding government policies for agriculture have largely been based on trying to artificially increase farmers’ incomes by raising prices above market prices, whether through restrictions on imports or government purchasing schemes. Promises of higher farm-gate prices are often made, but rarely if ever fulfilled. These policies have also sought to reduce farmers’ costs through fertilizer subsidies, which also rarely have much of an impact on incomes. While these subsidies may be politically attractive, fertilizer is typically such a small part of a farmer’s total production costs that even if fertilizer were given at no cost, it would not substantially increase farm profitability.

But government policies aiming at achieving self-sufficiency in rice have probably done more to suppress rural incomes than any other factor. This has led to restrictions that make it very difficult for farmers to shift production to more profitable crops which could increase incomes. In pursuing these policies, the discipline of market forces has been disrupted, to the detriment of the sector. (For example, farmers are able to sell paddy to government buyers at fixed prices regardless of the quality.) The result has been an agricultural sector that is largely oriented to a highly protected, captive domestic market which has meant that there are limited incentives to improve quality and productivity, such as with better handling methods. It has also meant little is done to actively develop higher value export opportunities for which there is considerable untapped potential.

It should be evident after years of government attempts to fix higher prices and increase fertilizer subsidies that these are not long term solutions to the problem. Successful sustained agricultural development will require substantial restructuring of the sector, including removing restrictions on crops and land ownership that limit formation of larger, more productive and more profitable farms. In virtually all countries, economic growth and development has entailed a substantial transformation away from small, high cost farms to larger more competitive commercial farms. This transformation also inevitably means that far fewer people are engaged in agriculture, even as total agricultural production increases, which is why it is often politically sensitive.

Options for Raising Rural Incomes

The key to raising rural incomes and reducing the excessive disparities between the rural and urban areas lies in less not more government interference in farmers’ production decisions and the functioning of agricultural markets. Increasing prosperity in rural areas can come about only if the real value of what is produced increases substantially, (as opposed to artificially manipulated values).

Although politically difficult, there is a need to begin to move away from self-sufficiency in rice as the central pillar of the country’s agricultural policy. Now that this goal has nearly been reached, continuing with these policies will only make it more difficult for farmers to pursue other more profitable opportunities. If this means that more rice is imported while farmers expand production of more profitable crops, then consumers will be better off and rural incomes will increase.

The government does need to invest far more in infrastructure in rural areas, but this should be done in ways that are more consistent with a longer term vision of a more market oriented, more export oriented agricultural sector.

The upcoming budget offers an opportunity to provide indications of a genuine commitment to reduce poverty and address the issues arising from the sharp disparity in incomes. But this can be achieved only of usual promises concerning farm-gate prices, fertilizer subsidies and infrastructure plans are to a large extent replaced with fundamentally different policies and programs.