Current economic and financial crises



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Usvatte-aratchi


From troubles of the world I turn to ducks- Beautiful comical things sleeping or curled….


I think God must have smiled a bit- Seeing those bright eyes blink on the day he fashioned it. (F.W.Harvey, 1919)


Much is being written on these crises and more talked about. Most of these writings and talk rest on misunderstanding what goes on; some of them written to mislead the reader so that their political masters can gain power and they can gain high office in government. Others write out of confusion with no ulterior motives. The ‘noise’ coming out of this din confuses the average reader. I want to try to suppress that noise and explain briefly the many crises from which we need to come out and discuss, in the most preliminary fashion, probable paths out of the crises.


We produce annually a certain amount of resources: goods and services. We have for more than 60 years used more resources than we produced either by drawing on what we had stored from previous years or more commonly by gaining access to resources from other economies and countries. We have access to resources of other economies when they invest here (FDI), make grants or lend money to our economy. The incontestable evidence is in the volume of foreign debt, that you are now familiar with. As we have no savings, and if, for whatever reasons, other countries, including the private sector there, do not want to give us resources, we are in an economic crisis that will spawn other crises. That is what the impending disaster is all about, about which all of us are agitated. Now whether you are Marxist, Stalinist, Maoist, liberal or neo-liberal in your understanding of the world this fundamental relationship you cannot deny without going astray in your understanding of the several crises that we are victims of.


Consequently when other countries demand too high a price to give us resources, we are in a balance of payments and foreign exchange crises. Our currency will fall in value, with an impending rise in prices. Unless we eliminate the fundamental problem that we cease to depend on resources from other economies, we will go the way of Zimbabwe and now Venezuela. The only way a solution will emerge in the short run, sans generosity on the part of the international community, is austerity, no matter who governs. And as austerity is a dirty word here, and the public will probably not tolerate such policies, tyrannical rule, which can enforce acceptance, is what many people, including members of bhikkhu sangha seem to approve of. Madeline Albright, in a book published earlier this year, cogently argues that that was how Fascism and Nazism came to rule in Italy and Germany. If statesmen at the Versailles Conference in1920 had but understood this danger, which John Maynard Keynes so clearly saw and strove so hard in vain to seek acceptance, the world may have been spared the horrors of Fascism and Nazism.


The emergence of the crises


Weaving all kinds of fancy stories, spokesmen for government and for the opposition create only obfuscation. The foreign debt crisis, the exchange rate crisis and the balance of payments crisis all have their roots in our persistent practice of spending more than we produce. Nestled within these three crises are two others which are domestic: a public finance crisis and domestic price stability crisis. Government which is responsible for paying back most of the foreign debt of the nation has to have rupees with which to buy the foreign exchange. To do that government must have a surplus of government revenue over and above what it spends domestically. To achieve that surplus government must raise taxes, because it is virtually impossible to cut down expenditure. It is irresponsible for the opposition in Parliament to tell us that they have a plan outside these considerations because there is none.


If the fundamental cause of the crises (causa causans) was spending more resources than our economy produced, the cure is producing more than we use and pay the surplus to reduce and eventually eliminate debt.


China during the last many years never used more resources than they produced. Households consumed about 60 percent of their disposable income and saved about 40 percent. Government ran current account deficits of about two percent of GDP. A good part of the balance was invested in China in grand infrastructure projects, in factories and farms, in buying up corporations and other assets in rich countries and technology and many other real assets. That part of total domestic output that was not consumed or invested at home was exported. By exporting mostly to rich countries more than it imported from rich countries, they earned an exports surplus.


The current account balance in the balance of payments was US $ 189 million in 2013, $278 billion in 2015 and $262 billion in 2017. Some good part of the high savings was in exports. The trade balance in China was US$ 259 billion in 2013 and U$ 519 billion in 2017, all positive. The savings that were not invested at home or abroad was used to buy foreign financial assets. That is how China amassed $5 trillion in foreign financial assets, including foreign bonds and securities. So did many other wise nations, especially after the 1997-1998 Asian currency crises. (GDP at [purchasing power parity prices] per capita in China, grew tenfold since 1990.) Japan, South Korea, Malaysia, Singapore and Norway all created Sovereign Wealth Funds which add up to several trillion US dollars. Less sagacious nations behaved as we did and here we are in a thick stinking soup.


Contrast that experience with


that in Sri Lanka


There is no comparable series of GDP data for Sri Lanka. There are no estimates of GDP at constant factor cost prices. In the Central Bank Annual Report, there are figures of the estimates of ‘changes in real output’, without adequate information on what precisely is being measured. It is unlikely that we can present good estimates of long term growth. There are no estimates of GDP at Purchasing Power Parity prices, either. I don’t know the quality of data for China. However, there is a series of data on public foreign debt in Sri Lanka which is roughly correct.


Public foreign debt of Sri Lanka (Central Bank of Sri Lanka)


Even allowing for the fall in the value of the rupee, staggering growth as shown in the ratio of foreign debt to GDP- from 4 percent to 52 percent in 40 years - it is an indication of the profligacy and fiscal irresponsibility of all governments and evidence that even with these additional resources the economy could not grow fast enough to bring down the ratio of foreign debt to GDP. Most likely these extra resources were invested in bad projects or used for consumption. In either case fiscal resources were wasted. These follies were perpetrated not by one government but by all, some more lavishly than others.


A brief account of solutions


Then the fundamental problem now is for the entire economy to reduce total resources use and for government to produce a current account surplus year after year for many years - total revenue must exceed current expenditure. Tax revenue must rise and current expenditure must fall. There is another name for these programmes: austerity programmes. In addition to the requirement that the economy generate savings, it must also generate an export surplus with which to re-pay foreign debt. Some suggest that import controls can reduce imports and that the resulting ‘export surplus’ be used to pay back loans. Would it were that easy! Of total imports in 2016, as much as 51 percent was intermediate goods goods used to make other goods. The less of them in the economy, the lower total output, employment, higher imports (because with less fertilizer, lower rice production and higher imports of rice) and lower exports. For that purpose you need to cut down expenditure, in the short run and secure higher production and more of that higher production sold abroad or the increased production bringing about import substitution, consequent upon structural changes in a growing economy.


It is that excess of exports over imports that will give the economy the foreign exchange to pay debt overseas. It is that excess government revenue over government current expenditure that will provide savings for government to buy foreign exchange with which to pay back foreign debt. To do so, society and its agent government, need to undertake austerity programmes. Paying back foreign debt requires saving and more exports than imports, secured one way or another. In the same way as we borrowed and enjoyed a higher standard of living using other economies’ resources when we repay that debt we will suffer a lower standard of life. Austerity programmes are not something designed in hell (hala ahala visa) and served up to destroy people’s lives. It was not invented by the IMF or by some economists in Chicago.


In the short run there is no alternative. US in 2009 cut down lending to the private sector to get over the binge of over spending that it had indulged in. Then there is a litmus test that all policies, programmes, and measures must pass to be acceptable as contributions to finding solutions to these crises. That is whether they promote savings in both the private sector and government and whether they earn a surplus of exports (including remittances) over imports. Further, it is necessary to ensure that austerity programmes do not hit hard those in the lowest income categories


The most optimistic expectation, even the most fanciful, is that there would be massive gifts from the rest of the world. The most ambitious and successful instances of that nature were the Marshall Plan for Western Europe and the programme of economic assistance to Japan1946-1952 under General Douglas MacArthur, both designed and executed by US government at the conclusion of World War II. The whole of Western Europe and Japan lay ravaged by the war and the Marshall Plan worked so well to revive her that the ensuing 20 years became ‘the golden age of capitalism’, as one economist named it.


In our instance, that is pie in the sky, unless the new rivalry between China and US produces a rabbit from a hat. And it is not likely to come about without a heavy price too costly to bear. There are not too many assets that can be sold to foreigners and to use proceeds to repay foreign debt and under present conditions may have to be sold at giveaway prices. In any case, it may be politically suicidal for any government to do so. A second means of supplying resources from abroad is for people in surplus countries to directly invest in deficit countries. The investor will sell foreign exchange to the Central Bank for rupees to spend here. However, political and economic conditions in the deficit country will need to be attractive enough to attract such investments. Vietnam attracts about 100 times more foreign investment than Sri Lanka, which tells you that this is not a land where foreign entrepreneurs want to invest.


A probable solution is to re-schedule debt repayments, including obtaining lower interest costs. A consortium of countries and intergovernmental organizations must be called forth who will decide the terms on which re-scheduling can be done. Whatever other conditions will be imposed, cutting down total resource use will be one. Austerity will be a necessary condition. The borrowing country will use those funds to pay back existing loans. It will now have the same amount of foreign debt but with much longer periods of re-payment and at lower rates of interest.


That we have accumulated debt re-payable to foreigners has been a major problem that brought about the crisis in foreign exchange markets. Debt accumulation takes place when you cannot pay interest and capital on loans you had taken. That inability is a result of the use of borrowed resources in projects that do not yield incomes in time. Hambantota Port and Mattala Airport are good examples. In those circumstances you borrow to pay obligations incurred. And the volume of outstanding debt grows. You are in a debt trap. Unless governments take steps to reduce total demand you will be in default on your foreign debt. Greece recently avoided debt default by agreeing with the European Union to take austerity measures in return for a temporary transfer of resources to keep the depth of austerity bearable. Greece is on the mend now. That solution is available to most countries with IMF playing the role of EU.


A common policy prescription is import restrictions. It is very attractive; it is easy to implement; and it bears results in three or four months. Of total expenditure on imports in 2016, as much as 8.4 percent was on rice, lentils and medical and pharmaceutical products 3.4 %, in total 11.8% and that is a bit over 50% of all expenditure on consumer goods imports. These cannot be reduced without prolonged island wide protests. Of all imports, 78 percent consists of intermediate and investment goods including fuel, cement, fertilizer and machinery and equipment, limits on the import of which will cause much unemployment and of course fall in income.


It is important to keep in mind all this while that we have to earn foreign exchange by exporting goods and services. Disruption of production processes, brought about by a fall in the supply of intermediate and capital goods will directly reduce exports. As a friend of mine pointed out a few days ago, the purchasing power that went to buy imports will now chase domestic products raising prices of domestically produced goods and services. Another word for that process is inflation, which we saw recently in Zimbabwe and is now devastating the Venezuelan economy. Further, the rise in prices will apply to all exportables. Unless the currency devalues to more than compensate for the rise in domestic prices, the demand for exports will be diverted to other suppliers. As restrictions on imports will cut short supplies of intermediate products, output will fall, so will employment. We will have austerity without relief from any of the crises that we identified at the outset.


Another common remedy canvassed is that government should print money and create jobs, when employment and incomes are lost consequent upon loss of employment because intermediate goods are in short supply. Every thousand rupees of income result in the purchase of about Rs. 300 of imports. As a result, more expenditure generated by printing money results in more imports without necessarily adding to exports. But we set out to raise a surplus of exports over imports. So this choice is no solution to that problem.


Another crisis is the continued fall in the value of the rupee in foreign exchange markets. The rupee has been falling in value over the long term and more rapidly this year. The Central Bank has told us many times that the value of the rupee can be stabilized at some point because the Bank has foreign exchange. This is on the assumption that instability of the value of the rupee arises on account of trade. As we learnt in Thailand in 1997, it was capital flight that made the baht fall in value. If dealers find it necessary to flee from the market for the rupee, Rs.10 billion cannot plug the drain of capital.


In the week to October 17, $3.3 was lost from our reserves in capital fight and total reserves do not exceed $.10 billion! The Central Bank of Thailand sold $25 billion from its reserves but the fall in the value of the baht continued uninterrupted. This is more the case because there are now massive piles of Sovereign Wealth Funds looking for perches where the risk of losing value is least and safe returns high.


These are roughly the nature of crises, approximate reasons for their emergence and a summary of likely solutions, some implausible. Economists have an obligation put to right deficiencies in this account and present alternate paths, without charlatans leading uninstructed politicians astray.


 
 
 
 
 
 
 
 
 
 
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