SRI LANKA’S ECONOMIC QUAGMIRE AND HOW MARGRET THATCHER SMASHED THE KEYNESIAN CONSENSUS

SRI LANKA’S ECONOMIC QUAGMIRE AND HOW MARGRET THATCHER SMASHED THE KEYNESIAN CONSENSUS

27 July 2021 07:31 am

By Sanjeewa Jayaweera

For quite some time, experts in economics and finance not associated with any political party have been raising the red flag about the severe economic challenges that our country was facing. Unfortunately, the politicians have consistently ignored these challenges. Many in the private sector believed that commonsense would prevail and necessary course correction will occur, and the ship will sail smoothly.

I recently reminded a few of my former colleagues about how some of them rebuked me (in a friendly manner) five years ago when I asked the regional team of a large multinational bank, “Will Sri Lanka default on foreign debt like Greece?” My colleagues felt that I was unnecessarily pessimistic, although I thought I was a realist. Fortunately for me, one of the regional team members came to my defence and said that the scenario was not so outrageous as “Sri Lanka was not out of the woods.” That was five years ago.

Since then, a debilitating pandemic, along with a decision to reduce government revenue by around Rs. 600 billion due to various tax cuts has severely depleted government coffers. Moreover, the loss of foreign exchange earnings due to the country being closed for tourism has been a body blow. I, however, contend that our inability, or should I say struggle to meet the repayment of foreign debt, was always ever-present. The pandemic has just fast-forwarded it. The challenge for a country with an annual deficit of around USD 8 billion in merchandise trade having to repay USD 23 billion between 2021-2025 was always tricky. Moreover, our ability to raise additional foreign currency debt has been severely constrained as international rating agencies have continuously downgraded our ability to repay the debt.

Many have spoken and written articles recommending that the Government (GOSL) seek assistance from the International Monetary Fund (IMF). To many, other than rabid socialists, it is the most sensible of options, not that there are too many available. The GOSL, on the other hand, has articulated to neither the public, the private sector or the international creditors how they intend to avoid a possible sovereign default immediately as well as going up to 2025 whilst also ensuring that there is sufficient foreign exchange to facilitate imports.

 

Keynesian economics

One can only assume that those reposed with economic strategy and management under President Gotabaya Rajapaksa are disciples of Keynesian economic theory. Keynesian economic theory was developed by the British economist John Maynard Keynes during the 1930s. Keynes advocated increased government expenditures and lower taxes to stimulate demand and pull the global economy out of the depression.

Keynes argued that during periods of economic woe, the government should undertake deficit spending to make up for the decline in investment and boost consumer spending to stabilize aggregate demand. He rejected the idea that the economy would return to a natural state of equilibrium if left to market forces. Instead, he proposed that the government spend more money and cut taxes to turn a budget deficit, which would increase consumer demand, viz overall economic activity, and reduce unemployment. Thus, he believed the government was better positioned than market forces when creating a robust economy.

The critics of deficit spending say that if left unchecked, it could threaten economic growth. Too much debt could cause a government to raise taxes and even default on its debt. What’s more, the sale of government bonds could crowd out corporate and other private issuers, which might distort prices and interest rates in capital markets. Many who oppose Keynesian theories will now use Sri Lanka to illustrate how continuous deficit spending and funding with mountains of debt will ultimately lead to economic disaster.


Modern Monetary Theory

A new school of economic thought called Modern Monetary Theory (MMT) has taken up the fight on behalf of Keynesian deficit spending. It is gaining influence, particularly on the left of the political spectrum. Proponents of MMT argue that as long as inflation is contained, a country with its own currency doesn’t need to worry about accumulating too much debt through deficit spending because it can always print more money to pay for it. This is precisely what our Central Bank has been doing, one presumes at the behest of the GOSL.


How Margeret Thatcher smashed the Keynesian consensus

To understand what Margeret Thacher (MT) achieved in upending the Keynesian theory, one needs to understand the decade and a half before that. The 1960s and 70s was a time of unrivalled sociopolitical activism. In the USA, which had established itself as the leading superpower both from an economic and a military perspective, there were protests against the war in Vietnam whilst the civil rights movement gained significant traction after the death of Martin Luther King. Elsewhere particularly in western Europe, pop music, recreational drugs, a liberal view towards sex and the gay community gained wide acceptance. As a result, the 1960s is fondly referred to by many as the “swinging sixties!’

In the political arena, across the world, many socialist governments were voted into power. For example, in both the UK and West Germany, socialist governments held power for most of the 1960s and 1970s. These governments underpinned their political philosophy with the concept of the social welfare state and that capitalism was not desirable. However, the aftermath of the 1973 war between Israel and several middle eastern countries caused significant economic upheaval in many countries. The oil price increased by 400 per cent, and supply was constrained due to an embargo impacting the USA and Western European countries.

In the UK, a full-scale energy crisis loomed due to a combination of a limited supply of oil and an overtime ban by the coal miners to support a significant pay increase. As a result, the government declared a state of emergency. To conserve energy, industries were told to work only three days a week, and all national television stations were switched off at 10.30 p.m. In addition, students had to do their homework in the evenings by candlelight. The following year the conservative government paid the ultimate price by being rejected by the voters.

Emboldened trade unions resorting to industrial action caused many headaches to the government and a great deal of inconvenience to the public. In addition, due to rising inflation which peaked at 26 per cent, the unions demanded higher wages, resulting in higher unemployment as many companies were unable to afford such increases. It was indeed a vicious circle.

The despondency amongst the British public due to the poor economy and the actions of the militant trade unions is aptly summed up by the comments made by the then minister James Callaghan. He warned his fellow Cabinet members in 1974 of the possibility of “a breakdown of democracy”, telling them: “If I were a young man, I would emigrate.” Ironically. he subsequently succeeded Harold Wilson as the Labour prime minister after the latter’s surprise resignation in April 1976.

The Labour government faced continuing economic difficulties with rising inflation, a balance of payments deficit arising from significant oil price increases, and a series of industrial disputes. Events came to a head in 1976 when markets began to lose confidence in the sterling. In September 1976, the government approached the IMF for a loan of US$3.9 billion, the largest ever requested from the fund. The IMF demanded significant cuts in public expenditure as a condition for the loan, which the government accepted.

But life in the UK got worse a few years later when, in 1978, a wage dispute between Labour Prime Minister James Callaghan and the trade unions culminated in the Winter of discontent. Streets were lined with litter, some dead went unburied, and parents rushed to feed their ill children in hospital as everyone from rubbish collectors to gravediggers and nurses went out on strike.

In May 1979, the public, fed up with the inability of the Labour government to curb the militant trade unions and bring down inflation, voted in the conservative party led by Margaret Thatcher (MT), with a parliamentary majority of 43 seats.

MT brought about many radical changes to British economic policy. The pillars on which she built her economic policies were:

* Reduce inflation through reduced money supply growth

*Reduce the budget deficit by initially increasing taxes and reducing public expenditure

*Privatize state-owned enterprises

*Deregulate the financial industry

*Bust the trade unions.

 

There is no doubt that she did achieve her objectives. She remained the PM for 12 years, and the conservative party was the ruling party for 17 long years. However, the initial years under MT were extremely tough for the British people. There was significant unemployment as her policy of increasing interest rates meant that many companies went into liquidation. I recall watching the one-minute segment on national TV every evening where the number of closed companies and how many were made redundant along with cumulative figures were announced.

In March 1981, as many as 364 eminent British economists published a letter condemning her plans to hike taxes even as her monetarist attack on inflation plunged the economy ever deeper into recession. However, MT stood firm. She famously said, “The lady’s not for turning ” in her speech to the Conservative Party Conference on 10 October 1980. It is considered a defining speech in Thatcher’s political development. As a result, she gained the nickname “Iron Lady”, and it was widely believed that she had more “balls” than any of her male colleagues in the cabinet!

There is no doubt that her economic policies upended the Keynesian theory of governments spending money and lowering taxes to increase aggregate demand. Along with Ronald Regan, the President of the USA, she led a renaissance of conservative politics that relegated socialist parties for nearly two decades.

Space constraints prevent me from going into details of the main initiatives that underpinned her economic policies. However, I wish to share two of them as I believe these are imperatives for Sri Lanka in the current context.


Privatization of State-Owned Enterprises

Under MT, the government aggressively sold off key industries that the British government had owned. Early in her term, she sold off British Aerospace and Cable & Wireless, followed later on by British Telecom, Britoil, British Gas, and Jaguar. In her third term, British Airways, British Petroleum (or BP), British Steel, Rolls Royce, and electric and water companies were privatized as well.

Many of those companies have gone on to be successful private firms. In addition, fans of the effort note that it freed up a great deal of money in the 1980s, preventing further spending cuts or tax increases and creating competitive telecommunications and fuel sectors.

 

Union busting

One of MT’s most heated political battles came in 1984 when the miner’s union struck work. Earlier in Thatcher’s term, in 1981, the miners almost struck, but the government immediately gave in and offered concessions. Thatcher spent the ensuing years plotting to make sure that this never happened again by changing trade union laws, stockpiling coal to blunt the impact of a strike on consumers and even having MI5 agents infiltrate the miner’s unions.

So when the miners struck in 1984, she was ready. After nearly a year, the miners returned to work without any concessions from the government. As a result, the National Union of Miners, which just 10 years earlier had toppled the Conservative government of Edward Heath, was permanently weakened. Smashing the unions meant more when they dominated every facet of economic and political life.


Will Sri Lanka adopt Margret Thatcher’s prescription?

I lived in the UK from 1975 onwards and experienced first-hand most of what I described in the preceding paragraphs. In 1979 when MT was elected to power, I was 20-years old and very much a committed socialist. I was, in fact, the General Secretary of the Student Union
for two years. However, I took to heart the famous quote, “Not to be a socialist at twenty is proof of want of heart; to be one at thirty is proof that you have no head.”

In my opinion, there is no doubt that if we genuinely want to come out of the economic quagmire that we are in, we all will need to undergo significant hardships and sacrifices. Unfortunately, that is the price we will have to pay for the extravagant lifestyle the country has enjoyed for several decades.

The pain would have been far less had corrective decisions been taken several years ago. However, we have elected successive governments who have failed to take tough decisions as appeasing the public, trade unions, and other vested parties have taken precedence.

An example that I wish to cite in support of my above comment is that we have hardly been subjected to any power cuts in the last two decades. Whenever there was insufficient hydropower or the coal power plant broke down, the government got the CEB to generate expensive thermal power. This was done to prevent any inconvenience to the public but at a significant cost. The CEB did not even levy a special surcharge to recover part of the additional cost. I am pretty confident that electricity prices have not been increased for the last five years.

About a decade ago, I regularly travelled to India as the company I worked for established a subsidiary company in New Delhi. It was difficult for the accountant of that company and me to go through the financial records on the system as every few minutes; there was a power outage or a power cut. There were long power cuts during the summer months in India and Pakistan, lasting more than six hours a day. However, in Sri Lanka, despite the perilous state of the economy, we enjoyed uninterrupted power.

About 80 per cent of government revenue is spent on paying public sector salaries. In 2015 the Yahapalana government granted salary increments of Rs. 10,000 per month to public servants. The present government gave 100,000 jobs to unemployed graduates, and the state also employed a further 35,000 who had not passed ordinary level exams. Just imagine the cost being borne by taxpayers to fund a bloated and highly inefficient public sector.

I wish to share a couple of examples with the readers so that they can understand my frustration with the public sector.

In 2002 or 2003, when as the Chief Financial Officer, I offered permanent employment at the largest conglomerate in the country to a trainee graduate working under the “Tharuna Aruna” scheme, he told me “, Sir, I prefer to work as a government teacher in Mahiyangana as there is no work pressure and also, I am guaranteed a pension!” Unfortunately, that was the limit of his ambitions which successive governments have inculcated in our people.

In 1984, I went to the Inland Revenue to represent the company I was working for an enquiry. When I approached the officer concerned, I realized that she had forgotten that an enquiry had been scheduled. I was asked to sit while she desperately rang the bell for the peon to bring the file. The guy was seated only 50 feet away but pretended not to hear! The lady was embarrassed and asked me whether I could go and find the file. I lost my temper and
told her that she’d better find the file herself. Finally, she said she would re-fix the hearing, but we had still not heard from her one year later when I went back to the UK.

That we need to restructure and privatize most state enterprises that are losing significant amounts of money as was done by MT in the UK is a given. To do that, the government needs to “bust” the trade unions. The public will need to undergo certain hardships as industrial action will disrupt our life. But, in my opinion, the sacrifice will be well worth it. At least we will leave a better place for our children.

The industrial action resorted to by health workers as well as the principals and teachers is absolutely deplorable. Furthermore, the cancellation of the East Container Terminal to be awarded to India and Japan and the reported grant of salary increments amounting to Rs. 9 billion for a year to CEB staff reflect how the GOSL is caving in to unreasonable demands made by trade unions.

Margaret Thatcher, from 1979 onwards, showcased to the British people and the world at large what can be achieved by strong, determined and courageous leadership. A quote of hers that our political leaders will do well to remember “If you set out to be liked, you would be prepared to compromise on anything at any time, and you would achieve nothing.”