The Budget and poverty alleviation vs. poverty elimination

Lloyd F. Yapa

POLICY STRATEGIES: The purpose of this article is to discuss the pros and cons of the main strategies and policies adopted by the present UPFA Government as well as those contained in the MOU signed between the two main parties, so far as they are relevant to the 2007 Government budget, in a constructive way.

The UPFA Government has unerringly selected poverty alleviation, particularly in rural areas, as its primary objective. Poverty is in fact the major problem confronted by the nation. About a quarter of the population are said to be earning less than Rs. 2000/- per person per month.

But this percentage is higher in rural and estate areas such as Uva, Sabaragamuwa, Southern, Central Provinces and certainly in the areas affected by the ethnic conflict and the tsunami.

As long as demand for goods and services by such a large number of people remains low due to poverty, the rest of the areas and therefore the entire country will not take off economically, because only a continuous rise in demand created by increases in real disposable incomes or purchasing power can pull up the supply of goods and services.

It cannot be gainsaid, that poverty also gives rise to a host of other problems such as ill health, crime, militancy, the unending exodus of unskilled youth in search of greener pastures in the towns and elsewhere in the world, ( in the latter mostly menial jobs and misery await them).

The first requirement of an implementable plan as presented in the Budget, is to announce quantifiable short and medium term targets with a time frame, ( especially for ease of estimating funding requirements and to measure/ monitor progress), always keeping the goal or long term objective of making the entire country free of poverty.

Having identified the objectives/targets, the next task in preparing a plan is to formulate high impact strategies to be adopted to realize the objectives, on the basis of an analysis of internal /external impeding and impelling factors. Too many strategies can clog the works.

A common feature of the policies of the government and those in the MOU is of course poverty alleviation through welfare measures such as 'samurdi', (free education and health, which suffer from absence of quality and therefore expensive) and not elimination of poverty. So it is a question of creating productive jobs by increasing investments as well as productivity improvements described as 'more and better with less' or cost reductions and value addition for customers by catering to their preferences.

If we take a careful look at the way the miracle economies of Asia have performed, it will be seen that poverty can be drastically reduced, if investments amounting to about 35-40% in GDP terms are made in a sustained manner over a period of about 20-30 years.

However in the case of Sri Lanka, investment both by the public and private sectors in the past has been about 25% in GDP terms as against the above desired rate for it to grow at more than 8 % per annum and create jobs, which help to produce goods and services for the local as well as export markets. What are the requirements or strategies to be implemented in a sustained manner for such a real rate of economic growth?

First it needs an enabling environment consisting of ethnic peace, political, economic (price) stability along with good governance. The writer will not dwell at length on most of these except price stability or curbing inflation.

The Colombo Consumer Price Index is reported to have hit 17% in recent months though the yearly average has been hovering at about 12%, which is still high compared to the single digit rates of less than 5% prevailing in the above mentioned countries.

Inflation is also a tax on the people as unproductive government expenditure (such as wages for 'armies' of excess staff in the public sector, defence, debt servicing, the various untargeted welfare measures demanded by the people as well as subsidies to loss making State Owned Institutions leading to budget deficits (about 9% in the last 6 years) can erode the purchasing power of consumers.

This year the deficit may reach double digit levels leading to further increases in prices, especially of imports as the currency may also depreciate (currently Rs. 107 to one US $), unless compensated by an increase income tax collections (only 15% as a percentage of revenue (59% in Indonesia and 36% Malaysia) from those who can pay, against VAT payments even by the poor at 43% of revenue in 2004.

Worse still, retirees have to pay a Withholding Tax of 10%, when interest incomes from their meagre savings exceed Rs. 108,000 per year, whereas for businesses the limit is Rs. 300,000!

Therefore socio-economic development can be achieved only by increasing real incomes or purchasing power and removing injustices like the above, in other words creating jobs yielding higher incomes accompanied by an increase in goods and services at a lower cost. In Sri Lanka only the private sector can do it, as the State Owned Enterprises are incorrigibly inefficient.

The policy of controlling inflation adopted by most governments has been to get the Central Bank to control the money supply or jack up interest rates and not curbing their fiscal profligacy. The latter is a negative approach, in that high interest rates discourage investment, which in turn affects creation of jobs unfavourably. In developing countries, rises in demand of course have to be helped along by relief of supply bottle- necks, such as underdeveloped infrastructure and rigid factor markets such as land, labour and capital.

Talking about jobs, it has to be stated that they can be proliferated only by setting up private sector industries and services. Invariably the products of these have to be exported to the rest of the world since Sri Lanka is a small country with a small market and as large scale production is the first requirement to reduce fixed costs (gain economies of scale), to be competitive against foreign competitors , especially in the case of standard goods and services.

Competitiveness also means being able to reduce costs on routine activities in the value chain (from suppliers to producers, distribution channels and marketers), where value cannot be created for customers, while increasing value on those do matter for them.

Firms could be pressured to do so, only if they have to compete among themselves. (Protection through high import tariffs, subsidies and preferential treatment will make them sluggish about catering to the preferences of customers, though a certain degree of protection of local firms is necessary to prevent foreign firms from dumping their goods and services at prices lower their own market prices).

This alone is not sufficient.

Firms have to always maintain a competitive edge over their international competitors by being innovative or uniquely different in their presentation of products and services with regard to quality, timely delivery, and availability as well as after sales services.

The international competitiveness of most local firms is low not only due to their small size but also because they do not possess sufficient capital to operate on a large scale nor the technologies, higher skills and knowledge of markets.

This is why foreign direct investments (FDI) have to be attracted. However, FDI will give a wide berth to this country as long as there is no peace, political stability, good governance including law and order and an efficient, accountable, uncorrupt, people friendly public service, world class infrastructure, higher skills (in science, technology and management) - not merely high literacy, liberalized land, labour and capital markets, equal treatment of public and private firms and proficiency in international languages such as English.

This is the reason why FDI in this country in commercial production (not merely on the basis of approvals) has rarely exceeded US $ 250,000 per year as against the billions of dollars (ranging from anything between $5 billion to $50 billion per year) regularly pouring into stable nations like Singapore, Malaysia, South Korea, Taiwan and China.

It is mainly through aggressive liberalisation and development of factors of production such as labour/skills, land, natural resources, capital (and infrastructure) that government can influence competitive advantage in this country, not its mere existence in abundance, which may even lower the pressure to innovate and force firms to compete on price rather than on differentiation, becoming easy prey to more competitive firms.

In a small natural resource poor country like Sri Lanka, competitive advantage for enterprises can be promoted faster mainly by creation of skilled human resources to develop their creative/innovative abilities, not just by achieving high literacy.

The opposite has been done in Sri Lanka, where more than 80% of students passing their A Levels are being denied entry to the universities, in which in any case standards are low because they are run by the public sector, which is inefficient and cannot find sufficient resources to enhance teaching facilities; private sector investment in the sector is therefore essential.

Besides liberalisation of the rigid labour laws in consultation with the unions in return for some legitimate rights, land reform is indispensable to give clear ownership of the land to farmers to prompt banks to give credit using the land as collateral, increase the size of lots to enable mechanisation and for them to be run on a larger scale as viable businesses, especially by forming corporate bodies, in which they will be shareholders.

The latter approach should be tried out in the paddy sector on a pilot basis as it could be the only solution to the travails of farmers in the sector.

If the rural regions are to be developed, at least infrastructure in such areas have to be developed (not just irrigation, roads and water/power supplies but also specialised facilities in research, training, banking, health, housing, health and education and supporting industries and services concentrated in naturally located urban centres or clusters connected by first class highways with Colombo, all of which heighten economies of scale and competitiveness).

All Governments since the eighties have spent/invested only an average of about 5% in terms of GDP in the entire country in such capital works, mainly funded by donors! It should gradually be increased to about 10% per annum by making an effort to prune the types of unproductive recurrent expenditure of the government mentioned above and increasing the absorption rates of such funds.

Government should in addition support research in firms, particularly the resource poor SMEs keen on innovation.

The EDB in collaboration with the Ministry of Finance, the Central Bank and the Customs made available around Rs 45 billion worth of incentives to the exporters and their suppliers between 1982 and 1998 through grants, duty rebates and tax holidays, apart from persuading the authorities concerned to avoid an overvaluation of the exchange rate, introducing exporters to the world market, making matching grants to help firms to increase value addition and simplification of procedures.

Later some of these have been phased out. All these strategies and policies can be implemented and poverty can be eliminated significantly in about a decade or so, if consensus on them can be reached by the two major parties, businesses and trades unions.