Two challenges to conventional economics

P V D Leo Samson

Many challenges have come to conventional economics taught and practised in Sri Lanka. In fact these conventional economic theories were not empirically tested in the context of developing economies such as Sri Lanka. But they have been widely communicated to local people and then made a pre-condition to development assistance and thereby everyone has come to accept them as scientifically proven theories valid universally.

The first relate to the growth of gross domestic product, which recorded 8 percent growth in Sri Lanka in 2010, up from 3.5 percent in 2009. As per conventional economic thought, this would require an investment rate of around 35 percent of the gross domestic product, but it has been around 26 percent during the growth period. The secret is that due to the end of war, the existing public investments started giving a return to the national economy. For example newly reconstructed highway network facilitated a free flow of goods and services across the country.

Gross domestic product

When public enterprises such as KKS cement factory, Valachchenai paper factory and fishery harbours already built, engage in full business activity. Gross domestic product will increase by using the existing public investments. This need to be contrasted with investments made in a developed country, where existing resources are used to provide goods and services to an optimum level.

The second economic theory debunked by Chinese economic growth model is devaluation of national currency. When currency is devalued, exports increase and imports decrease and country's trade account improves by having a favourable balance. This leads to improvement in overall balance of payments and strengthens the country's overall economic performance. This was the economic model followed by Sri Lanka since the economy was opened up in 1978 to encourage export led growth. In fact, when Sri Lanka lost GSP+ duty concession there was a hue and a cry that rupee needed a substantial depreciation to protect employment. Sri Lanka did not depreciate the rupee against the US dollar as per agitation, but rupee appreciated against US dollar and export volumes increased.

The Chinese have refused to appreciate Yuan, their currency against the US dollar stating that this is not the time to do so. As per economic theories, since Yuan is overvalued against the US dollar, imports should increase and exports should decrease and trade balance should be adversely affected. But China refused to do so, when temporarily there were setbacks to their economy and now the Chinese economy has regained the overall improvement momentum.

Currency fluctuations

The fact of the matter is that currency fluctuations reflecting the overall trade balance always favours US economy which is a major consumer of all goods and services. Therefore they profess that national currencies should reflect their balance of payment position.

These Harvard economic theories are favourable and true if the world wants to stabilize US economy and keep US dollar as world's lead currency. But if the national governments wish to look into the welfare of their citizens, it is upto the national economic planners to continuously defend the living standards of local people and not US consumers.