Age has become an increasingly discussed topic when it comes to our political leaders (i.e. Parliamentarians), the arguments have been that we are unduly saddled with older politicians that make the parliament system meaningless as it prevents the infusing of young energetic and more progressive leaders in to governing the country. Well, yes this is definitely one aspect that is on the table and it seems to be the dominant view shared by many of whom are frustrated about the responsibility and accountability of these members albeit their ability to comprehend the demands of the younger generations. Therefore the proposers of this debate are eager for changing the status quo. On the other hand there are those who contend that age is just a number and the ability of the person irrespective of one’s age is what matters in a participatory democracy, for people have many routes to representation and redress.
In order to really get to the bottom of this debate we need to analyse and understanding the dynamics of the global public office and the trends in life expectancy.
Scrutiny of Public Office
The evolution of democracies has meant that parliaments are indispensable and now are deemed to be an integral part of the institutional framework that represents the people’s democratic choice. The choice of selection (be it liberal or conservative or its varying compositions) is of course based on their own perceptions of what the future should be transformed into considering the stage of its economy, social and environmental concerns and the overbearing global geopolitical trends. Irrespective of country-specific rules, the role of parliamentarians, (of both men and women), remains the same: to represent the people and ensure that public policy is informed by the citizens on whose lives they impact. If we look at the political context of each country we find a unique disposition in their selection process, however, parliaments and Parliamentarians do face a common challenge, that is, how best to consult citizens and keep them informed about parliamentary deliberations and how such deliberations would eventually shape the people’s lives (for better or worse, as public policy cuts both ways). What is important here is that the relative maturity of parliamentarians is called into focus, as the people are now looking for responsibility, accountability and also the bottom-line, of delivery.
The UNDP Global parliamentary study undertaken in 2012 indicated that there are 46,552 Members of Parliament (MPs) in the world. Of which there are 8,716 women parliamentarians, or 19.25 pct. of the total number of MPs. While the global average number of parliamentarians per country is 245.China has the largest parliament with 3,000 members in the Chinese National People’s Congress. The world’s smallest parliament is in Micronesia, with just 14 MPs. While the global average age of a male MPs is 53 the average age a woman MP is 50. Sub-Saharan African MPs have the lowest regional average age at 49 with Arab countries the highest at 55.
Once upon a time, the leading car-maker of a developing country exported its first passenger cars to the US. Unfortunately, the product was a total failure. Most US consumers thought the little car looked lousy and were reluctant to spend serious money on a car that came from a place where only shoddy products were made. The car was such a failure that it had to be officially withdrawn from the US market.
This disaster led to a major debate in the country. Many argued that the industry should be shut down. Here was an industry, they said, whose best company could not penetrate even the lowest of the low end of the US market. And that was after the country’s government had given it 25 years of high tariff protection and banned foreign direct investment for 20 years.
The critics argued that the country should forget about industries like automobile, ship building and steel, which its government had been promoting – these industries were too capital-intensive for a country with very little capital and a lot of labour. The country should instead, they argued, concentrate on industries that intensively use its abundant labour force. After all, silk was the biggest export item of the country at the time.
They pointed out that the received economic theory supports their argument. The theory of comparative advantage, the most widely accepted trade theory, tells us that given its resource endowment, the country should specialise in labour-intensive products in which it has comparative advantage, rather than capital-intensive products in which it does not have comparative advantage.
The reader will be shockd to learn that the year was 1958, the country was Japan and the company was Toyota, and the car was called Toyopet. Japan’s automobile industry had been protected with high tariffs since its inception in 1933. Since it kicked out General Motors and Ford in 1939, in the run up to the Pacific War, the Japanese government had not allow any foreign company to produce automobiles in Japan. We may add that Toyota was doing so badly that in 1949 the Japanese government had to inject public money through the Bank of Japan, the Central Bank, to bail it out.
Today, Japanese cars are considered as ‘natural’ as Scottish salmon or French wine, but only two generations ago most people including many Japanese, thought that the Japanese car industry simply should not exist. Indeed, at the time, the Japanese car industry was, to put it bluntly, a joke. In 1955, all the Japanese car companies combined (there were around a dozen of them) produced 70,000 cars (with Toyota, the biggest company producing 35,000 cars) compared to 3.5 million cars that was produced by General Motors alone and 7 million cars by the US automobile industry as a whole.
Starting from this stark reality and going against one of the most widely accepted theories in economics (that is, the theory of comparative advantage), Japan persisted with the promotion of the automobile industry. By the late 1970s, it conquered the smaller car market, prompting the US and the European countries to impose quotas on Japanese car imports – euphemistically called ‘voluntary export restraints’. Even so, when the Japanese companies announced in the late 1980s that they are going to enter the luxury car market with new brands (Toyota’s Lexus, Nissan’s Infiniti, and Honda’s Accura), most people sniggered, muttering, “Japanese luxury car, that is an oxymoron, isn’t it?”. By 2008, however, Toyota became the biggest car-making company in the world beating General Motors, and the Japanese luxury car brands are neck-and-neck with BMW and Mercedes-Benz.
Do a little thought experiment to see how monumental the progress of the Japanese automobile industry has been. Suppose that you went back to 1958 and told people that there is this totally unknown third-rate car company called Toyota in Japan but that the company will in 50 years beat General Motors, you would be lucky if people thought you were writing a science fiction. More likely, they would have put you in a mental hospital.
The car industry is not alone. Japan developed its other key industries – such as steel, shipbuilding, electronics, and so on – by using similar mixtures of tariff protection, ban on foreign direct investment, subsidised loans from government-regulated banks, subsidies for R&D, special treatment for domestic firms in government procurement programmes (especially important for the development of the main frame computer industry), and many other internvetionist measures.
Moreover, Japan is not alone in this. It is well known that countries like Korea and Taiwan and more recently China, have used similar policies to industrialise and develop their economies. Less well known is the fact that virtually all other rich countries – the UK (in the 18th and the early 19th century), the US (throughout the 19th century and the early 20th century), Germany and Sweden (in the late 19th and the early 20th century), and others – also promoted their economic developments in similar ways.
Thus, given that virtually all countries have developed their economies by defying their comparative advantages and ‘artificially’ developed industries in which they do not have comparative advantage, we need to seriously re-examine the theory of comparative advange as the guideline for a country’s trade, industrial, and even development policies.
The concept of comparative advantage was first developed by the 19th century British economist David Ricardo. It is actually a very counter-intuitive idea. Before Ricardo, everyone believed that a country should trade with another only when it can produce something more cheaper than the other. This is known as the idea of absolute advantage. However, using the concept of comparative advantage, Ricardo argued that even a country with no absolute international cost advantage in any industry (that is, even if it cannot produce anything more cheaper than other countries can), the country will still be better off if it specialised in industries in which it is least bad at and traded with other nations. Conversely, even if a country can produce everything more cheaply than other countries can, it will still pay for that country to specialise in industries in which it is particularly good at and engage in international trade, rather than trying to produce everything itself.
The theory of comparative advantage is often misunderstood. I have heard professional economists saying things like “such-and-such poor country does not have comparative advantage in anything”. This is a logical impossibility. All countries, however inefficient they may be compared to other countries, have comparative advantage in something. To put it more starkly, even if you are rubbish at everything, there must be something at which you are the least rubbish at, and that is where your comparative advantage lies and that is therefore what you should specialise in.
From this concept, a whole body of theoretical edifice has been constructed to argue that free trade will naturally make countries specialise in industries in which they have comparative advantage, thereby making them better off. From there, it is but a small step to argue that following comparative advantage is the best development strategy.
The theory of comparative advantage is absolutely correct – in so far as the assumptions that underlie the theory are met. However, there are many assumptions that underlie the theory that do not hold in reality. The theory assumes that there is perfect competition, when the real world economy is dominated by monopolies and oligopolies. It assumes that there is no slack in the economy, when in the real world you have under-utilised resources and unemployed workers. And the theory does not work without the assumption that capital and labour can easily be re-deployed across sectors if changes in trade flows demand so. However, in reality machines and worker skills are very specific to the industry they are deployed in and cannot be used elsewhere.
There is nothing unusual about the fact that the theory of comparative advantage make all these assumptions that do not hold in reality. All theories, not just this theory, are constructed on the bases of certain assumptions and therefore do not hold if those assumptions are not met. What is special about the theory of comparative advantage, however, is that it has been used as a guide to economic development despite making assumptions that assume away the very core issues of economic development – that is, the nature of technology and the development of technological capabilities.
The currently dominant version of the theory of comparative advantage, known as the Heckscher-Ohlin-Samuelson model (after Eli Heckscher, Bertil Ohlin, and Paul Samuelson, who constructed the theory in the mid-20th century), assumes that there is only one best technology for producing a particular product and more importantly, that all countries have the same ability to use that technology. The only difference between countries in this model is the relative amounts of capital and labour they have – richer countries have more capital than labour and poorer countries have more labour than capital. So, in the Heckscher-Ohlin-Samuelson model (henceforth the HOS model), if Sri Lanka should not be producing things like BMWs, it is not because it cannot do it, but because doing that has too high an opportunity cost, as producing BMWs will use too much of its scarce factor of production, capital.
Thus seen, the main problem with the theory of comparative advantage is that it is not a theory that is useful in understanding the process of economic development. It is largely true that in the short run, a country will benefit the most by specialising in products in which it has comparative advantage in (I say ‘largely’ because the theory has assumptions that are often not met in reality even for this to be true). However, in the longer run, a country’s development success depends on how it finds a way to defy its comparative advantage and get into industries with dynamic demand growth, faster technological progress, and greater impacts on other sectors of the economy.
In doing so, the theory of comparative advantage can act as the ‘compass’ that tells a country’s policy-makers where their country stands and how much of the static gains from trade they are going to forego if they protected industries in which their country does not have comparative advantage. However, in the same way in which a compass cannot tell us where to go and, even less, how to get there, the theory of comparative advantage cannot tell the policy-makers which path of development path of their country should take and how to navigate the country through that path.
For far too long, developing countries, including Sri Lanka, have been told that sticking to their comparative advantages by following free-trade, free-market policies is the best development strategy. It is time that developing countries realise that the theory of comparative advantage is not a theory about economic development. It is only like a compass, helping us figure out where we are, but is of little use unless they have a clear destination, a good detailed map, and a knowledge of how to navigate the terrain that is full of physical obstacles, dangerous animals, and unpredictable weather conditions.
The Central Bank of Sri Lanka had come under increasing criticism over its Inflation Targeting hedonistic regime adopted over the past 5.5 years which saw the country pushed to a virtual standstill. During this period we witnessed the real economy crumble, recording its worst GDP growth trend recording a decline in GDP from 5.0pct in 2015 to 2.3pct in 2019¹, the lowest growth recorded since 2001². Despite the glaring evidence of a declining GDP trend the Central Bank of Sri Lanka ably supported by the IMF continued to drum up the rhetoric on the need for austerity measures, as a solution for Sri Lanka’s economic pains. The announcement sent shivers down the spines of many alternative schooled economists. World-renowned economist
Paul Krugman was quoted saying
“every country that introduced significant austerity has seen its economy suffer, with the depth of the suffering closely related to the harshness of the austerity”
therefore, it is mind-blowing how Sri Lankan Central Bank could advocate such policies. Fueling this announcement was also the common belief by Central Bankers that excess money supply or printing money caused ‘galloping inflation’ – a myth, which resulted in hawkish policy measures being adopted by Central Bank. It was, therefore, a matter of time before the real economy was choked with high real interest rates, which was among the highest in the Asia Pacific countries in 2018 (Figure 1).
What is interesting to note is that contrary to the theory that high real interest rates lead to increased national savings, Sri Lanka’s national savings to GDP data (i.e. national savings rate measures the amount of income that households, businesses, and governments save), did not indicate any such linear progression, as the national savings trend had steadily declined from a high of 30pct in 2014 to 25pct in 20194.
The declining GDP data trend captured in (Figure-2), confirms that the country was now in dire straits and heading towards greater depression, requiring a significant change in direction from the hawkish monetary policy approach and growth retarding fiscal framework that existed, to a pro-production and pro-growth framework. It can be argued that an inevitable outcome of both high tax rates and inconsistent monetary policy measures contributed to the rising of non-performing loans in the banking system, thereby increasing the gross NPL ratio by 38pct on a year on year basis, from 3.4pct in 2018 to 4.7pct in 2019, or in other words, gross NPLs increased from LKR 263 billion to LKR 382 billion which was the highest year on year increase since 2015, according to the 2019 Central Bank Annual Report.
It is evident that fresh thinking needs to be adopted towards inflation targeting and the problem must be approached from a business model perspective. Unfortunately, this fresh perspective was not forthcoming during the period under review (i.e. 2014 to 2019). Cambridge University, development economist Prof. Ha Joon Chang has highlighted in his book titled “Bad Samaritans- the myth of free trade and the secret history of capitalism” that many such growth retarding monetary and fiscal policy tools and false theories have been used extensively against developing countries by developed countries, preventing and stifling their economic development journeys. Empirical evidence suggests that Sri Lanka too has fallen prey to this austerity and inflation targeting trap.
THE MYTH OF INFLATION TARGETING
With the collapse of the Bretton Woods system in 1970 which focused on maintaining a fixed exchange rate, global superpowers and neo-classical i.e. monetarist school of economic thought were looking for another similar type of a potent policy tool to support their global monetary supremacy agenda, which would ensure that the standards were set for other countries to follow. Central Banks of developed countries had to demonstrate that they cannot control inflation as both the business community and the general public had lost faith in their ability to do so, having often missed their target by a long shot on many occasions. This very fact was aptly highlighted in 2009 by Maurice Saatchi, Chairman, of the Centre for Policy Studies, United Kingdom.
A closer examination of ‘inflation targeting’ would reveal that the whole notion is based on the premise that long-term economic growth is best achieved by maintaining stable prices, and that it could be done by controlling prices i.e. inflation. This approach is typically characterized, by the announcement of official target ranges for inflation by the Central Banks at one or more time horizons, while they explicitly acknowledge that low and stable inflation is the overriding goal of monetary policy.
Herein lies the problem, when the National Consumer Price Index NCPI (Base 2013=100), is based on data from the Household Income and Expenditure Survey conducted in 2012/13 which is highly skewed towards food (45pct of the basket) and even the non-food components (55pct of the basket). The weights in both categories are dependent on import prices. In such situations, exchange rate pressure builds up and as a tradeoff for managing the pass-through of exchange rates, monetary policy i.e. inflation targeting mantra, has been predominantly used as its solution. How can price stability be achieved in a country when it has sacrificed its domestic food supply and is heavily import depended on its basic food requirements for its people, apart from energy supply, household items, and fuel supply? If inflation rises because of such external supply-side shocks, it is a no brainer that the Central Bank of Sri Lanka would be compelled to increase its key policy rates expecting to go by the rule of inflation targeting. But in fact what it does is make matters worse causing more damage to the real economy, as balance sheets of companies suffer from higher debt financing costs and raw material costs, thus eroding profitability i.e. national savings. The International Labor Organization in a research paper (2011) validated this observation when it stated that “implementing inflation targeting regimes represents a major challenge in the presence of supply-shocks which are a common phenomenon in developing countries”.
Therefore, in adopting such a one-dimensional approach the Central Bank of Sri Lanka could be literally ‘shooting itself in the foot’ and together with it the entire real economy. This phenomenon is because most Central Banks are not trained to look at corporate balance sheet behavior, leverage, and factors affecting revenue conditions. Inflation targeting has been globally rebuked and many Central Banks do not go by this indicator alone, anymore. According
to a research paper published in 2015 by the Peterson Institute for International Economics (PIIE) claimed that inflation targeting is a myth and said to be the root cause for retarding economic growth of developing countries, quote, “Simple inflation targeting lowers growth in developing countries”. In a separate research study undertaken by Ricardo Brito and Brianne Bystedt titled ‘Inflation Targeting in Emerging Economies: Panel Evidence’, published in the Journal of Development Economics, 2010, (volume 91, issue 2, pages 198-210), the authors examined panel data samples of 46 developing countries over 27 years, (from 1980 to 2007), in which they found evidence that “inflation targeting by the developing country Central Banks, in fact, was the cause of reduced (economic) growth”.
This is could not be truer from a Sri Lankan perspective too. For at a time when corporate business sales turnovers have been negatively impacted as a result of internal shocks caused by draughts, floods, and terror attacks and the exchange rate depreciation viz a viz the US dollar, any form of growth reviving strategy seems to be a miss. While more growth retarding austerity measures were spoken of such as increased taxes (i.e. fiscal strangulation) more inflation targeting policy measures saw real interest rates at its highest making matters worse for corporate balance sheets as they hemorrhaged cash on the back of higher debt levels and continued low earnings saw the collapse in real GDP (Figure-3). Evidence indicates that the Central Bank without understating the implication on corporate balance sheets given their hedonistic inflation targeting policy approach – a purely mechanical process, caused many businesses to involuntarily close down, pushing the banking sector into jeopardy with un-serviceable loans that kept piling on in the books of banks and (i.e. banking non-performing loans reached 13.0 percent in some instances), thereby increasing the overall risk to the country’s financial stability (Figure-4). The decline of economic activity in the country also saw the national unemployment rate increase to 5.1pct in Q3 of 2019 from 4.4pct in Q2 2019.
BALANCE SHEET RECESSION, INFLATION TARGETING, AND DEMAND FOR CREDIT
Bank of Japan (BOJ) was faced with a balance sheet recession and attempted inflation targeting in the 1990s and until 2000s, and finally admitted that it failed to inflate the economy despite the flood of money in the domestic market. The excess money supply did not create inflation nor did it help pull the economy out of its 20-year long recession. In 2013 too Bank of Japan once again set an inflation target of 2.0pct as Governor Haruhiko Kuroda took office, seven years on, inflation has remained a significant distance from that goal. Data showed core consumer prices rose by just 0.37pct during this period. Unlike Japan, the USA’s President Donald Trump did understand that inflation cannot rise despite the flush of money supply when corporate balance sheets are significantly stressed with debt, and thus the demand for money is not plausible. While accelerated loan repayments i.e. debt repayments, only makes matters worse as BOJ too faced similar problems and was flushed with money supply, that no one wanted, as demand for money disappeared causing commercial bank lending to decline sharply recording a negative 1.0pct in the 1990s reaching negative 7.0pct by 20005. Nomura Research Institute economist, Richard Koo, wrote extensively on this matter and argued that deleveraging (i.e.paying down debt) by private sector companies caused the recession in Japan. He pointed out that when corporate balance sheet debt stock rises, servicing runs into trouble when there is a lack of domestic demand, resulting in an asset price collapse while debt i.e. liabilities remain on the balance sheet.
This phenomenon of cash flow compression causes private sector balance sheets to go underwater and deleveraging commences. During the period between 2002 and 2003 Japanese companies paid down USD 260 billion worth of loans, when as per the monetary theory companies should be borrowing at near-zero interest rates.
In such a situation, the turnaround is only possible with debt deflation (i.e. writing off/downsizing), and economic policies are targeted at regaining the financial health of companies and improving their balance sheets. It is important to note that in situations of debt deflation i.e. downsizing, (as a result of slower GDP and declining revenues) businesses are forced to take drastic action to repair their balance sheets by either increasing internal savings i.e. cutting costs, or paying down debt by fire sales of assets or a mix of both methods could also be on the table. This desperate act of deleveraging reduces aggregate demand for money and inflationary pressures decline, thereby throwing the economy into a tailspin and subsequent recession, which can be termed ‘Balance Sheet Recession’. It is important to have a mechanism to insulate companies when faced with or unknowingly placed in such balance sheet recessionary situation by the Central Bank’s own austerity measures. Therefore, in such situations, businesses should get some reprieve by way of a debt-moratorium or a write off as they require time to restructure their debt. In the USA according to Chapter-11 bankruptcy code 6, a petition could be filed, and voluntary bankruptcy could be declared by the debtor to reorganize existing debt, or it could be an involuntary petition, which is filed by creditors or creditors that meet certain requirements. Sri Lankan businesses do not have this luxury when faced with a ‘Balance Sheet Recession’ situation.
Therefore, until such time businesses are back in good shape with strong balance sheets, having gained production capacity in order to capture market share, growing revenues, and expanding its asset base any form of monetary stimulus or fiscal stimulus will not have any significant impact on inflation. For the lack of demand for money or credit, paves the way into the decline for goods and services. This is what saw in Japan and now we see it happening in the USA too and President Donald Trump has managed to put a stop to Federal Reserve’s inflation targeting phobia, understanding the implications of balance sheets and the need to gradually deleverage post an economic crisis, such as that witnessed in 2009/2010 period. President Trump was critical of the Fed’s hawkish monetary policy stance and called it “very, very disruptive” as they were contemplating raising interest rates too quickly too soon, thereby squeezing out the air in profitability and not making room for businesses’ balance sheets to be cured and repaired.
GROWTH ORIENTATED MONETARY POLICY
Thankfully in Sri Lanka too we see the dawn of a new monetary policy framework that is now gradually taking shape in the parlance of decision making, and that too is based on ‘Balance sheet based economics’ which is considered when factoring monetary and fiscal policies. Therefore, we could expect a more growth-oriented Central Banking to emerge in the months ahead. A pre-condition in this process must be to stimulate businesses and to create new
business models to look at external markets by enlarging the economic pie by way of using unconventional monetary and fiscal policy in the new normal economic environment that we have come to embrace. Herein, the restructuring of SME and ushering an Agro industrialization transformation is pivotal in this process of reorienting the economy. The Central Bank of Sri Lanka and Monetary Board should think out of the box and adopt new tools and have in place new mechanisms to examine corporate balance sheets, understand them, and work towards strengthening them as part of key focuses in achieving full employment and macroeconomic stability. Thus moving away from its preconditioned (flexible) inflation targeting and balance sheet contracting ‘austerity mindset’ which world-renowned economist Paul Krugman admitted has failed miserably globally7.
The Monetary Board and the present government seems to have understood this “Balance Sheet Recession” aspect and have moved expeditiously with initially providing fiscal support by way of tax cuts and also have decided to inject liquidity and reduce the cost of borrowing for companies by slashing the Statutory Reserve Ratio (SRR) by 2pct, and the Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR) of the Central Bank to 5.5pct and 6.5pct respectively. The cost of debt was reduced on four occasions within the year initially by 50 basis points and 25 basis points, respectively, with effect from 30 January, 16th March, and thereafter by 50 basis points once again on the 3rd April and on 6th May 2020. While introducing the debt repayment moratorium and credit guarantee scheme to enable businesses to access much-needed funds to function and encouraging banks to restructure corporate balance sheet debt with the intention of gradually deleverage over time. This synchronized
action is a very important point of departure in the context of the Sri Lanka inflation-targeting approach, which suffered in the past 5 years with below-par growth rates achieved, and was placed even below the Afghanistan rate of growth of 2.3 pct.