Mahoshada

Is there a consensus in this country on the role of the public sector in the economy? There does not seem to be much substantive discussion on this issue, let alone any sort of broad agreement on the appropriate size or which activities should be undertaken by the public sector. The fact that there is no substantive debate should not be seen as a reasonable basis for believing that there is consensus on what the role of the public sector should be in the economy.

One would also have considerable difficulty in looking to the recently concluded presidential election to provide much help in this regard. Besides the fact that the result was very close to being dead even, when addressing economic issues both of the main candidates tended to focus more narrowly on controlling the cost of living or various subsidies and support measures. And of course both candidates agreed on the necessity of maintaining a substantially higher economic growth rate – although they disagreed how this might be achieved. In this context it is, however, worth noting that in Mahinda Chintana the new president promises that he would “not prune the public sector during my tenure in office.”

A Replacement Budget
It was announced this week that a revised budget will be presented on 8th December to replace the budget presented one month earlier, immediately prior to the presidential election. We are told that this new budget will faithfully reflect the proposals contained in the new president’s manifesto, Mahinda Chintana. We can only wait to see what this will mean in practice. Certainly investors here and abroad will be looking closely at this replacement budget to see which way economic policies are going to go under the new president.

Since the manifesto primarily includes more government spending, a number of important questions arise: Will the new spending initiatives be accompanied by reductions of other types of spending – or will total spending increase substantially? If it is the latter, then how will these new initiatives be paid for under the budget? Will there be significant tax increases to raise revenue or will the deficit expand further – to be financed through some combination of borrowing and printing money?

How will the commitment to increase the growth rate to 8 percent be reflected in the new budget?

It will also be interesting to see to what extent changes announced in the pre-election budget are retained. In particular, it will be important to see whether the substantial (85 percent) reduction in the fuel subsidies, from an estimated Rs 20 billion to Rs 3 billion is included.

A Declining Public Sector
In considering the future role of the public sector, it should be understood that despite some of the political rhetoric, the public sector has in fact been declining significantly in both relative and absolute terms over the last decade. In trying to assess the changes that have taken place, it is important to keep in mind that it is usually quite difficult to measure the value of the outputs of many of the public sector’s activities. What we can usually easily measure, however, is the costs of the inputs used to produce these public services.

For example, it is nearly impossible to realistically measure the value of the output of the police services – increased security for people and property. Yet we can easily identify the costs of the people, equipment, buildings and other resources used to provide these services. It is then usually assumed, often with little foundation, that the value of the police and security services produced is equal to the costs of production.

Relative to the entire economy, government expenditure fell from 30.5 percent of GDP in 1995 to 23.5 percent in 2004. This is about a 23 percent reduction in the relative size of the public sector over last ten years. (Note, however, that the Central Bank projects for the year 2005 that it will rise by about one percent of GDP.)

We can use employment as an indicator of the absolute size of the public sector. During this same period, total public sector employment fell from 1.3 million in 1995 to slightly less than 1.1 million in 2004 – a total drop of about 16 percent or an average decline of 1.8 percent per year. (Contrary to what many might expect, most of this decline in employment took place under the PA government, reflecting the greater privatization activity during these years.)

Debating the Future Role of the Public Sector
The one thing that nearly everyone can agree on is that it is essential that the economy start to perform better. It will be possible to make significant progress in reducing poverty only if growth rates are substantially increased and maintained for a number of years. Providing adequate employment opportunities for all of those that need jobs will require generating several million jobs in the coming years. At the same time, increasing real incomes for those who are working will depend upon higher growth leading to a sustained increase in the overall demand for labour. But to achieve the higher growth rates that will be needed will almost certainly require a much more efficient public sector.

Making the changes that will need to be made will require the consensus that is now lacking. To do this requires reaching broad agreements to the following questions:

How much does the country want to spend on services that can be provided only by the pubic sector – “public goods” such as justice, defence and public health? Many would argue that these activities are now seriously under-funded and much more needs to be spent. One reason for the financial neglect of these key public services has been the failure to establish clear priorities for which activities should be undertaken by the public sector – leading to nothing being done very effectively.

How far should the country go towards trying to redistribute incomes from the more successful to those with less? A great deal of what the government is now doing entails little more than taking money from one group and giving it to another. And while these subsidies are ostensibly meant to benefit the poor and working class, given the nature of the tax system, it is these same people that end up bearing most of the costs. Examples include fertilizer subsidies for farmers and fuel subsidies, both of which are essentially paid for through higher prices that include indirect taxes, which fall most heavily on the poor and middle classes.

How can we be more confident that the public sector is using the public’s finances efficiently and ways that are not corrupt? There is no question that enormous amounts of the country’s resources are being wasted through inefficient and/or poorly managed public sector activities. This not only leads to failures in providing the needed public services, it also draws resources away from more productive private investment that might otherwise take place. Any consensus on the role of the public sector would depend on broad agreements on ways to ensure that the financial resources being provided by the public are being used effectively.

How large are the economic costs imposed by the system of taxation? It is often overlooked by politicians, but the types of taxes used and the ways that they are implemented also impose major costs on the economy. A good example is high taxes on trade, which inhibit the ability to export competitively and also tends to reduce efficiency of local producers. These costs associated with tax policies have to be added to the costs of the public sector undertaking activities if we are to be able to assess the true costs and benefits of public sector activities.

The process of putting together a government budget necessarily addresses these questions, either implicitly or explicitly. And it is to be hoped that in the upcoming budget the government will endeavor to make clear its views on these questions rather than presenting a list of goodies designed to capture voter support and reward special interests.

But there also should be greater public debate of these issues, rather than leaving the process entirely in the hands of the politicians and bureaucracy. Major changes will be needed if the country is to grow and develop more rapidly in the coming years. To do this, a broad consensus ought to be developed that recognizes that leaving important responsibilities with public sector but not providing adequate resources is recipe for the sort of deterioration in public services that has been experienced over many years.

We also have to recognize that the higher the proportion of the population dependent on public spending the more difficult it is to control public finances. It seems that nearly every identifiable interest group has some form of subsidy or tax benefit built into the present structure. But there is little realization that for the most part we all are paying for these benefits – and in many cases the costs are greater than the benefits. Only by coming to some broad agreement on how the country should proceed will it be possible to begin to make the changes that will be necessary.