Mahoshada

“Protectionism is the institutionalization of economic failure.” Edward Heath

The government introduced two economic measures recently; both of them reflect the continuing trend towards raising the country’s barriers to trade. Both measures are aimed at protecting domestic production and in the end both will hurt the economy and add to the already heavy burden borne by the poor and middle class as well as making Sri Lanka a less attractive home for exporters. These are good examples of bad policy making driven by short term political expediency.

It is, however, important to keep in mind that the perceived political payoff for the government from these types of policies arises primarily because most voters have little or no idea of the amounts that they are personally going to have to pay for the benefits that the government intends to hand out. If the public fully appreciated what the government was doing and how much it will cost them, there might be very much less political support for the government’s actions.

Wheat, Flour and Rice
Treasury Secretary P B Jayasundara announced last week (30 May) that the government would be substantially increasing the import taxes on wheat and wheat flour – 16 percent on flour and 6 percent on grain. His stated objective is to increase wheat and flour prices to make these basics sufficiently expensive so that people will shift consumption away from bread and wheat products and will consume more rice. What is more, Dr Jayasundara made it very clear that he is prepared to continue raising these taxes and driving up the prices of bread and wheat products, saying: “We will revise duties based on the availability of rice in the market. If we observe that rice prices are going down further, then we will increase taxes at the appropriate time.”

How much will this cost the average family? According to the latest Household and Income Expenditure Survey (2002) carried out by the Department of Census and Statistics, the average family spends Rs 6,358 every month on food (including alcohol and tobacco). Of this, Rs 333 or about 5 percent is spent on wheat flour and bread. Note that this does not include expenditures for other products that are made with wheat flour, including items such as biscuits, noodles, etc.

However, these data give a distorted picture. For the entire country, an average of 44 percent of total expenditure is spent on food. But for those families whose total monthly expenditure falls below the national average, a much higher share allocated to food, somewhere between 61 and 69 percent. The reason for the large difference between the national average and what those less well off spend on food is that those with high incomes, the top 10 percent, devote only 24 percent of their total expenditure to food. According to the Survey, nearly 80 percent of all households spend more than 50 percent on food. This makes clear that the financial burden of higher prices for basic food items will fall much more heavily on the poor and middle classes, who must devote such a large proportion of their available income to purchasing food.

To make matters worse, these measures are being introduced by the government at a time when the cost of living has again begun to increase even more rapidly. The Central Bank announced last week that the inflation rate for May increased to 13.2 percent, from the 9.2 percent rise in prices recorded for April.

Failed Policies for Paddy Producers
Why is the government resorting to imposing additional financial burdens on those already struggling with the ever increasing cost of living? The central reason is the utter failure of the government’s policies to improve conditions for paddy producers. At election time, promises of high guaranteed paddy prices were made to win the votes of farmers and their families. The government has failed to deliver on these promises and now aims to redeem these pledges on the backs of poor and middle class consumers.

How bad is the situation? Consider the information circulated by email recently by two local NGOs, the Movement for the Protection of Indigenous Seeds and the Movement for National Land and Agricultural Reform. According to these groups:

“A million paddy farmers in Sri Lanka are facing disaster. In the last decades, cost of production has increased beyond the price farmers can get for their harvest in the market. Many have fallen into debt. Some have committed suicide. … State intervention in the market is now ineffective. Farmers cannot get the guaranteed prices of Rs. 16.50 per kg for nadu and Rs. 17.50 per kg for samba.”

They also provide two statements by paddy farmers that illustrate the difficulties being faced:

M H M Ratnayake Banda, Ruhunugama, Mahaweli Zone C: “I got 12,000 kg of paddy this season. I sold samba at Rs. 12.50 per kg and nadu at Rs. 11.50 per kg. I couldn’t repay all the loans I took out to cultivate my land. I still have some more to pay for the fertilizer. It was announced on TV that they would pay the guaranteed price to paddy producers. Maybe they do that in areas where there’s no paddy. In the paddy-growing zones of the Mahaweli scheme, however, nowhere do they buy at the guaranteed price. They shout out from morning till night that they’ll buy paddy. Aren’t these big people ashamed to lie in this way? In some areas there are banners saying paddy will be bought at the guaranteed price. They must be buying coconuts or something, certainly not paddy.”

T B Somawati, Weeralanda, Mahaweli Zone C: “We sold Rs. 40,000 worth of paddy from our fields. We sold it for Rs. 11 per kg. We still have some paddy left. This season, cultivation costs came to Rs. 80,000. I pawned my jewellery and got Rs. 10,000. Even if we sell the paddy that’s left over, we can’t pay back our loans. I wanted to put bars on the windows this season, but that won’t happen now. Now the only thing to do is to buy a coffin. But I will not drink poison and kill myself in this house. I will not create more problems for my innocent children. I will kill myself in front of those people who came to ask for our votes. There is nothing left for me to do now, except kill myself.”

The root cause of the failure of the government’s paddy policies is their failure to address the underlying economic constraints facing producers. Simply promising increased prices without establishing ways to significantly improve productivity and ensure that markets function efficiently is a recipe for sort of disaster described above. Resorting to increasing protection through higher trade barriers that artificially drive up prices is, as Edward Heath once said, “the institutionalization of economic failure.” These local NGOs have some ideas on how to increase paddy farmers’ productivity and thereby improve their economic situation. (These ideas are to be discussed at an upcoming program to be held at the Sri Lanka Association for the Advancement of Science on 9th June.)

Protecting Producers of Building Materials
The government is taking a similar approach in another area – effectively increasing trade barriers in order to protect domestic producers of building materials. The Board of Investment (BOI) announced last week that it was limiting the facility previously available to BOI firms to import a range of goods and materials. It will no longer be possible for BOI firms to import the following items duty free: cement, asbestos sheets, wires and cables, PVC pipes and fittings, paints, steel (importation of steel would be allowed for fabrication of steel products, especially for export), furniture including pantry cupboards, tiles (floor, wall and roof), electrical fittings, aluminium extrusions, and lubricants.

Why were BOI firms allowed to import these goods duty free in the first place? The main reason was that this was among the incentives used to attract the investment needed to stimulate economic growth and create employment, especially in export oriented businesses. Most countries provide duty concessions to exporters so that they will be able to compete on a more nearly level playing field. Unlike businesses producing for the domestic market, exporters are unable to pass on taxes and import duties on to their final customers. Any taxes and import duties they pay must be absorbed, making these types of activities less profitable and therefore less attractive to potential investors.

The reality is that if these investors could obtain the same quality goods and materials at competitive prices locally they would generally do so. Shipping and clearing charges substantially add to the cost of importing these sorts of goods, even without the imposition of import duties. No investor would stay in business very long if they ignored suitable cheaper alternatives available locally. Now the BOI has decided to substitute its judgment for that of investors. By imposing import duties for imports of these goods, they are going to increase the costs of doing business in Sri Lanka for BOI firms, making this country a less attractive place for investment. Reduced investment will mean lower economic growth, fewer jobs and lower incomes.

Institutionalizing Economic Failure
Whether it is aimed at indirectly protecting paddy farmers by artificially raising the prices of wheat and flour or protecting producers of building materials by making imported alternatives more costly, erecting higher trade barriers has rarely been a successful strategy. In a country where exports are the true ‘engine of growth’, attempting to protect domestic activities by restricting competition from imports inevitably imposes substantial costs throughout the economy. And these costs are borne by consumers, especially the poor and middle class, and by exporters who must compete in an increasingly competitive global economy. By erecting trade barriers in this way, domestic producers rarely make the changes necessary to improve productivity, leading to a high cost economy that faces great difficulties in attracting investment. And in a very real sense, this approach does institutionalize economic failure.