ECONOMYNEXT – Sri Lanka needs the state to provide public goods, including national defence, law and order and justice; to control market power; to address high levels of information asymmetry and externalities. Sri Lanka needs a state that does a few things well.
That Sri Lanka needs a state that seeks to give stability to the public, not excluding those who create wealth and employment for others, was posited in the inaugural column as what we should strive for.
What are the few things that the Sri Lankan state should do well?
The following discussion may be helpful in structuring a political conversation on statecraft to develop a consensus on the core functions of the state.
Sri Lanka also needs a state to remedy problems caused by negative externalities; and to optimize gains from positive externalities.
Given length constraints, the important discussion on externalities is left for the next column.
What are Public goods?
Public goods are not whatever one feels like labeling as public goods or goods that are currently provided by the state, but those that meet the tests of non-rivalry and non-excludability. They are definitely not what are currently provided by the state.
Recall, the Sri Lankan state at one time manufactured cooking pots in Enderamulla; and ran a biryani restaurant in Maradana.
If my consumption of a good or service does not affect your ability to consume it, it is non-rivalrous. The classic example is national defense, which every stateprovides, more or less. The second condition is that of non-excludability.
It should be possible to exclude a user from consuming the good or service, without a great deal of trouble and expense. Very few goods and services qualify as public goods. The market will not produce public goods. If they are needed, they would have to be produced using taxes.
Most text-book examples such as national defense have little impact on daily lives of citizens. A public good that affects everyone, particularly in cities, is clean air.It is impossible to exclude people from clean air and to charge for access.
Therefore, it is unlikely that any private provider will invest in producing clean air or in acting to prevent air pollution. Those activities have to be supported by taxpayer funding and backed up by state coercion.
There are different ways by which the public good of national defense (defined as protection from foreign invasion and coercion) can be supplied. National defense does not necessarily require the maintenance of an army, an air force and a navy.
Upon winning a civil war, President Jose Figueres Ferrer abolished the Costa Rican military in 1948.In 1949, the abolition of the military was codified in Article 12 of the Constitution of Costa Rica.The budget allocated to the military is now dedicated to security, education and culture.
Costa Rica maintains Police Guard forces. It has not suffered any invasions or engaged in any wars with its neighbors (it’s not an island). It has also proved immune to the perennial coups that afflicted other Latin American countries.
Many in Sri Lanka would be shocked by the idea that we could do without a massive military. There is no question that the military was needed to defeat the LTTE. But the LTTE was a domestic actor, not a foreign force.
Actions against domestic actors such as the LTTE are best taken by specialized anti-insurgency units such as the STF, which is part of the Police, not the tri-forces.
Some may point to the Indian violations of Sri Lanka’s national sovereignty in 1987 as evidence of a need for military capacity at sea and in the air. But again, dispassionate assessment will show that the Sri Lankan Navy’s actions in turning away the Indian vessels was purely symbolic.
When the Indian aircraft violated our airspace, not even symbolicresistance was shown by the Air Force.
Given the massive asymmetry of power and our location, our national defense is best achieved by giving weight to international diplomacy and use of multilateral instruments rather than maintenance of large military forces.
The model most efficacious in terms of safeguarding our national sovereignty is that of Singapore, not that of Taiwan.
Management of the India-Sri Lanka relationship through regular high-level interactions during Eelam War IV did more for national defense (defined as protection from foreign invasion or coercion) than any expenditures on weapons and men.
This is not to deny the value of effective and properly trained police units of maintaining internal peace or of coast guard units to ensure security of shipping and the exclusive economic zone.
The current confusion of roles and training yields sub-optimal results.
Understandingthe contribution a competent foreign service can make to national defense in a small country like ours will yield significant benefits.
Sadly, our embassies are today seen mostly as providers of protocol services and familiar foodfor the powerful and connected away from home, or as sinecures for friends and family, with little weight being placed on effective execution of foreign policy objectives.
Law and order
Law and order in the abstract exhibitsthe qualities of a public good. Yet, in specific form, it does not satisfy the criteria of non-rivalry and non-excludability.
The massive and growing backlog of court cases, with only certain cases jumping the queue, shows that the use of judicial resources by one deprives others of those resources. Commercial arbitration is evidence that conflict resolution can be provided through market means.
Many farmers complain that the police provide no solutions for theft of agricultural produce, asking them to catch the thieves and bring them to the police. Large farms can self-supply by investing in security equipment and personnel.
The monied few enjoy the benefits of law and order while others are left out in the cold.
No political or economic theorist would argue that the state should not be engaged in the provision of law and order. Even extreme libertarians would see a role for the state in law and order.
In the same way that wars can be fought with mercenary troops and territory is ceded because the supply of the public good of national defense still requires the use of limited resources, in actual practice the supply of law and order does not pass the tests of a true public good.
The recent announcement by the responsible Minister that more than half the 80,000 personnel employed by the Sri Lanka Police are guarding politicians suggests that a tremendous misallocation of resources is responsible for the undersupply of the order component of law and order.
The hesitancy of the decision makers in successive governments to take on the legal mafia blocking court modernization is evidence of lack of appreciation of the significance of this core function of the state.
This neglect has broad economic ramifications, such as in the perceptions of high risks for investors as shown by the low Ease of Doing Business rankings.
Clear-eyed analysis of the way certain public goods (e.g., national defense in the period prior to 1987 and during Eelam War IV) were supplied, certain others such as law and order and undersupplied, and yet others (e.g., clean air in major cities) are not supplied at all, should provide guidance on priorities for state reform and optimal use of public funds.
When one firm or a few dominate supply of a good or service, output is restricted, quality is lowered, and prices arekept high. Many countries have competition laws and enforce measures to ensure monopolies are broken up and collusion among a few suppliers is made difficult.
In small economies such as ours, it is also possible to make the exercise of market power difficult by reducing barriers to imports. For example, the prices charged for sanitaryware (bathroom fittings) in Sri Lanka were kept low by permitting imports.
Now that imports have been banned, the local producers have ganged up to almost double the prices for the locally manufactured products.
The Sri Lankan state does not act against those accumulating and profiting from market power. It actively encourages the gouging of consumers using import restrictions and para tariffs.
In many cases the monopolists are state owned. In almost all cases of state-owned or state-supported monopolies/oligopolies, the profits are not taken out in the normal manner as dividends but in the form of politically motivated measures such as keeping supporters on payroll, maintaining excess workforces, disbursing corrupt CSR funding, support of politicians and political campaigns, and so on. In some cases, monopolies even lose money and are supported by taxpayer funded subsidies.
It is possible to have a competitive marketplace in bathroom fittings if the state gives priority to ensuring the welfare of consumers over the protection of inefficient domestic suppliers.
Of course, they make the usual arguments about input costs being high or their foreign competitors engaging in dumping.
The input that may make local manufacturers uncompetitive is energy. Instead of reforming the energy sector that is deformed by inefficient state-owned monopoliesand politically driven pricing decisions, the current government is rolling back even the minuscule reforms that had been undertaken, such as safeguards against corrupt short-term power purchases by the CEB and the fuel price formula.
The Sri Lankan state lacks the capacity to engage in the sophisticated economic analysis needed to enforce anti-dumping. Yet, the previous government made considerable progress on anti-dumping legislation.
So, the remedies for the root causes exist, but kleptocratic incentives favor restrictions and para tariffs that yield political and personal benefits.
Control of market power is an area where reforms must give priority tothe correction of wrong government policies ahead of the establishment of a formal mechanism such as a Competition Commission.
Deposit-taking financial institutions take your money and give you promises of future benefits and return of your money in the future. Physicians diagnose the causes of illnesses and prescribe remedies that in many cases they themselves perform.
It is difficult for ordinary consumers to make informed decisions about the ability of financial organizations to keep their promises or of the disinterested nature of the treatments offered by physicians.
Solutions may be provided for information problems without state involvement. For example, information and related trust problems inherent to international trade have been solved without the creation of a world government.
Banks and various certification authorities have provided solutions and made a good business out of it. But sometimes, coercion is needed. That is where the state is useful.
If the state does not actively supervise banks and finance companies, people will start stashing money under their mattresses. Active supervision requires expertise and resources; it also requires coercive powers. If truthful accounts are not kept and reported, the regulator must have the power to punish.
Recurrent failures of finance companies causing losses to depositors indicates that the Sri Lankan state is doing a poor job of reducing asymmetries of information in those markets.
On the other hand, improved labeling of food products is evidence that incremental progress is being made. Greater emphasis on addressing information asymmetries will encourage decentralized supply of goods and services and thereby contribute to a better economy.
In Part 2, the critical role that the state can play in addressing problems caused by negative externalities and in optimizing gains from positive externalities will be discussed.