ECONOMYNEXT – Sri Lanka’s Yahapalanaya administration has tarnished the United National Party’s reputation for good economic management built up over the years, with some damaging interventions, just as Donald Trump has started to do in the US.

Donald Trump’s interventions are in different areas compared to Sri Lanka, but if bad interventions overshadow any good liberalisations, people from both countries will suffer in the longer term.

Two of the most damaging policies that hurt the poor are minimum wage legislation and protectionism aimed at helping a few businessmen.

But to understand which policies will expand investment and jobs, and which will undermine growth and generate poverty and misery, it is useful to look at the underlying philosophies driving sections of the elected ruling class in modern day nation-states.

The Ideological Divide

A government based on true classical liberal ideology will give maximum economic freedom to the people. Proponents of such a philosophy will be indifferent to race and religion, and people under such a regime will also get maximum social freedoms. The role of the state and its capacity to impose its will on the people through police power will be minimised, and just rule of law will be maximised.

A leftist administration will try to intervene more and obstruct people’s actions and blunt their initiative, but will be socially liberal. Many modern, left-leaning European parties and the Democratic Party of the US intervenes in the economy with minimum wages and the other moves out of good intentions, though massive harm is created in the process.

Nationalists will back a majority ethno-religious group. Modern day nationalists can be pro free market like Trump. But traditional fascist-nationalists were more statist (like National Socialists or Nazis) and typically wanted a ‘mixed economy’.

Unlike India, Sri Lanka has a main party advocating free market economic policies with a strong socially liberal non-nationalist wing in the form of the United National Party. In theory, a UNP administration can not only give economic freedom, but also social freedom to the people.

In India, the Congress party was suspicious of free markets for decades (more economic freedom was given to the people after 1991), but the party is socially liberal and is indifferent to race and religion. Both true capitalists and socialists are indifferent to race and religion.

The Hindu rate of growth in India, up to the 1991 reforms, was due to state planning and interventions. Protectionism prevented competition and innovation, and helped some businessmen at the expense of poor consumers. A nationalised central bank that inflated and depreciated the currency after independence from British rule – partly to finance so-called five year plans – also impoverished the people in general.

The Bharathiya Janatha Party is free market oriented, but unfortunately nationalist. Nationalists tend to be authoritarian, and that tendency could eventually move such an administration closer to fascism. The recent demonetisation of the rupee is a case in point. It’s a slippery slope.

The same problem is predicted in the US. Already wags are calling the President-elect Generalissimo Trump. In general, the more interventions, the more unintended consequences, the more poverty and misery. In addition to deficit spending, the central bank’s loose policy will produce big bubbles and economic collapses. Nationalism will create conflict with neighbours, triggering wars in some case and more deficit spending.

Trumponomics

In the US, the nationalist, far right wing of the Republican Party has come to the fore under Donald Trump. Although core Republican free market ideology is still seen in some early Trump appointments, whether they will do enough good to undo the damage from any fascist-nationalism and Mercantilism remains to be seen.

For example, Trump’s proposed tax cuts may do some good. With the economy growing and the possibility of an increase in total taxes, there is a chance that it may not increase the deficit too much. But a massive increase in infrastructure spending, which is a descent into Keynesian stimulus, on top of a tax cut is almost guaranteed to de-stabilise state finances.

If a budget deficit expands when an economy is growing, it can create an unsustainable bubble that will collapse into a recession. Or if the Fed tightens with extra rate hikes to counter the deficit, it may crowd out private enterprises and eliminate any benefit from a tax cut.

On the other hand, Trump’s plans to cut excessive banking regulations can help expand investment and create new jobs. There are also expectations that the so-called ‘Green Overreach’ under the Obama administration will be rolled back.

Trump’s opposition to a minimum wage hike will help African Americans, immigrants and least qualified people get employment. Not raising the minimum wage can also slow down the movement of low wage jobs to Asia and Mexico, and keep some manufacturing jobs in the US for a few years longer.

But his trade policies and protectionism will be disastrous. Trump has threatened retribution against firms that move jobs overseas. He has also singled out some businesses to attack (so far) including Carrier, Boeing and Lockheed Martin. There is an ideological confusion here, which may create problems with the Republican Party in the long and short term.

The Republican Party in the recent past has favoured free trade and had forced businesses to compete and kneel before consumers, generating, innovative, world beating US companies in the process.

Yahapalanomics

Sri Lanka’s Yahapalanomics similarly has a confused hotchpotch of ideology. The budget for 2017 is a case in point. A big plus point is that the administration is not nationalist. But it is engaging in damaging economic interventions, which has kept away private investors.

The current administration came to power promising a Social Market Economy. Egged on by the civil society, there were some early successes in rule of law. But price controls trashed any claims to a Social Market Economy early in the new administration. Then came deficit spending and money printing. Now, taxes have been raised to correct fiscal mistakes made in the 2015 budget.

Corruption gathered pace. The corrupt old guard seemed to have sidelined younger people who had a clean record.

Central Bank independence seems to be under fire—the effects of this can be dire.

Yahapalanomics has also undermined investor confidence by charging retrospective taxes, which is only a couple of steps behind outright expropriation practised by the last regime.

The new budget said foreign ownership of land will be relaxed, but under some conditions (this discretion may also sow corruption). Against this is a Venezuelan-style move to break up large plantations.

The administration is still messing around with import taxes.

None of this inspires confidence and makes investors rush to Sri Lanka to create new jobs.

On the most damaging policies that hurt the poor  – minimum wage and the lack free trade – Trumponomics and Yahapalanomics are on opposite sides of the spectrum.

Trade Stance

Unlike Trump, Sri Lanka’s administration seems to be of the mind that free trade is necessary to take a country forward, though it is still messing around with trade taxes for nefarious reasons or to please farmers and other interest groups despite knowing that it is bad for the poor. In the 2017 budget, a statement was made that some import taxes would be cut.

But Trump is immersed in the old Mercantilist idea that trade deficits are a problem, and seems to be convinced of it ideologically.

A country runs a trade deficit (in the absence of money printing) simply because there are inflows from non-merchandise goods exports or through capital inflows, which residents spend, generating imports.

Sri Lanka has a trade deficit because there are remittance inflows, and because the government is a net borrower abroad. Foreign direct investment also tends to boost the trade deficit, because investment in factories or hotels necessarily generates imports to build them.

In the same way, the US runs a trade deficit because of foreign direct investment and purchases of US bonds by foreigners and foreign central banks. Mercantilists ignore all this and say a trade imbalance is due to the exchange rate. Either the currency of the importing nation is ‘overvalued’ or someone else’s currency is ‘undervalued’.

One of Trump’s first acts (if he is to be believed) was to increase the US trade deficit by arranging a $50 billion investment in the US by Softbank, a Japanese investment group.

"I wonder if Mr. Trump – who appears to be very proud of having brokered this deal – realizes that he has just arranged for an economic outcome of exactly the sort that he and his advisors repeatedly insist spells doom for the American economy – namely, a rise in the US trade deficit, in this case to the tune of $50 billion!,” wrote Donald J. Boudreaux, an economics professor at George Mason University.

Trump also persuaded Carrier, an industrial group, to stop part of a relocation of a factory to Mexico apparently in return for some undisclosed subsidies in the form of tax breaks or otherwise at the cost of taxpayers in the state of Indiana. The loss will have to be borne by the taxpayers of Indiana. Meanwhile, poor Mexicans who expected a job from a capitalist company will also be denied the opportunity to work. They may instead try to immigrate to the US, which is something Trump wants to prevent.

Trump’s threats of 35% import tax can harm Sri Lankans and Chinese, as well as Mexicans who work in factories. More damaging may be the harm Trump does to US companies.

“If the US government, either through law or presidential threats, forbids US companies from eliminating certain jobs, it will make it more difficult and costly to create jobs,” writes Dan Griswold, from Cato Insitute, a think tank. “The dynamism of the US economy will be diminished, reducing our long-term prospects for growth in productivity, output and employment.”

Out of the 4.32 trillion in goods that affiliates of US firms supplied, 339 billion, or less than 8 percent, was sold as imports to the United States according to 2013 data, says Grisworld. US firms prevented from investing abroad will lose customers not only at home, but all over the world.

Minimum Wages

A key reason Carrier is shifting the factory to Mexico is because wages are too high in the US factory where most workers are with the United Steelworkers Union. Wages are around $21 an hour at the factory compared to less than $5 in Mexico, according to reports.

The Clinton campaign proposed to raise the Federal minimum wage to $12 or $15 from around $7.25 an hour, which could have harmed a lot of less-skilled workers. Trump is known to be opposed to the minimum wage.

Minimum wages were originally devised by Western Eugenicists to keep minorities, the disabled, immigrants and other people viewed as undesirables out of the workplace. The idea was to push them to the margins of society in an effort to create a superior, more productive society in line with the wishes of the Eugenicists.

Minimum wages ensured that the most highly skilled (usually white) people were hired by employers. Early proponents of minimum wages clearly understood the results of a minimum wage.

“Legal Minimum Wage positively increases the productivity of the nation’s industry by ensuring that the surplus of unemployed workmen shall be exclusively the least efficient workmen,” Fabian socialist Sydney Webb wrote in 1912. “Or, to put it in another way, by ensuring that all situations shall be filled by the most efficient operatives who are available.”

In the US state of Massachusetts, minimum wages were originally enacted in 1912 to keep women out of the workplace and make them stay at home. Minimum wage undermines the freedom of a person to contract and sell labour at a price he or she wants to. In the US, some of the original minimum wage laws were opposed on this basis.

“When I left home at the age of 17, going out into the world as a black high school dropout with very little experience and no skills, the minimum wage law had been rendered meaningless by ten years of inflation since the law was passed,” writes Thomas Sowell, an economist at Stanford University.

“In other words, there was no minimum wage law in effect, for all practical purposes. It was far easier for me to find jobs then than it is for teenage black high school dropouts today.”

“After the minimum wage was raised to keep up with inflation, for decades, the unemployment rate for black male 17-year-olds never fell below TRIPLE what it was for me — and in some years their unemployment rate was as much as five times what it was when I was a teenager.”

The Yahalapana minimum wage law at Rs10,000 a month is quite low, and perhaps has no effect also.

But the minimum wage law has set a damaging precedent, allowing leftists and interventionists to push the threshold higher in the future and deny less skilled people work in the formal economy. The new budget set a minimum wage of $400 for people going to the Middle East. It is not yet clear how this proposal will be enforced. Nobody would go to the Middle East and suffer for say $300 if they could get a similar paying job in Sri Lanka.

If job agencies are prevented from say recruiting people for $350, the danger is that people will go out falsifying data, or without registering for insurance or at embassies undermining their own safety. In fact, people will be encouraged to break the law.

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This column is based on ‘The Price Signal by Bellwether‘ published in the January 2016 issue of the Echelon Magazine. To read Bellwether columns as soon as they are published, subscribe to Echelon Magazine at this link. The i-tunes app can be downloaded from here.