Sri Lanka import substitution, neo-liberalism, Raul Prebisch in focus

MONETARY INSTABILITY: Chile, a hotbed of the anti- ‘neo-liberal’ backlash originally had gold standard central bank which exited and floated after currency pressure.

ECONOMYNEXT – Sri Lanka’s budget for 2021 based on import substitution and state driven industrialization strategies of Latin America involving Raul Prebisch has not produced results in the past a legislator has warned amid questions over the failure to implement better policies in the last regime.

“Import substitution industrialization means minimizing depending on develop countries while developing a country,” former state minister and economist Harsha de Silva told parliament.

“It is reducing dependence on industrialized countries and reaching self-sufficiency. That is the ideology. (Raul Prebisch and Dependencia Theory).

“It is mentioned in this budget in a very appealing way. However to make it work tariffs and duties are increased limit imports.”

Dependencia

Raul Prebisch the creator of Argentina’s central bank pushed the theory after he was sacked from the agency later and headed the United Nations Economic Commission on Latin America (ECLA) and later the UNCTAD.

Most developing countries ‘economists’, particularly those who had studied at Mercantilist universities in the West had lapped up the idea, critics say.

It was particularly attractive to countries that had Prebisch style central banks, which were promoted by the Latin America unit of the Federal Reserve under Robert Triffin who became an ally of Prebisch.

Critics have said that all central bank which were created under Fed tutelage in Latin America the 1940s including Sri Lanka ran into forex shortage. Many countries with Triffin-Prebisch style central banks also had to re-denominate their currencies suffer sovereign default or dollarize.

De Silva said the budget was contradictory as it also talked about comparative advantage. Comparative advantage is a classical economics concept.

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Failed Past

Import substitution was tried out in Argentina, Brazil, Mexico and also in India, he said.

“As you remember this is the policy that was followed in 1959-1968 to create a socialist country,” de Silva explained.

“The unemployment rate was highest in 1975, you can see that if you check the central bank report. Unemployment rate went above 20 percent. In 1975 foreign reserves we had was only enough for a 1.5 months. The economy collapsed.

“It was at that time that former President J R Jayawardena came into power and did a system change. But that was not continued with the war breaking out and due to the changes in policy that each government after that had.”

Under the UNP led administration Sri Lanka depreciated the rupee claiming that the currency was overvalued, a strategy once followed by arch-Keynesian New Dealers who busted the US dollar in the Great Depression from 22 to 35 dollars an ounce.

Some analysts had pointed out that the 1978 reforms did not bring full results amid high inflation and severe currency depreciation because Sri Lanka failed to reform the central bank and restrain its powers to inject liquidity as well as depreciating the currency to cut real wages of workers.

University Lecture

“Former Minister Harsha de Silva explained and mentioned some valuable thoughts,” Sri Lanka ruling party legislator Ranjith Bandara, himself a former economics lecturer replied.

“I felt like I am going to the university again and listening to a lecture on economics.

“But I want to ask that why they were unable to implement those ideas in their time of governance.

“After we gained independence there were lots of times where we made mistakes. But I think the time from 2015-19 is the worst. Our country’s economy went to a really dark place during that time.

“We name that kind of a period as a headless man’s journey.”

Critics had warned ahead of the time that plans for Sri Lanka to have a social market economy would fail without central bank reform. The foundation of an economy with a similar name in post- World War II was based on hard money Bundesbank.

Prime Minister Margaret Thatcher’s reforms and President Ronald Reagan’s reforms were also based on a foundation of monetary tightening.

Related: Sri Lanka heading for Sozialpolitik not a social market economy: Bellwether

“Sri Lanka new administration seems to be travelling on an increasingly risky path, stirring a deadly witches’ brew of deficit spending, subsidies, wage hikes for state workers and assaults on large and small businesses perhaps not seen since the 1970s and reminiscent of Sozialpolitik in Germany,” EconomyNext’s columnist Bellwether said in April 2015.

“It is ironic that these problems are happening under a regime headed by the United National Party, which in the past had a reputation for creating better conditions for private enterprise and ordinary people to exercise their entrepreneurial spirits.

“It is happening under a regime where key politicians who actually understand the value of economic freedoms want to have a social market economy.”

Monetary Instability

Sri Lanka released large volumes liquidity in 2015 and then floated the currency with excess liquidity intact in a so-called highly unstable ‘flexible exchange rate’ and was forced to tighten policy, triggering an output shock.

In 2018, as the economy was recovering from the 2015/16 crisis liquidity was against released from early 2018, rates cut in April and enforced with more liquidity injections. After the currency stabilized around 161 in June, more liquidity was injected through dollar rupee swaps.

As the currency slid import controls were brought, making nonsense of the free trade agenda of the administration.

The money was printed to push down rates in 2018 in a ‘monetary stimulus’ despite severe fiscal corrections, taking the rupee down and another output shock followed.

Critics have warned that all liberal reforms fail in countries with monetary instability in general and Prebisch-Triffin central banks in particular.

In Chile where a gold standard central bank was converted to a Triffin-Prebisch central partial success was achieved like in Sri Lanka after 1978, under Augusto Pinochet.

Chile’s gold linked central bank was forced off the standard in the early 1930 amid capital flight, though it was set up to be restrained by gold.

In 1974, shortly after the collapse of the Bretton Woods system and import substitution a military dictatorship came. In 1975 the a new peso replaced the busted escudo at 1,000 to 1.

Though liberalization and reforms were brought some success to some Latin American countries, particularly Chile, a backlash developed amid monetary instability, though similar policies followed in Malaysia and Singapore and UK, which had monetary stability brought big benefits to the people.

As late as last year people were in the streets of Chile against the government as the Peso collapsed from 600 to 800 to the US dollar, despite having an almost floating exchange rate. It stabilized only after credit fell amid a Coronavirus shock.

In most Latin American countries International Monetary Fund backed programs failed amid currency collapses driven partly by a false Mercantilist concept that currencies were undervalued.

Before monetary tightening under Bank of England Governor Gordon Richardson and Reagan’s by then Fed Chief Paul Volcker, Mercantilists have claimed in 1960s that the both the Sterlign and US dollar was ‘overvalued’ and the collapse of the Bretton woods was due to ‘overvaluation’ rather than wrong monetary policy.

Like in Sri Lanka 364 Mercantilists protested Thatcher’s policies, and monetary tightening, shortly before the recession ended and the economy went on a growth path. (How 364 economists got it totally wrong – Telegraph)

Neo-Liberal Bandwagon

Academics and activists in Santiago were key players among those who fanned the flames of an ‘anti-neo-liberal’ bandwagon. It was in Santiago that Prebisch led, United Nations Economic Commission on Latin America (ECLA) was headquartered.

The idea ‘anti-Neo-liberal’ ideology was popularized in Sri Lanka by legislator Wimal Weerawansa and is now being promoted strongly by Central Bank Governor W D Lakshman.

In a remarkable development Harini Amarasuriya a legislator for the Marxist Janatha Vimukthi Peramuna, a party that Weerawansa once belonged to claimed that the 2021 budget was ‘neo-liberal’.

“This budget is a great example to say that we again in for a neo liberal capitalism principle called trickle-down economics,” she claimed, despite over 100,000 new state worker set to be absorbed to the public service at the expense of society.

“But we have proved it for many decades that principal is not effective.

“Whatever said in these budgets during past years does not solve the problems of the people in this country.

“These neo liberalism ideology only applied in these words and but nothing has been done in practical world regarding changing this long lasting system,” she claimed.

The budget however had cut income taxes, which generally destroy capital and future jobs, by transferring investible capital into the hands of the elected ruling class and bureaucrats to dissipate in subsidies. (Colombo/Dec15/2020)

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