Economic Growth, National Security, And What Next For Sri Lanka

By W A Wijewardena –

Complementarity between security and growth

For millennia, nations have recognised that for a country to ensure its national security, it should have enough wealth in surplus. That is the wealth that does not help it to use for current production or enhancement of future production capacity directly. Hence, it does not contribute to an immediate improvement of the welfare of the people. But it is essential to have national security as a precondition for undertaking all economic activities, namely, production, distribution, and consumption.

The consumption part may be within the economy if the output is consumed by people within its borders. It can be by people outside the borders if a part of the production is exported. To do so, there should be an environment conducive for people to undertake all these economic activities. Therefore, the money used for national security is not a waste. At the same time, for a nation to generate the surplus needed, it should have economic growth as well.

Consequently, economic growth and national security are complementary to each other. Without growth, there cannot be national security. Without national security, it cannot have economic growth either. Hence, a nation striving to protect its borders should necessarily strive for a high economic growth.

Security: absence of risk

Security has a special meaning in economics. Security involves the absence or the reduction of risk and a heightened predictability of the future events. Homo sapiens, the category of species to which we belong, are normally risk aversive. Risk brings uncertainty and uncertainty brings losses in our welfare. Hence, given a chance, Homo sapiens will choose a situation where there is no risk, or if it cannot be avoided, it is at a minimum. Once, people are fully secured, they can predict the events in the future with a high degree of certainty. For instance, suppose a country has a neighbour. If the relationship with that neighbour is amicable, citizens in either country can attend to their daily chores without the fear of losing their property or lives. This is the economic meaning of security and since it adds to one’s welfare, he or she is willing to pay for attaining it. That is why it is necessary to provide security as a public good which is financed by community contributions by way of taxes.

Heightened transaction costs

In modern economies, people should buy inputs for producing the needed goods and services from others or should sell the excess they produce to others so that they can buy from others what they need but do not produce by themselves. This process is called conducting transactions. For instance, when one works for another person, he conducts a transaction by selling his labour for a remuneration. Similarly, when one buys a loaf of bread, he also conducts a transaction with the bread-seller. Therefore, the modern economies are based on transactions, and it is necessary to conduct them at convenience and at the lowest cost. When there is no security, these transactions get impeded by making them more time-consuming, riskier, and expensive.

For instance, people in Ukraine or in the Gaza Strip where the national security is largely lost, conducting transactions in insecure conditions is not easy compared to a similar transaction conducted by a citizen in Paris or London. In the former case, it is more difficult, time-consuming, and riskier. Hence, it adds to the costs and becomes more expensive. These additional costs in the form of time-waste or inconvenience are a sacrifice by the person involved but not a gain by anyone else in the economy. It is a loss, and such losses are known in economics as deadweight losses. A society need not sacrifice its scarce resources unnecessarily for this purpose. Hence, the job of the national security is to keep these deadweight losses at a zero or, if it is not possible, at a trivial level.

Market coordinators

In modern economies, there are three coordination mechanisms. One is the competition among the participating people. Another is the market mechanism with which people are organised. The third is the adherence to the rule of law so that all citizens get equal treatment from the State, and no one gets a special preference. National security is needed to establish and maintain all these three requirements.

Competitive mode

Competition will cause the markets to integrate with each other with no undue costs and make them more efficient. It will in turn reduce the transaction costs. These three developments are needed to remove or reduce the risk of conducting all economic activities. In the same way, when States fail to observe the Rule of Law and maintain the Law and Order, markets will start disintegrating themselves leading to a collapse of the same. Collapsed markets will stunt economic growth and stunted growth, as we have explained earlier, will reduce national security. Consequently, the resources spent on national security is not a waste but an essential cost to ensure the smooth operation of all the needed economic activities. Hence, no nation should compromise the national security on the ground of saving resources. It will cause the nations to sacrifice all their gains on all the economic fronts.

Economic challenges

Sri Lanka is at present faced with this crucial choice because of the severest economic crisis it has gone through in its post-independence history. Its economic growth has degenerated to the negative region with a shrinking economy year after year since 2020. The size of its economy, measured by the Gross Domestic Product or GDP, amounted to $ 95 billion in 2018. It fell to $ 89 billion in in 2019, $ 84 billion in 2020, and rose temporarily to $ 89 billion in 2021. But it fell again to $ 77 billion in 2022 to rise again to $ 84 billion in 2023. Thus, all Sri Lankans have become poorer year after year.

Though the economy is recovering slowly from this severest condition, it is still not out of the woods. The forecasts made by the International Monetary Fund or IMF show that it will reach the level of the economy which it had in 2018 by 2027. The annual economic growth during this period will be low at 2-3%, an achievement about which the country cannot be proud of. Since Sri Lanka’s average economic growth during the post-independence period amounted to 4%, a growth rate which the country can attain without doing anything, any growth below this annual average is a negative economic growth in my view.

Therefore, Sri Lanka should take immediate action to push up its economic growth rate well above its natural growth rate of 4%. This is a formidable challenge faced by the country. It requires the country to adopt a different type of economic strategy.

Cost of living

Inflation rate has declined from 70% in September 2022 to 1.5% by April 2024. But this is not a matter to be rejoiced. Inflation rate is useful to the Central Bank to assess the success or failure of its monetary policy. However, for the public, it is the cost of living that matters. In January 2021 when the new series of the country’s official price index was rebased, the basket of goods and services relating to the Colombo Consumers’ Price Index or CCPI cost a family of 3.8 Rs. 91,880. This cost has accelerated to Rs. 179,350 by April 2024, or by 95%. Hence, despite the deceleration in the inflation rate, the cost of living of people is still very high. It is a threat to national security.

The Dutch Disease

The foreign exchange inflows to the country following the EFF from IMF has caused the exchange rate to appreciate from around Rs. 370 a dollar in late 2022 to Rs. 300 a dollar by early May 2024. This is a relief for those who plan to use foreign exchange for effecting imports and buying services from abroad. However, on the other side of the coin, the exporters, and sellers of services to foreigners will find it costly unless their costs of production declines along with the appreciation of the exchange rate. As a result, it will displace the traditional export sector, an ailment known as the Dutch Disease following the experience of the Netherlands after it discovered the North Sea Oil and Gas deposits. This is a serious issue for Sri Lanka because it threatens the development of the traditional exports like tea, rubber, coconut, and apparels. Hence, the gain by importers will cause losses across the economy unless the exchange rate management is planned properly.

A developed country by 2048

To overcome these crucial issues, what Sri Lanka should do is to place the country on a fast growth path. This is indeed a different type of economic game. Sri Lanka has entered this game by pronouncing that its goal has been to make the country a developed nation by 2048 when it celebrates the centenary of independence from Britain. This goal is parallel to India’s goal of making it a rich country when it will celebrate the centenary of independence from Britain in 2047. Since India has the political will, technological power, and the resource base to do so, it is to the advantage of Sri Lanka to jump on to the bandwagon of India to reach this goal. If Sri Lanka plans to do it alone, it will be both difficult and challenging.

An annual growth rate of 7-8%

Countries are ranked into different states of development like low income, lower middle income, upper middle income, and high income by the World Bank by using thresholds based on the per capita gross national income or GNI. At present, the threshold for a high-income country is $ 13,845. This threshold is revised upward annually considering the domestic inflation in USA. In the past decade, the annual revision has been at about 10%. If the same criterion is used for the next 25 years, the per capita GNI for a high-income country by 2048 will be around $ 17,000. According to current population projections, Sri Lanka’s population in 2048 will between 22 and 25 million. So, if Sri Lanka is to become a rich country by 2048, its GNI should be between $ 374 and 425 billion.

The current GNI projections reveal that Sri Lanka’s GNI in 2027 will be around $ 94 billion. Accordingly, Sri Lanka should attain and maintain an annual compound growth rate of 7-8% between 2027 and 2048 to reach the required GNI level to be classified as a high-income country. This is a formidable challenge since the country’s average annual growth rate during the post-independence period happened to be about 4%. Doubling it over the next 25-year period requires specific strategies.

Teaming up with India

First, Sri Lanka could and should team up with India which is also on a mission to become a high-income country over the same period. India should be viewed not as a competitor but as a development partner in this collaborative game. Its target is to increase the present $ 3 trillion economy to a $ 29 trillion economy by 2047 by maintaining an average economic growth of 8-9% annually. It has the political, technological, administrative, and financial capacity to attain and maintain this high growth rate. Hence, it is to the advantage of Sri Lanka to tap India’s fast growing middle class as a potential market access. According to current projections, the middle class is to grow to 715 million by 2030 and further to 1,000 million by 2047. This market should be accessed via a comprehensive economic partnership agreement which India has signed with many developed countries now.

Integration to global markets

Second, Sri Lanka should seamlessly integrate to the global production system just by producing one or two inputs and make them available to a factory located elsewhere for final assembling. Gone are the days of Thomas Friedman who advocated some 20 years ago that the world was flat. He wrote this book when the process of globalisation was at its peak and major manufacturers were seeking low-labour cost countries to off-shore their plants. But today with all kinds of protection measures introduced in national interest, the world is not flat and not even globular. It is crooked.

In today’s world, the fashion is to locate the plants in home countries, called on-shoring or home-shoring, in countries near to them called near-shoring or in friendly countries called friend-shoring. Sri Lanka should produce to this market if it wants to become a developed country by 2048. This is because Sri Lanka’s domestic market is not large enough to offer economies of scale to manufacturers.

Take for example the tea industry. It produces about 330 million kg per annum but the local population with its per capita annual consumption of 1.5 kg can absorb only 30 million kg. Even if Sri Lankans double their consumption, they can absorb only 60 million kg, leaving a surplus of 270 million kg. That should necessarily be exported. Hence, Sri Lankans or foreigners who want to invest in the country should be encouraged to join this global production sharing network.

Industry 4.0

Third, it is high-tech products that will salvage Sri Lanka in its journey toward a developed country. The world has moved into the Fourth Industrial Revolution or Industry 4.0 and is moving fast to the Fifth Industrial Revolution or Industry 5.0. Sri Lanka is still in the Second Industrial Revolution or Industry 2.0 in which manufacturing is done principally by electricity-powered machines. Hence, Sri Lanka’s strategy should be to bypass the Third Industrial Revolution or Industry 3.0 and leapfrog to Industry 4.0 before it moves to the next stage. All production systems should be geared to attaining this goal.

Productivity growth

Fourth, Sri Lanka should increase productivity across the economy if it wants to successfully compete with rival producers. Improvement in productivity will reduce the costs and place the country in a better position to supply to the global markets at competitive prices. This should be top priority of all the successive governments from today. Without the productivity growth, the country’s production system, be it agriculture, industry, or services, will be displaced in the global system which is committed to improve productivity across the respective economies.

These are the essential strategies which Sri Lanka should adopt if it wants to become a developed nation by 2048.

*The writer, a former Deputy Governor of the Central Bank of Sri Lanka, can be reached at waw1949@gmail.com

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