KEYNES’ GHOST, AMERICAN CURSE AND OBAMA’S WOES

It was indeed like an Alfred Hitchcock thriller. In every passing second, the audience, this time the global financial community, world leaders and a section of US citizenry, was gripped by suspense, excitement and uncertainty. Uncertainty first led them to fear and then to horror. The actors who played the leading roles appeared briefly on the set, read out the dialogue prepared for them and disappeared abruptly leaving the audience in a state of panic. As the clock started ticking down to the final day of reckoning, the mighty US Dollar started falling against other currencies which were also sickly, but less sickly than the dollar. On the other side of the coin, the prices of crude oil and gold started to rise to compensate for the fall in the value of paper currencies. The angry and panic – driven US public, fearing that they would lose everything they had been lavishly enjoying so far, started to jam the telephone lines and blog sites with protest messages addressed to Republican lawmakers who they have been told were the villains in plot.
What everyone did not know or conveniently chose to forget was that this movie had been screened many times before. On all those occasions, the movie was abruptly taken off the projector before the audience could reach an explosive climax.
The current battle between the Democratic President Barack Obama and Republican – held US House of Representatives over the raising of the US national Debt Limit is yet another screening of the same movie. It is widely believed that the thriller would be taken off the projector as it had been done on previous occasions just before the dawn of August 2, 2011 thereby denying the audience of the expected thrilling climax but delivering a sense of relief.
The US Debt Ceiling Crisis
The debt ceiling crisis has occurred due to an obvious reason: the US Federal Government does not have enough cash to pay its obligations unless it borrows money by issuing new US Treasury bills and bonds.
Why cannot it borrow more to pay its bills? This is because it has already reached the ceiling on borrowings fixed by the US Congress at US $ 14.3 trillion. This ceiling was reached by May, 2011 and unless the ceiling is increased, the Treasury does not earn enough revenue to pay its bills. When the problem started to knock at its door the Obama administration requested the Congress to raise the ceiling by $ 2.4 trillion but it was refused by the Republican held Congress by the support of some Democratic Congressmen from Obama’s own party by majority vote, 318 opposing and 97 voting for.

In the interim period, like any person who has been faced with a cash problem, the US Treasury has paid its bills by scraping up all the available cash in the funds under its control and using the pension contributions by the US Federal Government employees. This cash too is to exhaust by August 2, 2011 and if the Congress does not raise the ceiling on borrowings by that date, as Obama himself has publicly warned, the US Government will have to default its obligations for the first time in its history. Obama made history by becoming the first coloured President of the US in 2008. Three years later, it appears that he is going to make history again by overseeing the default of obligations by his government.
The bills involved are all public and investor sensitive payments such as social security payments, medical payments, salaries and interest on US debt. Hence, any default of these bills will cause wide – spread public and investor uproar leading perhaps to street riots.
The parties to the dispute are well aware of these perilous consequences. Yet, they have locked horns blaming each other and making attacks and counter – attacks while the world at large which has a stake in the affair is watching impatiently till an acceptable resolution is made.
The Dispute
The dispute has been over whether a ‘clean increase’ in the debt ceiling should be given or whether conditions should be attached to it. Obama wants a clean increase to wade through the current crisis. Republicans want to attach the condition that the debt ceiling increase should be accompanied by a deficit reduction programme based on spending cuts and not on increases in taxes.
Both parties agree that the US cannot continue with its current overspending as reflected by soaring budget deficits and rising national debt. In 2000, President Bill Clinton managed to convert US’s deficit budgets to a surplus of $ 400 billion. But, that was a temporary gain because under President George W Bush, the US went back to budget deficits due to the global wars it was engaged in and the rising economic problems it was facing back at home. Hence, by the time Obama took over in 2008, the US budget deficit had soared to an unmanageable $ 1.2 trillion or about 10% of the country’s GDP. By now, the deficit has increased to $ 1.5 trillion.
Obama in his State of the Union address 2011 promised to cut the budget deficit by about $ 500 billion by freezing the spending at the current levels over the next five year period. He also promised the US citizenry and the global community that the US will be a good boy by trying to live within its means, the way a normal family would plan its incomes and spending.
So, the bone of contention is whether the US should go for a short term solution now and plan for the future later or whether it should do both simultaneously. Up to the end of July, there was no agreement on this, but many believe that it is possible to reach a compromise solution before the country faces the actual threat of self - destruction.
Raising the Debt Ceiling has a long history
It was in 1917 that the US decided to fix a debt ceiling to facilitate borrowing funds in large amounts so that the Congress does not have to approve it annually as it had done before. Since this time, the US has increased its debt ceiling from time to time. From 1962, the ceiling has been increased by 74 times; from 1980, by 36 times. During Obama’s period, it has been raised 3 times from $ 10.6 trillion in 2008 to $ 14.3 trillion in February 2010.
Every time the debt ceiling was raised, the desire to restore budgetary balance and reduce the public debt was expressed by the legislators and the promise was delivered by the incumbent presidents. In 2006 when President Bush wanted the Congress to raise the ceiling, it was Obama himself who made the strongest protest: he said that the need to raise the ceiling was a sign of leadership failure. He further added that it was a sign that ‘the US government cannot pay its own bills’. But that was when he was in the opposition and when in the government, he had to play the same game as his predecessors.
Hence, the US budget deficits and rising public debts have been a concern.
Summarising these concerns, the US Congress Budget Office in its 2011 Report on Long term Budget Outlook has warned that without major policy changes, the large budget deficits and growing

public debt will continue with the adverse consequences of reducing the national savings, raising foreign borrowings, increasing interest rates and moderating domestic investments.
So, the US authorities are well aware of the ailment with which the US economy is chronically and now acutely afflicted. What they appear not to know is the solution.
The US Government: the Bad Boy that delivered the ‘American Curse’
There are two reasons why the US has become a bad boy, especially after the World War II. One reason is the Keynesian Ghost that has influenced and still continuing to influence the US policy makers. The second reason is the elevation of the US to the world’s central banker nation, a blessing at that time but now turned out to be the ‘American curse’, and the desire for enjoying the perks associated with that role.
Keynes has been far more influential on the US economic policy than any other economic philosopher of the day. His policy prescription that the governments in advanced countries can beat economic recessions successfully by increasing the government expenditure was considered a plausible solution to the problem of economies fluctuating from economic booms to economic slumps, a phenomenon known as business cycles. Daniel Yergin and Joseph Stanislaw have described in their ‘The Commanding Heights’ how Keynesianism got rooted in the policy base of the US administration. According to them, it was the Economics Department of Harvard University, more specifically its leading academic Alvin Hansen that was first converted to Keynesianism. From Harvard, it soon spread to Washington like a wild fire because it enabled the government to intervene in the economy for the public good without adopting more intrusive methods that had been practised in countries like the Soviet Union. So, Keynesianism provided the philosophical foundation to stop the spread of communism.
Since the World War II, the US administration adopted the Keynes’ policies to attain full employment in the US economy by raising government expenditure. The result was the emergence of deficit budgets and ensuing increases in the public debt to unmanageable levels threatening the very leadership of the US in the global economy unless a quick policy reversal is made.
Profits from being the World’s Central Banker Nation
In terms of the Bretton Wood Agreement under which the IMF and the World Bank were created, the US became the world’s official central banker nation. Even after the US relinquished these responsibilities unilaterally in 1971, it became the world’s unofficial central banker nation.
One privilege which any central banker enjoys is the enormous profits it can make as long as the cost of producing its currency is less than the face value of the currency it produces. In economic parlance, this profit is known as ‘seigniorage’ and central bankers are termed ‘seigniorage seekers’.
Suppose the cost of issuing a US dollar is just 5 cents. When the US government issues one dollar, it acquires from the public goods and services worth of one dollar on credit because a dollar bill is a debt note issued by the US government. Its obligation to the holder is to allow him to buy a dollar’s worth of goods and services from the US economy or from any other place where a seller is willing to accept it in exchange of a dollar’s worth of goods and services. This may or may not happen depending on the desire of the holder of the dollar bill.
Hence, for every dollar bill issued, the US government makes a profit of 95 cents, according to the above example. The US has been lavishly enjoying this seigniorage without thinking that it could become a curse one day.
Central bankers are normally restricted in their use of the seigniorage for lavish expenditure programmes by the governments. For instance, in the Monetary Law Act under which the Central Bank of Sri Lanka has been set up, seigniorage has been deliberately hidden by the Act’s architect, John Exter, within the Bank’s accounting system. Accordingly, any profit earned by the Bank, while it is still a liability of the Bank, is simultaneously reduced from its demand liabilities thereby keeping the total liabilities of the Bank unchanged. The use of profits for government expenditure programmes is a separate process under which the Bank has to appropriate its profits deliberately to the government.

This wisdom of responsible use of the seigniorage has not been practised by the US government. It can continue to use the seigniorage because the other nations use those dollar bills as reserves or a medium of payment without repatriating them to the US.
The Tense Global Community
But the global community which has relied on the Dollar as a reserve currency and a medium of payment has become tense, nervous and panicky. If the dollar falls, it would wipe out a substantial portion of their wealth. To protect themselves in a small way, they are transferring dollar assets to other currency assets and converting dollars to gold. But the global community cannot get rid of dollars completely, because in their wild race to buy other currencies and gold, their prices would rise to exorbitant levels. That currency and gold bubble, when eventually pricked, would be the end of the world’s monetary system.
Hence, countries like China, Japan, India and Taiwan which hold huge dollar assets have become more nervous than Obama in this present US debt ceiling crisis.
Prescriptions: Some are Hilarious
Now that Obama and the US Congress are in a deadly deadlock, some have offered wise counsel as to how he could overcome the impasse.
The Yale Law School Professor Jack Balkin has offered three suggestions, all being circumventions of law rather than finding a lasting solution to the problem created by the irresponsible deficit financing and rising public debts.
First, he says that Obama can take cover under section 4 of the 14th Amendment to the US Constitution. According to this section, the US public debt, including that is raised to pay pensions and soldiers suppressing rebellions and insurrections shall not be questioned. Hence, the Congress has no power to block Obama and he can continue to raise public debt irrespective of the debt ceiling fixed by the Congress.
The second suggestion is the more hilarious one. According to US laws, the US Treasury can issue platinum coins of any denomination without the approval of the congress. He, therefore, suggests that the Treasury issue two platinum coins in the denomination of $ 1 trillion each and deposit the same with the US Federal Reserve Bank, the country’s central bank, to its credit. Then, the Treasury can draw cheques against its deposit balance and make payments.
The third suggestion is that the Federal Reserve Bank can buy assets worth of $ 2 trillion from the Federal Government and allow the Treasury to draw cheques to that amount.
These three suggestions will help Obama to circumvent the law and survive for one more day. But it will not give confidence to the international community since the first one calls upon Obama to function like a dictator ignoring the laws and the wishes of his law makers and the last two call upon the Federal Reserve Bank to increase its money supply against either worthless or unusable assets thereby sowing the seeds of the future inflation and causing the eventual downfall of the dollar.
Keynes’ Ghost being resurrected by mainstream economists
Leading economists such as Paul Krugman, Larry Summers and Brad De Long have made somewhat a rebellious suggestion. They have opined that the debt ceiling should be raised and the government, instead of cutting, should actually increase its spending. This is in order to stimulate the economy and thereby raise output and employment so that in the long run, the US government has no either a budgetary problem or a national debt problem. A similar view was expressed by the Federal Reserve Bank’s Chairman Ben Bernanke when he addressed a congressional meeting. He said that if the Congress does not raise the debt ceiling, he has no choice but to stimulate the US economy with a new stimulus package.
It is inconceivable that, as Albert Einstein once remarked, how a cause of a problem can become its solution as well.
Despite the massive size, these stimulus packages have not delivered the desired results as demonstrated by rising unemployment, low economic growth and shattering consumer confidence in
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the US. Instead, they have delivered bigger trade deficits, bigger budget deficits and need for raising additional national debt.
This is the popular Keynesian Ghost being resurrected without Keynes’ consent. Since it allows everyone to continue to dance on the table, it would be sweet music to both politicians and angry US citizenry.
Keynes’ Ghost has wreaked havoc to the US economy threatening its status as the global economic leader. It was William McChesney Martin Jr, Federal Reserve Chairman during the 1950s that said that Federal Reserve’s job is to take the punch bowl away just as the party gets going. The suggestions by the leading economists and Bernanke point to the opposite. That is, the Federal Reserve should continue to refill the punch bowl and allow the dancers at the party to dance on the table, perhaps until they all get exhausted and collapse.
The global community, especially China which has the biggest stake, is watching sadly whether this is happening.
(W.A. Wijewardena can be reached at waw1949@gmail.com )

THE GLOBAL TALENT INDEX: SRI LANKA’S LOW RANKING SHOULD BE AN EYE OPENER

MY VIEW 30 – ECONOMICS MATTERS
By W.A. Wijewardena
THE GLOBAL TALENT INDEX: SRI LANKA’S LOW RANKING SHOULD BE AN EYE OPENER
The Need for Developing Talents and Skills
It was the Sinhala Scholar, Poet and Writer of renown, Munidasa Kumaratunga, who once said that a nation that does not invent and produce new things cannot prosper in this world. To invent and produce new things, a nation should develop its talents and skills, individually as well as collectively. Modern economists call this developing knowledge capital and attribute the current global economic prosperity to its rapid advancement. Having recognised its importance in the country’s march toward making Sri Lanka the Wonder of Asia, Mahinda Chintahana, the policy package of the government, has laid down plans to convert Sri Lanka to a ‘knowledge hub’, an aspiration to become a producer of world class knowledge, talents and skills so that Sri Lanka could disseminate the same to the rest of the world. So the proposed knowledge hub while helping Sri Lanka to attain prosperity within the domestic economy is expected to make it a foreign exchange earner by exporting knowledge, talents and skills.
The goal of becoming a knowledge hub requires Sri Lanka to develop its talent pool far ahead of the rest of the world. Hence, an international comparison to find out where Sri Lanka presently stands and how much effort it has to make to win and outperform others is timely and opportune.
The Global Talent Survey
In this regard, the results of the Global Talent Survey for 2011 and the outlook for 2015 released last week are a pointer. This survey covering 60 countries has been conducted by the London based The Economist Intelligence Unit and published by the international consultancy firm, Heidrick and Struggles. A country is assessed by seven broad aspects relating to talent development and its

capacity for attracting and retaining talents. The final scores earned by countries have been produced in the form of a global talent index that ranks countries from the best to the worst (available at www.globaltalentindex.com ). Most of the data for ranking have been obtained from the Economist Intelligence Unit data bases, while country executives and experts have been surveyed to learn of their own perceptions about talent development challenges in their respective countries. The maximum scoreable points for a country are 100.
The previous survey conducted by the Economist Intelligence Unit for 2007 covered only 30 countries and did not include Sri Lanka. Hence, the current survey does not throw light on Sri Lanka’s past performance in talent development.
Sri Lankans are poorly talented
In the survey for 2011, Sri Lanka which has scored 26.3 points has been ranked at the 59th position out of 60 countries, just one notch above Nigeria. The survey also prepares a global talent index prospectively for 2015 taking into account the policies being adopted by the 60 countries included in the survey. In terms of this, Sri Lanka would improve itself just by two notches in 2015 to occupy the 57th position by scoring 29.2 points and driving Algeria, Nigeria and Azerbaijan to the last three slots.
According to the Survey, USA which has scored 74.2 points has been ranked number one in the global talents in 2011. Even in 2015, it is to maintain its position unrivalled as the global leader in talents. USA’s supremacy as the leader of global talents has been due to the high quality of university education (of the top 500 universities in the world, one in three is a US university), flexibility and the innovativeness of its workers, high research and development outlays and ability to attract and retain talents to that country. Its closest rival, Denmark, is a way below scoring 64.7 points in 2011 and marginally improving to 65.4 points in 2015. From the Asian region, Singapore which has scored 60.2 points has been ranked at the 5th place in 2011 well above its one time colonial master, the UK, which has been ranked at 12; Singapore’s position has been downgraded to the 6th position in 2015 though it is projected to improve its score by 1.7 points over its score in 2011, simply because the other countries have improved their talents much faster. China and India, the two countries which Asians believe will take over the world in the next few decades are ranked at 33 and 35, respectively, in the global talents in 2011. While China has managed to upgrade itself to the 31st position in 2015, India has remained at 35, co – sharing that position with a new comer, Mexico. Russia, another country of promise by many, is ranked at the 34th position in both 2011 and 2015.
Hence, Sri Lanka has a long way to go to convert itself to a global knowledge hub of importance. The need of the day is not rhetoric but concrete and consistent action to reach that goal.
Global Perceptions should not be ignored
The publisher of the index, Heidrick and Struggles, has been in business as an international consultancy firm in human resource and talent management for over 60 years. It has a presence in all the five continents, namely, North America, South America, Europe, Asia and the Oceania. Its collaborator and compiler of the index, The Economist Intelligence Unit, is a part of the renowned economic weekly, The Economist of the UK. In view of this Western orientation of the two compilers, one may just dismiss its results as yet another Western conspiracy to tarnish the good image of Sri Lanka, while attempting to boost their own. But, if Sri Lanka aspires to develop itself as a global knowledge hub of worth, it has to deal with the perceptions of the global community which has looked at Sri Lanka’s talent landscape in a different way. In this respect, the humble and modest approach made by China, the country which Sri Lanka treats in awe and with respect, may be a lesson to those who may wish to jump on the bandwagon of conspiracy theories.
The Chinese President Hu Jintao himself requested the academics and students of Tsinghua University at its centenary celebrations in April, 2011 to be research oriented and independent in thinking. Noting that China lags behind the rest of the world in talent development, Hu further said that, as reported by The South China Morning Post, building ‘several world class universities and many more with higher standards in teaching and research is a major step for a country to cultivate its talents’. This comment by the Chinese President was made despite the high global ranking which Tsinghua had got among the world’s top universities: in fact it has been ranked the top 58th university in the world by the UK based newspaper, The Times. The example set by China’s leadership to eat

the humble pie amidst the adverse international criticism is a sure way for a nation to progress forward.
Hence, the publication of the Global Talent Index ranking Sri Lanka at the 59th place out of 60 countries is a good opportunity for Sri Lanka to reflect inward and make a judgment for itself how and why the country has gone wrong and what measures are needed today to rectify its mistakes.
The Coverage of the Index
Seven important criteria have been used by the compilers of the index to assess the status of the talent development in each country. They are,
1. The demographic conditions
2. The quality of compulsory education
3. The quality of university education
4. The quality of labour force
5. The degree to which the work environment in the country nurtures talent
6. The mobility and the relative openness of the labour market and
7. The country’s proclivity to attract talents
In all the seven criteria, Sri Lanka has been ranked very low, either at the bottom or close to the bottom of the list.
Though all the seven criteria need careful investigation, I will touch upon the two most important ones, namely, the pathetic state of the compulsory general education and the university education.
The Low Quality of General Education
In the case of the compulsory education, Sri Lanka has earned a moderate score of 54.1 well above India which has scored only 32.0 points. Sri Lanka’s moderate score has been due to its better performance with respect to the duration of compulsory education, enrolment ratios and adult literacy rates. But it has scored low with respect to two other criteria in the category, namely, the low education expenditure in the total gross domestic product (less than 2 percent in recent years and is on the decline), the low amount spent per student as a percent of per capita income (about 5 percent). The poor resource allocation on compulsory education, due to growing budgetary constraints, has adversely affected the ability of the country to maintain its quality. This is an area where Sri Lanka has to pay urgent attention since it is the quality of the compulsory education that supplies quality inputs for the development of the future talent pool of a country.
University Education is pathetic
The quality of Sri Lanka’s university education, as revealed by the global talent survey, has been pathetic. Its ability to provide university places for all those aspirants of higher education has been very low: the average number enrolled in universities has been about one in every five students who qualify to enter a university. The current university system which has a physical constraint by way of infrastructure, modern class room facilities and university teachers has been faced with the problem of meeting the growing demand for university education in the country in the future. Further, Sri Lanka does not have a single university that is ranked within the top 500 universities in the world. Its total expenditure on higher education amounting to Rs 19 billion in 2010 has been about 0.3 percent of the gross domestic product of Rs 5602 billion in that year.
On all these three counts, Sri Lanka has scored a zero point in the index. This has to be compared with 82.9 scored by USA, 38.2 by Singapore, 30.0 by Malaysia, 24.4 by China and 15.2 by India.
The conversion of Sri Lanka to a knowledge hub crucially depends on developing a world class university system in the country. During the British period and in the first decade after independence, Sri Lanka’s only university at that time, namely, the University of Ceylon at Peradeniya was ranked on par with the University of London on which the University of Ceylon had been modelled. However, after the second decade of independence, especially after the university

system went for the Swabhasha education system, Sri Lanka lost this unique position. The poor funding, poor remuneration and poor research facilities all contributed to this pathetic development in the country’s higher education system. To add further woes to the already ailing universities, new universities were set up as a matter of political expediency without proper planning or funding. Some of these universities were just namesakes and became recognised universities simply on the strength of the government’s seal that had been given to them and not on the quality of teaching or research. Hence, if Sri Lanka is to develop as a knowledge hub today, it is necessary that the country’s university system should regain the old glory which the University of Ceylon had during the British time.
Essential Attributes of a world class university
What makes a world class university? This question was posed to Andrew Hamilton, currently Vice Chancellor of the University of Oxford and formerly the Provost of Yale by the China’s Xinhua News Agency in April, on the sideline of the Tsinghua University’s centenary celebrations. ‘The spirit of a university centres on two things...’ was the answer of the world renowned academic. ‘...and those are the commitment to excellence and free debate’. He further elaborated his second point by adding that at Oxford, students and tutors exchange views on different subjects in a free robust and rigorous debate. According to him, such a free environment helps students to develop intellectual self confidence which is essential for developing a person’s innovative capacity and creativity.
There are two main characteristics attributed to world class universities. One is academic freedom and the other is independent thinking.
Academic freedom
Academic freedom is the freedom enjoyed by university academia to teach, write or express what they believe to be true without having to doctor their views to conform to official or any other social line of thinking. If an opinion expressed by one academic is subject to dispute as it should always be, there are procedures for resolving such disputes by using again an accepted ethical and moral disputation resolution code. The creation of such an environment in a university will help everyone, that is, academics, students and the general public, to advance their intellectual capacity. The countries which have tried to deliberately engineer academic views to fall in line with dogmas or ideals of their political leaders have miserably failed to create creative societies endowed with talents.
Independent thinking
Independent thinking, like the academic freedom, helps academics and students to develop their intellectual capacities free from biases or uncritical conformity to accepted views. It breeds a class of free thinkers and not blind followers. Independent thinking as related to undergraduates has been succinctly presented by Rev Weliwitiye Soratha, founding Vice Chancellor of the then Vidyodaya University as follows: ‘The university students should be probing, critical, rebellious, ethical and honest’. A similar view has been expressed by the 12th century Egyptian physician and philosopher Moses Maimonides when he said, ‘men like the opinions to which they have accustomed from youth; this prevents them from finding the truth, for they cling to the opinions of habit’. A world class university promotes and appreciates such independent thinking in both academics and students. This is what the Chinese President Hu Jintao meant when he requested the students of Tsinghua University to maintain their individuality by thinking independently.
Restore the lost university autonomy
Many including previous university vice chancellors and current and retired academics have charged that Sri Lanka’s university system has lost both these core values. There are charges that universities, instead of developing a true intellectual environment, have become regimental organisations by trying to control the free thinking of both academics and students. In the case of academics, it has been alleged that those who toe the political leaders’ line are rewarded while those who do not are penalised. Of late, university academics and concerned citizens have charged that universities have lost even the autonomy provided to them by statutes to decide on curricula and course materials. This development in fact does not augur well for developing a world class university system in the country or converting Sri Lanka to a knowledge hub of worth.

The global talent survey is therefore an eye opener for Sri Lanka to take early action to reform its education system and the labour market to promote talents and skills in its citizens both individually and collectively.
(W.A. Wijewardena can be reached at waw1949@gmail.com )

IF CHINDIA CANNOT OUST THE WEST, WHY NOT USE BRIC PLUS?

Two readers, one domiciled in the Middle East and the other in Canada, of my previous My View on “Asia’s Return to World Leadership: Not a Cakewalk at all” have drawn my attention to two important factors which I had overlooked therein.
The first is that, Chindia (China and India) may be unable to oust the West from its supreme position, but an augmented group like BRIC or BRIC Plus has a good chance of doing so. Hence, the future world will be a world of BRIC Plus that will draw its strength from four continents, Latin America, part of Europe, Africa and Asia.
The other overlooked factor is in fact supportive of my view. It has drawn attention to China’s one child policy and the consequential aging of population imposing a constraint on its ability to continue with high economic growth.
Both these factors are important and deserve our attention.
The BRIC Plus Factor
The original BRIC factor was the unofficial grouping of four fast growing economies in the world, namely, Brazil, Russia, India and China, by the US based investment bank, Goldman Sachs. According to Wikipedia, the cyberspace encyclopaedia, Goldman Sachs’ Chief Economist Jim O’Neill coined the acronym BRIC in 2001 in a paper titled “The World Needs Better BRICs”. Since then, all those who were interested in having a shift in the world power from the West to a new group carried it forward arguing that BRIC was on its way to gain world supremacy. Though BRIC countries did not have any wish to have themselves organised as a separate power group at first, the continuous reference to them as an emerging world power made them meet at high levels to discuss issues of common interest. Accordingly, Russia hosted the first BRIC Summit Meeting in 2009 and Brazil the second in 2010. The third is going to be hosted by China in 2011.
Towards the end of 2010, a fifth emerging economy, namely, South Africa, has been invited to the BRIC Group making it now BRIC Plus to accommodate any other new member to be enrolled in the future.

The common view today is that BRIC Plus is now on its march to displace the West from its world leadership.
BRIC Plus is a diverse group
BRIC Plus is a diverse group of countries occupying different stages of development and possessing different economic potential for the future.
Of them, China is the most promising in terms of future economic potential. Given its current economic size, growth prospects, reserve level, integration to global markets and commitment to upgrading technology, if needed, it could stand on its own and the other four have to just follow it. The old superpower, Russia, today is a spent force requiring a complete overhaul in its economy and management if it is to contest for world leadership. The other three countries are low income to upper mid income countries with their own internal economic woes.
The average per capita income of BRIC Plus in 2009 amounted to US $ 5494. The comparable figure for the developed nations, represented by Organisation for Economic Cooperation and Development or OECD, was nearly eight times higher at US $ 40714. The combined population of BRIC Plus stood at 3 billion in 2009, but, out of that, 2.5 billion lived in Chindia. The high population in Chindia is an asset at the moment, because it can accommodate as many labour intensive industries as possible. But, it also poses the challenge of upgrading the living conditions of such a large number of people within a space of one generation and making their living more comfortable with modern amenities. The high incidence of poverty, ranging between 15 to 20 percent of the population has been the most formidable challenge. Though population-wise less in number, this is a common problem in the other three countries too. Hence, a greater portion of the newly acquired economic growth will have to be spent by these countries for upgrading their own citizens.
Thus, the intended march to victory by BRIC Plus will not be a rosy one at all.
Division of Production among BRIC Plus
According to Goldman Sachs, BRIC countries will have high economic growth continuously based on specialising in different product lines. Accordingly, China will specialise in manufacturing, India in services and both Russia and Brazil in raw materials. South Africa too will fall into this last category of a raw material supplier to the world.
In my view, it is unusual for a country to record a high sustainable growth having specialised in a single line of production.
BRIC Plus: The Projected High Economic Growth
It is again analysts outside BRIC Plus who have advocated its cause. Goldman Sachs, in three reports each presenting a more optimistic view than the previous one, has carved out a very clear and an accelerated path for BRIC Plus to ascend to world supremacy in the next four decades. In terms of the latest, China will be the largest economy in the world by 2027 surpassing USA. By 2050, the world’s five largest economies would be China, USA, India, Brazil and Mexico, in that order. Of them, three are BRIC Plus countries. If one considers the six largest economies, Russia being the

sixth, all the four major BRIC countries are in the league. Thus, by size of the economy, BRIC Plus is projected to lead the world.
However, the scorecard with respect to per capita income shows a less convincing story. In 2050, by per capita income, these projections have kept USA at the top, followed by South Korea and the UK. Of BRIC Plus members, Russia is ranked at 4th, Brazil at 11th, China at 12th and India at 17th. South Africa is ranked below the highest 22 countries. A clearer picture is shown when the income per capita of the four major BRIC countries is taken as a percentage of USA’s per capita income: Russia, 85 percent of USA; both Brazil and China, 53 percent and India, 22 percent. On average, the four major BRIC countries will have a per capita income of US $ 49,000 as against USA’s per capita income of US $ 91000.
In my view, even if one accepts Goldman Sachs’ projections, they point to a number of hidden factors about the real state of BRIC Plus group.
Goldman Sachs’ projections have shown that BRIC Plus countries will grow enormously in size over the next four decades. But, like an overly obese person, they will be inefficient compared to even a small country like South Korea, which is currently a member of OECD. With low income, they would find it difficult to sustain that economic size purely out of domestic consumption and will have, as they do it today, to depend on the rich West for sustainability. According to projections by National Geographic Magazine, by 2050, the world’s population will be a little over 9 billion. Of that population, BRIC Plus will account for a little over 3.5 billion. The productivity of all those 3.5 billion people will be so low that on average, a person in BRIC will produce only about a half of what a US or a South Korean citizen has produced.
This low productivity and low per capita income will make BRIC plus countries still vulnerable and dependent on the rich West. Further, due to lower income, their citizens will be devoid of many comforts which the citizens of other rich countries will be enjoying at that time.
In my view, BRIC Plus will be blessed with more man – power and, hence, a larger economy. But they have to confront themselves with a new type of problem. That is how to feed more mouths which are less productive.
This is hardly a capability for throwing a formidable challenge to the ruling world leadership.
Can a Country sustain infinite growth?
The projections by Goldman Sachs have assumed that over the next four decades, the BRIC countries will grow at supernatural rates.
For instance, China will grow at 35 percent per annum, India at 70 percent, Brazil at 19 percent and Russia at 13 percent.
In my view, this type of linear growth at high rates will make a significant call on the world’s natural resources and will require the use of ever advancing technology supported by an ever improving work force. The prices of natural resources will surely surge driving the whole world economy to a chaotic situation as it had done in the last energy and natural resource price increase in 2007 and 2008. Internally, super high economic growth will over heat the BRIC economies, like a motor car getting over heated, if it is driven continuously at high speed without a respite. The internal work force will get exhausted, worn out, obsolete and less productive, while becoming more

and more costly along with the increase in the per capita income. Environmentally too, it may call for a massive exploitation of environment for dumping the waste matter that is to be produced by super natural economic growth.
Hence, countries will have to slow down and even abandon the high economic growth due to these impeding factors.
To be fair, Goldman Sachs has assumed a very modest economic growth in the developed West. For instance, it has assumed that USA will grow at an annual average of 3.4 percent over the next dour decades. The other leading economies are to grow even at lesser rates: Japan at 1.1 percent, UK at 2.6 percent, Germany at 1.5 percent and France at 2.5 percent.
It is not understandable how BRIC countries will be able to sustain their high economic growth rates when its main clients grow at snail’s pace.
Super Technology is Key to Future World Leadership
In my view, future world will be driven by super technology and anyone who has acquired this weapon will be able to rule the rest.
At the turn of the new millennium, Singapore’s authorities had identified four areas which would give super leadership to a country in the new century. They were genetic engineering, information and communication technology or ICT, nano technology and entertainment. Accordingly, Singapore insisted that all its universities and institutions of higher learning should concentrate on developing the country’s skills in these four areas. The logic behind this move was that it was USA and the UK which were leading in these areas and Singapore wanted to be a partner of the new global leadership by acquiring the necessary skills in the four fields.
Genetic Engineering a Must
Given the projected surging of world’s population to over 9 billion in the next four decades, the biggest challenge for the survival of mankind would be how to feed the more mouths that are added to its rank year after year, especially in the developing world. When the world was confronted with a similar problem in 1950s, the solution was found in launching a green revolution that produced more food per hectare of land. It has been suggested that the world should go for a second green revolution now. The production of more output through genetically modified foods will be the main component of this second green revolution. Understandably, it is the rich West which has taken leadership in research in genetic engineering.
Genetic engineering will boost in the advancement of medical sciences too. While it helps in the discovery of new drugs, it will also help in engineering essential and vital body parts. As reported by Newsweek in its issue of 13 December 2010, scientists at Harvard Medical School and Massachusetts Institute of Technology have made a breakthrough in engineering body parts by using natural cells of a person with a non – cellular frame or scaffolding. According to Newsweek, already a few patients in USA have been given a new lease of life with these engineered body parts.
ICT and Nano will open new horizons
New advancement in ICT, especially research into distributed intelligence, will revolutionise the future world. The smart machines to be developed under this will

replace the costly manpower and reduce the comparative advantage which BRIC and other developing countries hold in this area at present.
China’s one child policy, compared to India’s surging population, will place China at a disadvantageous position in decades to come. But, the future production will be automated and the manpower requirements for mass production will be less. At that point, it will not matter whether industries are located in BRIC or other developing countries or simply in the developed countries. Given the leadership which the developed world, especially USA, Canada, the UK and Germany, has taken in ICT research at present, a relocation of mass production factories in developed countries is to be anticipated.
Nano technology where a nano means one billionth of any measure and in this case, one billionth of a metre, is a completely new area of research for developing countries. It has wide applications in medicine, energy and power, military matters and also consumer durables. The current leader in nano technology research is understandably the rich West and with that weapon in their arsenal, they are in a position to rule the world.
Entertainment: An Area in which Chindia can Excel
Entertainment, the final consumption product, has the largest market in the globe. Whoever who will excel in this will have a high growth prospects in the future. Both China and India have the built in potential to produce entertainment to the rest of the world, provided they could produce entertainment which the rich West demands. Recently, as a preliminary step, India signed a Memorandum of Understanding with France to launch a collaborative movie project targeting the global market. China has gone into the animated movie production field in a big way in this area and is set to capture the global market.
Future World: A Cooperative and Collaborative Business
Despite the wishes of many, the future world will be a cooperative and collaborative business with the rich West and the rest of the world. While the West has to accept the emerging economic strength of some selected countries like China and India, the rest of the world has to accept the good collaborative services being provided by the West.
The emerging global problems have to be tackled by the mankind together and not in isolation.
(W.A. Wijewardena practiced economics, taught economics
and wrote on economics for more than three decades.
He is a free lance writer and a consultant on economic matters.
He could be reached on waw1949@gmail.com)

THE FRENCH REVOLUTION: THE WORLD NEEDS REFORMS AND NOT REVOLUTIONS TODAY

MY VIEW 29 – ECONOMICS MATTERS
By W.A. Wijewardena
THE FRENCH REVOLUTION: THE WORLD NEEDS REFORMS AND NOT REVOLUTIONS TODAY
The Attack on the Bastille
Two hundred and twenty two years ago on July 14, 1789, the first shot of what later came to be known as the French Revolution was fired in the streets of Paris, the capital of France. That historic moment took place when the people in the streets led by France’s leftist middle class stormed the Bastille, the notorious fortress- prison run by the government. The reason for singling out Bastille for attack was that it was the place where the opponents and dissidents had been kept in dungeons without trial, tortured and eventually murdered. So, Bastille was the symbol of despotism in the eyes of the people and an attack on it was considered an attack on France’s ruling powers jointly enjoyed at that time by the monarchy, aristocracy and the Church.
The French Revolution caused a transfer of powers from the monarchy and other two privileged classes to ‘the citizens’; it also led to the establishment of the French Republic in 1791which had indeed been preceded by the Declaration of the Right of Man and the Citizen two years ago. Thus, the new republic already had a set of guiding principles to go by. Hence, the French Revolution symbolised the return to justice, fairness and people’s, here meaning the common man’s, power. At a time when family and connection to high places were needed by a person to rise in the society’s ladder, the French Revolution created the ground for people to rise in society based on ability, skills and merits.
The Reign of Terror
Yet, like any revolution, the French Revolution too was bloody, violent and destructive. It spawned a reign of terror that claimed more than 40,000 lives during and immediately after the revolution. It also gave birth, as an invention of necessity, to such a mass death machine as the guillotine that could execute prisoners swiftly in what looked like public mass execution ceremonies.
The leaders of the revolution who sat in a Committee of Public Safety passed death sentences on the enemies of the revolution and the victims were promptly walked to the guillotine for swift execution. King Louis XVI, the ruling monarch of France at the time of the revolution was accused of

‘conspiring against the public liberty and safety’ and was found guilty by 361 votes of the Committee for immediate execution versus 288 against. Accordingly, on January 21, 1793, he was guillotined as Citizen Louis Capet, an ordinary Frenchman, for the Committee had already reduced him to that status. But, before his head was pushed through the slot of the machine for the blade to do its job, he had the courage to shout at the public who was witnessing the execution, ‘I am innocent’.
His wife, Queen Marie Antoinette, again reduced to the status of an ordinary Frenchwoman, followed him to the guillotine ten months later.
Commenting on the reign of terror unleashed by the liberators, economic historian William Woodruff in his 2005 publication, ‘A Concise History of the Modern World’, says that ‘...they coerced a nation of twenty seven million, arrested hundreds of thousands and put thousands to death. Not liberty, but the guillotine became the symbol of France’.
The Running Budget Deficits and Economic Hardships
It was economics mixed up with politics that led to the French Revolution. The blame does not squarely go to King Louis XVI, but to his predecessors who had separated France into two, a privileged class consisting of the monarch, aristocracy and the clergy on one side and the rest of the citizens, on the other. Louis XVI in fact inherited a bad legacy and his crime was failing to introduce the necessary economic reforms well in advance in the face of the boiling and steaming social upheaval. At that time, the French government was bankrupt, its expenditures exceeding incomes for many years. In today’s parlance, this is equivalent to running a deficit in the current account of the government’s budget. Since at that time, the currency issue had been strictly controlled by the gold stocks owned by the government under the gold standard system, the French government could not, like many governments of the day, keep itself afloat temporarily by borrowing abroad or printing money and inflating the economy.
Hence, the ordinary citizens had to pay for the lavishness of the rulers. The tax burdens on them were too heavy and according to caricatures drawn at that time they were carrying on their backs both the aristocrats and the churchmen. But this latter group that enjoyed special privileges at the expense of the common tax payers prevented the government from introducing the needed reforms under which they too should have been made to shoulder the burden of the government.
So, King Louis XVI failed to introduce reforms in time and had to reap the whirlwind that had been created by his predecessors and the prevailing unjust system.
The Universal Chain of Events
What followed thereafter was exactly in accordance with ‘the economics of despotism’ which economists have noted throughout the history. The chain of events that takes place in a similar situation is as follows.
The ordinary citizens are forced to bear greater and greater burdens. The privileged classes enjoying their ‘rents’ (because they do not do any productive work to earn such privileges) become fatter and fatter. Lured by these rents, more and more people try to join the privileged class, but since all cannot be accommodated, there are entry restrictions after sometime. Such rejected parties also turn against the government and make the biggest voice. Society becomes infested with bribery and corruption. The public rise against the government when economic hardships become unbearable and such hardships are not borne by all equally. The government becomes repressive and uses more and more repressive measures to control the agitating public. Justice, freedoms and rights, the cornerstones of an orderly society, get thrown away. The system starts imploding from within and it is also subject to explosive attacks from outside. A simple event, maybe a false rumour, is sufficient at this stage to spark a massive public uprising. Within days, the government which was perceived as very strong up to that time is forced to come to its knees and eventually overthrown.
This is exactly what happened to the government of the all powerful King Louis XVI on that fateful day 222 years ago.
Revolutionary Leaders no better
But the leaders of the French Revolution were not better than the accursed government of King Louis XVI. They too ran a reign of terror because of the feeling of insecurity on one hand and what social psychologists today call ‘bias blind spots’ of despotic leaders on the other. Accordingly,

the ideals of human rights, justice and fairness for which they had fought in the revolution were very quickly forgotten. While all of them were accused of being ‘blood thirsty’, some leaders like Georges Danton were accused of corruption too. The result was that, within one year of the execution of King Louis XVI, three prominent leaders of the revolution were arrested and guillotined.
The first one to be executed was Georges Danton who was accused of financial misdeeds and becoming a millionaire after the revolution. After the trial, he was promptly guillotined, but like King Louis XVI, he walked to the execution site valiantly. Then it was the turn of the man who had accused Danton at the Committee, Maximillien Robespierre.
Robespierre had ascended to the leadership of the Committee by winning enemies through favours and putting those who could not be won to the guillotine. But this strategy did not serve him well for long. He too fell a victim to the same terror tactic which he had been employing on others. It was an irony that Robespierre who accused King Louis XVI of conspiring against the public liberty and safety and demanded of the King’s the prompt execution was subsequently being charged with the same crime by his accusers with the same demand for prompt execution.
The third man was Robespierre’s close ally Louis Saint – Just who too was executed with his master for the same crime.
Affliction by Bias Blind Spot
Why do people throw away the ideals for which they have fought valiantly and become completely strange people after they come to power? Is it due to normal human frailty that people in power are more prone to become corrupt and morally decadent? It may be, but there is a more compelling reason for them to become strangers to their once cherished ideals later. That reason is the tendency for people to get afflicted by what is known as ‘bias blind spot’ after they start enjoying the fruits of newly acquired powers.
This term was coined by the Princeton University’s social psychologist Emily Pronin and her colleagues to refer to a condition in which a person fails to notice his weaknesses because of a bias in his understanding. Pronin did not apply it to despotic leaders, but one could safely see the parallels. It happens in the following way: After a despotic leader starts enjoying his newly acquired powers and all others around him start praising him and his abilities simply to win his favours, the despotic leader develops a bias toward himself. He gets a mental feeling known as ‘illusory superiority’ supported by the ‘halo effect’ created by those who constantly praise him. The corollary of this illusory superiority is his thinking that he is better than all others in the world. Driven by this superiority complex, he becomes a monster who throws all accepted norms, rules, ethics and good practices down the drain. But as has been shown by the inevitable fate of all despotic leaders in the history, pretty soon he becomes a victim of his own exaggerated feeling of superiority.
Revolutions are launched in the name of democracy, justice and fairness. But these are the very terms which the leaders of revolutions tend to forget soon after they capture power. This same tendency has been observed in the case of leaders who come to power by popular ballot too. Is it due to a misunderstanding of the three terms or due to their riding on the sentiments of the public who demand of same? The answer depends on what we really perceive as democracy, justice and fairness.
The Idea of Justice
The Nobel Laureate Amartya Sen has tried to resolve this issue in a book published in 2009 under the title ‘The Idea of Justice’. In fact, before Sen, it was the Harvard Philosopher the late John Rawls who explained justice as ‘fairness’. Sen, while admitting that he immensely benefited from Rawls’ philosophical underpinnings, has tried to take it beyond Rawls by incorporating reasoning to justice in a society characterised by diverse views and opinions. In view of this, Sen says that justice cannot be precisely and consensually defined. But, everybody perceives injustice and justice should be tackled from the point of view of eliminating or reducing injustice. According to Sen, this was exactly what Parisians did when they stormed Bastille 222 years ago, Gandhi when he fought with the British Empire and Martin Luther King Jr., when he fought against the white supremacy. That is to fight injustice rather than to restore justice in the society.

Democracy: Government by Discussion
The usual way to define democracy has been to draw on the US President Abraham Lincoln who said that ‘democracy is the government of the people, by the people and for the people’. Of late, this definition has been criticised on the ground that the people referred to therein are not the same and therefore it leads to a dictatorship of one type of people on other types. Hence, Sen goes for a new definition of democracy. He says that democracy should be understood as ‘government by discussion’. It is not the well known systems like the elections, parliaments, majority rule, or opposition parties that should constitute a democratic system. They may be necessary, but not sufficient to create a perfect democracy. He says for democracy to become perfect, people should be able to join the decision making processes through interactive discussions and active engagements. Hence, according to him, ‘democracy has to be judged not just by the institutions that formally exist but by the extent to which different voices from diverse sections of the people can actually be heard’.
Honour your opponents
In a previous book titled ‘The Argumentative Indian’ and published in 2005, Sen has elaborated how effective interactive discussions should be conducted in societies so that the perception of injustice would not prevail. Drawing on Emperor Ashoka’s edicts, Sen says that ‘it was indeed a Buddhist Emperor of India, Ashoka, who in the third century BCE, not only outlined the need for toleration and the richness of heterodoxy, but also laid down what are perhaps the oldest rules for conducting debates and disputations’. Ashoka’s edict has simply said that ‘one should duly honour his opponents in every way on all occasions’.
This applies equally to opponents in the intellectual world, opponents in the civil society, opponents in the government and opponents in the war. As recorded by Greek historian Plutarch, Taxila University’s sage Dandamis has said it in a different way when Alexander the Great asked him ‘how best may a man make himself beloved?’ Dandamis’ reply has been that ‘one is beloved if he has enormous powers but if he does not instil fear in others’. It is said that this reply taught Alexander the Great of the importance of being fair, just and magnanimous in victory toward the defeated.
China needs Reforms and not Revolutions
On the 222nd Anniversary of the French Revolution, the Central China Television or CCTV had a panel dialogue on the lessons to be learnt by China from the French Revolution. The dialogue was hosted by the veteran broadcaster Yang Rui and participated by Richard Bamle, Professor at China’s Tsinghua University and Francisco Sisci, a free lance journalist.
The consensus at the dialogue was that revolutions are bloody and violent and they should be avoided at all costs. To avoid them, people should be given real powers. It is not sufficient only to give more income to their hands. Instead, they should have access to justice strengthened by rule of law and the maintenance of law and order. It is not welfare which people seek; it is the access to possibilities and opportunities. If these are not ensured, people perceive the system as unjust and unfair. The panel noted that even King Louis XVI tried to introduce the necessary reforms in France, but he did so toward the tail end when it was too late. Hence, it is of utmost importance to introduce the required reforms well in advance. The recent street demonstrations in Kuala Lumpur in Malaysia and popular uprisings in Tunisia and Egypt followed by bloody riots in Syria, Libya and Yemen, despite their high economic prosperity, are cases in point.
The final conclusion by the dialogue panel, as applicable to China, was that it does not need another bloody and destructive revolution, but reforms in advance before the socio – economic systems start boiling and become explosive.
This frank soul searching self inquiry by a Chinese State media is a lesson to many other countries.
Reform or face revolutions
This is equally valid for other countries which allow people to perceive the system as unjust and unfair by ignoring the rule of law, law and order, freedoms of thought and expression and right to be consulted and engaged. They may be lethargic in introducing these reforms. But then they should be prepared to reap the whirlwind of bloody and destructive revolutions. So, the motto is ‘introduce reforms in time or perish’.

This is the lesson to be learned from the celebrated French Revolution.
(W.A. Wijewardena could be reached at waw1949@gmail.com )

CHINA, INC – RUNS THE RISK OF IMPLODING IF CORRUPTION IS NOT CHECKED

Stunning News on China
China has been in the headline news in the recent few years. First, it was China’s impressive growth rate exceeding even 10 percent per annum year after year that hit the world news. Then the whole world was stunned by a prediction by Goldman Sach’s Chief Economist, Jim O’Neill that by 2027 China would overtake USA as the global economic giant.
At the beginning of 2011, China again made headline news by becoming the world’s second largest economy overtaking Japan which has now been relegated to the third place, but with prospects of regaining its earlier position easily since the gap between the two is still very narrow. The rest of the world, especially those in Asia, went into jubilation over this news of 1339 million Chinese producing an output of $ 5.9 trillion as against a one tenth of that numbering 128 million Japanese producing $ 5.5 trillion. But the Chinese leaders very quickly downplayed it by admitting that China was still a poor country holding the 100th position in the ranking in the world by income per person known as the per capita income.
While the world has been stunned by the news about China Incorporated, the Chinese leaders in fact played a different game, having been privy to the risk factors involved in their much talked about vibrant economy. In April, this year, on the occasion of the Centenary Celebrations of China’s Tsinghua University, Chinese President Hu Jintao, having noted the grave need for upgrading the country’s university system, encouraged the academics of the university to enhance the innovativeness and their research capability and students to maintain their individuality by thinking independently. The President of the Tsinghua University, humbling himself in a later press interview with The South China Morning Post, put a very long date like 2050 by which his university, presently ranked within the top 75 in the world, could join the elite league of universities comprising Harvard, Yale, or MIT in USA or Oxford or Cambridge in the UK.
Hu Jintao’s Warning of Corruption
The latest news maker on China, Inc. was the address made by President Hu Jintao on the occasion of the 90th Anniversary of the Communist Party of China last week.
In his address, Hu emphasised several key points relating to China’s future. He said that for the Communist Party to continue its rule over China, it must adapt to a changing nation and a changing world. If for some reason China fails to continue its fast economic development and maintain social order, it will have to give up all the gains it has made during the past 20 years. For this, the Party should fight corruption and create a clean government. Hu warned the party members
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that acts of corruption by those who hold political office could cause the public to lose trust in the party.
Surely, the 90th birthday celebration is not an occasion for a leader of a great party to talk about corruption of party members unless, in his opinion, it has become chronic, pandemic and acute. This is serious because unlike other countries in the world China does not hesitate to execute, by a single bullet fired to the back of the head, those found guilty of corruption which has been categorised as an economic crime.
Confucius on Corruption
The incidence of bribery and corruption is not unique to China. It is everywhere including the developed countries like USA. But, if corruption becomes pandemic and a way of the day to day life of people, both instigators and their victims, then, it has serious repercussions on the social order and the sustainability of the economic, social and political systems. Even as early as the sixth century BCE, the Chinese Philosopher Confucius warned that the misuse of the state power, if allowed to happen without being checked, could spread like wild fires from top to the bottom. He said that, ‘one of the evils of the political life was the lawful princes usurping the powers of the king, (that is, acquiring without authority the privileges and other perks), and their supporters following their masters in great numbers’. Confucius’ observation on the spread of corruption across a society if it is not weeded at the very root has been vindicated by another celebrated theory in modern times known as Gresham’s Law.
Gresham’s Law: Corrupt people drive out honest people
Of course, Sir Thomas Gresham, Advisor to the Queen Elizabeth I and after whom the celebrated law has been named, did not talk about corruption. All he said in a letter t the Queen in 1558 was that if the British government issued coins made of cheaper metals along with the gold coins for the same denomination, people would simply hoard the gold coins when they come to their hands and release only the cheap metal coins. Thus, there would be only cheap metals in circulation, while gold coins would disappear. This led to the famous saying that, ‘bad money will drive out good money’ and today, economists use this phenomenon liberally to explain any situation where a low quality product driving out a good quality one when both are issued to the market at the same time. Thus, when applied to unchecked corruption, the corrupt people, if allowed to practise their folly with total impunity, will drive out honest people and as warned by Confucius, will make the whole society corrupt.
Governments lose themselves when they lose people’s trust
The wide – spread corruption leads to a loss of trust of people in the government, since people begin to believe that government officials and politicians practise corruption with the connivance of the top. It is inevitable that they begin to believe that a part of the spoil is even shared with the top leaders. This is a dangerous development and according to Confucius, ‘the most important duty of a government is to earn and maintain the confidence of the people because, a government which loses a people’s trust is itself lost’. Hence, a top leader of a government cannot sit back and ignore, according to Confucius, when his supporters are engaged in acts of corruption. This Confucian observation would have been the reason for Hu Jintao to warn the party members of the importance of keeping public’s trust undiminished.
Kautilya’s Prescription
Kautilya, the fourth century BCE Indian economist of The Arthashastra fame, made a more elaborative analysis of the bribery and corruption by king’s officers. Noting that it is a human tendency to enjoy the fruits of ill – earned money if the practice goes unchecked or uncontrolled, Kautilya said that ‘just as it is impossible not to taste honey or poison that one may find at the tip of one’s tongue, so it is impossible for one dealing with government funds not to taste at least, a little bit of the king’s wealth’. Hence, the king should be careful not to place honey at the tip of someone. Also, public servants may develop crafty and ingenious schemes to hide the illegal practices of corruption in which they freely engage themselves. Kautilya noted this fact in a practical example when he said that, ‘just as it is impossible to know when a fish moving in water is drinking it, so it is impossible to find out when government servants in charge of undertakings misappropriate money’.
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Hence, continuous vigilance is needed on the part of the king to prevent his officers getting unduly enriched out of his resources.
According to Kautilya, even the loss of revenue due to the king constitutes a corrupt practice, because, ‘such officers eat the king’s wealth’. Kautilya has gone a one step further. He has said that those who causes losses to king’s enterprises, (in today’s parlance, loss making public enterprises), not only cause a loss to the king. They ‘by not bringing any profits, eat up the labour of the workers’ too. According to Kautilya’s prescriptions, the heads of such loss making enterprises should be made to pay back to the king the multiples of the losses made. In the case of the head of the king’s treasury, Kautilya has recommended that if losses have been caused to the Treasury by his deliberate action, he should be whipped. However, Kautilya has been merciful to those who have abetted the head of the treasury in such deliberate acts. He has recommended that such abettors should be given only half the punishment given to their boss.
The Incidence of Corruption in China
The wide spread corruption in China has been known well before Hu Jintao’s warning at the 90th Anniversary Celebration of the Communist party. According to the Cyberspace Encyclopaedia, Wikipedia, Opinion surveys conducted from time to time have revealed corruption as the top concern of the Chinese society. The researchers of the Central Party School, Communist Party’s organ for training senior and midlevel officials, conduct an opinion survey of about 100 officials attending the courses. Between 1999 and 2004, the respondents have ranked corruption as the most serious or the second most serious problem faced by China. In 2006, State Council’s development research surveyed 4586 business executives about the integrity of party officers. Of the respondents, 12 percent said that the integrity of the party officers was very bad while 25 percent said it was bad.
Common Types of Corruption in China
There are three types of corrupt practices used by Chinese party officials.
The first is the common graft, that is, obtaining money or other gifts as compulsory payments for doing or accelerating the work within the legitimate purview of the official concerned. This has happened in giving licences and approvals for the Chinese or foreign companies, allocating houses to people in housing estates and other normal government duties like distribution of water or fertiliser to farmers, just to mention a few of such occurrences.
The second type is rent seeking which government officials resort to by using their discretionary powers relating to the administration of the government duties. Since all public officers have these discretionary powers given to them by laws, it is inevitable that they use them like the Kautilyan public servant ‘tasting the honey placed on the tip of his tongue’. Hence, discretionary powers, unguarded and uncontrolled, are the prime source of rent seeking by public officers. It causes the government to lose its revenue on one hand and the trust of the people on the other.
The third type is ‘prebendalism’, a system where public officers’ getting perks and privileges illegally through their office. This was the crime about which Confucius warned about as usurpation by regional lords and their supporters. In today’s parlance, it can be compared to ministers and other senior officials holding public office acquiring to themselves without authority privileges and perquisites to which they are not entitled. Even at lower levels, using public facilities for private gains or businesses is an example for prebendalism. In this manner, the public officers convert their work stations from public serving offices to ‘resource banks’ for private gains.
These types of corrupt practices are common in other countries as well.
The Corruption Perception Index or CPI
Transparency International or TI, the global watchdog of corruption, has prepared a Corruption Perception Index or CPI since 1995 ranking countries in the world in terms of the level of perceived corruption. Corruption has been defined by TI as the ‘abuse of entrusted power for private gain’. According to TI, such corruption makes poor people poorer, deprives their children of facilities to advance themselves and leads to an unfair distribution of wealth leading to social disorder. Hence, corruption is a malady which has to be fought globally and locally. The purpose of compiling CPI is to show countries where they stand and take anti corruption measures to improve the conditions. However, many countries ranked low in the CPI have accused TI of interfering with their internal affairs and misrepresenting them in an attempt to discredit their development programmes.
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In terms of the index, the least corrupt country scores 10 points while the most corrupt country scores 0. To compile the index, TI conducts 16 different polls and surveys from 10 leading institutions. The views of these expert institutions are then correlated with the opinions of the public in the respective countries.
Out of the 182 countries that are included in the index, China is ranked midway at 78 and has not improved its position between 2002 and 2010, scoring a midpoint of 3.5 out of 10. However, compared to Sri Lanka, China’s level of perceived corruption is less than that of Sri Lanka which is ranked 13 notches below China at 91. While China’s corruption level has remained stagnant during 2002 to 2010 at 3.5 scores, Sri Lanka’s perceived corruption level has indeed increased during this period with a decline in the score from 3.7 in 2002 to 3.2 in 2010. India where there is a wide perception of corruption is however ranked 4 notches above Sri Lanka at 87. India, to its credit, has improved its corruption perception marginally during this period. All other countries in the South Asia Region are ranked below Sri Lanka.
Corruption, an invisible implosive
Rulers may ignore the incidence of corruption and safeguard those who practice corruption by denying their existence. They may even counter-charge those who charge governments of corruption. But that they would do to their own peril. This is because corruption is an invisible implosive that causes an internal implosion without warning. Governments which appear to the outside world as strong and stable collapse all of a sudden as the former Soviet Union did in 1989. That is because, as Confucius warned, the continued corrupt practices cause governments to lose public trust and losing public trust is the biggest enemy which a government can create for itself.
This truth has been driven home in a hard way to the current leadership in China. That is why on a celebratory occasion like the 90th anniversary of the Communist Party of China the incumbent President Hu Jintao thought it fitting to give an advance warning to party members of the impending catastrophe created by the party itself. Taking cue from the Chinese leadership, the other countries which are ranked below China in TI’s CPI should take immediate measures to stamp out corruption before it becomes too late.
China may be wise in identifying even as late as today the growing catastrophe. But, uprooting corruption is no easy task, since as one commentator, Yan Sun has said that China may have to execute every other party official to create a clean government there.
Hence, in my view, if China does not take effective action to uproot corruption totally from the political and civil life, it runs the risk of imploding, thereby having to sacrifice all gains it has made so far, including the ascendancy to the second largest economy in the world, as warned by Hu Jintao.
(W.A. Wijewardena can be reached at waw1949@gmail.com )

THE GENERAL THEORY AFTER 75 YEARS: KEYNES STILL PRETTY MUCH ALIVE AND INFLUENTIAL

Seventy five years have now passed since the publication of ‘The General Theory of Employment, Interest and Money’ by the 20th century’s most influential economist, John Maynard Keynes in 1936. This was therefore considered as a fitting occasion for commemorating Keynes’ masterpiece by his alma mater and one time employer, University of Cambridge in the UK, by inviting renowned academics from both sides of the Atlantic to a conference held in Cambridge during 19 -21 June, 2011. The honour of delivering the plenary lecture at the conference was done by the Nobel Laureate and Princeton Professor, Paul Krugman, who talked on ‘Mr Keynes and the Moderns’ (available at http://www.princeton.edu/~pkrugman/keynes_and_the_moderns.pdf). Krugman in a tone of modesty and humbleness admitted that he was not the best qualified to speak at the conference due to three disqualifications. First, he was not a Keynes scholar (but others believe that he has been very much influenced by Keynes). Second, he has not done much work in macroeconomics area (but his specialty, international trade, is a sub part of macroeconomics). Third, he was not a serious intellectual historian (again, an economic policy advisor of Krugman’s calibre cannot do his job unless he has a good knowledge of history).
In my view, Krugman had a unique qualification to be there. Both Krugman and Keynes are of the same breed and Krugman, like Keynes, is a ‘critic of critics’ and does not dare to express his true views on issues of importance. His regular economic columns in The New York Times, Slate and USA Today bear ample evidence to this side of his personality. Hence, as expected, once his speech was out, it was like stirring up a hornets’ nest and his critics started to fill web page after web page with scathing criticisms. Some even had found fault with the organisers for not including genuine Keynesians in the conference (see the web column of Ann Pettifor in www.debtonation.org).
Keynes, the Rebel in the family
Keynes was indeed a rebel in the family of economists. He questioned his seniors who were known as classics and his peers equally. This quality earned him both reputation and wrath. While at Cambridge, he was a member of a secret society known as Apostles that examined contemporary ethical and political issues by deviating from the established norms. He was a member of the British delegation to Versailles Summit that had been summoned to impose war reparation measures on the defeated Germany after the World War I. While others in the summit were after Germany‟s pound of

flesh, Keynes held a different opinion. He felt that the proposed measures were too harsh. Having resigned from the membership of the delegation over this disagreement, he returned to England and wrote „The Economic Consequences of the Peace‟ in 1919. His argument was that the harsh penalties imposed on Germany would not augur well for the peace in Europe and the conquerors had thereby left a boiling cauldron in Europe. The subsequent events in Europe leading to the World War II within the next two decades proved Keynes correct.
Keynes‟ more open battle took place in 1925 with Winston Churchill, Chancellor of Exchequer, over the latter‟s attempt at returning Britain to the gold standard, a system of fixing the value of the Sterling Pound in terms of gold and making it necessary to maintain a balance of gold to back every Pound note issued by Britain. Churchill could not be faulted for this, because the overwhelming advice he got was supportive of that move. Keynes, along with a minority of others, disagreed with him. His argument, which Churchill downplayed as a naivety of a Cambridge economist, was that if Britain returned to the gold standard, it would create a „paradox of unemployment amidst dearth‟, implying that when there is an excess demand for goods, there cannot be an excess supply of labour. This is because the suppliers who step up production to take advantage of the demand in the market should hire those unemployed people. But, if money supply growths are constrained by the straight – jacketed gold standard, there will not be enough money income with people to buy those goods, thereby making unemployment a permanent feature. Perhaps, this was an early hint of what Keynes was going to present in a more formal way in 1936 in The General Theory.
Keynes and others lost their battle and Britain returned to the gold standard in 1925. Angry Keynes wrote a pamphlet titled „The Economic Consequences of Mr Churchill‟ criticising Churchill, a satirical twist of the title of his earlier successful book. But many felt, according to Churchill‟s biographer, Roy Jenkins, that singling out Churchill for the full blame by Keynes was unfair, because it was a collective decision made by many attached to the British Treasury. However, six years later, Keynes proved correct again. In 1931, the very same Churchill, as Chancellor of Exchequer, had to oversee Britain‟s exit from the gold standard, but by that time, it was too late, because Britain had already got into the worst kind of economic depression marked by massive unemployment. Strangely, that appeared to be a natural evolution of the process set forth in 1925, the „paradox of unemployment amidst the plenty‟. Goods were produced, but could not be sold because people did not have enough money incomes. Hence, they could not be continuously employed.
Keynesian Prescription: Spend out of Recession
The emerging situation then spawned an open debate as to what should be done to correct the malady. The growing economic depression in Britain put the Sterling Pound under pressure in international markets and that was not good news for the world‟s number one reserve currency at that time. The government appointed a committee under the chairmanship of Sir George May, a private sector financial expert, to come up with appropriate policy prescriptions. The May Committee, taking both the domestic and international conditions into account, suggested that Britain should cut its expenditure, especially unemployment benefits and balance the budget so as to instil confidence among the international community about the British economy and its currency. Again, the Committee could not be faulted for taking this broader view because there were other contenders like France, Germany and USA to become the global economic leader. Hence, in the long run, though the adjustment is slow and painful, Britain would gain its old glory once again.
Keynes disagreed. He angrily wrote to the then Prime Minister that in his opinion, the May Committee Report was the most foolish document he had set his eyes on. His suggestion was that Britain should increase its public spending, devalue the Sterling Pound and curtail its foreign investments. It appears that this was a battle between the short run survival and long run stability. As Keynes very boldly pronounced in The General Theory, people should be concerned only about the short run because in the long run, according to him, „we all are dead‟. His desire was to come out of the depression as quickly as possible because it was permanently hurting the British economy by

making unemployment a permanent feature. By implication, it meant that the goals of regaining the old glory and attaining long term stability should be attempted only after arresting the immediate problem. This in fact made sense because in early 1930s, the British economy was very sick and the sick man was going to die taking everything with him. This had to be avoided.
But as expected, this critic of the critics and rebel in the family did not have many supporters in the government or among academics. For most of the part, he was a loner and stood separate from the rest of the herd. But it trained him to come out with his masterpiece, The General Theory, which revolutionised the science of economics in the coming decades.
The General Theory: the misunderstood policy prescription
The General Theory is considered by many as one of the most tedious readings. This is despite the fact that it does not contain frightening mathematical equations like many standard books on economics. Yet, it cannot be understood properly just by reading once. According to Goh Keng Swee, Singapore‟s first Finance Minister and architect of that country‟s economic miracle, as an undergraduate in early 1940s, he read the book from cover to cover no fewer than three times, some chapters even more, but still could not understand the basic message delivered in the book. Because of this fact, according to some, what came to be practised as Keynesian economics and what Keynes actually said were two different concepts. Decades later in early 1970s, Axel Leijonhufvud of the University of California at Los Angeles had to write a new book on „Keynesian Economics and the Economics of Keynes‟ to separate the two.
Krugman: See how Keynes is relevant today
Today, we are in a bigger predicament. We cannot go back to 1930s to get a first hand feeling of the situation that prevailed in the world at that time to understand what Keynes actually said. We have to depend on secondary sources and get the help of numerous simplified versions of The General Theory written by Keynes‟ disciples like Alvin Hanson and Dudley Dillard. This practical difficulty would have worried Krugman when he had to deliver a lecture on The General Theory seventy five years later. That would have been the reason for him to start his speech by disclaiming that he was not a historian. He therefore proposes a pragmatic approach. One should not get into an irrelevant debate today to resolve what Keynes actually said. „What matters is what we make of Keynes, not what he really meant‟ he pronounces boldly in his plenary lecture. In other words, the questions which one should ask today are whether Keynes is useful and relevant. He further says that „Keynes was a great man, but only a man, and our goal now is not to be faithful to his original intentions, but rather to enlist his help in dealing with the world as best we can‟
Keynes: If people don’t buy, let the government
But what did Keynes say? To a layman, it goes like the following. An economy is a huge enterprise where thousands of people producing and consuming. To produce, they use various inputs and by selling those inputs, they earn incomes. Then, the very same producers are converted to consumers and use those incomes to buy those goods available in the market. This enables producers to continue with production without having unsold stocks. If this process goes on well, then there are no those so called economic recessions. But how does an economy get into a recession? That is because, according to Keynes‟ diagnosis, people do not use all their incomes to buy what they have produced. This deficiency in buying leads to the accumulation of unsold goods with producers who then produce less in the next cycle hiring less people. So, it gives rise to recession and unemployment. This is what Britain and other countries experienced in 1930s and, according to Krugman, what the world is experiencing today.
Keynes came up with a unique solution to this problem which others had thought of risky and dangerous. That is, if people do not buy enough, get another to buy enough and take the economy out

of recessions. This other person is the government which can place a huge purchase order to complement what people are already buying inadequately. The best thing about the government is that it can finance the huge purchase order by borrowing or printing money or both. So, the unsold stocks getting accumulated with producers get sold out, unemployed people get hired back and more and more new wealth is created. Thus, it is spending more by governments in the face of recessions and not less that would take economies out of recessions. That is why Keynes found the May Committee Report suggesting a cut in the government spending the most foolish document which he had ever set his eyes on.
Magic Multiplication of wealth
Keynes‟ policy prescription was augmented by another unique discovery made by him. That was the dynamism of the government‟s new expenditure or how a single expenditure made today would affect an economy over a period. He found that when one man spent, another man earned and when that second man spent, a third man earned. This goes on infinitely but at a lesser rate because each person saves some of his income and does not spend in full. But, the new series of income created over a period of time raises the wealth of people to still higher levels. Keynes called this the multiplier process because it multiplied the initial government expenditure into a bigger income later.
So, who would reject such a beautiful way of creating new incomes and making people richer just by spending a smaller amount of money? No one and when this was revealed, politicians in both developed and developing countries, with the exception of a few, embraced it ardently.
JR: an Early Convert to Keynesianism
According to the biographers of J.R Jayewardene of Sri Lanka, K.M.de Silva and Howard Wriggins, JR is said to have read The General Theory and become an instant convert. His subsequent work, the first budget speech, creation of the Central Bank, his speech at the opening of the Central Bank and many more things he did in the first few years of independent Ceylon testify to his Keynesian leanings. In the first budget speech for 1947, he found fault with the colonial administration for balancing the budget thereby subordinating all other goals, namely, development and employment, to that obsession. He even warned the Central Bank in the opening ceremony that money should be produced not for the sake of money, but to serve the people. This was in sharp contrast to what his Prime Minister, D.S Senanayake, said at the same ceremony that the new central bank should be mindful of the harmful consequences of following a loose money printing policy.
JR was not alone in having faith in this type of magic to quick prosperity. All his successors and many mainstream academics were Keynesian faithfuls. In the developed world, almost all academics and politicians were Keynesians. But there were a few exceptions. John Exter, architect of the Central Bank of Ceylon and its founding Governor, warned in his report known as the Exter Report that Ceylon which spent about a half of its income on imports would find that the money pumped by the government through deficit financing would leak out of the country through increased imports and create enormous balance of payments problems. Ceylon‟s experience throughout its post independence history has vindicated Exter.
The Sceptics of Keynes
To the east of Ceylon in Singapore, Goh Keng Swee says that his colleagues did not believe that the central bank credit could create wealth. Instead, it was diligence, education and skills that were to create wealth in a country. Hence, Singapore, right from the beginning, avoided Keynesian policies because they would, as was also pointed out by Exter, invariably lead to balance of payments problems forcing a country to resort to foreign exchange controls or devaluation of its currency. Ceylon did both to the detriment of its future wealth creation.
In the US, Ayn Rand, the philosopher cum novelist, launched a lone battle against Keynesian invasion of the US, because she had first-hand experience of what would happen to an economy when there is state control over all economic activities in her former country of living, the Soviet Union.

Friedrich von Hayek took issue with Keynesianistic state expansion in a book titled “The Road to Serfdom” which Keynes himself categorised as unworthy of reading. Margaret Thatcher is also reported to have read both The General Theory and The Road to Serfdom in late 1940s whilst at Oxford and become an instant fan of the latter.
Today, Keynesians are everywhere including in central banks
Today, there are Keynesians in governments, in politics and also in central banks. In developed countries whenever there are economic recessions, all these parties resort to Keynesian deficit financing, now renamed „stimulus packages‟. In developing countries, that has been the magic wand to quick prosperity. The risk factors associated with this policy, namely, displacement of the private sector, over expansion of the government sector, long term debt and budgetary issues, balance of payments problems and consequential inflation have not deterred those who prescribe it. Many hold the opinion that had Keynes known that his policies would be misused by corrupt politicians and ineffective bureaucrats, he would not have prescribed them. The history of the world since Keynes abounds examples of countries falling into severe difficulties simply because once they started deficit financing or stimulus packages, they did not know how and when they should exit them when the risk factors are present. One good example is Sri Lanka‟s fertiliser subsidy which started with Rs 4 billion in 2006 and has ballooned to Rs 50 billion in 2011. As the heavily - indebted Greece is experiencing today, the recovery path punctures the nation‟s sovereignty, imposes enormous social and economic burdens on people and brings in political instability.
The Tiger’s enmity with its Guru, the Cat
This is because Keynes prescribed deficit financing, but did not live long enough to see how his policy would be misused. He therefore could not teach errant nations when and how they should apply breaks. Even his disciples, including Krugman, do not have an antidote when the patient starts to die due to heavy doses of stimulus packages. Keynes did not bother about it, because he was so faithful to his prescription that he did not anticipate failures. An Indian folk tale says that the cat, the small member of the feline family, taught its big brother, tiger, how to climb trees but did not teach it how it should climb down. So, the tiger after climbing freely to the top of the tree with its new skills has to jump to the ground risking its paws or life. For this omission in the teaching content, the folk tale says that whenever a tiger meets a cat, it would kill the cat, but because it is tiger‟s guru, places the dead body on a branch of a tree out of veneration.
In my view, today, the relationship between Keynes and his errant followers is exactly equal to the enmity between the tiger and its guru, the cat.
(W.A Wijewardena can be reached at waw1949@gmail.com )

FOREIGN DIRECT INVESTMENTS: NOT A STRATEGY TO BE DOWNPLAYED

An interesting open forum was held last week in Colombo on ‘Foreign Direct Investment for Growth and Equity in Sri Lanka’ under the patronage of the Sri Lanka Economic Association or SLEA and Germany’s Friedrich Ebert Stiftung. The Session Chair, Professor A.D.V.de S Indraratna, SLEA’s Chairman, opened the forum highlighting the country’s current development needs and the importance of using foreign direct investments or FDIs in filling the wide savings – investment gap in the country. This was followed by brief presentations by three distinguished panellists, namely, Dr Anura Ekanayake, Chairman, Ceylon Chamber of Commerce, Dr Sarath Rajapatirana, former Economic Advisor of the World Bank and Professor Anoma Abhayaratne, Dean of the Faulty of Arts of the University of Peradeniya.
Anura Ekanayake, taking a broader view of the subject, highlighted the importance of investments in general for development refraining from calling FDIs the saviour of the country today. His stand was that local investments are as equally important as FDIs and therefore, the country’s policy package promoting investments should cover both. However, he cautioned that the local investments, while supplying the local market, should target to capture foreign markets too and for this purpose it is necessary for local investors to team up with foreign investors.
Sarath Rajapatirana, while agreeing with Anura, said that the most important contribution which FDIs could make to Sri Lanka was helping the country to acquire advanced technology and foreign markets. He also emphasised that Sri Lanka should now free itself from ‘cheap labour supply syndrome’ and ‘tax concession syndrome’ because it is the high tech and high brain – power industries that are moving into the emerging economies today. The shifting of industries on the ground of cheap labour to developing countries is now a thing in the past. Hence, it is necessary to upgrade the quality of the country’s labour force to facilitate the use of the high technology that comes along with FDIs.
Anoma Abhayaratne, in her presentation, examined the global direction of FDIs and found countries like USA, China, and India were receiving the lion’s share of FDIs. Sri Lanka’s performance in this respect has been woefully inadequate. Even according to

the future projections, it is these three countries which have been lined up as the biggest recipients of global FDI flows.
In my view, the attractiveness of FDIs in Sri Lanka’s current economic strategies comes from a different policy issue. That policy issue is the need for keeping foreign commercial borrowings at a minimal level and avoid a future debt crisis.
Low FDIs and High Commercial Borrowings
Sri Lanka’s past experience in FDIs has been disappointing despite the massive incentive package offered by the country to foreign investors. The main ingredients of this incentive package were the generous tax holidays, supply of the needed infrastructure facilities and freeing the FDI enterprises registered with the Board of Investments from the country’s normal stringent labour laws. Yet, the country could attract only a few hundred million dollars as FDI inflows annually when other countries of comparable size were counting them in billions. One reason attributed to this poor performance was the uncertainty created by the disastrous internecine war that had plagued the country till mid 2009. Now the war is over but the FDI flows have not shown a visible improvement as revealed by its poor performance in 2010. In that year, the country attracted only $ 475 million as FDIs.
Dr Mahathir’s Advice: Slow on Debt and faster on FDIs
The low FDI rate attained by Sri Lanka has compelled the policy makers to use external borrowings liberally for financing the country’s widening current account deficit in the balance of payments. Initially, these borrowings were from concessionary sources like the Asian Development Bank, International Development Association and some of the bilateral donors in the West. However, with Sri Lanka’s move toward graduating from low income country to lower middle income country in the new millennium (this move culminated in early 2010), these concessionary funding sources have begun to dry up forcing Sri Lanka to tap the high cost commercial markets for acquiring the needed funding resources. Accordingly, non – concessionary foreign loan stock in the total foreign loan stock owed by the Sri Lankan Government rose from 8 percent in 2006 to 38 percent in 2010. This is not a salutary development at all.
Noting the onset of this unfavourable development, Dr Mahathir Mohamed, former Prime Minister of Malaysia and architect of its economic miracle, gave a fine piece of advice to Sri Lanka when he met the press after a three day visit to the country in June 2010: go slow on debt and faster on FDIs.
Why FDIs?
The rationale behind this advice is clear enough. Sri Lanka’s foreign debt is already at unmanageable levels rising from 37 percent of GDP in 2008 to 43 percent in 2010, though it has come down to that level from a peak of 74 percent in 1989. The country has not defaulted any foreign loan so far, but its fragile foreign reserve base consisting largely of short term borrowed funds poses a great deal of risk of default in the short to medium term. The government’s planned borrowing of a further US $ 1000 million from international markets in 2011 and other foreign commercial borrowings from friendly countries for capital projects already started or in the pipeline will add more to the country’s debt stock instead of reducing it. FDIs, on the other hand are a non – debt source and will help Sri Lanka to acquire the much needed technology, better production techniques, markets, improved management practices and an easy gateway to the rest of the world.

Colonial Era: Large Scale FDIs and minor Scale Prudent Market Borrowings
There were massive investments in roads, transport systems, town developments and new economic enterprises in Sri Lanka during the colonial era. Yet, the bulk of this resource requirement was met through FDIs. According to the late Mr N.U Jayawardena (NUJ) who wrote a seminal paper in 1934 titled ‘Development of Ceylon’s Trade Since 1834 – From the Coffee Bubble to the latest Depression’, the resources needed for investment during the early 19th century were brought in physical form, namely, bullion and specie (or coins), by the daring entrepreneurs at that time. NUJ calls them coffee prospectors similar to the gold prospectors in 19th Century California and remarks that ‘vast sums of money were released for expenditure by (these) prospectors’. The result was the development of a vibrant plantation industry, with ups and downs from time to time, in the country. According to Professor B Bastiampillai who submitted a thesis on ‘The Administration of Sir William Gregory 1872 - 1877’ to the University of London for M.A Degree, the Colombo Port was developed during Sir Gregory’s time on a loan from the British Treasury amounting to Sterling 250,000 and a market borrowing of Sterling 380,000. Professor Indrani Munasinghe in her ‘Colonial Economy on Track’ (her PhD Thesis submitted to the University of London) says that the country’s railway system was built during the colonial time by raising loans from time to time in the London capital market. On all these occasions when borrowings were made, the Secretary of State had not approved of them until the relevant borrowing units of the government came up with viable plans to repay the loans in a bid to ensure proper repayment and effective use of the funds.
Thus, borrowings were used by colonial rulers as sparingly as possible. This was shown by the low level of foreign borrowings of the country at the time of independence which amounted to about 4 percent of GDP.
Post – Independence Era: High Foreign Debt Dependency
The fiscal prudence which the colonial rulers maintained so laboriously during the colonial time underwent ‘a 180 degree turn’ after independence. The country’s new rulers were guided by the desire to attain quick prosperity through a ‘big push’ of the economy, a development model which had gained popularity at that time. They were also ideologically strengthened by the then popular Keynesian economics which advocated deficit financing as a desirable strategy for accelerating economic growth. To make it a reality, an enormous amount of resources had to be invested in physical as well as human infrastructure. But the nation lacked domestically generated savings to finance such expenditure programmes on account of high consumption levels. The average savings during the first two decades after independence amounted to about 12 percent of GDP, while investments amounted to about 18 percent of GDP. The terms of trade were unfavourable to Sri Lanka, meaning that the country had to sacrifice more than one unit of exports to bring in one unit of imports to the country. The current account of the Balance of Payments was eternally in deficit except in the rubber boom years of the early 1950s. Consequently, with no adequate domestic savings, the country did not have a choice except resorting to foreign borrowings.
The Liberal Use of Concessionary Funding
Thus, Sri Lanka went for foreign borrowings in a big way and they were facilitated by the availability of multilateral and bilateral concessionary funding during

the first five decades after independence. Foreign debt component as a percent of GDP amounted to mere 3 percent in 1950. But it rose slowly and steadily to 18 percent by 1970, 41 percent by 1980 and 72 percent by 1990. Thereafter, there was a decline in foreign borrowings as a percent of GDP, but it did not mean that the country had reduced its total public debt levels. The decline in foreign borrowing ratio was simply replaced by domestic borrowings which rose from 42 percent of GDP in 1990 to 54 percent in 2000.
Increased Reliance on Commercial Borrowings
In the first decade of the new millennium, Sri Lanka’s per capita income crossed the $ 1000 threshold, elevating the country from a low income one to a lower middle income one. It also resulted in the country’s losing its access to concessionary funding, thereby forcing it to tap commercial markets. The result was the gradual increase in the non – concessionary and commercial loans in the total foreign borrowings of the government: in 2005, they accounted for 4 percent of total foreign borrowings; by 2009, the share went up to 28 percent and in 2010, they peaked 38 percent.
Ills of Commercial Borrowings
Commercial lenders do not try to impose conditions on the borrowers, especially those relating to economic reforms and human rights. The negotiations on such borrowings could also be completed in a shorter period than concessionary borrowings. Money is also available promptly for the borrower to use for any budgetary purpose. Hence, many governments have found commercial borrowings more palatable than concessionary borrowings.
Yet, the terms and conditions of commercial borrowings are harsher than those of concessionary borrowings forcing the borrowing countries to make tougher sacrifices. Their interest rates are significantly higher, maturity and grace periods are shorter and repayments are in a single payment known as a ‘single bullet payment’. Hence, unless a country utilises these borrowings for projects which are priorities, have shorter gestation periods and generate higher rates of return than the interest paid on them, the borrowing country cannot avoid falling into an inescapable foreign debt trap. The observation of these prudent norms are specifically relevant for commercial borrowings from countries like Iran and China whose loan conditions are much harsher than those raised from international financial markets in view of the tie-up of the loans to purchase of goods and services from the respective domestic markets.
No Ponzi Schemes
Though Sri Lanka has not got into a serious foreign debt problem as yet, the fast increase in its borrowings from commercial sources may increase the country’s vulnerability significantly. It now appears that, to repay the commercial loans raised in the last few years, the country will have to borrow more in the next few years. The critics have equated this to operating a huge ‘Ponzi Scheme’ by the government because, like the legendary Charles Ponzi of early 20th Century who paid his previous lenders out of the money borrowed from the new lenders, the government too has to continually raise new loans to repay the previous loans. The critics have brought out the risk factor involved in this type of an operation: Ponzi had to default everyone when he later found it impossible to find new investors; the same fate may befall on the government if it too is unable to raise new loans, especially in periods of global financial crises.

The Colonial Wisdom comes in handy
The colonial wisdom in raising commercial loans for investment was that the borrower had to build a sinking fund to repay the loan out of the sale proceeds of the enterprise. For instance, when the Ceylon Railway Authorities raised commercial loans in the London financial market to build the country’s railway system, the Secretary of State made it mandatory for the railway authorities to charge economic fares from railway users and build sinking funds to repay the loans when they matured. According to Professor Indrani Munasinghe, the prudent management made railways remunerative from the start and, after transferring the required amounts to sinking funds, there was a balance surplus available to be credited to the general revenue of the government. It, therefore, took the Ponzi feature present in the current commercial borrowings out of the system by avoiding the necessity for raising new loans to repay old ones.
It behoves the government to infuse this colonial wisdom of prudent debt management to large scale commercial borrowers like the Ports Authority and Ceylon Electricity Board by making it mandatory for them to build the required sinking funds out of revenue to save the country from potential future foreign debt crises.
FDIs: Non - Repayable Debt involved
As Dr Mahathir Mohamed has advised and as was practised by colonial authorities, Sri Lanka should promote FDIs to compensate for the inadequacy of country’s savings. Since FDIs do not help the government directly to fill the budget gap, it may have to go for a certain amount of loans in the short to medium term. But, it is necessary that the government should go slow on such borrowings. To facilitate the government to reduce its reliance on borrowings, it should reduce its expenditure programmes and raise its revenue sources. When the government cuts down its budget deficit, it will be able to release funds for the private sector to engage in economic activities, a process known as ‘crowding in’ of the private sector rather than ‘crowding it out’ as is being presently done.
Improve Human Capital and Get Technology through FDIs
FDIs help a country to acquire new technology without costs. This is specifically important to Sri Lanka because it does not invest sufficiently in the development of new technology. Without technology, it cannot produce goods for the global market. This was the strategy adopted by the original Asian tigers, namely, Singapore, Hong Kong, Taiwan and South Korea in their initial phase of economic development and the strategy being adopted by new Asian tigers, China, Malaysia and Thailand in their present phase of development.
It is also important to develop the country’s human capital base to enable it to use the advanced technology. Singapore and South Korea did it by developing the higher education systems in the line of the best universities in the world. China is also presently engaged in a similar exercise. For Sri Lanka to attract high tech related FDIs, it is absolutely necessary to build the required human capital base. Sri Lanka could not attract any giant in the pharmaceutical industry in the past because of the shortage of biomedical scientists. It is, therefore, time for Sri Lanka to take measures to train the scientists, engineers and managers needed by the high tech industries which may show interest in the country.
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In my view, though domestic investments are important, FDIs are more important and should not be downplayed by Sri Lanka in its current push for rapid economic development.
(W.A. Wijewardena can be reached at waw1949@gmail.com )