My Say: Bad politics and bad economics – The Edge Markets MY

The World Bank summarisesSri Lankas economic woes this way: Sri Lankas macroeconomic challenges are linked to years of high fiscal deficits, driven primarily by low revenue collection, and erosion of export competitiveness due to a restrictive trade regime and weak investment climate. The description could fit many other economies, including Malaysias, which is why the crisis has invited many commentaries on the parallels and prospects for these countries.

Sri Lanka has witnessed years of fiscal deficits and yet a populist government has promised and delivered tax cuts. It has an economy whose production structure remains largely the same. Sri Lankas economic problems are captured by two numbers its twin deficits in fiscal and current accounts, which means the country has been spending more than what it earned, and its production of tradable goods and services were inadequate to make up for the shortages. All of these meant that it has been an economy that has been borrowing and because there have not been surpluses in the economy, it has been borrowing externally, which added another dimension of risk.

The Covid pandemic broke the already broken economy, which depended largely on tourism and remittances from Sri Lankans abroad to bring in foreign exchange. When those two pipelines stopped flowing, the economy convulsed. There was simply no money to pay for imports and to service existing loans, which then resulted in defaults. And as the currency weakened and shortages occurred, inflation soared and a vicious cycle ensued. The misery from this economic collapse is far worse than that of Covid-19. It is far more pervasive.

For all its advantages when it gained independence, its economy never really developed beyond what made it economically useful to the British producing tea and minerals. India is the neighbour with 1.38 billion people to the countrys 23 million and yet they lived separate economic lives. That has its origins in how history unfolded between them but they have not been able to go beyond that juncture, and this lack of economic integration has been especially bad for Sri Lanka. The potential to leverage such a neighbour to grow its tradable sector was never exploited. It went on to do the same things while also failing to attract other investors. When things became desperately bad, the government embarked on some harebrained schemes that worsened conditions.

It was politics that is defined by the incendiary combination of race and religion that held back and eventually caused the economic crisis in Sri Lanka. Here, we see parallels. There are always the intertwining interests of economic and political elites anywhere, but when power is concentrated among the few in the presence of weakened institutions, it is both corrupting and debilitating. One would have thought such powers would enable difficult decisions to be taken, but that is rarely the case. Political interests would typically be driven by self-preservation and self-perpetuation; they are rarely altruistic. Political survival can be at the expense of almost anything, including things that are bad economically or divisive socially.

If Sri Lanka was largely a case of bad politics creating bad economics, Venezuela is arguably a case of bad economics resulting in bad politics. Venezuela still has the worlds largest oil reserves in the world. This manna from heaven is a natural endowment, potentially good for the country in the long run, but one that has to be managed carefully for that to be true and avoid the resource curse the failure of many economies to benefit fully from this natural endowment. The hydrocarbon economy is still the dominant part of the global economy so oil riches are still riches. Oil-rich states are still producing oil and despite the cyclical prices, are making money.

The jury is still out on whether predominantly oil-producing countries have successfully hedged against the day when oil runs out or for when the demand for it dwindles but Venezuela, the country with the largest oil reserves, is the only such country that has gone bankrupt. Venezuela went through the Sri Lankan experience much earlier.

Governance is always problematic in economies that are dominated by extractive natural resources such as oil and gas and all types of minerals. One can extend that argument to large-scale plantations as well; they are extractive in a different sense, and plantations involve large tracts of land and access to such lands, like access to mining tracts, involves the state and therefore political lobbying of some sort. Oil and mining companies take care of the government who are supposed to take care of the people.

Whichever way the natural resources are extracted or cultivated, and how revenues flow from these activities into the treasury, it is the case that the accountability on the government is markedly different if revenues that flow into the treasury were taxes paid by the populace instead. The issue of taxation without representation is exactly about how taxpayers money is spent. A citizenry that largely does not pay taxes still expects things from the government but does not hold government accountable for how it raises revenues and how they are spent.

These dynamics create bad politics as the citizenry view the government as custodians instead of elected managers and caretakers of their collective interests. The Venezuelan experience shows how politics became dominated by the military or some strongman which, despite the oil wealth, left a huge part of the population behind. That eventually gave rise to populist politics that led to the election of leaders who spent the wealth that oil created without investing in any new productive capacities an unsustainable path waiting to collapse regardless of the intentions. This was where Venezuela found itself: a major oil-producing and exporting economy that validated the resource curse.

While Malaysia is not exactly Sri Lanka or Venezuela, it shares parallels with both countries. Developments in the last two decades or so are eerily similar. While the fiscal deficits have persisted for over two decades in Malaysia, the current account, while still in surplus, is barely a surplus. We are also seeing the same paralysis in taking corrective action in an environment that is increasingly divisive, all the while on a gentle glide downwards.

A key element in Malaysias political economy is rents. The resource-based industries and the plantation sector, and one can also include property development in that group, are all defined by rents. Any enterprise that depends crucially on state approval contains rents. Even the governments so-called distributive policies are effectively about distribution of rents in the forms of quotas, permits, licences or contracts. Where there are rents, there are all kinds of rent-seeking activities which are totally unproductive economic activities at the aggregate level, but worthwhile enterprises at the micro level. These competitions for rents are not just wasteful and distort resource allocation, thereby creating inefficiencies everywhere, they are corrupting and undermine the rule of law, which explains why investors shy away from such jurisdictions.

The failure of the distributive policies all these decades to address inequality or create a vibrant commercial class are ample proof that they do not work. They benefit the already able, winners in the lobbying game, and waste a lot of resources. Beyond that, these policies inhibit the growth of new businesses. The farmers who cultivate state land to develop produce that is competitive, despite the lack of any security of tenure, will always lose out to the lobbyist for a property developer.

The rentier culture is anti-competitive and inhibits innovation and risk-taking, which goes a long way to explain the problems Malaysia is facing in creating new sources of economic growth. As was the case for Venezuela, it was never about the lack of resources whether to aid the needy or develop the economy. There were just inefficiencies, wastage and leakages. That is why we spent hundreds of billions on infrastructure and have bigger traffic jams and floods.

I have written in an earlier essay cautioning how the normalisation of monetary policy in developed economies in the post-Covid era, made a whole lot more complicated by the Russia-Ukraine war, will pose serious challenges to the Malaysian economy. We are not where Sri Lanka was before its default, but we see the tell-tale signs: a weakening ringgit, rising inflation, increasing costs of financing the fiscal deficits and elements of fiscal populism in spite of declining revenues. We have seen an economy unable to create decent paying jobs. This year will be another challenging year and the coming months will be quite telling.

Some have argued that the solution is a strong government, something I disagree with. It will just be exploited to win votes or suppress dissent. We need an effective government to provide the basic services and protect our rights and liberties, and a government that is not in the way of things. Avoiding the fates of Sri Lanka or Venezuela requires less, not more government to obtain good economics in spite of bad politics.

Dr Nungsari A Radhi is an economist

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My Say: Bad politics and bad economics - The Edge Markets MY