Where is the money behind our politicians from?

In this weekly column on The Sunday Morning Business titled “The Coordination Problem”, the scholars and fellows associated with Advocata attempt to explore issues around economics, public policy, the institutions that govern them and their impact on our lives and society.

Originally appeared on The Morning

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By Thiloka Yapa and Aneetha Warusavitarana

Election campaigns tend to be one of the driving forces behind corrupt practices even after candidates are elected.

Therefore, with a monumentally significant presidential election just over a month away, conversations around the issue of campaign finance and corruption in public office should be gathering steam.

Running a campaign in Sri Lanka is a costly affair; an aspiring candidate needs to connect with people on a grassroots level as well as a policy level. This exercise requires a great deal of manpower, posters, social media engagement, travel, and lots of “buth packets” – none of which come cheap. As a result, adequate campaign finance is a prerequisite for a successful election bid.

The problem lies in the issue of who is providing this finance and whether there are strings attached. If money is being funnelled into an election campaign on the understanding that once the candidate is in power, the financier will be afforded special privileges and benefits, this is when citizens need to be concerned.

Of course, campaign finance is not the root of all evil in the world of corruption. Regulating campaign financing would not address blatant theft within the government, nepotism, irregular procurement procedures, and the handing out of government jobs to political supporters. However, it is a step in the right direction and, interestingly, is something that Sri Lankan law has addressed in the past.

Regulating campaign finance

The Ceylon (Parliamentary Elections) Order in Council of 1946 specifies that a candidate would have to appoint an agent known as the “election agent”. This agent is responsible for the accounting and reporting of all expenses spent on elections, along with a declaration by the candidate. These financial reports have to be submitted within 31 days of the result of the election being published in the gazette. If it is not conveyed within the stipulated time period, the candidate would not be given the chance to sit or vote as a member in the House of Representatives, until such a conveyance is made.

However, this was repealed by the Parliamentary Elections Act No. 1 of 1981. Under this law, the sources of campaign financing would have to be tracked and reported. The fact that non-compliance would prohibit an individual from taking their seat in Parliament provides a strong and effective incentive for candidates to ensure that reporting is completed in the stipulated time period. While this law did not provide caps on spending during campaigns, making these declarations open to the public would provide another avenue through which elected officials could be held accountable.

However, this accountability mechanism is no longer in place. Under the Parliamentary Elections Act No. 1 of 1981, the entire section on reporting campaign finance was repealed, thus removing this avenue of accountability.

Bringing regulations back

The Commission to Investigate Allegations of Bribery or Corruption (CIABOC) has detailed the National Action Plan 2019-2023, aimed at tackling corruption in its various forms. The section on policy suggestions for proposed legislative amendments is all the more relevant in the context of elections. While the amendments proposed to the Bribery and Corruption Act aim to strengthen the powers of CIABOC and increase their ability to tackle corruption across the board, the proposals on campaign finance and asset declarations aim to curb opportunities for corruption in public office.

The proposed legislative framework for campaign finance puts in restrictions and accountability mechanisms on the finances of candidates. This ensures that when an individual comes into office, they do not bring with them the strings and influence of external parties, and are free to prioritise the needs and requirements of their electorate.

While the suggestions do include a cap on campaign financing, the amendments which prevent conflicts of interest and introduce accountability mechanisms may be more practical to enforce.

Restrictions on donations extend to donations made by government departments, companies registered under the Companies Act in which the government owns shares, donations from foreign governments, and organisations registered outside Sri Lanka. The proposed reform also includes a section on accounting and auditing of campaign finances, making this a prerequisite for an individual to come into power and acting as an accountability mechanism.

Beyond campaign financing

Through the proposed amendments to the Declaration of Assets and Liabilities Law, the checks on financing of elected officials continue once they enter office, expanding the scope of the law to encompass the President, private staff of elected officials, provincial council members, and members of local government authorities, to mention a few. The amendments specify that officials would have to submit asset declarations at the point of their initial appointment on a yearly basis while they hold office, at the point of retirement, and for two years post-retirement.

Additionally, asset declarations of the elected official’s spouse, dependent children, and other persons who live with the elected official or have similar ties are also required.

Tackling corruption is a mammoth task, but these reforms could form the backbone of a culture where citizens hold their representatives responsible and demand increased transparency and accountability.

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Yahapalanaya: A tale of confusion and ineffectuality?

Originally appeared on Echelon

By Ravi Ratnasabapathy

“Whenever we send papers for approval, authorities first look at how to stop it. The only way to activate it is to give something and because we don’t, we have to budget 12-18 months – wait 12-18 months where they (authorities) find different excuses not to give approval.”

Many businessmen are disgusted by the state of the government: rules are uncertain and nothing ever seems to get done. Many also claim that things have got more difficult under the Yahapalanaya regime.

Is this true?

The government has two components, elected representatives (politicians) and non-elected bureaucrats. Policies are normally the result of both political and bureaucratic intervention. There is no question that Sri Lanka’s bureaucracy has been decaying for decades, but it now seems to have almost ground to a halt. It is difficult to judge if the bureaucracy has become a lot worse in the past few years – there have been few obvious changes to the system that prevailed before.

What’s changed are politicians, and particularly, a change in the structure of power. What typically used to happen in the past was that when businesses encountered obstacles in the bureaucracy, they would simply approach a politician. Under the previous regime, power was centralised and resided in a few positions.

If a businessman complained to the right channel, a quick response and a firm decision could be expected. These decisions simply cut through all red tape and regulations, which meant the bureaucracy was simply bypassed. The inefficiencies of the bureaucracy thus remained hidden from view.

Under Yahapalanaya, power is diffused and split among warring factions, contributing to an uncertain policy framework. Lacking an overarching vision, few have a clear idea of policy and even fewer are willing to take bold decisions that cut through the bureaucracy. When businesses approach politicians for solutions, they are directed into the maze of the bureaucracy where they experience the grim decline of decades.

This may explain the dilemma, but what is the solution?

Investors shy away from countries where rules are unclear or are constantly changing, and where approvals are dependent on ad-hoc decisions. What is needed are simple, clear rules and standardised processes that deliver predictable outcomes. If X paperwork is submitted, an approval should be received within Y time with no further intervention.

“The solution is not to allow politicians to bypass laws, but to fix the processes”

The solution is not to allow politicians to bypass laws and regulations, but to fix the processes. This will not just help investors and businesses, it helps the public and small businesses who must get approval for many things from cutting a tree to digging a well or obtaining an electricity connection. Migrant women have to submit a myriad of documents beyond those specified in the Circular and make multiple visits to the DS office in order to obtain the Family Background Report.

Small businesses struggle with taxes. The Inland Revenue refuses to issue VAT registration to a new business unless they can show that they have reached the threshold (Rs3 million per quarter), forcing them to incur the additional cost of VAT. Once registered, even if the business later falls below the threshold, they are harassed for payment, even though they are technically no longer liable.

Small businesses and individuals lacking access to politicians have been dealing with these issues all the time. Fixing the processes should be a priority, but this is an enormous task. It can only be approached by multiple taskforces working together.

At the top, there needs to be a central “Administrative Simplification Agency” – promoting administrative simplification “across the board” for businesses, citizens, and the public sector. The central bureau must be supported by smaller teams working in all the departments to cut and simplify paperwork. Outside taskforces, perhaps supported by external consultants, can help with co-ordination and keeping up the pace of reforms. Relevant partners and affected parties can be involved in the administrative simplification reforms, which will contribute to gaining constituency.

The agency must have the highest level of political backing. The approach is to re-engineer processes, cutting redundant regulations, approvals or documents.

The challenge is to balance the use of administrative processes to implement public policies, minimising the interferences of these requirements in terms of the resources needed to comply with them.

All this is back office work that is dull, dreary, difficult and lacks political visibility. No politician will back such a venture as they will get no political mileage from this.

Transparency is needed in the cutting of red tape, which brings public support, builds political capital and sustain reform.

There is a useful model in Peru that set up a tribunal to gather and evaluate proposals from citizens for deregulation, and to check up on how various bureaucracies were responding to the law. To encourage public participation, bright yellow boxes were placed in the agency, government offices, and at all the radio, television and newspaper outlets to make it as convenient as possible for people to deposit their grievances. The media were encouraged to review the grievances they received, and when they saw an astonishing or outrageous story, they took up the cause, creating the kind of public pressure that politicians found impossible to ignore.

“The agency must have the highest level of political backing. The approach is to re-engineer processes”

The tribunal did not cut the red tape. What it did was bring the problems to public view, and involved the public in the process. The body that cut the red tape worked after the tribunal but in Sri Lanka, the mechanism to cut the red tape must be set up beforehand. This must be done without much fanfare, otherwise the public will once again witness the delays in setting up such a body. Ideally, some preliminary analysis should be done beforehand and several solutions must be kept ready for immediate implementation once the publicity campaign is launched. People should experience real results.

The process must also include evaluation and measurement of changes so further improvements can be done. The principle is to first organise and once this is done, as far as possible, to securely digitise. (Current government efforts to digitise are rickety and intrusive, requiring registration via social media accounts, and are prone to failure).

In Peru, over the years the Tribunal was in operation —with the President, by law, in attendance—more than 200 bureaucratic knots were untied. The time previously required to fulfill hundreds of different kinds of official procedures, including obtaining a passport, applying to university and getting a marriage license, was cut across the board by at least 75 percent.

At the end of President Garcia’s term in July 1990, 79% of the population (and 84% of the poorest among them) rated the Law of Administrative Simplification as the best law enacted during the 1985-1990 legislative period.

If the government is willing to take this approach, it can result in a win-win situation for politicians and the country.

The kind of ‘liberals’ we are

Originally appeared on Daily FT

In an Op-ed published in the Daily FT recently, a group called ‘Avocado Collective’ provided a critique of a lecture by Prof. Razeen Sally organised by The Advocata Institute. Whilst much of it is a critique on the lecture, it casts aspersions on the motives of Advocata. We thought this was a good time to explain what the organisation is about and why we exist.

The Advocata Institute was set up in 2016 as an independent public policy think tank focusing on economic freedom. Sri Lanka’s public debate on economic policy has been dominated by those who believe that state intervention is the answer to all our problems. Advocata has sought to present an alternative view. 

Poor policy and governance are at the root of our problems. 

Take for example State-Owned Enterprises (SOEs), a major area of research for Advocata. The 55 largest State enterprises collectively lost Rs. 87 b in 2017, almost double the Rs. 43 b allocated to Samurdhi, the largest social welfare programme in the country. The losses of SriLankan Airlines alone were Rs. 28 b. 

The Auditor General has exposed billions of rupees in procurement corruption and mismanagement in the State and State enterprises. These losses are paid by taxpayers and, taxes are paid by everyone not just the rich. 

Last year alone, the Government raised Rs. 71 b by taxing food. This is partly responsible for the high cost of living in Sri Lanka. Is funding losses the best use of our tax money?

The country has some 200+ State enterprises but no comprehensive list is readily available. Procedurally, State enterprises must be incorporated by an Act of Parliament and be held accountable to Parliament. In Sri Lanka, all manner of entities are incorporated under the Companies Act with no debate in Parliament and minimal accountability.

Audited accounts of the 55 enterprises where more data is available are chronically late. When they are published, they frequently carry audit qualifications. Some – such as LakSathosa – have not submitted accounts from 2010. Poor accountability results in fraud. For example, the Auditor General reported a fraud of Rs. 15 b in rice procurement at LakSathosa. There are many others. 

We need to ask the question whether the running of a supermarket is the proper role of the Government. Or whether there are better ways of achieving the stated policy objectives of running LakSathosa. Similar questions can be asked about many other institutions, including the State Timber Corporation, which had its last two chairmen arrested under corruption charges. 

The State is engaged in economic activities that range from the strategic to the absurd. From hotels catering to tourists to firms claiming to convert polythene into diesel. What public interest do these enterprises serve?

Posing these questions is hardly a neoliberal conspiracy. It is only reasonable to assume a state that tries to do a limited, well defined set of things has a greater chance of success than a one that tries to do everything and failing at great cost to the people

This is particularly relevant since over several decades Sri Lanka’s once-effective public service has been broken. Some have even questioned the capacity of the State to deliver the most fundamental of public goods: the rule of law and a system of justice.

Is there a conspiracy in asking for sound money and low inflation? Is not keeping the cost of living low the most important safety net for the poor?

Protectionism is another problem. Sri Lankan consumers have to bear extraordinarily high prices due to high taxes. Protective tariffs are rampant in common consumer goods such as footwear, electronics and in vital industries like construction. These tariffs serve narrow political and business interests at the expense of all others. 

Tariff reform is naturally opposed by businesses who have a captive market. Their opposition to competition is at least understandable. What is more surprising is the opposition from groups such as the ‘Avocado Collective’ who perhaps inadvertently, find themselves siding with these groups, and indeed Donald Trump, on his views on trade. 

Sri Lanka faces multiple challenges including an unsustainable fiscal position characterised by persistent fiscal deficits and high levels of debt, particularly foreign commercial debt. Tightening global conditions could increase the cost of debt and make rolling over the Eurobonds maturing from 2019, more difficult. 

Uncertain property rights and trade restrictions deter investment, impairing job creation. The State has stepped in to fill the vacuum of jobs, it employs one in every 15 people, but the narrow tax base does not support the superstructure of the expenditure. Resorting to debt to fund recurrent expenditure is no longer sustainable.

The lack of opportunities and the cost of living cause many Sri Lankans to look overseas for advancement.

New challenges loom in health as the population ages while risks from climate change have increased. Is the education system geared to meet the needs of a knowledge economy? There are important questions to be raised on the priorities of public spending as well as the quality and effectiveness of spending. 

We believe that we need to rethink these issues and our objective is to bring alternative ideas for discussion since they are absent in the current discourse. We hold lectures and publish research and commentary, all of which, including videos of lectures are available online at advocata.org and our social media pages. Our public lectures have been open to all. 

We have always been open about our priorities. Our ideal Sri Lanka is one that is prosperous, open and free. A system that allows for maximum individual freedoms, particularly economic freedom. A country where anyone can succeed through hard work, personal responsibility and determination. 

Are these good things? How do we get there? There can be legitimate disagreement. Our role is to provide ideas, stimulate debate and offer practical solutions based on evidence, not to be the ultimate arbiter. 

Shooting down messengers is a spectator sport among Sri Lanka’s political elite. Constructing conspiracy theories is a fanciful, if entertaining, exercise practiced by those trying to de-legitimize real issues and will do little to move us forward.

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By Fellows of the Advocata Institute in response to the article ‘What kind of liberals are these?’ published in the Daily FT, Friday 29 June. More information on Advocata is on www.advocata.org.

Politicians or technocrats?

Originally appeared on Echelon

By Ravi Ratnasabapathy

A layer of technocrats working with ministers can improve policy.

Sri Lanka’s long-suffering citizens face yet another election this month. Many are disappointed by the performance of the current government. The dreary parade of candidates for the upcoming election, actresses, singers and other sundry characters (mostly unsavoury), is uninspiring.

People yearn for technocrats, people with knowledge and skills, to come in and clean the house (similar to Plato’s ideal of a Philosopher King); but how can this be achieved?

Is the solution ‘qualifying criteria’ for politicians? The problem with electoral democracy is that such a thing is not possible; it would be seen as inherently unfair. Other countries also have their share of lunatics in the fray: South Korea created a blacklist to filter unsuitable candidates, an idea that is worth exploring, but a better solution is to have a layer of technocrats below the elected politicians. Technocracy should be in charge of day-to-day administration, to advise and guide politicians as to good, workable policy, and then implement it impartially. This is an attractive idea, but is it only wishful thinking? No; and in fact, independent Ceylon did in fact have this in the form of Civil Service, a body of people famed for intellect, independence and probity.

When we refer to a civil servant, it is not a crony who owes his appointment to some political master. A civil servant should be one selected on the basis of excellent academic credentials and a rigorous entrance exam. This ensures that only bright and intelligent people are brought into the service. This is then followed by a two-year period of internship (that was called a “cadetship”), where they learn the practical aspects of administration by working alongside senior colleagues. It is only after this process that they will be fit for the real administrative work in running a country.

Thus, the people entrusted with administration will have a minimum of three years of university study and two years of practical experience even before they start real work. Note that only the best of the graduates (based on their grades) were originally selected and subjected to a further rigorous examination, so there is reasonable certainty that the basic intake is of intelligent people whose minds have been trained to think. Invested with a further two years of on-the-job training, by the end of a total process of five years, we have the basic material on which an efficient system of administration may be built.

With no entry qualifications, minimal or zero education, and only the ability to appeal to the basest of popular sentiment, the politician, unchecked, is the most dangerous creature in which to vest the reins of power.

“A civil servant should be one selected on the basis of excellent academic credentials and a rigorous entrance exam. This ensures that only bright and intelligent people are brought into the service”

Yet, electoral democracy calls for persons to be elected by popular ballot, and the field should be open to all. How can these be reconciled? The technocrat must guide the politician, advise him (or her) on the options available and check their wildest impulses. But, if this is to work, the technocrat must not be beholden to the politician. The civil service must be independent and, most importantly, politically neutral.

Independence is ensured if politicians have no say in the appointment, dismissal, promotion, transfer, pay or other matters, which must be in the hands of an independent Civil Service Commission. The service must also be politically neutral and serve governments of different political hues equally. If the service is seen as impartial, then politicians have less incentive to interfere, contributing to its independence.

Civil servants should not engage in any political activity: they must not campaign for or against any party, nor misuse state resources or power for partisan purposes; nor should they shy away from carrying out their duties when a matter is politically controversial. Politicians have democratic legitimacy, while civil servants, as unelected officials, do not. Political neutrality is necessary to bring democratic legitimacy to technocrats, the scholar mandarins who influence and implement policy.

Politicians suggest broad policies; civil servants need to advise ministers as to how these can be implemented in a workable manner. Civil servants need to examine all options: Martin Donnelly, a senior UK civil servant, stated that civil servants should avoid having to answer the question “Why wasn’t I told about this?” by disclosing all potential outcomes that might take place at the outset.

He went on to say that civil servants should also “offer some advice that is not accepted to ensure a genuine fair hearing of all options that are within a government’s political direction”. If politicians’ views are not subject to scrutiny, they may miss the opportunity to consider changing them.

Politicians generally view things on a shorter time horizon; permanent civil servants, who have to work and live with the consequences of policy in the long term, naturally take a much more longer term view. Politicians want to make the big announcement at the right time, while civil servants are more apt to take the necessary time to examine all options, resource constraints and the scale of risks, even if that means taking longer. Such a system allows collective and personal experience to be drawn and built upon, safe policy debates to occur, and experts to be brought in for shorter or longer periods.

The minister does not have unbridled power, so hasty promises made at election time cannot be implemented ad-hoc: they are refined and adjusted in keeping with the constitution, the law and practical considerations. It is through this process that promises are turned into practical policy. Often, the relationship between the two will be tense; the inexperienced and idealistic politician will demand things that sound nice but may be unfair to some citizens (people outside his particular constituency), too expensive, unsustainable or otherwise impractical.

The comedy ‘Yes Minister/Yes Prime Minister’ is based on the tension between the well-meaning but bumbling minister and the crafty permanent secretary Sir Humphrey Appleby. Although the comedy portrays Sir Humphrey as being devious, he is performing a vital function in checking and tempering the enthusiasm of the minister.

The education, training and experience of the civil servant is thus essential in tempering policy. The politician is involved only at the larger policy level, and unless there are pressing problems to be resolved, has little to do with routine administration.

Belgium ran quite successfully for a better part of two years without a proper government (i.e. politicians), and could have carried on for much longer with no serious difficulty; its administration was functioning properly under its civil service.

“Technocracy should be in charge of day-to-day administration, to advise and guide politicians as to good, workable policy, and then implement it impartially”

These ideas are far from new or radical. They were first practised by the imperial Chinese, with the first formal exams being introduced in around 605AD. This was refined and expanded over a period of 1,300 years, until 1905. These bureaucrats, the Mandarins, were the scholar officials who ran the Chinese empire, at one time the greatest in the world. This system was adopted and further refined by the British, who in turn ran their empire on these lines. It is estimated that around 120,000 people were involved in running the British Empire, although only 4,000 were directly involved. Sri Lanka today boasts 1.3 million in public service, about 500,000 of who are in the military, leaving about 800,000 to run the civil administration.

It is also the system that was used in independent Ceylon, until 1962, when short-sighted politicians facing difficulties with implementing their various hare-brained schemes decided to abolish the civil service, starting the rot that leaves citizens today wondering whether to even cast their vote at all.

An important check on the politicians was removed; so now it is irrepressible politicians who hold the reins of power.

What is needed to try and restore this system? It is very difficult, but the first step would be the creation of a completely independent Public Services Commission, which would be responsible for the appointment, transfers and
promotion of all public servants.

Ministers should no longer control the fate of public servants.

The next step would be to change mindsets: Instil the values of the civil service code through training. A basic training to instil the core values of honesty, integrity, impartiality and objectivity should be carried out throughout the service. This must be followed up by more specific work to address skills gaps.

In general, training must focus more on senior ranks, if they are to set and demand higher standards of work from juniors.

Any policy or programme is only as good as its implementation. Given the abysmal quality of politicians, even getting policies right is a problem. Working to build an independent technocracy is essential to improve policymaking and its implementation.

Recreating something that was built over a century, but destroyed within a couple of decades, will not be easy, but it’s the only way forward. Leave it to degenerate further and we will be left with a situation where it grinds to a complete halt, under its own sloth and inertia.

SL is running out of input-led ‘perspiration’ growth: Sally

Originally appeared on Daily FT

Shortages of labour, land and an ageing population mean that Sri Lanka’s opportunities for rapid catch-up growth are diminishing and institutional transformation is needed for innovation and output-led growth, a top economist has said.

The first stage of growth involves a poor country catching up with more advanced economies, using inputs like cheap labour and land, involving ‘perspiration’. 

“Once you become middle-income, especially the upper middle income categories, your growth rate inevitably slows down; this model no longer works,” said Razeen Sally, the Associate Professor of the Lew Kwan Yew School of Public Policy in Singapore.

“We are already seeing that in Sri Lanka. The population begins to age. You have less availability of labour - particularly cheap labour. Capital becomes more expensive. Wasting capital becomes more obvious, land becomes scarcer.”

Sally was speaking at an event in Colombo on ‘Asian capitalism and what it means for Sri Lanka’ organised by the Advocata Institute, a free market think tank and Echelon, a business magazine.

Inspiration vs. perspiration

When a country exhausts catch-up growth, a second stage involving innovation, which economist Paul Krugman called ‘inspiration’ or output-led growth, was needed.

“Now you have to use your brains much more, less your sweat or brawn,” Sally said.

Output-led growth requires liberal institutions and a different type of entrepreneurial capitalism.

Economists and thinkers had defined free enterprise and capitalism in different ways.

Economist Adam Smith believed that if people had freedom to produce and consume, with secure property rights, then the market economy would flourish with increased specialisation driving efficiency. 

“Specialisation goes deeper and if you do it across borders with freer trade, it goes wider.”

This was ‘Smithian’ growth. It was not about technology as such and describes the catch-up phase.

Friedrich List, a German, wrote his ‘National System of Political Economy’ against the economics of freedom of Smith. 

While Smith believed in free trade and removing state blockages to entrepreneurship, List advocated state support for business through protectionism and a variety of state interventions for young and upcoming countries like Germany to catch up with a leader like Britain.

“And that is an argument for state intervention and industrial policy, particularly to support infant industry - so-called - that has been used in countries like Japan, South Korea and Taiwan,” Sally said. “And that argument finds it echoes here in Sri Lanka.”

Marx in turn had an apocalyptic vision, that capitalism would destroy itself while Weber had an almost religious view. 

Joseph Schumpeter, an Austrian finance minister and banker who became a professor at Harvard University and one of the top economist theorists of the 20th Century, observed another pattern.

Constant change vs. equilibrium

In contrast to standard neo-classical economics which is about a stable equilibrium, Schumpeter’s economic system is highly dynamic. Capitalist economies are constantly changing. Everything is being disrupted and re-created. It is disruptive innovation which has parallels to Anichcha in Buddhism, which means impermanence. It is about constant change the central agent of which is the entrepreneur. 

“What Schumpeter’s entrepreneur basically does is beg, borrow or steal ideas and turn them into marketable, profitable products - goods and services,” Sally said.

“So you take inventions, and rarely is the inventor the innovator and turn them into innovations. An invention is a new idea. And an innovation is turning that into something for the mass market, which makes profits, which generates investment, which creates jobs and livelihoods.

“Most of the really big ideas of the past like gun powder, the printing press and algebra had come from China and the Middle East. But they were not innovated in China and the Middle East,” said Sally. 

“They were innovated in Europe by European entrepreneurs in the commercial revolution and subsequent agriculture-industrial revolutions that Europe had but China and the Middle East did not. That is a genuine puzzle.”

Creative destruction

Schumpeter talks about “perennial gales of creative destruction” which is at the heart of his capitalist economic system. 

“So capitalism is not about stable equilibrium, but about creative destruction,” Sally said. “New entrepreneurs swarm around new ideas, inventions. And they turn them into innovations at crucial junctures, in the process destroying old incumbent industries.”

IBM was disrupted by Microsoft and Apple, who will in turn be destroyed by different technologies from more nimble firms. If the system is open enough, this kind of creative destruction will happen.

“In other words we cannot have prospering capitalism without this kind of disruption, which can be socially very disruptive,” Sally said. “This can upend politics, society and indeed the world.”

In poor Asia there was room for catch up growth but the opportunities dwindle as countries become richer so they must move to Schumpeterian growth, which means improving productivity.

Schumpeterian growth

“You want to improve the efficiency of your inputs, particularly your land, labour and capital. So it is not the quantity or mass of them but the quality or efficiency.”

Malaysia, Thailand and China had an urgent need for innovation-led growth. Middle Asian countries were seeing conditions similar to Japan in the 1970s and South Korea in the 1980s, when they exhausted the catch-up period. 

The Asian re-emergence of the last century was based on imitating the West, which was fine in the catch-up phase. Sally said in the first phase, it was possible to grow with weak institutions and rule of law and even corruption.  But the changes needed to go forward does not happen automatically.

“You need to be open to international trade,” Sally said. “It is crucial. You need to improve labour markets, primary and secondary education, you need to improve hard infrastructure.

“Friedrich List would argue that you also need industrial policy. The reality is that results are mixed. Asian Tiger countries have used a combination of policies from the Adam Smith and Friedrich list textbook, but not from the Schumpeterian textbook.”

Liberal institutions and complex reforms

“But when you come to that second stage, when you really need to boost your factors of production, your overall productivity and innovation, not only do you need to get your basics right, you need to improve the quality of your institutions,” Sally says.

“You need to improve the quality of your financial system including regulations, education, skills,  better public administration, a more efficient judiciary and legal system, a tax system and bankruptcy procedures, going well beyond the basics.”

The World Bank’s Ease of Doing Business Index was a reflection of how good the business climate and institutions were. Only Singapore, Hong Kong and Korea were in the global top 10. Taiwan was 15. All are part of rich Asia. For middle and poorer Asia to join this club their institutions must be as good but Sally says improving financial systems, legal systems and educations systems is politically difficult and complicated.

“Improving institutions depends on politics,” Sally said. “So I have my doubts about Asia being successful in the future as it has in the past.” 

There was a growing belief that China’s ‘Mao and Markets’ system, where a few people at the top made decisions, may allow it to overtake the West. But doubts remained whether real innovation could take place. Sally says there were questions whether people in the top would really give up the power and rents that can be earned in an autocracy.

Sally says innovation is happening in Asia, especially in the digital space. Young people in Asia are adopting digital technologies quickly. In China, a number of tech companies were emerging. The venture capital market in China for tech was now worth $ 60 billion a year, the same as the US.

China was now promoting some state and private tech firms aggressively in a type of industrial policy. But less efficient state firms were a drag. There was also a crony private sector. Productivity growth was slowing.

Power shift

Meanwhile, the so-called Pax America which provided a relative stable geopolitical environment which allowed Asia to grow was changing, Sally said. There was a possibility of a Chinese-led ‘Pax Sinica’ emerging under different rules.

The US had maintained the peace in Asia and prevented China, India and Japan from getting into a major war with each other. After 9/11, the US became increasingly fixated on the problems in the Middle East. Obama was reluctant to intervene in Asia and Trump, a ‘gut isolationist’, is even less engaged. Another possibility was a power vacuum, which could lead to a major conflict. Meanwhile, it was not a foregone conclusion that the US would continue to pull back and a Pax Sinica will come.

Meanwhile, Sri Lanka had not initiated the major reforms required and was coming increasingly under China. Sri Lanka’s current administration had initially got the basics wrong and had to go to the IMF. It was now sticking to a broad program agreed with the IMF in getting some of the basics right.

But no major reforms had taken place in land, the banking system or education. The reform window was closing and perhaps had already closed, he said.