Trade, deglobalization and the new mercantilism

Originally appeared on the Hinrich Foundation

By Prof. Razeen Sally

The COVID-19 pandemic is accelerating shifts underway since the last global financial crisis (GFC). It ushers in a new era of deglobalisation and protectionism, indeed a new mercantilist world order.

Three global shifts will shape international trade. They will probably last beyond the immediate crisis to the “post-vaccine” future. The first is an accelerated shift from Market to State: more government interventions will further restrict markets. The second is to national unilateralism – governments acting on their own, often against each other – at the expense of global cooperation. The third is to more contested and unstable geopolitics, centred on US-China rivalry. Taken together, they herald a new mercantilism, whose main precedents are Europe and its colonial expansion in the seventeenth and eighteenth centuries, and the period between the two world wars in the first half of the twentieth century.

Mercantilism – the exercise of state power to control markets domestically and internationally – existed after 1945, but was constrained by the expansion of markets: it was relatively benign. But malign mercantilism governed the preceding decades, shattering domestic economies, shrinking individual freedom, destroying the world economy, and so poisoning international politics as to culminate in global war. Today’s emerging mercantilism is still far from that reality, but it risks heading in that direction.

Another set of historical precedents is also relevant. Increasingly, the US-China conflict today echoes that of the US and the Soviet Union in the “old” cold war. But China today, unlike the former Soviet Union, is an authoritarian (not totalitarian) power with a state-directed and partly globalised market economy (not a sealed-off command economy). China better resembles Germany and Japan as rising powers in the late nineteenth and early twentieth centuries. And US-China rivalry today better resembles that of the UK and Germany before the first world war: a contest between the established power, with a liberal-democratic political system and a free-market economy, and a rising power, with an authoritarian political system and a state-guided market economy.

Three eras of international trade preceded the present pandemic. The first – the quarter-century until the GFC – was an era of unprecedented liberalisation and globalisation. The second – the near-decade after the GFC – saw globalisation stall, though not reverse, and trade growth stagnate alongside “creeping” protectionism. The third, starting in early 2017, was triggered by President Trump, partly to retaliate against increasing Chinese protectionism. It centred on a US-China trade war but rippled out into copycatting protectionism by other countries. Protectionism went from creeping to galloping.

This pandemic has triggered the worst deglobalisation since 1945. International trade may shrink by up to a third, foreign direct investment by up to 40 per cent, and international remittances by 20 per cent, this year. The trade outlook is worse than it was during the GFC in two ways. Now economic contraction is synchronised around the world; during and after the GFC, fast growth in emerging markets, led by China, cushioned the fall in trade and enabled a recovery. Now services trade is suffering even more than goods trade; travel and tourism have collapsed. The GFC, in contrast, hit goods trade hard but services trade was more resilient, especially fast-growing travel and tourism. Now there are signs of a protectionist upsurge, starting with export bans on medical equipment, with new restrictions on foreign ownership in the pipeline.

What is the medium-term – post-vaccine – trade outlook?

First, protectionism is likely to increase as a spillover of domestic state – particularly industrial-policy – interventions that last beyond the present crisis. Crisis-induced subsidies will be difficult to reverse wholesale and will have trade-discriminating effects. New screening requirements might have a chilling effect on foreign investment. These and other interventions to protect domestic sectors and national champions have a home-production bias. The list of “strategic” sectors to protect on “national security” grounds against foreign competition will likely expand. There will probably be more restrictions on migration and the cross-border movement of workers.

Two precedents are relevant: the “new protectionism” of the 1970s and ‘80s, which partly resulted from bigger, more interventionist government in domestic markets; and, more perniciously, the expansion of government after the first world war, which empowered interest groups to lobby effectively for restricted imports, foreign investment and immigration.

Second, national unilateralism – this time “illiberal unilateralism” – will likely expand and make effective regional and global policy cooperation more difficult. It bodes ill for the WTO, APEC and the G20, also for regional organisations such as ASEAN, and will cramp the liberalising effects of stronger preferential trade agreements. This only increases the prospect of tit-for-tat retaliation, starting with the Big Three (the US, EU and China), and copycatting protectionism that will spread around the world.

Third, the reorientation of global value chains will accelerate. Western multinationals will relocate parts of their production from China to other countries on cost grounds, as they have been doing, but increasingly on political-risk and security grounds as well. There will be a combination of onshoring, near-shoring and regionalisation of value chains, which will vary widely by sector. But the overall effect will be to raise costs for producers and consumers.

Fourth, international trade will be hit harder by a more fractured and conflictual geopolitical environment, especially US-China rivalry, but not helped either by an inward-looking and divided EU. It will be squeezed between more unstable geopolitics and the recalibration of states and markets – more “state” and less “market” – domestically.

All the above points to a new mercantilist trade order that might be more malign than benign, echoing the “new protectionism” of the 1970s and early ‘80s, or, even more worryingly, the 1920s and ‘30s.

My ideal world is a classical-liberal one: limited government, free markets and free trade, underpinned by appropriate domestic and international rules. I would add political liberalism and legally protected individual freedoms. The post-1945 global order was some distance from this classical-liberal ideal, but it was liberal enough to deliver unprecedented freedom and prosperity. From this vantage point, the new mercantilist order, with emerging malign characteristics, is alarming – bad economics, politics and international relations; bad for individual freedoms and global prosperity. As a realist, however, I must take the world “as it is” rather than indulge in wishful thinking. To improve the world, principled liberalism must be combined with practical realism.

I believe the two biggest threats to global order are rising illiberal populism in the West, endangering the West’s adherence to its own liberal values, and the increasingly aggressive illiberalism of the Chinese party-state. Both have mercantilist features that spill over the border into protectionism and restricted globalisation. Both feed off each other in a global negative-sum game. Hence both must be resisted: naivety and complacency should apply to neither.

China under Xi Jinping, with its mix of authoritarianism, a state-directed market economy and external assertiveness, is becoming a classic mercantilist power, like Germany and Japan in the late nineteenth century and early twentieth century. Its external power projection, especially in the last decade, looks quite different to that of the US in the Pax Americana. Of course, at times, here and there, the US threw its weight about unilaterally and arbitrarily. But the essence of US leadership was to provide public goods for a stable, open and prosperous world order. It did so by organising concerts of international and regional cooperation. In international trade, that took the form of the GATT, later the WTO, and the multilateral rules it administers.

China, in contrast, prioritises a combination of unilateral and bilateral action to expand and entrench its power. That subsumes the expansion of the PLA Navy in the East China Sea, South China Sea and Indian Ocean; and tight, asymmetric bilateral relations with smaller, weaker states in a twenty-first-century recreation of the ancient tributary system. The Belt and Road Initiative should be seen in this frame: a network of hub-and-spoke bilateral relationships in which China wields power over-dependent states. This is classic mercantilism. It privileges discretionary power, exercised unilaterally and bilaterally, over plurilateral and multilateral rules that constrain such power.

China – meaning the Chinese Communist party-state – presents a pressing challenge to the liberal world order. Dealing with this challenge will require some trade, technological and investment restrictions, and limited supply-chain decoupling. But that could easily descend into an all-round mercantilist and deglobalisation spiral. Hence China must be engaged at the same time, not least to preserve existing links that are mutually beneficial. Engagement and strategic decoupling need not be mutually exclusive. Still, this will prove an incredibly difficult, perhaps elusive, balancing act.

Liberal or semi-liberal small states and middle powers in Asia, the West and elsewhere have a crucial role to combat malign mercantilism. In Asia, this group includes Japan, South Korea, Taiwan, Singapore, Australia and New Zealand. They need to keep their economies and societies open; demonstrate best policy and institutional practice (as they have done in this pandemic crisis); build coalitions of the willing on trade and other issues; strengthen alliances with the US and EU to nudge them to be more outward-looking and globally constructive, and finesse a mix of strategic decoupling and engagement on China. But doing all that in a global mercantilist environment will be an uphill struggle.

Prof. Razeen Sally is a visiting associate professor at the Lee Kuan Yew School of Public Policy at the National University of Singapore. He is also the author of "Return to Sri Lanka: Travels in a Paradoxical Island."

Sri Lanka's Rajapaksa restoration is complete. What comes next?

Originally appeared on Nikkei Asia

By Prof. Razeen Sally

Government may have to rely on new Chinese loans to avert a macroeconomic crisis

Sri Lanka's parliamentary election on August 5 delivered a thumping victory for President Gotabaya Rajapaksa and his older brother Prime Minister Mahinda Rajapaksa's Sri Lanka Podujana Peramuna, or SLPP, party. Following Gotabaya Rajapaksa's decisive victory in the presidential election last November, what does the Rajapaksa family's unlimited rule portend for Sri Lanka and its external relations?

Illiberal democracy, a state-led economy, Sinhala-Buddhist supremacy -- Sinhala Buddhists are about 70% of the population, and a China-centric foreign policy were the hallmarks of Mahinda Rajapaksa's rule when he served as president until 2015. His surprise election defeat opened a window for liberal democracy, a more internationally open, private sector-led economy, reconciliation with ethno-religious minorities, and a more balanced foreign policy to reengage with the West and India.

But the coalition government that followed was a total disaster, crippled by no reform strategy, venomous internal warfare, corruption scandals and rank incompetence. The Rajapaksa restoration last November revived the core features of the previous Rajapaksa rule. But now Gotabaya Rajapaksa is in the driving seat, and Sri Lanka faces a COVID-19 plagued world.

With a handful of allies, the SLPP will have a two-thirds parliamentary majority, which will allow it to change the constitution at will. First will come the repeal of the Nineteenth Amendment, which limits presidential powers and strengthens parliament and the judiciary.

Optimists argue that Sri Lanka now has the political stability and decisive governance it lacked under the previous government. President Rajapaksa has centralized power in his small circle, crowded with retired senior military officers. Even more than his brother Mahinda, he favours Big Man rule, exercising untrammelled power, issuing orders and expecting them to be executed without dissent or delay. That has worked, so far, to limit the spread of COVID-19 in Sri Lanka. But will it work to tackle more complex and long-standing problems concerning the economy, interethnic relations, public administration and much else besides?

Countries become stable and prosperous by nurturing effective institutions and social trust over time, not with Big Man politics with its never-ending command-and-control, short-term, ad hoc fixes. That is something the Rajapaksas -- and all but a tiny minority of Sri Lankans -- don't seem to understand. Sri Lanka is now hurtling back to illiberal democracy. It may provide short-term political stability, but I doubt it will lead to better governance.

This Rajapaksa government, like the last one, espouses a collectivist economic ideology. Its first budget was full of tax cuts and expenditure entitlements, guaranteed to increase the fiscal deficit and public debt. The policy consists of diktats and constantly changing regulations on taxes, monetary expansion and import controls.

Sri Lanka was already in a debt trap when this government came to power. Total public debt is about 90% of gross domestic product, and total external debt, at over $50 billion, is about 60% of GDP. Then COVID-19 struck. The budget deficit may go up to 10% of GDP this year, and the economy may shrink by up to 5%. There is no fiscal space for tax cuts and extra public expenditure. The government desperately needs to negotiate debt moratoria, extra loans and possible debt restructuring with the International Monetary Fund and others. But, for now, it has no plan.

The Rajapaksas are unapologetic Sinhala-Buddhist nationalists. President Rajapaksa and the SLPP were elected with a huge majority of Sinhala votes but only a tiny percentage of ethnic-minority votes.

The Sinhala-Tamil cleavage is long-standing. The Easter Sunday blasts last year, perpetrated by Islamic radicals, opened a new cleavage between Sinhala Buddhists and Christians, on the one hand, and Muslims, on the other. The Rajapaksa Sinhala-Buddhist supremacist agenda is guaranteed to keep ethnic tensions on the boil. Muslims will be most at risk if that gets out of control.

President Rajapaksa has largely ignored the West, the IMF and other international organizations, but he is friendly with Narendra Modi, a fellow strongman and ethno-religious nationalist. China, however, remains "first friend." Money talks: Chinese state-backed investment is the only big game in town. There is a real possibility that Sri Lanka will rely on new Chinese loans to avert a macroeconomic crisis, especially if it does not come to a new agreement with the IMF.

Sri Lanka increasingly resembles a Chinese tributary state -- rather like a brief interlude in the fifteenth century, when Admiral Zheng He abducted a local king and took him to Beijing to pay obeisance to the emperor, after which an annual tribute was sent to China.

Sri Lanka is a bewitchingly beautiful country. Since ancient times, it has won the hearts of many a visitor. I would know since I grew up there -- I am half Sri Lankan, half British -- and have spent the past decade travelling all over the island to write a travel memoir.

But Sri Lanka is a little country with layer upon layer of complexity and paradox, and a dark side that has benighted its post-independence politics and institutions. As an adviser to the last government, I saw up close its shambolic disintegration. Understandably, Sri Lankans voted for the only realistic alternative: the Rajapaksas. The prospect of another decade of Rajapaksa hegemony does not fill me with optimism.

Prof. Razeen Sally is a visiting associate professor at the Lee Kuan Yew School of Public Policy at the National University of Singapore. He is also the author of "Return to Sri Lanka: Travels in a Paradoxical Island."

Stimulus could add to perilous public finances: Dr. Sally

Published in The Daily FT.

By Chandani Kirinde

The stimulus packages put in place by the new Government for various sectors are not sustainable, with the extra layer of spending adding to the already perilous state of the country’s public finances, well known economist Dr. Razeen Sally said.

“The budget deficit and the current account deficit required an IMF bailout. The IMF conditions are being broken, which means another crisis is in the works. There is ever more spending with ever more entitlements. The tax concessions mean there is probably going to be even less revenue coming into the exchequer and all these problems in the macroeconomic front are going to be prevent Sri Lanka getting out of its rut, however well certain projects may get done, Dr. Sally said in an interview with Daily FT.

He said some of the welfare measures announced by the Government may be election gimmickry with the upcoming Parliamentary Election in mind but reversing them after securing a victory was going to be difficult.

“This is an extra layer of spending entitlements which are going to be difficult to reverse because your vote banks are there.”

Dr. Sally said those in power don’t understand this going up to the very top. “The best of them, on a good day, understand projects but not these complicated policy issues and the importance of building up institutions to get the job done over a period,” he said.

Asked about the appointment of more technocrats to some key Government bodies since taking office, Dr. Sally said while having better technocrats was good, there were no easy technical fixes.

“However good an appointment maybe, whether it’s the head of the Tourist Board or the Board of Investment (BOI), without other things changing, the outcomes are not really going to change. If you have an economy that is on the brink or spills over into a macro economic crisis where a new bailout is required, if you have continuing corruption, if you have as part of the bargaining game within the family some bad appointments made somewhere, say two or three bad appointments in return for one good appointment, that’s still not going to change the problem of SriLankan Airlines or the Ceylon Electricity Board (CEB) or the Ceylon Petroleum Corporation (CPC) where you have the really big losses,” he said.

On the plus side, he said the new Government would get some projects done which the last Government could not do whereas the Rajapaksas and particularly Gotabaya Rajapaksa had a track record of getting big projects. 

“But what I think they don’t understand are policies and institutions because they have been making things so personalised,” he pointed out.

Dr. Sally also said that with the return to power of the Rajapaksas, he feared the country would be back to illiberal democracy and authoritarian populism.

“Our institutions are so fragile the little that was accomplished by the last Government was not on the economy certainly, where they did a worse job than the Rajapaksas; it was more on a liberal political space, so I think that’s going to go,” he said.

He said the new man in charge, President Gotabaya Rajapaksa, was different from his brother Mahinda Rajapaksa in his style of governance and it would certainly resonate with a big portion of the population.

“The big man culture in Sinhala society in particular, which probably exists in other parts of Sri Lankan society too, is strongly rooted in Sinhala hierarchy. Every so often there is this yearning for this big man to come in and cleanse society, sweep things clean, and sort out all the big problems. We’ve seen it happen from the day after the election and not only among the Sinhala Buddhists but also among some Muslims, who, having being arch opponents of the Rajapaksas before the elections, have now become enthusiastic supporters because he is different from Mahinda,” he said.

He said this yearning for the big man propelled J.R. Jayewardene and then Ranasinghe Premadasa to high office too.

“If any person takes a step away from these events, we know this is not a good permanent solution because big men have their own flaws and they abuse power and most importantly they don’t nurture institutions, they destroy them, they make things worse, they make society worse and disputes within society worse.”

Asked if the preference for big man politics was a global phenomenon given Modi in India and Trump in the USA, Dr. Sally said that while it was happening in many places, there were reasons to fear it more in Sri Lanka than in many other places.

“In the West, where institutions are stronger, there are checks and balances. In the USA there is the Trump phenomenon, but the institutions have survived Donald Trump reasonably well. The media, the Supreme Court, strong state governments, vibrant civil society – we don’t have that as such or are much weaker.”

On developments in India, Dr. Sally said that what differentiated Sri Lanka from its closest neighbour is that India was big and diverse. 

“Even though Modi and the present incarnation of the BJP is getting more of a Hindu agenda through than before, it is a too big and a complicated place whereas 20 million people in a small space, two-thirds of them Sinhala Buddhists, it means you can take over the institutions and wreak damage much more and much more quickly; that is my fear.”

He said there was a difference between Lee Kuan Yew and Singapore and the Modis and the Rajapaksas of this world or even the Putins in Russia. 

“Lee Kuan Yew was populist, he was charismatic, he was ruthless and in his prime he was a dictator of sorts, but he was highly unusual in that he built institutions to outlast him. He had that farsighted vision that Singapore wasn’t going to really turn the corner by him ordering this, this and this. That’s a city, it’s not a complicated country. It was about attracting the talent in his generation, delegating, saying ‘you do this, you do this, and we have a division of labour among us’ and gradually building up the institutions over three generations to survive his death, which is the story of Singapore. But as a big man politician he is exceptional.”

Dr. Sally, who is a visiting Associate Professor of the Lee Kuan Yew School of Public Policy of the National University of Singapore and worked briefly as an Advisor to the Finance Ministry, said he found working with the last Government a “complete waste of time” because it was “so spectacularly bad”.

He said they came in without any kind of plan as they didn’t expect to win that Presidential Election and what eventually materialised, more than halfway into their term, was a Christmas tree wish list.

“These are all the good things that are going to happen by waving a magic wand in in 2020 and 2025. So, there was never a credible plan with maybe a list of two or three priorities on which they really focused as opposed to 100 or 200 priorities.”

He also said that the last Government made some terrible appointments starting with Ravi Karunanayake (Finance Minister) and the then Prime Minister (Ranil Wickremesinghe) appointing his Royal College classmates and by the time there was some realisation about these bad appointments it was too late.

“We know that the JVP and the LTTE combined did a very good job of assassinating the best of Sri Lankans. What’s left is the dregs, particularly in the UNP, so there is very little talent left even if the party acquires some kind of democracy.”

He said the last Government went to the IMF and were told to do this or that. “This was again part of the problem. The IMF wrote the blueprint, the Government half adopted it and then it was easy for the other side to point to them as a way of selling out. It was never homegrown and then came the bomb blasts which showed the last Government was a genuine national security threat.”

Asked what reforms should be put in place by the new Government, Dr. Sally said public finances must be made sustainable which means reining in public expenditure, and simplifying the tax systems, not higher taxes but simpler taxes with a much bigger incentive for everybody to pay taxes other than get around it.

“We need a medium-term fiscal sustainability program going beyond the IMF program to rein in these twin deficits, to keep the currency stable and prevent going for another bailout. I think we still need another big deregulation agenda.”

He also said Sri Lanka would remain fairly entrenched in the China camp even though the President had declared his Government would remain neutral in its foreign relations, particularly given the geopolitics in the Indian Ocean region.

“Maybe more than his brother, Gotabaya Rajapaksa will try to be on friendly terms with India and maybe the West I am not sure, but I think the direction of movement is still towards China. It was the same under the last Government. They repaired relations with the last Government very quickly. That I think will continue but what will accelerate the momentum is that the Chinese have personal connection with the Rajapaksas which they didn’t have with the previous Government and they’ll be all too ready to bail out.”

He said the Rajapaksas come with baggage, vis-à-vis India and the West, on human rights issues and on minority issues which is inevitably going to complicate relations with the West and India while there were no complications seemingly in their relationship with China.

“We will be going further in the Chinese direction which of course means that whatever the rhetoric, Sri Lanka is not going to remain natural. Sri Lanka is in the China camp is far as politics/geopolitics in the Indian Ocean is concerned and thinking anything else is wishful thinking.”

Dr. Sally said he remained pessimistic. “I don’t follow the conventional wisdom of some people who are very bullish on the Rajapaksas.”

---

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.

Razeen Sally : Open up shipping and Tea to competition

If the outlined measures are implemented, two prominent sectors will be opened up to international competition: shipping and tea

Read the full article originally appeared on Financial Times

Sri Lanka desperately needs a new global economic strategy as part of a broader strategy for national renewal. It needs a decisive shift to markets and globalisation. A prospering, globalised market economy is the sturdiest foundation for a genuinely open society – for constitutional liberalism, the rule of law, ethnic peace and balanced international relations. Without it, all else fails. It has to be among the Government’s top priorities. The good news is that Sri Lanka has its most golden opportunity to achieve its long-advertised potential since the victory of the UNP in June 1977. 

But no economic reforms have materialised since the change of government last year. As I argued in my last Daily FT column, there should be four economic priorities for the remainder of this Government’s term: 1) “first do no harm” – no more senseless public sector salary hikes, price controls and ad hoc taxes; 2) fiscal stability, especially through tax and expenditure reforms; 3) improving the domestic business climate; and 4) trade and FDI liberalisation. They are all connected. Together they would greatly strengthen Sri Lanka’s competitiveness for higher productivity, growth and prosperity. Here I focus on the last component – a new trade policy.