Expert view: Sri Lanka needs a global economic strategy, says Razeen Sally

A NEW GLOBAL ECONOMIC STRATEGY FOR SRI LANKA Razeen Sally Sri Lanka desperately needs a new global economic strategy, and that is what the government has promised. But this is not just about dry economics: it must be part of a broader strategy for national renewal. Sri Lanka needs a decisive shift to markets and globalisation. That requires the Prime Minister and his core economic team to have a clear vision with a good sense of direction, an iron determination to succeed, and a strong dose of practical implementation skills. This is going to be a gargantuan challenge. 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. The bad news is that Sri Lankans squandered that opportunity, as they have squandered opportunities before and after since independence. How can this time be different? What has gone wrong? I will start with diagnosis before moving to prescription. What I have to say is hardly original. Other Sri Lankans, with far better local knowledge and expertise, have said it better. What has gone wrong with Sri Lanka in the global economy? Why is its trade and investment performance so under par? The answer is part of a wider national malaise. From 1956 – that fateful, calamitous year – Sri Lanka went down the Indian, not East Asian, path of heavy-handed government intervention in the economy, including import-substituting protectionism. This got much worse in the 1970s. The opening of the economy after the ’77 election ushered in substantial gains, including the emergence of a garments industry. That is why ordinary Sri Lankans are much better clothed, housed and fed than they were in my childhood, despite a quarter-century of civil war. But ethnic conflict prevented these gains from being much larger. So did perennial macroeconomic instability. The latter has a simple cause: Sri Lankan governments’ chronic inability to live within their means – their never-ending “auction of non-existent resources “, as Singapore’s Lee Kuan Yew put it. There were attempts to reboot liberalisation, especially under Chandrika Kumaratunga in the ‘90s and Ranil Wickremesinghe when he was PM last time around. Sadly, his Regaining Sri Lanka package failed due to the unravelling of the ceasefire and a public backlash that Mahinda Rajapaksa exploited so deftly. The next decade of Rajapaksa rule is a study in retrogression, despite the end of the war and newfound peace. First, Sri Lanka swung to authoritarian politics; it became an “illiberal democracy”. Second, Sinhala-Buddhist chauvinism got worse, increasing ethnic tensions. Third, foreign policy became unbalanced, with China as “first friend” and deteriorating relations with the West and India. And fourth, the economy was deliberalised in the nationalist spirit of Mahinda Chintanaya. The government intervened much more in the economy, with a predictable rise in cronyism and corruption. Trade protection increased. The tariff structure became more complicated, especially with cesses (additional duties) on imports and exports. Non-tariff barriers proliferated. Agricultural protectionism soared. One estimate is that import protection effectively doubled during the Rajapaksa years. Regulation of foreign direct investment (FDI) also became more interventionist and opaque, with greater ministerial discretion to grant tax incentives. The Board of Investment was marginalised. More widely, a worsening domestic business climate – the result of bewildering ad hoc government interventions on taxes, permits and sundry regulation – deterred foreign investors and traders.
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Last, post-war growth has been debt-fuelled and led by the low-productivity public sector, while crowding out private investment from local and foreign sources. It has wreaked havoc with public finances, and left Sri Lanka dangerously exposed to foreign commercial borrowings at a time of volatile capital flows to emerging markets. This type of growth has boosted non-tradable sectors at the expense of higher-productivity tradable sectors. So Sri Lanka has deliberalised and deglobalised at the same time. The big numbers tell the story. Sri Lanka is in 99th place in the World Bank’s Doing Business Index – OK by South Asian standards, but terrible by the standards of all but low-income countries in East Asia. Trade (imports and exports) has shrunk to little over 50 per cent of GDP – extraordinarily low for an island of 20 million people. Sri Lanka’s export share in global markets has shrunk to 0.05 per cent. East Asian countries with much larger populations, such as Vietnam, Thailand and South Korea, have trade-to-GDP ratios of more than 100 per cent. Taiwan and Malaysia, with comparably small populations to Sri Lanka, have trade-to-GDP ratios of 140 per cent and 160 per cent respectively. Correspondingly, Sri Lanka receives about USD 1.5 billion annually in FDI – less than 2 per cent of GDP. Again, this is not bad by South Asian standards but pathetic by East Asian standards. Apart from hotel and real-estate projects, FDI has practically dried up. The upshot is that, except for garments, Sri Lanka is absent from the global value chains (GVCs) that are key drivers of productivity, employment and growth. East Asian success owes much to insertion in these value chains in goods and services. ICT is the core of GVCs in East Asia, but ICT accounts for barely 5 per cent of Sri Lankan exports. Sri Lanka’s poor globalisation performance is one of the main reasons why it has fallen so far behind the East Asian Miracle economies since the 1960s. Back in 1960, Sri Lankan living standards were higher than in South Korea and Taiwan; they were on a par with Malaysian living standards well into the ‘60s. But now they are 4-5 times lower than they are in Malaysia, and much further behind South Korea. That condemns Sri Lankans – not the rich, but the rest – to life-choices and life-chances – employment, housing, health care, education, spending power – that are a fraction of those in most of East Asia. What has changed since the January presidential election that toppled the Rajapaksas? The authoritarian slide has been arrested, and the country is moving towards political liberalism. Sinhala-Buddhist chauvinism has been tempered, and early moves made to redress the grievances of the minorities, particularly Tamils in the north and east. And foreign policy has been rebalanced, repairing relations with the West and India while attempting not to alienate China. But the economy remains a black spot. The Rajapaksas’ illiberal economic policies have not been reversed. On the contrary, the UNP-led government’s first budget contained spending giveaways, price controls and other gimmicky interventions. The central bank has printed money freely. Opposition forces united to defeat Mr Rajapaksa, but they had no consensus on market reforms, and lacked a majority in Parliament. Ahead of the parliamentary election, Mr Wickremesinghe campaigned for big market reforms under the label of a “social market economy”. Now he has a mandate for economic reform – not a decisive one, but a mandate nonetheless. Pro-market reforms are imperative for sustained growth and prosperity – and to attain key non-economic objectives. Previous bouts of economic collectivism, going back to the 1950s, ruined the economy, destabilised politics, damaged relations with the West, and stoked ethnic conflict. Lack of economic opportunity drove unemployed Sinhalese and Tamil youth into the arms of violent militant groups. By the 1970s, Sri Lanka’s first friends abroad were Mrs Gandhi, Marshal Tito, Colonel Gaddafi, Mr Brezhnev and Chairman Mao. 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 the government’s top priority. And Mr Wickremesinghe needs to proceed fast before his window of opportunity closes. To mention the title of one of Lenin’s famous pamphlets -- What is to be done? What needs to be done? A new global economic strategy has to be part of a bigger market reform package. The Pathfinder Foundation provides a sensible checklist. Most urgent is macroeconomic stability. Continuing macroeconomic volatility erodes export competitiveness (through inflation and an appreciating real exchange rate) and leads to import restrictions to protect the balance of payments. It will derail liberalisation attempts, as it has done before. Now, fiscal and current-account deficits are widening, the rupee is under pressure, and the debt pile-up is unsustainable. Sri Lanka looks like it is heading for another balance-of-payments crisis. This could require another IMF bailout. With or without a bailout, taxation and expenditure need radical surgery to prevent further public-debt accumulation and make debt financing more sustainable. The printing press must be stopped rather than continuing to fund government profligacy. The good thing about a looming crisis is that it can focus attention and force corrective action. As Dr Johnson quipped, “When a man knows he is going to be hanged in a fortnight, it concentrates the mind wonderfully.” Second, there should be an overhaul of domestic business regulation -- a bonfire of red tape to liberate the private sector. This should focus on product and factor (land, labour and capital) markets. Licensing needs to be simplified radically. Mr Wickremesinghe’s idea to have just two or three agencies responsible for issuing permits, with a 40-day deadline for approvals, would be a good start. More complex, politically sensitive reforms – to buy and sell land, hire and fire labour, and deepen the capital market – need to follow. Third, education reform is needed to upgrade knowledge and skills, given that Sri Lanka is now a lower middle-income country that cannot compete with cheap labour. Fourth, bloated, loss-making public-sector enterprises should be restructured and downsized. That should include partial or full privatisations, and more reliance on public-private partnerships. And there are other important reforms besides. Now turn to a new global economic strategy. The overall objective should be to make Sri Lanka the most open, globalised and competitive economy in South Asia by 2020-2025. By then it should be integrated into GVCs, and be an Indian Ocean hub for trade, investment and foreign talent. This would be a reconnection with Sri Lanka’s ancient history, when its ports – Manthai, Gokanna, and later Colombo and Galle – were magnets for seagoing trade, halfway between the Arabian Gulf and Southeast Asia and on India’s doorstep. Such a vision is no use without making a powerful case for free trade. This has never really been done in Sri Lanka, leaving the field free for protectionist nostrums. Openness -- to imports, exports, foreign investment and foreign talent -- allocates resources more efficiently, exposes the economy to best international practice, speeds up technology transfer, drives productivity growth, creates better companies, jobs and skills, and is a boon to consumers. This is not just theory: it is, overwhelmingly, the track record around the world. No country has prospered without being open to commerce with the rest of the world; and the more open the country, the more it has prospered. This is especially important for small countries that do not have large internal markets for growth. Age-old mercantilist myths must also be demolished. One is that “exports are good but imports are bad”. How often one hears the refrain: “the government must promote exports, but it must also restrict imports to nurture infant industries and protect the balance of payments”. This is nonsense. A tax on imports is a tax on exports: an import tax boosts non-tradable goods and services at the expense of tradables, including exports. That might sound abstract, but the world of GVCs, the driving force of early 21st-century international trade, makes it concrete. In GVCs, exports rely on imports of parts and components, and of assorted services: without an open border to imports, there is no export competitiveness, and no insertion into GVCs. Apple’s products – iPods, iPhones, iPads and Macs – make that crystal-clear. A second myth is that export restrictions are needed to encourage processing activity at home, which promotes value-added exports. This has failed wherever it has been tried. It limits export potential, cossets inefficient domestic firms, breeds corruption and raises prices. One of Sri Lanka’s most idiotic trade regulations is the export tax on tea and rubber. In the case of tea, revenues from the cess are used to promote exports. In other words, exports are first restricted, then, via a cumbersome bureaucracy, revenue is used to market Ceylon Tea abroad. Protectionism, almost always, is mind-bogglingly stupid. It also favours a small knot of politically well-connected producers at the rest of society’s expense. As John Stuart Mill said, protectionism is an “organised system of pillage of the many by the few”. And beware when patriotism is invoked and protectionism wrapped up in the national flag. That, said Mill, “is the last resort of the scoundrel”. Next, the government must set key targets to achieve its global economic objectives.
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These should be ambitious but realistic, with a five-to-ten year timeframe. I suggest five. Trade: The trade-to-GDP ratio should at least double to over 100 per cent by 2020-2025. This would take Sri Lanka out of the South Asian second division and into the East Asian first division. It would mean at least a tripling of export volumes. Given the connection between exports and imports, especially in GVCs, imports would rise correspondingly. That should be welcomed, not disparaged. Export markets: The USA and EU will remain the two key export markets, though with a diversified export basket – not only garments and plantation crops. India should be a much bigger export market, especially the four states of South India with a population of 300 million. Southeast Asia and the Far East, including China, should also be bigger export markets. But the Big Three will remain the EU, USA and India. FDI: The FDI-to-GDP ratio should at least double to 4-5 per cent by 2020. Sri Lanka should get about USD 5 billion in inward investment annually. And it should be in manufacturing, assorted services and agro-processing, in addition to hotels and real estate. Sri Lanka should play host to a wide array of multinationals from the USA, Europe, India, ASEAN and the Far East. GVCs: Sri Lanka should be embedded in GVCs beyond garments. That will happen if the afore-mentioned trade and FDI targets are achieved. Multinationals with export operations will occupy manufacturing niches. But I do not expect a manufacturing take-off, since Sri Lanka lacks a labour-cost advantage (for labour-intensive production) and lags behind East Asian countries in education, skills and connectivity (for mid-value production). Rather the greater promise lies in services. ICT services should expand, though its potential is limited by Sri Lanka’s small skill pool. But the biggest prize is for Sri Lanka – Colombo in particular – to become a logistics hub. This would be centred on the port and perhaps the airport, with feed-in from a cluster of transport, financial and business services. These GVC niches depend critically on Sri Lanka linking up with value chains in South India. Domestic competitiveness: Attracting international trade and FDI depends as much on improving the domestic business climate as it does on trade and investment policies in the narrow sense. Sri Lanka should be in the top 50 of the World Bank’s Doing Business Index by 2020. A domestic deregulation agenda should be geared to that end. Corresponding targets should be set for other global scorecards that foreign investors track keenly, such as Trading Across Borders (a Doing Business sub-index), the World Bank’s Logistics Performance Index, the World Economic Forum’s Global Competitiveness Index and its Enabling Trade Index, and the Simon Fraser Institute’s Economic Freedom of the World Index. Overall, these targets should be aimed at lifting Sri Lanka out of a South Asian bracket and into an East Asian bracket of comparison, especially with foreign traders and investors in mind. Hence Sri Lanka should benchmark itself against middle and upper-income East Asian countries. That is where most of the relevant best-practice examples lie. I would add one other benchmark: the five best-performing states in India, including Tamil Nadu and Gujarat. They are the locus of India’s economic reforms and its globalisation. Sri Lanka should track these states carefully. How to do it? Let’s move to concrete measures to meet economic targets. The watchword should be: KEEP IT SIMPLE. The measures needed are not rocket science; they should not be overcomplicated. The mantra should be: Deregulate as much as possible to expand individuals’ economic freedom and unleash the animal spirits of entrepreneurs. And simplify rules of the game for market actors. “Getting the basics right” – prudent fiscal and monetary policies, a stable exchange rate, domestic competition, openness to trade and foreign investment, improving education, skills and infrastructure – is the essence of the East Asian Miracle. That is what Sri Lanka should emulate. And simplicity is as important as anything else. Trade: There should be a bonfire of cesses and non-tariff barriers on imports and exports as soon as possible. Exports should face no restrictions except on narrow national-security grounds. Import protection should be confined to ad valorem tariffs. But the tariff structure needs to be simplified radically, and average nominal tariff protection more than halved. Sri Lanka should move to a uniform tariff of 5 per cent on industrial goods by 2020. All other industrial goods should enter duty-free. This is what Chile did, with spectacular results. Why a modest uniform tariff? First, it is the best way of removing distortions, including corruption, arising from different tariffs on different products and at different stages of production. It has the cardinal virtue of simplicity. And second, East Asian trade-weighted import tariffs average 5 per cent or less – which is where Sri Lanka should be. The obvious objection to tariff-slashing is that the government would lose much-needed revenue. That is why tariff cuts should be accompanied by tax reform, so that more revenue is raised from domestic taxes, preferably a simple consumption tax. Furthermore, evidence from other countries shows that revenue loss is minimised because simple, low tariffs increase trade volumes and provide the incentive for previously illicit trade to become licit. In many instances, the effect is to increase, not decrease, revenues. Sadly, it is politically impossible to reduce agricultural protectionism in the same way. But the government should move to reduce it gradually. Import protection, price controls and subsidies to agriculture condemn a large percentage of the population to living in a low-productivity welfare trap, while forcing up taxes and consumer prices. Finally, customs administration needs to be simplified radically to reduce paperwork, delays at the border and corruption. Studies show these trade costs are higher than tariffs. “Automation” and “automaticity” should be the watchwords. Many customs procedures could be put online, with more automatic approval procedures. Where checking is required, there should be tight deadlines for inspection and approval. There are several best-practice models that Sri Lanka could follow, including APEC’s Single Window procedure. FDI: Sri Lanka has a fairly liberal regime on inward investment by developing-country standards. Full foreign ownership and non-discriminatory treatment are allowed in many sectors. But the government should go further. All sectors should be fully open except for a short negative list. That leaves the question of tax incentives and the role of the Board of Investment. Tax holidays have dominated investment policy since the economy was opened up in the late 1970s. The results have disappointed. Indeed, tax incentives have probably done more harm than good. They have been highly discretionary – a boon for corrupt politicians, officials and shady businessmen. This reached its nadir under the Rajapaksas. The BOI was sidelined. But it has long been politicised, overstaffed and inefficient. Investment policy needs a thorough reorientation. There should be much less emphasis on tax incentives. They should be simplified, with less room for the bureaucratic and political discretion that invites delays and corruption. Rather the emphasis should be on “getting the basics right” – to attract investment with a welcoming domestic business climate with the pro-market policies I described earlier. That is far more important than selective incentives. Where investment policy can add value is by providing the foreign investor with a genuine “one-stop-shop” – a statutory agency that advertises Sri Lanka as an investment destination abroad, and deals with paperwork and approvals so that the investor’s path to operating a local business is smooth and seamless. That should be the BOI’s central function, rather than dishing out incentives as a “one-more-stop-shop” among the thicket of ministries and agencies the investor has to deal with. Singapore is often singled out as the gold standard in attracting inward investment; its Economic Development Board (EDB) is considered the paragon of investment agencies. That is merited. But it is important to learn the right lessons from this Singapore experience. From the 1960s, Singapore has attracted multinationals chiefly by getting the basics right; tax incentives have not been the main factor. The EDB does grant incentives, but its success comes down to being an excellent one-stop-shop. Industrial policy: In Sri Lanka, as elsewhere, governments are obsessed with targeting particular sectors and firms. Supposedly intelligent, disinterested politicians, officials and experts promote this-or-that sector or firm to be a hub of productive activity and for export success. This is the lesson they draw from “industrial-policy success” in Japan, South Korea and other East Asian economies. But this is wrong. Industrial policy has a decidedly mixed record in East Asia, and been an abysmal failure in South Asia, Africa and Latin America. To repeat, the East Asian Miracle was much more about getting the basics right than anything else. Sri Lankan governments have wasted enormous amounts of taxpayers’ money, stoked corruption and exacerbated market distortions with industrial policy. To borrow F.A. Hayek’s term, it is a “fatal conceit” to assume that politicians and bureaucrats have better market sense than entrepreneurs and corporate executives. The lesson, therefore, is to cut back on “vertical” industrial policy that targets selected sectors and firms with specific measures – and focus instead on “horizontal” (economy-wide) policies to get the basics right. The government could help with “soft” industrial policy – marketing campaigns abroad, organising exhibitions and fairs, one-stop-shops for investors, providing infrastructure through industrial and science parks, and even creating special economic zones (SEZs). But that should be the extent of it. And one should be cautious with SEZs: numerous small SEZs end up as tax boondoggles rather than hubs of enterprise, as the Indian experience shows. GVCs: Inserting Sri Lanka into GVCs can only be done by attracting multinationals who bring in big-ticket investment. They favour countries with open borders to imports, exports and investment. But the right trade and FDI policies are only elements of a package needed for GVCs. A welcoming domestic business climate is as important. That includes strong intellectual-property protection; transparent and competitive public-procurement regulations; ready availability of land; good infrastructure; a flexible labour market; and uncomplicated tax regulations, licensing procedures and work permits for foreign nationals. In other words, trade, investment and domestic competitiveness policies must be joined up. That is a huge challenge – even more so for a government splintered into scores of ministries and regulatory agencies. Trade negotiations: All measures recommended above should be implemented unilaterally, not, in the first instance, through trade negotiations. They should proceed regardless of what other countries do. I call this the Nike strategy: “Just Do It!” This will benefit Sri Lanka by signalling it is wide open for business. So why wait for cumbersome, long-drawn-out international negotiations where bargaining chips are exchanged? Sri Lanka will lose precious time and benefits if it delays liberalisation in order to extract concessions from negotiating partners. That would be a classic case of shooting oneself in the foot. East Asian countries did the bulk of their trade and FDI liberalisation unilaterally, not through the WTO and free trade agreements (FTAs). That is how they inserted themselves into GVCs. Sri Lanka should be no different. International trade agreements, however, can be a helpful auxiliary to unilateral liberalisation. If done well, they lock in and extend domestic reforms, as well as open export markets. But they should never be seen as a substitute for unilateral reforms. So what should be Sri Lanka’s trade-negotiations strategy? It should be ambitious but realistic. Let’s look first at FTAs. India: The government should aim to complete the Indo-Lanka CEPA as soon as possible, and be ambitious about market-opening on both sides. But India is generally protectionist, and the CEPA will inevitably be partial, with lots of exemptions and loopholes. Like other Indian FTAs, it will be “trade-light” by international standards. Ideally, there would be progress on a South Asian Free Trade Area (SAFTA). But it has long been stalled; absent Indian leadership, nothing will change. So Sri Lanka should not waste time on SAFTA, unless India becomes serious about regional liberalisation. USA and TPP: The government should aim for an FTA with the USA. This should be its top priority for trade negotiations. Why? Because the USA is Sri Lanka’s second biggest export market; it is and will remain the most innovative economy in the world; it is home to the world’s best multinationals who can integrate Sri Lanka into GVCs, particularly in services; and, geopolitically, it would cement an alliance with the world’s only superpower and “balancing power” in Asia, which is also a civilised liberal democracy. Also, US FTAs, unlike Asian FTAs, are serious: they are comprehensive and deep. They demand substantial liberalisation in goods, services, investment and public procurement, underpinned by strong disciplines (also on product standards, intellectual property and subsidies), and enforced by strong dispute-settlement procedures. Unlike FTAs with China, India and other Asian partners, an FTA with the USA would spur domestic market reforms and expand competition in the economy, in addition to gaining extra access to the US market. But negotiating an FTA with the USA is usually excruciating and often induces a domestic political backlash. So it is important to do a careful cost-benefit analysis before proceeding. However, there may be no need to negotiate a bilateral FTA with the USA. It and ten other Asia-Pacific countries are in the final stages of negotiating the Trans-Pacific Partnership (TPP), intended to be an ambitious FTA covering 40 per cent of the world economy. If and when the TPP is concluded, Sri Lanka should consider lodging an application to join it. That would obviate bilateral FTAs with other potentially important trading partners such as Japan, Australia, Malaysia and Singapore. And it would be a great signal to foreign investors: Sri Lanka would be the first South Asian country in the TPP. EU: The government should aim for an FTA with the EU as well. EU FTAs are relatively strong, though not as strong as US FTAs. The EU has a long-stalled FTA negotiation with India, so an EU-Lanka FTA could be the EU’s first in South Asia. China: The government should complete the China-Lanka FTA. But this will be trade-light, like China’s other FTAs. Prioritisation: It is imperative the government does not agree to FTA negotiations with all and sundry. Rather its priorities should be India, the USA (ideally via the TPP) and EU. For one thing, Sri Lanka has hardly any trade-negotiating capacity. It will have to be built up virtually from scratch; and it will have more than enough on its plate with India, TPP, the EU and China. WTO: The Doha Round has been stalled for many years, and action on trade negotiations shifted to FTAs over a decade ago. But a multilateral rules-based trading system is still important, especially for small economies like Sri Lanka. So it should not disengage from the WTO. On the contrary, it should re-engage, only this time with a different strategy. It should break ranks with India and other Third World foot draggers, and join forces with the OECD and emerging-market countries (like Chile, Colombia, Costa Rica, Singapore and Hong Kong) that favour liberalisation and pro-market rules. In this spirit, Sri Lanka should join the Information Technology Agreement, which has zero tariffs on IT goods, as well as the plurilateral TISA negotiations to liberalise trade in services. Process issues: Having the right ideas and policies is one thing. But, ultimately, success depends on effective implementation. The national unity government’s monstrously large Cabinet does not augur well. On the other hand, it was the right decision to create a new Ministry of International Trade and Investment, and to have a senior figure enjoying the Prime Minister’s full confidence at its helm. Trade and FDI are joined at the hip in today’s world of GVCs, so they should be housed in a single ministry. All relevant statutory boards such as the BOI and EDB should come under this ministry. The new minister faces three challenges: 1) formulating the right policies; 2) building up in-house capacity for policy implementation and trade negotiations; and 3) sourcing good-quality policy research and analysis. The task is daunting, for all this will have to be built up from scratch. Foreign governments and donor agencies can assist with trade capacity-building programmes. And I hope the Institute of Policy Studies will feed in useful policy research and analysis. Reform politics: The politics of trade and other economic reforms will be extremely difficult. Reforms will have to be sequenced carefully, proceeding from “easy” to “hard”. The next few months and first couple of years should prioritise big reforms to cut red tape and liberalise international trade and investment. Tax and expenditure reforms should have short-term and medium-term components. Public-sector and agricultural reforms will have to be last in the queue, given their extreme political sensitivity. Ultimately, reforms depend on Mr. Wickremesinghe – Sri Lanka’s only senior politician who gets the case for markets and globalisation – and a handful of clean, competent professionals in his inner circle. It is vital they control the major reform areas. The danger is that a national unity government, full of old-style populist politicians, will dilute and slow down reforms, thereby perpetuating Sri Lanka’s pattern of squandering heaven-sent opportunities. Conclusion: a plea for economic liberalism Economic collectivism is the central source of Sri Lanka’s post-independence failure. It has bred too much politics at all levels of society. It has metastasised a political class that has served the country so disastrously since independence. Political connections are needed to get even the most basic things done – fine for the rich and influential, but terrible for everyone else, particularly the poor and excluded. Very few Sri Lankan politicians, intellectuals and even businesspeople understand the damage done by collectivist policies and the importance of economic freedom. There is a growing constituency for liberalism in politics, but still a tiny one for economic liberalism. But what Sri Lankans need most is economic freedom – the freedom to produce and consume goods and services. This is the kind of freedom that affects ordinary people’s daily lives most. That demands better rules of the game for markets and competition, and much less room for politicians to control people’s livelihoods. This is what Adam Smith had in mind when he called for “natural liberty, upon the liberal plan of freedom, equality and justice” almost two-and-a-half centuries ago. In his Wealth of Nations, he conceived of government as an effective umpire, policing the rule-framework of a free market economy. He assailed governments that were also players in the market, distorting the game and compromising their umpiring role. As the German sociologist Alexander Rüstow put it, the state should be “small but strong”, performing its legitimate limited functions well. But the modern state has become “big and weak”, intervening badly left, right and centre while neglecting its core functions. A new global economic strategy for Sri Lanka should be seen in this frame. It should be part of a bigger agenda to limit the state and expand economic freedom. Without greater economic freedom, Sri Lanka will never achieve its potential for prosperity with political stability, the rule of law and ethnic harmony. (Razeen Sally is an associate professor at the Lee Kuan Yew School of Public Policy at the National University of Singapore)