Rizwan Muzzammil

M. Rizwan Muzzammil is currently resides in Singapore where he works as a civil engineer. He has a keen interest in economics. He can be reached by email at write2rizwan.m@gmail.com

What Sri Lanka Can Learn from China’s Bitter Experience

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9 mins read

The following article, describing the economic growth of China, extracts information from “The Power of Capitalism” by Rainer Zitelmann. The reader is encouraged to refer to this book for more details and references.

The Great Leap Forward

Mao Zedong wanted to turn China into a shining example of Marxist Socialism, and in 1957 proclaimed the Great Leap Forward to the “worker’s paradise”.

The population was informed of the plan “to overtake all capitalist countries in a fairly short time, and become one of the richest, most advanced and powerful countries in the world”.

This ambitious experiment started with millions of farmers (around one-in-six of the population) being forced to work on massive irrigation projects such as dams and canals without sufficient food or rest. The removal of a large part of the agricultural workforce was one of several reasons for which famines started to spread across China.

During this period private ownership was abolished, and peasants were forced to leave their properties and live in factory-like barracks.

Private plots, which comprised “houses, animals and trees” were confiscated for the purposes of “benefiting production and control”. Homes were to be dismantled if a commune needed bricks, tiles, or timber.

People were also banned from eating at home. Food was served in canteens often hours away from the workplace. This forced people to move to the sites of canteens and live in crammed spaces with no privacy.

Food production was too low and due to the climate of fear created by their own works the Communist Party officials avoided acknowledging the problems. Communes that submitted false data showing phenomenal harvests were taken at face value, while those that submitted realistic numbers were punished.

There were also logistical problems which resulted in large parts of the harvest being destroyed by pests, in particular sparrows. Mao mobilized the entire population to wave sticks and brooms to create a racket that would scare away these birds. This was so effective that pests controlled by sparrows flourished with catastrophic results. The government then sent a “top secret” request to the Soviet Embassy for 200,000 sparrows.

Despite the worsening famine the government was loath to lose face. They were too proud to suspend Russian grain exports, defer debt repayments or accept Western offers of aid. In keeping with the ‘export above all else’ policy they even donated wheat to Albania and other allies when the famine was most severe. According to government propaganda, the Chinese economy was going from strength to strength and breaking records.

Mao was particularly obsessed with steel production. In 1957 steel production was 5.35 million tons and in 1958 the government set a goal of 12 million tons. At the time, Chinese steel was largely produced in small blast furnaces (many of which were unfit for purpose).

The piles of iron ingots produced by rural communes were too small and brittle to be usable in the modern rolling mills. The lack of good raw material led to party cadres going from door to door confiscating household and agricultural equipment such as farm tools, water wagons, cooking utensils, iron door handles and even women’s hairclips. Later Mao was forced to admit that “only 40 per cent is good steel”.

Mao was aware that millions would have to die to bring about his bright future. He told Soviet leaders “We are prepared to sacrifice 300 million Chinese for the victory of the world revolution.”. He said of labour-intensive steel manufacturing: “Working like this, with all these projects, half of China may well have to die. If not half, then maybe one-third or one-tenth – 50 million – die.”

Mao’s experiment caused 32.5 million people officially (unofficially around 45 million) to die between 1958 and 62. Most died of starvation, but around 2.5 million were tortured or beaten to death, killed because they were rich or dragged their feet, or killed because they spoke out or were simply not liked.

The Chinese historian Jisheng says as follows: “The starvation that preceded death was worse than death itself. The grain was gone, the wild herbs had all been eaten, even the bark had been stripped from the trees, and bird droppings, rats and cotton batting were used to fill stomachs. In the kaolin clay fields, starving people chewed on the clay as they dug it. There were frequent cases of cannibalism. At first, desperate villagers would only eat the cadavers of animals, but soon they started digging up dead neighbours to cook and eat. Human flesh was sold on the black market along with other types of meat”.

Mao was eventually forced to abandon his Great Leap Forward. However, this did not stop him from launching his even more radical Cultural Revolution in 1966 where hundreds of thousands were killed in forced labour camps.

Learning from the world

Following Mao’s death in 1976 the government sensed that the Chinese people had had enough of socialist experiments.

Mao’s immediate successor, Hua Guofeng, paved the way for Deng Xiaoping to contribute towards China’s transformation. Deng and his party members took some Confucian wisdom to heart: “By three methods we may learn wisdom: first, by reflection, which is noblest; second, by imitation, which is easiest; and third by experience, which is the bitterest.”

Having learned some hard lessons the Chinese looked at what was happening in other countries. From 1978 began the busy period of foreign travel to bring back valuable economic insights.

Chinese delegations made trips to more than 50 countries including Japan, Thailand, Malaysia, Singapore, the US, Canada, France, Germany, and Switzerland. Deng asked the delegations to see as much as they could and to ask questions about how economies were managed.

The delegations were greatly impressed by what they saw in Western Europe: modern airports such as Charles de Gaulle in Paris, car factories in Germany and ports with automated loading facilities. They were surprised to see the high standard of living even ordinary workers enjoyed. Deng himself traveled, and after an eye-opening visit to the Nissan plant in Japan, he commented, “now I understand what modernisation means”.

The economic dynamism of neighboring countries, such as Japan and Singapore, were seen as role models. Lee Kuan Yew, the founding father of Singapore, remembers “I had told Deng over dinner in 1978 in Singapore that we, the Singapore Chinese, were the descendants of illiterate landless peasants from Guandong and Fujian in South China … There was nothing that Singapore had done that China could not do, and do better. He stayed silent then. When I read that he had told the Chinese people to do better than Singapore, I knew he had taken up the challenge I quietly tossed to him that night fourteen years earlier.”

The delegations’ findings were widely circulated in China. It led to the realisation that the alleged benefits of socialism for the working class were based on lies and fabrication. Deng noted repeatedly “The more we see (of the world), the more we realize how backward we are”.

Difficulties with privatisation

However, this newfound enthusiasm did not instantly result in a conversion to capitalism. It was a slow process of transition, starting with tentative efforts to grant public enterprises greater autonomy. This process, which relied on initiatives from both the grassroots as well as top-down from policy, took years or decades to mature.

Peasants began to circumvent the official ban on private farming. Since they were able to achieve far greater output the party cadres allowed it to carry on, and starvation was alleviated long before the ban was finally lifted. By 1983 all Chinese agriculture was de-collectivised.

The 1980s saw the establishment of an increasing number of collectively owned enterprises and township and village enterprises. Being legally owned by municipal authorities, the distinction between state and private ownership was blurred, resulting in these companies having the guise of public companies but being de-facto privately run. Between 1978 and 1996 the total number of employees in these companies rose from 28 million to 135 million, while their share of the economy grew from 6% to 26%.

Subsequent waves of privatisation saw municipal owned companies become less important compared to genuine private businesses.

Individuals who started or worked for private businesses suffered hardship and discrimination. Parents wouldn’t allow their daughters to marry someone who worked for these businesses as their economic prospects were uncertain.

Eventually, more people came to realize that running a business conferred financial advantages as well as greater levels of freedom. Self-employed barbers were earning more than state hospital surgeons, street vendors more than nuclear scientists.

The number of self-employed household businesses and single proprietorships increased from 140,000 in 1978 to 2.6 million in 1981. However, the proponents of socialism passed a resolution which saw over 30,000 arrested. In many cases their only crime was making profits or employing more than the legal limit of seven people.

Special Economic Areas

The erosion of socialism was accelerated by the creation of Special Economic Areas (SEA) where socialism was suspended, and capitalist experiments were permitted.

Shenzhen was an area through which, year after year, many thousands would try to illegally escape to Hong Kong. When the authorities investigated in more detail, they found refugees had set up businesses across the Shenzhen River in Hong Kong territory, where they were earning a hundred times more than people in the mainland.

Deng’s response was that China would need to increase living standards to stem the flow. Shenzhen then became the site of the first SEA experiment.

The experiment was so successful that, only a few years later, the authorities had to build a barbed-wire fence to cope with the influx of migrants from other parts of China. Soon other regions also began following the SEA model.

Low taxes, land lease prices and bureaucratic requirements made SEAs extremely attractive to foreign investors. The economies were less heavily regulated and more market-oriented than those of many European countries today.

The co-existence of public and private enterprises

Over time economic reforms became half-hearted. Public enterprises continued to co-exist with private businesses and SEAs. This co-existence caused a chaotic pricing situation, leading to inflation, discontent, and unrest.

Proponents of socialism believed that the reforms had gone too far. In response, Deng (who held no public office at the time), decided to intervene and visit Shenzhen. He expressed his amazement at the extent of the region’s transformation. He was impressed by the magnificent boulevards, resplendent high-rise buildings, busy shopping streets and seemingly infinite number of factories. The people were dressed in fashionable clothes and were the proud owners of expensive watches and other luxury items. Their incomes were three times higher than in the rest of China.

Deng’s tour and subsequent criticism of those who opposed reforms were featured prominently in Chinese media. Deng and his fellow proponents of free-market reforms continued to pay lip service to socialism, but they redefined the term to mean an “open system that should ‘draw on the achievements of all cultures and learn from other countries, including the developed capitalist countries”.

Increasingly, the reformers won the day. Capital investments in private businesses multiplied by twenty. In 1992, 120,000 civil servants quit their jobs, and 10 million took unpaid leave to set up private enterprises. Millions of university professors, engineers and graduates followed suit.

Furthermore, the list of government-set prices for raw materials, transportation services and capital goods was shortened from 737 to 89, with a further reduction to only 13 in 2001.

Reforming the public sector

The reformers hoped to make public enterprises more efficient by introducing performance-related payment schemes and replacing high ranking cadres with professionals. However, these changes failed to address the key issue, which is that public enterprises cannot go bankrupt.

In a market economy a constant selection process takes place which ensures only the survival of well managed companies that satisfy consumer demand. Badly managed companies go bankrupt and disappear, freeing up resources for other ventures. This natural selection does not occur in public enterprises, as losses are financed by the taxpayer. Thus, public enterprises were frequently in bad economic health.

Furthermore, in the market economy there are strong natural incentives to build and maintain a good reputation for the long term. With public enterprises these incentives do not exist and so executives were more interested in raising their income for the short term. Since there was no means for consumers to hold dishonest executives accountable, corruption was a persistent problem.

Still privatisation continued and by 1996, the share of public enterprises had dropped by about 50%, and around 30 to 40 million people had lost their jobs.

Income inequality

China’s development demonstrated that, rising economic growth, even with rising inequality, still benefited the majority of the population. Deng instructed “let some people get rich first”.

Contrary to popular belief, the statistics showed that the relative income gaps were narrowest in the regions with highest per capita GDP, where the markets were most open and companies made the highest profits. Regions with low growth and more restrictive conditions had wider relative income gaps.

Conclusions

In 2016 China overtook the US and Germany to become the world’s largest exporter. The quality of life for ordinary citizens had improved beyond recognition.

Many economists and politicians believe that the impressive growth is due to a special “Chinese way” which comprises a high degree of government influence.

This was not the case. The Chinese progress was not dissimilar to the progress of other developed nations, such as the UK, US, Germany, South Korea and Japan, which were all facilitated by reducing government involvement and increasing freedoms.

Chinese growth happened partly through the SEAs, and partly by decentralizing power to local governments, which in turn circumvented restrictive laws insuch a manner as to create the space needed for both private business and privatisation.

China grew not because of a special way of government, but rather in-spite of it.

Sri Lanka: “Saving” the Economy

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5 mins read

The economy is shrinking

The economy can be likened to a train engine pulling carriages up a hill.

The engine represents the wealth-generating component of the economy, which is the private sector. This is because the existence of the private sector depends on profits, and since profits are an increase in value over costs, the private sector is always a surplus to the economy. The carriages, on the other hand, are in the government sector. Though this sector is important, it relies on private sector resources to maintain its size.

Despite the efforts of the engine to pull the carriages, the train has stopped moving forward and is now sliding back down the hill. This is the Sri Lankan economy in recession. Currently, there is a lack of foreign investment and the local private sector is the only means to stop the slide.

The government sector is doubly burdensome

The government obtains private sector resources through inflation (money printing), or seizes resources through taxation. What resources the government sector consumes becomes unavailable for the private sector to use. Thus the government sector is doubly burdensome to the economy, as on the one hand its weight must be pulled along by the private sector, and on the other hand, it is starving the private sector of valuable resources needed for growth.

In order to stop the slide and start to inch up again the first priority is to reduce government expenditure. Just as the current size of the government sector is doubly harming the economy, a reduction in size will provide double the relief. It will have the effect of both lightenings the carriages and increasing the size of the engine.

The importance of savings

The main resource of the private sector is savings. All economic growth takes place when entrepreneurs in the private sector make capital investments from savings. It is therefore vital to note that savings is the source and lifeblood of any economy, and the encouragement of savings translates to the encouragement of the economy.

What is savings

Savings come from underconsumption. By saving, the individual forgoes spending money today for some future date. In addition to improving discipline through thrift, savings also helps to prepare for unforeseen events such as medical emergencies, job losses, natural disasters and so on.

If the individual deposits money in a bank (as is often the case) the bank is able to lend that money to entrepreneurs for investment. Bank deposits make the savings of individuals available to the wider public, and in so doing more easily facilitates economic growth.

If the individual saves money outside of the banking system, such as by keeping it under a pillow, the economy is still improved. This is because prices of goods and services are a function of money in circulation. When money is removed from circulation, prices will correspondingly fall.

In the following sections, the negative impact of economic policies on savings will be discussed in brief.

Individual income taxes must also consider expenses

The income taxes for companies are on profits (i.e. income after expenses), but the income taxes for individuals have no relief from expenses (e.g. medical, food, rent etc.).

This creates a situation where an individual with high expenses may have to use savings to pay for income tax. This is unfair and particularly damaging to employees and fixed-income earners.

The income tax law should therefore be amended to take account of expenses and be consistent with corporate tax law. This will benefit savings in society.

Corporate taxes and income taxes are a double whammy

Private sector business is facilitated by profit margins, i.e. the percentage difference between the selling price and the costs. Corporate taxes are one such cost to businesses.

If the tax increases so must the selling price in order to maintain the profit margin, or the business will cease to exist.

Thus corporate taxes are simply an indirect tax to consumers. The government has now increased corporate taxes. This is counterproductive as that cost, when passed on to employees or fixed-income earners, diminish their ability to save.

Employees and fixed-income earners are in effect, doubly taxed as they must pay both the corporate tax and income tax.

The impact of marginal taxes on savings

If income increases so also does savings ability. The government must therefore incentivise earning higher income.

The current policy of higher marginal taxes can cause individuals to refuse higher salary in favour of other non monetary benefits. This is so that they can try staying within a lower tax bracket.

The policy also contributes to the brain-drain to foreign nations where an individual may be better able to hold on to their earnings.

Though marginal tax policy is common globally it is counterproductive to economic growth as it influences the wrong behavior in employees and discourages savings.

Income taxes are counterproductive

Due to the aforesaid reasons income taxes are counterproductive to the economy. They are a burden and cost to business and individuals, difficult to administer for the government and substantially hurtful towards employees and fixed income earners.

The government would therefore do well to abandon this means of income completely and focus on the consumption tax (e.g. GST) as a means to earning what it needs.

How interest influences savings

The incentive for individuals to deposit money in banks is the interest rate. If inflation is higher than interest, savings is discouraged and consumption is encouraged.

Interest rates are related to money availability. The more money banks hold, the lower the interest must go. A society that is unable to save will have high-interest rates reflecting the scarcity of saved money.

Central bank (CBSL) printing discourages savings

In Sri Lanka, the savings interest is relatively high when compared to what is global, but it not as high as inflation (measured at about 50% in June). Sri Lankans are therefore being encouraged to consume and not save.

The reason why interest is low (in relation to inflation) is because banks are indirect recipients of free money printed by the central bank (e.g. through public sector deposits).

In order to raise interest rates and encourage savings, the central bank must stop printing. This will create money scarcity in banks, which will cause interest rates to exceed inflation naturally.

Capital controls

The government has implemented capital controls which prevents individuals from holding significant amounts of foreign currency. Holding wealth in foreign currencies is particularly attractive now due to central bank-induced inflation.

These controls have the unintended consequence of discouraging Sri Lankans abroad from transferring their savings to local banks. Foreign remittances are therefore not taking place as they should.

The government should remove capital controls in order to encourage remittances.

Conclusions

The government is adopting common traditional methods to restore the economy. These methods are not universally applicable and in the context of Sri Lanka will fail. The government must revise its stance and think out of the box by focusing on savings as a priority.

Savings are the lifeblood of the economy. In order to improve savings the government must reduce expenditure first. In addition the policies of income tax, marginal tax, money printing and capital controls discourage savings and must be revised.

As a means to address budget deficits taxes have been increased. This will have the effect of diminishing the strength of the (already weak) engine thereby causing the slide down the hill to become uncontrolled.

As a consequence the LKR may lose all of its value and hyperinflate. The economy will lose a substantial portion of its remaining vigor. The brain-drain will reach unprecedented levels hitherto unseen, and food starvation of a broad segment of society can become reality. The government must therefore reverse this policy before it’s too late.

What Sri Lanka Can Learn From Thatcher’s Legacy

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5 mins read

The following article, describing the economic situation of post-war United Kingdom (UK), extracts information from “The Power of Capitalism” by Rainer Zitelmann. The reader is encouraged to refer to this book for more details and references.

After the War

In 1945 the Labour Party won the general elections, and prime minister Clement Atlee began implementing democratic socialism. About a fifth of the UK economy, comprising banks, civil aviation, mining, telecommunications, railways, shipping canals, road freight transport, power and gas, manufacturing industries including iron and steel, was nationalised.

When the Conservative Party (Tories) returned to power in 1951 Winston Churchill retained the majority of the socialist policies. During the 50s and 60s the UK enjoyed an improved standard of living by having low unemployment and increased consumption. But it still lagged behind other European countries such as West Germany, where the number of telephones, refrigerators, TV sets and washing machines were higher per 100 residents. The gap continued to widen because productivity was too low.

The Impact of Unions and Strikes

During the 70s the UK’s weakness became obvious. The country was disabled with frequent strikes. The German magazine Der Spiegel in 1974 reported:

“A row about wages and nationalised collieries turned into a showdown between the government and unions, which has plunged the country into ‘a new dark age’. Over a million people are already unemployed, over two million only in part-time employment, with a further ten million plus – almost half of the British workforce – likely to suffer the same fate in the next few weeks… the imperial avenues (of London) more sparsely lit than the streets in the urban slums of the UK’s former colonies. Candles flicker in the offices of the financial district, while hurricane lamps provide emergency lighting in department stores, and warehouses are illuminated by the headlights of lorries. Only one in four radiators is turned on inside the prime minister’s residence at 10, Downing Street, and signs at underground stations advise passengers to take the stairs as escalators have been taken out of service to save power”.

The trade unions were very powerful. The shop stewards (the union’s spokesmen within companies) were able to call a strike and break agreements whenever they wanted to. Neither the unions nor their officials could be held accountable for damages.

For some union officials their own interest and envy of co-workers mattered more. The rivalry between two steelworkers’ unions delayed the testing of new manufacturing equipment for months. The dockworkers’ union protested against the construction of state-of-the-art container terminals, because loading was to be done by a different sector. England’s most advanced high-speed train stood idle for half a year because railroad workers’ union insisted on two drivers, although there was only room enough for one in the operator’s cabin. During the 70s, 466 unions averaged 2000 strikes and 13 million working day losses per year.

Conditions escalated during the winter of 1978, when the country was paralysed by more strikes leading to the transport system breaking down and rotting garbage piling up on pavements.

Thatcher Begins Reforms

In 1979 Margaret Thatcher became prime minister. She had studied the writings of the classical liberal economist Friedrich Hayek, and being impressed by his criticisms of welfare state socialism she put his free-market ideas into practice. She faced massive resistance from unions as well as many socialists in her own Tory government.

Thatcher’s pro-market reforms focused initially on inflation. She resisted price controls and abolished the Price Commission. This led to a sharp rise in unemployment from 1.3 to 3 million between 1979 and 83. Thatcher said “The paradox which neither the British trade unions nor the socialists were prepared to accept was that an increase of productivity is likely initially, to reduce the number of jobs before creating the wealth that sustains new ones”. Inflation fell in the short term, accompanied by a significant improvement in productivity.

Thatcher cut marginal tax rates from 33% to 25% in the lowest brackets, and from 83% to 40% in the highest. To balance the budget she was forced to increase VAT from 12.5% to 15%. She reduced bureaucracy by expediting planning permissions and simplifying or abolishing planning controls.

Restricting Unions

Thatcher implemented laws restricting unions. Arthur Scargill, a prominent union leader, led miners into a large-scale strike against planned pit closures and privatisations, despite three in four pits operating at a loss and receiving 1.3 billion pounds of taxpayer money.

Many miners didn’t the support the strike, and violence was used to prevent them from working. Attacks on police by striking workers or sympathizers resulted in serious injuries. Families of miners who did not participate were threatened or bullied. A Welsh taxi driver was killed by two miners who dropped a concrete block from a footbridge onto his taxi while he was transporting a strike-breaking miner to work. Thatcher refused to give in, and the unions had to abandon the strike when money ran out. Their defeat had a symbolic impact and broke the power of the unions, who had lost a third of their members and much political influence.

The Impact of Privatisation

Thatcher saw privatisation as “one of the central means of reversing the corrosive and corrupting effects of socialism”. Far from putting the people in control, public ownership simply “amounts to control by politicians and civil servants. But through privatisation – particularly the kind of privatisation which leads to the widest possible share ownership by members of the public – the state’s power is reduced and the power of the people enhanced”.

When British Telecom, employing 250,000, was privatised 2 million Britons bought shares in what was then the largest Initial Public Offering (IPO) in history. Around half had never owned shares before. During Thatcher’s premiership, public share ownership rose from 7% to 25%.

Subsequent privatisations included British Airways, British Petroleum (BP), Rolls Royce, Jaguar, shipbuilding companies and several utilities. This resulted in the state losing its dominance in the economy. Local councils sold off much of their housing stock to tenants to create a million new homeowners.

Privatisation caused prices to fall and service quality to improve. New telephone line subscriptions, which previously took months or a bribe to obtain, could now be obtained in just 8 days with the price having dropped 50%.

Deregulating the Finance Industry

Thatcher deregulated the finance sector by abolishing currency and capital controls. In 1986 she liberalized rules on share trading and the stock exchange, and eliminated restrictions on foreign banks. As a result London became the world’s leading financial centre, rivalled only by New York, with thousands of new jobs created by foreign bank branches.

In 1976 sovereign default was imminent and the government was forced to borrow 3.9 billion USD from the IMF. In 1989 this situation had completely turned around and the economy generated a surplus of 1.6%. This was possible due to increased tax revenue from foreign businesses.

Thatcher’s Legacy

Thatcher in her memoirs says there “was still much I would have liked to do”, “Britain under my premiership was the first country to reverse the onward march of socialism”.

The stuffy socialist culture of envy was replaced by a pro-market and pro-business environment where ambition was richly rewarded, leading to sharp increases in the number of private business and self-employment. The number of businesses registered rose from 1.89 to 3 million between 1979 to 89, while self-employment grew from 1.9 to 3.5 million. State-ownership reduced by 60%, 600,000 jobs had passed from the public to private sector, with 3.32 million jobs created between 1983 and 90.

Thatcher was voted into office to liberate the economy from state control. The British honoured her by re-electing her twice. Her premiership lasted 11 years, longer than any other 20th century British politician. Her policies were so successful that, in the following years, Tony Blair’s Labour government broke with party tradition and made no attempt to reverse them.

Conclusion

The Sri Lankan crisis is caused by an excess of government control and an overlarge public sector. Thatcher was faced with a similar situation. Despite public opposition, she resisted currency and capital controls and adopted free markets. Her courage was rewarded with a flourishing British economy.

West Germany and Chile are two other examples of countries that have had problems similar to Sri Lanka. They also adopted free-market policies and have now become first world nations.

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