The Dead-End Formula of Neo-Liberal Economics Sumanasiri Liyanage

Although I teach economics at the University of Peradeniya for my bread and butter, I have been quite distant from the discipline for some time and my readings on the subject has been limited to the two courses I teach at the university. My principal research work is on conflicts. Hence, it was not strange for people to call me oftentimes as a teacher attached to the Department of Politics. However, in the last three-four months, I had to re-enter this interesting area of work as I was invited to make comments on two books, one in Sinhala (Sri Lanka Arthikaya edited by O G Dayarathna Banda et al) and one in English (Development and Conflict by Kumar Rupesinghe). I had to refresh my knowledge and do some additional readings in the course of my preparation for the two presentations. The more I read on the subject, the more I got convinced on the ineffectiveness and the incorrectness of the economic policies proposed by the neo-cons and the international trio—the IMF, the World Bank and the WTO. All successive Sri Lankan governments since 1977 adopted those incorrect policies. When I say ‘incorrect’ I mean not some elements of the policy package but the policy package in toto and its underlying theoretical premises. The policy package includes inter alia the following:

  1. The government should adopt free trade regime with lower tariff rates: Annual Report of the Central Bank of Sri Lanka 2007 boasted that ‘the depth of openness continued to remain high as reflected in the low average tariff rate of 4.1 per cent in 2007.’
  2. The government should maintain lower budget deficit (something like 5% of the GDP) since inflation is the main evil: Annual Report of the Central Bank of Sri Lanka 2007 lamented that the government managed to reduce the budget deficit to 7.7 per cent in 2007; it was not able to do it adequately because of constraints beyond the control of the government.
  3. The government should liberalize both current and capital transactions of the balance of payments.
  4. The government should close down inefficient state enterprises.
  5. State enterprises should be privatized.
  6. Interest rate should be maintained at higher level in order to discourage wasteful investments.
  7. Labour market imperfections should be corrected.

Of course, some of these measures taken separately make sense. For example, Cuba reduced its budget deficit to 3.8% in recent years in order to counter inflationary tendencies although inflation may not be attributed only to budgetary policies. Leon Trotsky commenting on the development policies of the USSR in the late 1920s and 1930s emphasized the prime importance of maintaining stable currency for development. However, the policy prescription of neo-liberals in its totality is absolutely flawed. The policy package is based on three principles and the three principles characterize the neo-liberal economic theory. The following are the three principles:

  1. Free trade enhances economic growth and all economic activities tend to reach equilibrium through the operation of the market. This is what I call the Smithian Principle as the neo-classical writers attribute this view to Adam Smith and his book, The Wealth of Nations. Although, by free trade Smith means the absence of monopolies, neo-classicists do not put much emphasis on private monopolies.
  2. The countries engaging in free trade get benefits if they produce least ineffective goods or, in other words, goods with comparative advantage. This is what I call the Ricardian Principle.
  3. Governments are ineffective and their intervention in the economy invariably creates disequilibrium and has adverse effects. This is what I call Friedmanian Principle since Milton Friedman revived this anti-state perspective.

From a development perspective, all these three principles are theoretically incorrect, and not substantiated by contemporary experience and/or supported by historical data. However, this flawed theory supports the needs of the industrially-developed economies and benefits the world capital markets. This theory works well when an industrially developed country interacts with an industrially undeveloped country and invariably works in favour of the former and against the latter. None of the present-day industrially-developed countries (England, the USA, Germany, Japan, and Australia), however, adopted economic policies based on these three principles when they were in their early phase of industrialization. Countries such as South Korea were able to break the trap of underdevelopment in the 1960s and 1970s by consciously adopting economic polices that countered these three principles. Those under-developed countries that adopt these policies and base their economic thinking on the above-mentioned three pillars of neo-liberal theory will fail to break the vicious circle of underdevelopment.

Capitalistic growth needs specific social relations and structures (Karl Marx) within which the operation of the principle of increasing returns, technological change, and synergy and cluster effects (Schumpeter) are made possible. The presence of market and availability of capital, by themselves, do not provide an adequate basis for capitalistic growth. A country can develop if, and only if, it produces more commodities that encompass the three elements of, increasing returns, technological change, and synergy and cluster effects. Free market and lower tariff structure do not help but rather hampers production of such commodities. No country in the world has developed without tariff barriers and protection for its infant industries that were characterized by increasing returns, technological change and synergies. Sri Lanka’s economic policies of 1977 are flawed not because those policies reactivated internal market mechanisms by eliminating restrictions imposed by the dirigisme regime but because those policies were detrimental to industries that are characterized by increasing returns, technological change and synergies. The whole exercise has been trade-based not production-based. It favours merchant capital not production capital.

Take the case of Sri Lanka’s principal export products. The production of tea by nature is subject to diminishing returns, and the production process does not require constant technological changes to reduce the unit cost. Moreover, it has a very few synergy or cluster effects. One may argue that it is different in the case of garments. Up to a certain point, the production of garments involves increasing returns and technological change. Since there are backward and forward linkages, it can possibly link with other production processes. Therefore, it was not incorrect to build such an industry at the early phase of development. But we have to keep two things in mind. Garment production depends still on an extensive use of labour and the sectors that can be mechanized are limited. Still one person needs one sewing machine. So, Sri Lanka entered garment production when advanced capitalist countries gave it up because it had reached a technological saturation point. When an industry reaches its technological saturation point, its market competitiveness depends on the availability of cheap labour. Hence, we do not compete with other garment producing countries in the world on the basis of technology but on the basis of the cost of labour, an advantage we are losing at an increasing rate. The second factor is that no important steps were taken to advance the synergy and cluster effect element when the garment industry progressed in the last three decades. Countries that began with garment and textiles have gradually moved to technologically more advanced sectors with more synergy effects by producing goods that are characterized by increasing returns. These success stories showed that these countries gave reasonable protection to their ‘infant’ industries ignoring the advice by international organizations. Flying geese model explaining East Asian industrialization is a good example of such successes. We have followed, in the last two decades or so, what is known in development discourse as dead-end model. There is no fundamental difference now between the tea industry and garment industry.

The whole debate on GSP+ today signifies the flawed economic policies adopted by the successive governments including the present one since 1977. The principal issue discourse on GSP+ should be: Will Sri Lanka continue to follow the dead-end formula of the IMF, World Bank and the WTO or will it adopt a new formula that brought development to today’s advanced countries in the world?

It is better to do what the developed countries did in the past rather that what they tell us to do today.

(The writer teaches political economy at the University of Peradeniya. E-mail: