A History of Underdevelopment and Political Economy of Inflation in Sri Lanka

With an Outline of Nationalisms

Dhanusha Gihan Pathirana, Chandana Aluthge

• Publisher: Palgrave Pivot
• Year: 2020
• Print ISBN: 9789811556630
• eBook ISBN: 9789811556647
• Topic: Business
• Subtopic: International Business
• Index: Business

The book provides a new conceptualisation of inflation in underdeveloped economies, through Sri Lanka's historical experience. It outlines a general theory of nationalisms in their diverse manifestations across the world, within a historical perspective of capitalist development and underdevelopment. The book, therefore, seeks to capture the production mode holistically, within both its infrastructural and superstructural levels probing their interactions. The theoretical structure through which inflation is analysed synthesises the theory of unproductive labour and Marxian theory of prices of production with labour surplus theory of late Dr. S. B. D. De Silva in the context of underdevelopment. In this light, Professor David Laibman's Allocation Problem is resolved within a Marxist framework to provide an operational significance to the theory and its application. In the same vein the book also provides a new theoretical interpretation of Sri Lanka's historical development fromthe British period onwards through application of theories of capitalist development and surplus labour.

© The Author(s) 2020

D. G. Pathirana, C. AluthgeA History of Underdevelopment and Political Economy of Inflation in Sri Lankahttps://doi.org/10.1007/978-981-15-5664-7_1

Begin Abstract

1. An Introduction to the Critique of Theories of Inflation in the Context of Underdevelopment

Dhanusha Gihan Pathirana¹ and Chandana Aluthge²

(1)

Senior Economic Analyst, Asia Capital PLC, Colombo, Sri Lanka

(2)

University of Colombo, Colombo, Sri Lanka

Dhanusha Gihan Pathirana (Corresponding author)

Chandana Aluthge

Abstract

Contrary to established approaches, the chapter probes inflation in Sri Lanka and underdeveloped economies employing Marxist categories of mode of production and class structure, productive and unproductive labour and the gap between production and labour time specifically in agricultural sector, which shapes the composition of surplus labour in the economy. The chapter asserts that ‘capitalism proper’ employing capital accumulation, and therefore, dominance of relative surplus value over its absolute form, as the main distinction between itself and its predecessors. Concomitantly it illustrates higher relative inflation in Sri Lanka and underdeveloped economies through predominance of absolute surplus value which stagnate organic composition of capital hand in hand with higher unproductive activity in the economy compared to advanced and industrialising countries.

Keywords

InflationUnproductive labourCapital accumulationUnderdevelopmentSurplus labourAbsolute and Relative Surplus Value

End Abstract

1.1 Inflation in Sri Lanka: An Empirical Sketch

Existing studies assert that inflation in Sri Lanka is primarily driven by untenable fiscal deficits leading to excess of money supply over goods and services (see Athukorala 2009; De Silva 2009; Indraratna 2009; Ratnasiri 2009; Bandara 2000). This proposition means to say that fiscal deficit is a homogenous entity capable of delivering only one inevitable outcome with regard to internal price level. On the other hand it suggests that theoretical explanation provided in existing studies on inflation in Sri Lanka strictly rests on Monetarist theory and merely reiterates the postulates it predicts. The conventional view on Sri Lanka’s inflation therefore disregards the nature of the relationship the state establishes with production forces through its deficit spending and its particular effect on the internal price level. That is to say the existing literature assumes the effects of fiscal deficit as being homogenous and hence its impact on the internal price level is assumed to yield identical results irrespective of its composition. In our view the deficit yields heterogeneous effects on the price level determined by its composition. This is empirically verifiable from Sri Lanka’s experience since independence.

The pre-liberalisation period from 1948 to 1977 saw high fiscal deficits hand in hand with low inflation except during 1973 oil crisis which fused with world grain crisis during 1972–1975. A brief period of relatively high inflation emerged during the partial liberalisation attempted in 1968–70 under the United National Party (UNP) regime. Average CCPI inflation in Sri Lanka from 1953–67 was as low as 0.93% while the fiscal deficit as a share of GDP averaged 4.69% which is significantly high considering the remarkably low inflation during the period. The pre-liberalisation phase of Sri Lanka is a clear example of non-homogeneity between inflation—fiscal deficit nexus contrary to the expectations of Monetarist theory. Specific composition of the fiscal deficit during the period dominated by the food subsidy and social services (Moore 1985; Nicholas and Yatawara 1991; Atapattu 1997; Kelegama 2006) was designed to keep inflation in general and food inflation in particular low. It lowered inflation even below that of advanced economies while subsequently necessitating high fiscal deficits. Deficit spending hence reduced the internal price level and controlled inflation, in contrast to the existing explanations which ascribe inflation to high fiscal deficits. This also contradicts the Political Economic view of inflation proposed by Alesina (1987) asserting that left-wing governments are more averse to ‘unemployment’ relative to ‘inflation’ and right-wing governments are more averse to ‘inflation’ as opposed to ‘unemployment’. Sri Lanka’s experience of inflation after independence does not comply with this contention.

On the other hand low inflation maintained through deficit spending assisted the expansion of predominantly the simple reproductive manufacturing activity through conversion of former retailers and traders into what Marx called ‘merchant-manufacturers’—whose involvement in exchange/trade predominates their involvement in production structure—during the pre-liberalisation period (see Chap. 7). Manufacturing activity benefitted from persistent low wages facilitated by low inflation. Stability of the internal price level was a product of specific composition of deficit spending, and low inflation which derived from it improved price competitiveness of emerging manufactures. ‘[S]ince part of the cost of production of labour power was borne by the government [during the pre-liberalisation phase] through the provision of education and health facilities and various consumer subsidies, private companies could benefit from a labour supply at a low wage rate’ (Liyanage 1997, p. 438).

The deindustrialisation wave which overtook the economy was fuelled by sharp and sudden increase in inflation following liberalisation in 1977 (see Fig. 1.1 below) in an environment where the new regime completely repressed Trade Union activity. It hence indicates unmistakably that sharp increase in inflation following 1977 cannot be attributed to Trade Union pressure for higher wages and to rising wages. The new regime immediately lifted import restrictions and phased off subsidies (Moore 1985) and hence broke the levee which contained the surge of prices. High inflation coupled with significantly high fiscal deficits occupied the economy under the tutelage of neoclassicists and sealed its permanence following liberalisation despite continuous attempts to arrest it. Low inflation–high fiscal deficits nexus which prevailed till liberalisation was hence permanently reversed. The study in this backdrop reflects on the experience of inflation during post-liberalisation period of Sri Lanka since 1977. It analyses causes of inflation through a critique of existing formulations which primarily explain it through continuation of high fiscal deficits.

Fig. 1.1

Sri Lanka inflation. (Source: CBSL Annual Reports)

Seriousness of the problem of inflation in Sri Lanka is held in great importance by economists and government authorities as well as by mass of the people. It’s underscored in IMFs policy framework to assist Sri Lanka resolve its balance of payments and public debt crisis. IMF highlights the need to contain inflation and convert Monetary Targeting policy structure of CBSL to an Inflation Targeting regime (IMF 2016). CBSL welcomed these views indicating the great level of significance rendered by authorities on containing inflation. CBSL’s monthly survey of inflation expectations consulting all major financial institutions provides further evidence of significance imparted by monetary authority to understand and contain inflation.

CBSL ascribed the phase of relatively high inflation in 2016 to persistent growth in private and public credit despite tightening monetary policy in 2016 and raised policy rates twice by 50 basis points during the year. Further, severe floods and droughts prevailed throughout last one and a half years also aided forces of high inflation (CBSL 2017). CBSL under this backdrop restricted credit availability to finance companies through commercial banks to contain inflation. Credit growth to Financial and Business Services sub-sphere was as high as 70.7% from June 2015 to June 2016 and absorbed 7.3% of total outstanding private sector credit. It’s the second largest sub-sphere in terms of credit absorption exceeded only by Personal Housing accounting for 9.2% of private borrowings which also grew by leaps and bounds reaching a growth rate of 41.7% during the corresponding period. CBSL imposed these quantitative restrictions on commercial banks’ lending with the aim of restricting the relending activity of finance companies. Hence, in theoretical terms and as a matter of practice, CBSL currently comprehends the issue of inflation in terms of excess demand on one hand and supply shortages in agricultural sector on the other. In this study, both these aspects will be theoretically examined under the context of underdevelopment and monopoly-finance capitalism.

1.2 Fiscal Deficit as an Endogenous Variable in Determining Inflation

Crux of the mainstream explanation of inflation is that due to fiscal policy dominance of monetary policy in Sri Lanka money supply increased without a corresponding increase in real output. Hence, large scale fiscal deficits maintained in the long run by successive governments as means of securing political popularity is at the heart of the issue (see Indraratna 2009; De Silva 2009; Ratnasiri 2009 and Bandara 2000). The established view on Sri Lanka’s inflation therefore has not examined the economic structure when analysing changes in the internal price level. It’s as if money supply, prices and output interact to realise the internal price level in a political economic and structural vacuum. Monetarist view of inflation therefore considers structure of the economy and class relations as passive elements in price determination.

More importantly, mainstream analysis does not elaborate why governments in Sri Lanka resort to expansionary fiscal policy to remain politically popular, in contrast to governments in developed capitalist economies disregarding their conduct under periods of stagnation. The problem was also raised by Sebastian Edwards who sought to resolve it through mainly a Game Theoretic approach to relationships between rival political parties contending for political power (see Edwards 1994). However, in contrast, we attempt to develop a structural elaboration of the problem. Public are objectively forced by living conditions produced by state of the economy to strongly expect government’s assistance, given that private sector has not delivered economic conditions required to realise a fair living standard. To fill this political economic void, governments have to maintain expansionary fiscal policy providing subsidies and employment as a means of curbing the ‘supply gap’ within private sector. Hence, fiscal deficit itself can be determined by stagnation of real incomes, unemployment, underemployment, insecurity of employment highlighted by 68.1% of Sri Lanka’s workforce employed in informal sector (DCSSL 2019, p. 48) and indebtedness of lower classes. For instance, high unemployment in Sri Lanka prevailed throughout post-independence history up to the mid-2000s until labour migration since the 1990s gradually reduced it below 5% in 2010. Despite the reduction of official unemployment rate, underemployment in rural areas and in services remains a major concern. Underemployment in agriculture and services tends to withstand in spite of inflation stemming from rigidities in labour mobility, which will be examined in Chap....

Table of contents

• Cover
• Front Matter
• 1. An Introduction to the Critique of Theories of Inflation in the Context of Underdevelopment
• 2. Towards a Theory of Inflation in Underdeveloped Economies
• 3. Plantations and the Rise of Merchant Cum Usurer Class during the British Rule in Sri Lanka
• 4. Modelling Inflation in the Context of Underdevelopment
• 5. Discussion of Socio-Economic and Statistical Results
• 6. Facets of Economic Control in the West and Northeast Asia: Implications to Sri Lanka
• 7. Political Economy of Nationalisms and Sri Lanka’s Left-Wing Politics: An Outline
• Back Matter