BY Chandeepa Wettasinghe

Fraser Institute Canada Economic Freedom Research Michael Walker Chair Fred McMahon, one of the contributors to the institute’s Economic Freedom of the World 2017 Annual Report, was recently in Colombo to attend the Advocata Economic Freedom Summit. Mirror Business sat down with McMahon for a chat.

Here are the excerpts from the interview:

Can you start off by telling us a bit about Sri Lanka’s performance in the Economic Freedom Rankings in the 2017 report?

Sri Lanka has come up in the ranks a little bit but not really significantly. Some very difficult problem areas have developed for Sri Lanka.

This is since the 1980s, the first period Sri Lanka is analysed in a report?

Yes.

The 2017 report was released recently but the data is from 2015, isn’t it?

Yes. We want to compare as many nations as we can across as many data points as we can.

Unfortunately, that means the economic data is two years old.

But, do you have enough data to form an opinion on Sri Lanka’s improvement since 2015?

I’ve gone through the various reports and they talk favourably of Sri Lanka’s reform agenda but there seems to be some real scepticism as to whether it will be carried forward. International reports, as you know, are very diplomatically written. So, they never say ‘you’re doing an awful job’ but they are pretty open about it. They say ‘good intentions, but we want to see action’. Particularly problematic for Sri Lanka is its awful ranking in freedom to trade and it’s not clear to me whether it has improved at all. We measured trade barriers across 159 nations. You’re at 135 out of the world. You’re down in freedom to trade, with some of the worst nations on the planet – Venezuela, Sub-Saharan African nations, Myanmar. Sri Lanka is in a disastrous position in relation to trade.

How harmful are Sri Lanka’s inward-looking trade policies?

I have to emphasis, that’s a huge tragedy for Sri Lanka. For one, people have to pay higher prices, especially the poorest. Two, it means that Sri Lankan companies and businesses are protected. They will never get globally competitive. Sri Lanka will never become prosperous by selling to a nation of 22 million people, rather than a market of eight billion people as its marketplace. And finally, for your readers, as a reality check, can they name one nation on the planet that has become rich behind trade barriers? You know people often talk about the Scandinavian nations being socialist or whatever. The Scandinavian nations have very large governments. That is true, but they compensate by having about the most open, free trade economies in the world. If you want a model of a trading nation, go to Norway, Sweden and Denmark. You want a successful Asian nation; it’s not the nations that have closed down their borders like Nepal and Myanmar —I know Myanmar is a bad example now because there are so many other problems there now—but it’s the free traders – Singapore. It’s a nation built on a swamp and it’s now rich. South Korea, a nation ridden by war, has opened itself up to the world and it’s now rich. Taiwan became rich by trading with the world. So, this idiocy that Sri Lanka can become rich by Sri Lankans selling back and forth between Sri Lankans is idiotic. I ask your readers to look around the world and see what the rich nations are. You’re ranked 135th in freedom to trade. That’s how bad you are. Not only that, you’re getting worse.

What role do the big businesses, which have influence with the government, play in this?

They say they’re doing it for Sri Lanka. They’re doing it for themselves. What they’re doing is robbing Sri Lankans’ inexpensive, high-quality products. I’m told food is more expensive in Sri Lanka than in India. That makes no sense at all. New Zealand was facing a financial crisis, I think in the 1980s. They had a highly protected agricultural sector and a left-wing government. And the left-wing government said, ‘we’re not going to go on like this’. It said, ‘we’re not going to pull down one or two barriers to trade. We’re going to pull them all down and we’re going to pull them all at once, so you better learn to live with it’. And what happened to the New Zealand agricultural sector? It took off. It became one of the richest and most powerful in the world. New Zealand went from having a lousy, non-competitive agriculture sector to one where if you go to any store in any rich nation, they will have shelves of New Zealand food. The same could happen for Sri Lanka and it would mean less expensive food for Sri Lankans and more employment in the agricultural sector.

Could you imagine telling the government to liberalize the agriculture sector, since the president’s brother owns the rice monopoly?

You should tell him to get competitive and start selling high-quality rice to the world.

Even on the export side, it seems like some companies have been enjoying incentives for decades, which robs other potential growth sectors from enjoying similar benefits. Doesn’t that also hamper our competitiveness?

Yes. I absolutely agree with you. You give subsidies not for being competitive and not for making Sri Lanka more prosperous and not for creating jobs but for political connections and for power. That means companies that could give better lives to Sri Lankans get stuffed and companies that have the political connections get the goods.

There are now concerns, valid ones—I’m not talking of Trump’s—that increasing freedom to trade and globalization, contributes to higher inequality within a country. What are your thoughts?

There’s no evidence to that. A lot of research has been done on it. What I would like to tell you is that economic freedom reduces inequality but I can’t say that because it’s not true. But economic freedom does not increase inequality. It doesn’t make it worse; it doesn’t make it better. In economically free nations, the poorest 10 percent receive about the same percentage of income as the poorest 10 percent in the non-economically free nations. It’s typically about 2.5 percent of national income. But here’s the miracle. The economically free nations produce so much more prosperity that the income of the poorest 10 percent is about US $ 12,000. Imagine if the average Sri Lankan was earning as much as the poorest people in economically free nations. Just imagine that. In non-economically free nations, the poorest 10 percent earns about US $ 1,000 a year. So, inequality doesn’t go up; it doesn’t go down, but poverty goes down. Look, there’s a different dynamic between people getting rich in economically free countries compared to getting rich in non-economically free countries. We’ll take rice as an example. How does your friend, the rice magnet, make money? He makes money by making people worse off, by stopping them from buying less expensive Indian rice, by becoming less competitive with the world. He gets ahead by making people worse off. Now imagine a free marketer in New Zealand. How does he get ahead? Let’s replace lamb with rice. He gets ahead by producing rice that Sri Lankans honestly want to buy because it’s better and cheaper than the alternative. He gets ahead in a free market economy by making better products, creating wealth, jobs and prosperity. So on the one side, you get rich and create inequality by making others worse off and on the other side, you create wealth—and yes inequality—by making people better off. That’s a change in societal dynamics.

In terms of Sri Lanka signing multiple free trade agreements (FTAs), do you think it matters if we can become freer by ourselves?

It’s a difficult world today. I would recommend Sri Lanka sign as many free trade agreements that it can get its hands on. Imagine selling to India, a billion plus people. Imagine what it would do to the competitiveness of Sri Lankan businesses? Imagine selling in Singapore. You can produce luxury products for Singapore. Luxury rice varieties even. 

Would signing these trade agreements make up for remaining fairly protected?

Oh god, no. The best thing for Sri Lanka to do would be to unilaterally remove trade barriers.

So, the second best option is signing FTAs?

Yeah.

Even if we sign FTAs with India and China, won’t there be para-tariffs and other barriers, which will anyway hinder trade?

There’s a debate in the economic community whether free trade agreements are actually free trade agreements or protectionist agreements and I’m not an expert on trade agreements with India, China or Singapore to make a judgement on that. But, I would say, with your borders tightening every day, anything that would help keep it open is a good thing.

You were favourable in your ratings on the size of the government, which many locals think is too big. Could you explain your reasoning?

For lower-middle-income nations, the size of the government is small, so we typically give it a good score and the reason the government tends to be smaller in lower-income nations is because you can afford less government, where the governments in countries like France go overboard and hobble their economies by building overly big governments. But, yes, there is a vital piece of information that’s not in our report, which would change Sri Lanka’s ranking. We want to put it in our report; it’s the size of government employment and that’s out of control in Sri Lanka. If we could get that data in the report, your score would go down in that area.

Do you think the government is employing people in areas that have the potential to become productive or is it mostly in bureaucratic roles?

As far as I can tell, it’s not in productive areas at all; it’s straight government employment and large government employment creates many, many problems. One, it creates corruption. When you have a lot of government employees, you can’t afford to pay them well and therefore, they supplement their income with bribes. Two, it increases bureaucracy. You have a lot more people than you need and they’re trying to find something to do. Trying to find something to do makes other people’s lives much more difficult or it takes people out of the productive workforce. Some of the most productive, best educated people in Sri Lanka are doing nothing jobs, when they could be out and contributing to the economy. Next, it hurts work discipline because when you have an overly large civil service, with a lot of people who don’t really have full-time jobs, you get used to not working most of the day and that’s spread throughout the economy. So, having a workforce in the government the size you do—I’m told between 1.2-1.4 million, which is somewhere around 16 percent of the labour force—so one in every seven or one in every eight Sri Lankans in the labour force work for the government. That doesn’t make any sense at all. So, take the good score in the size of the government. By the way, the reason we don’t have the employment size in the index is not because it’s not important. We think it’s hugely important but it’s because we can’t get enough data from enough nations to compare.

But, do you have enough data from countries of a similar profile to Sri Lanka, to see what the public sector size should be?

The size should probably be about a quarter to a third, maybe a half of what it is. A government workforce should be well under 10 percent, but no, I can’t give a precise number.

Our legal system is quite poorly ranked though, isn’t it?

People try to claim that Sri Lanka’s system—whatever it is—will be good for the poor and the dispossessed. The state of the legal system just puts the life to that. Nothing is more important when you’re poor and dispossessed, to have a legal system that treats you equal, that protects your property as much as the richest person in Sri Lanka, that protects your ability to get a job in the formal market every bit as much as someone who has gone to the best university, but the legal system is in disarray. It’s a real tragedy for the poorest and dispossessed in Sri Lanka. It means the rich and the powerful can manipulate the system to their advantage. They can manipulate it through raw power, cash payments or favours or by slowing the process down. That’s a really important area for Sri Lanka to resolve.

‘‘Particularly problematic for Sri Lanka is its awful ranking in freedom to trade and it’s not clear to me whether it has improved at all. We measured trade barriers across 159 nations. You’re at 135 out of the world. You’re down in freedom to trade, with some of the worst nations on the planet – Venezuela, Sub-Saharan African nations, Myanmar. Sri Lanka’s in a disastrous position in relation to trade

Was the government expropriating some private companies responsible for such a low ranking?
Well, there are a number of reasons, but yes. If the property rights are not protected, that’s a problem. Taking over the big companies is going to go on the headlines but it also means the rich and powerful are probably squeezing the smaller operators out too. The general sense is that the legal system in Sri Lanka is getting more politicized all the time. Look at the length of time it takes to get a judgement. You’ve probably heard the saying ‘Justice delayed is justice denied’. That again is a bigger problem for the poorest people in society. The rich and powerful can afford to outwait you and you need justice now.

Moving on to our sound money ranking, I was a bit surprised because in 2015, we had a very easy monetary policy, which supported a populist budget and contributed to later problems. Why have you sort of given the monetary policy a higher score?

You’ve got to put that in relative terms. All around the world, nations have learnt that they have got to keep the monetary policy in line. Your rating is around 8.7. That may sound high but there are 159 nations in the index. Where do you think Sri Lanka would rank, not score, but rank? It’s at 135th.

That’s because everybody else does so much better than you. Venezuela does worse than you.

Why have you given a better rating for our regulations?

In terms of the ranking, it’s around 90th, so that’s around your average ranking. But over regulation is deadly and it’s important to understand that regulations help the already well off – the people who know how to manipulate the regulations, who know the regulators, who know how much to pay the regulators. Economic freedom is one of the cures for corruption. If I’m free to do what I want, there’s nobody to pay off. Corruption withers. So, the high regulatory state you have is feeding into the high level of government employment; if you really wanted to boost corruption in Sri Lanka, you’ve found a way to do it.

But don’t you think lax regulations also help create distortions, like the 2008 financial crisis?

When you look around the world, there’s no relationship between regulations and the financial crisis. For instance, Canada has a very non-regulated financial market. In fact, our financial market is less regulated than in the United States. The United States had a financial crisis, we didn’t. Ireland had a non-regulated market. They had a huge financial crisis. The interesting thing is, the Irish stuck to their guns. Now they’re soaring again. So no, and the thickness of the regulation book doesn’t tell you the wisdom of the regulations. People can point to a specific event, the financial crisis that happened in a number of nations. That was awful. I’m not trying to downplay it. But how many nations can they point to that grew on regulations? Zero? So, you have a bad incident on the one side and those nations that are free market recovered from it quickly. Then you ask somebody of the nations that grew on regulations.

But, now you see in the US, businesses are calling for deregulation and you see the same mistakes that led to the crisis starting to emerge and repeat. So, is it a cultural thing? Does it depend on the culture?

I’m not clear on that at all. Financial regulations need to prevent self-dealing. A large part of the financial crisis was caused by self-dealing directly and indirectly. So, regulations that keep markets open and prevent self-dealing are important and to prevent conflicts of interest, of which there were many. But look, people talk of the financial crisis as if it was some sort of disaster, but you don’t see Europeans getting into small boats to go to the Arab world because it’s more regulated. You don’t see flotillas of boats lining up in Florida to go to Cuba because it’s more regulated. You don’t see people fleeing Sweden, which has a very open financial system and didn’t have a crisis—it did have a crisis around 1998, but you don’t see Swedes flying to Sri Lanka because you have a more regulated credit system. You need to look around the world to review what you already know. The financial crisis may have been a bad thing, but it’s better to have a dip in economic growth than no growth ever.

Speaking of bad regulations, what do you think of our labour regulations, which permit the hiring of an employee but prevent firing?

It’s horrible. It’s disastrous. If you’re an employer, you’re not going to hire someone if you can’t fire him and I’m told that the economic conditions are not an excuse for firing someone, so you can go bankrupt because of this. So no, it’s a horrible thing and it keeps Sri Lankans out of jobs and 60 percent of jobs, I’m told, are in the informal economy because people are afraid to hire in the formal economy. And the idea that you have higher regulations and costs kicking in after you go over 15 employees means that the businesses instead of growing and creating jobs and prosperity, stop growing at 15 and again it’s the worst for the least skilled Sri Lankans. If you’re a highly-skilled engineer, they will hire you. They won’t worry about firing. If you’re a low-skilled Sri Lankan, people are going to be afraid of hiring you because if you don’t work out, there you are, destroying their business for the rest of your life. It hurts the poor and the low-skilled, for whom the first job is more important than anything else. All the research shows that that first job gives you the job discipline and other skills you need and you start going up the income ladder. Your firing regulations cut off the poorest at the first step of the income ladder.

But do you agree that at least in terms of anti-trust and fair competition, we require regulations?

Yes, I’m a supporter of proper anti-trust laws. But the danger in anti-trust laws, if they aren’t well written and enforced, is that they become a weapon in the hands of other people. Look, monopolies in Sri Lanka are not caused by the lack of anti-trust laws. They are caused by government protectionism, regulations that keep other people out of the markets and government favouritism. It’s not the lack of anti-trust laws that’s creating monopolies in Sri Lanka. It’s political power. If you had a free and open market, where competitors from Sri Lanka and Canada could step in, monopolies would disappear. If you don’t allow competition, how can you have anti-trust laws because there’s nobody able to come in?

This year you’ve included gender disparities in your index. How is Sri Lanka faring in this regard?

We used World Bank data to look at the legal restrictions on women. Not societal restrictions, just legal restrictions. So, we aren’t picking up societal prejudices. We’d love to be able to but we don’t have the data to do so. Even in the legal side, there’s discrimination in Sri Lanka against women. That hugely hobbles your economy. It means half of your population doesn’t have the same rights as the other half. It seems like women are restricted from performing certain physically demanding or dangerous on-the-job tasks and entering dangerous or physically demanding occupations. But on other factors such as property rights, freedom of movement, legal status and the other indicators of labour market regulations, there is no suggestion of any differential treatment of men and women.

Finally, what is the main challenge Sri Lanka faces when attempting to become economically free?

Trying to get across the evidence to the people. It’s remarkable. People will demonstrate, argue and go out carrying placards on the streets against free markets but given the chance, they will get out of Sri Lanka and go to the United States or Canada or Ireland in just a second. So, they think in one part of the brain that free markets are awful. Then in another part of the brain they want nothing more than to live in a free market economy.

Why do you think that is? Is it because of past colonialism, which prejudices against trade and the western world? 

I think there’s a problem with past colonialism, where the British said they were running the economy but they excluded others. So, you develop that sort of paternalism. A lot of that is because of greedy special interests, who want you to believe that their monopoly and you not being able to buy products from around the world is good for you. A lot of it is just raw ideology.

And the conflicts of interest between the government and monopolies?

No, unfortunately in places like Sri Lanka, it’s a brotherhood between monopolies and government. It should be a conflict, but it isn’t, too often.