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Why Sri Lanka should Repeal the Expropriation Act?

Sweden, Nov. 14 -- On Wednesday the November 09th the Washington Post with reported that Sri Lanka's Parliament has passed a law allowing the government to take over private businesses which are deemed to be under-performing.

Authorities have listed 37 companies to be taken over under the law, titled "Revival of Underperforming Enterprises and Underutilized Assets." Media around the world it seems took interest on this piece of legislation.

The Supreme Court previously had decided that the bill proposed to acquire private businesses was consistent with the constitution. But the bill was not consistent with the fundamentals of economics or with the economic realities of the country hence it is not in the best interest of the country's economic development. This law is required to be repealed as early as possible.

Let me explain my point in just plain economics without addressing any legal or moral issue behind the law.

Any producer country's economic stability depends on two equilibriums in the system. The first is the demand and supply equilibrium at consumption level and the other is the demand and supply equilibrium at the total output level. If these equilibriums break the economy should hit a major crisis and this law has the power to break these two equilibriums in near future.

In the economic system entrepreneurs present their consumable goods and services to the market expecting that consumers would buy those goods. Therefore if entrepreneurs get back what they expect from consumers out of their expenditure then we will have the first (demand and supply) equilibrium.

The second equilibrium must achieve at total output level. Total output includes consumable goods and the goods that are used for the production of goods (capital goods). First equilibrium leads to the second equilibrium at total output level because capital goods and services are in demand in order to produce consumer goods. This means we will have the equilibrium at total output level only if consumers spend enough money for the economic system to achieve the first equilibrium said above.

If these equilibriums break we will have an unavoidable great economic crisis. The bill approved on November 09 by the parliament in all haste will set the background that leads to break up of the said two equilibriums at least at current growth levels. How could this happen?

In a developing country like ours the said first level equilibrium is basically achieved through four mechanisms. Firstly, consumer income allocated from existing enterprises. Secondly consumer income allocated from new business investments.

Thirdly from the consumer borrowings. Fourthly from the government's deficit spending. Other than these four mechanisms a small portion of consumer income is derived from the stock market in periods of booms.

This law definitely is going to change the methods of achieving those equilibriums.

Firstly, it disturbs investor confidence local and foreign. The word "entrepreneur" was coined by Jean Baptiste Say, a French economist to define "risk-taking capitalist investor". Entrepreneurship is not just involved taking risk but it demands a great deal of human creativity and management. This creativity is not simply aroused when you think that your business might be taken over by the government for having to lease a piece of land from the government on which the business is built upon. This law will badly affect to the "creative enthusiasm" of entrepreneurs as well as bankers.

If the entrepreneurs did not invest in new businesses that will reduce the increment of debt free consumer income. This affects to reduce the consumers' collective ability to borrow. This means if entrepreneurs do not invest in new businesses we will not have enough consumer liquidity in the system as a result that will break up the first equilibrium. In such a situation the only mechanism to maintain the status quo of the consumer spending is to increase the government's deficit spending. If the government can't increase deficit spending then equilibriums break and we will have an economic crisis instead of development. Can the government increase deficit spending in the event if consumer income is not raised at desired level due to the reason that entrepreneurs pull back or freeze or reduce new investments? Let us investigate this point?

According to the Central Bank, in 2010 the GDP has increased 8%. The government's spending over budget (which is known as deficit spending) was nearly 8%. Guess what would have happened if deficit spending was zero.

GDP or the Gross Domestic Product is a measure of the goods and services produced in the country; in fact it is a relatively good measure of economic output. GDP is calculated in adding up four quantities namely C+I+G+(NE). Here, C=private consumption, I= investment by industry excluding investments in stocks and bonds, G= government expenditure again excluding interest and capital paid on loans and NE= net exports (exports - imports).

So, the government expenditure is a component in GDP. If the government spends Rs. 100 the GDP should increase by Rs. 100. Similarly if the government increased its expenditure by 8% over the budget which is known as deficit spending, then the GDP should be increased by 8%. If the deficit spending has generated a multiplier effect then the GDP should have been increased more than 8%. We do not see that happened in 2010.

The general rule is that if deficit spending is " x% " and the increase of GDP is equal or less than 'x' then country is heading towards a national debt crisis or unwanted inflationary situation. If deficit spending is "x%" and the GDP increase is greater than "x " then the country is far from having a debt crisis. Accordingly anybody can see that Sri Lanka is already not doing great in regard to preventing a crisis even though the government is happy about some growth statistics.

Economies collapse amidst growth if the said equilibriums cannot be sustained. If you want an example forget about Greece but look carefully at Spain which was the best growing economy in euro zone for nearly a decade before it crash. Sri Lanka's problem is without high deficit spending the equilibriums break reducing GDP growth virtually to zero and with continuing high deficit spending economic crisis is imminent. Until Sri Lanka experiment with new policy approach to mitigate this problem, traditionally this is a situation where the country should find refuge on private business community if the government wants to reduce deficit spending without creating economic crisis.

We saw above deficit spending contributes to consumer income/liquidity. If Sri Lanka wants to reduce deficit spending then some other mechanism should compensate the consumer income that could reduce due to the reduction of deficit spending, in order to ensure that we achieve the both economic equilibriums at consumption level and total output level to prevent a crisis. So the only viable mechanism left is to increase consumer income through new business (not stock market) investments.

What does this mean? This means that in a time Sri Lanka wants to boost the "creative enthusiasm" of all potential entrepreneurs both local and foreign the government enacted a law to do just the opposite. The above said economic equilibriums that are required to maintain growth or economic stability cannot simply be achieved under any condition and any law. What is consistent with the constitution may easily not be consistent with economics.

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Publication:Asian Tribune (India)
Geographic Code:9SRIL
Date:Nov 14, 2011
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