Regional integration 

By R. M. B Senanayake-August 17, 2018, 10:22 pm

Regional Integration is a controversial subject amongst Sri Lankans who seem to dislike big brother India perhaps because of the history of repeated South Indian invasions we faced in the past. But the world has changed and South India today is very much integrated with the omnibus State of India. South India cannot take unilateral actions to invade Sri Lanka as in the past unless the whole State of India decides to do so. The regional states of India are very much under the central control of the greater Indian State. So we must look at the case for regional integration through trade at least from a different perspective.

We must form a single trading market with India and get the benefits of a single large market where we can expand our production facilities to supply the larger Indian market. This will enable us to specialise to a much greater extent since our products would be saleable without facing tariffs duties, cess etc on our exports to India, which is the closest and nearest market where the costs of transportation are a minimum and where our products could be most competitive vis-a-vis the rest of the world.

Look at Europe which earlier consisted of a multitude of economic regions but is today integrated into the European Union where goods move freely without the different States of the EU imposing tariffs each time the goods cross the frontiers of each nation state. This enables larger trading regions with a common single tariff for entry into any constituent State without additional tariffs being imposed by the separate nation states which form the EU. So, a single large market with a single tariff is created and is imposed only once at the initial point of entry to any of the constituent states of the EU and any movement thereafter within the constituent states is free of tariffs. Contrast this with a situation where each time the goods cross a frontier of a state forming a single region such as the EU, tariffs are imposed at every national border. National borders would still exist and operate. if there was no free trade and payments union like the EU.

Small countries like ours can’t easily obtain the economies of large scale operations since our domestic market is small. In order to specialize in the production of goods at lower prices we need large scale operations which generate economies of scale. Large scale production generates economies of scale which reduce the unit cost of production which enables such production to be competitive on the world market. This is one of the reasons for the movement towards regional integration observed in Europe and the Far East. The Indian sub-continent has failed to realize such economies since the region is politically divided into India, Pakistan, Bangladesh, Sri Lanka and the Maldives.

If we can produce for a larger tariff free market and import therefrom goods which are also tariff free, our costs will go down and we can be more competitive in the worlds markets and also enjoy cheaper living conditions. Immediately after Independence we made a big mistake in failing to take notice of the need to relate our domestic costs to world market production. There was no scope for deficit financing and money creation, a point unfortunately promoted by some economists too who derided traditional economics. Their wrong ideas were taken up by SLFP governments from 1956 onwards.

But our policy makers did not understand the need for relating domestic cost to the world market costs and prices which definitely excluded domestic deficit financing by the government. Earlier the domestic money supply was linked to the Pound Sterling and the Foreign Reserve was held in Sterling Pounds. When the foreign Reserve increased due to a surplus of exports over imports the country's Reserves increased making it possible to increase the domestic money supply when the Reserves declined the money supply automatically declined. But with the establishment of the Central Bank this close connection of the domestic money supply to the Foreign Reserve was done away with;paving the way for irresponsible political leaders to engage in money creation through the Central Bank buying government securities and allowing for excessive import expenditure with such created money. some economists had argued against a domestic central bank for this very reason. But a domestic central bank came to be identified as a mark of national independence and it was allowed to lend to the government.

Initially, there was a limit of Central Bank lending to the government, but the limit was raised several times presumably to assist domestic economic growth which would otherwise be constrained by lack of money supply. But since much of our domestic expenditure was on imported goods and services the relaxation of the link between the domestic money supply and import expenditure was removed with deficit financing and money creation permitted to the government by the establishment of a central bank. The public did not understand these ramifications and their implication for policy making but blindly trusted their political leaders and SWRD proved a disaster for prudent public finance. We have had to go to the IMF several times owing to the irresponsible conduct of the public finances by our political leaders. The IMF of course takes charge of the fiances when they grant loans. we are still under IMF control and unfortunately so far our political leaders cannot act prudently even when they know the adverse consequences because the people expect free lunches from the government and rival politicians pander to their desire in our flawed and irresponsible democracy. It seems to me that it is better for us to be under IMF control than give power to our politicians.