Crowdspring: December 2021

Friday, 31 December 2021

[New post] A coupon system that enforces quotas and rationing will not solve the balance of payments problem – Advocata

A coupon system that enforces quotas and rationing will not solve the balance of payments problem – Advocata

by Pratheesha

The media has reported that the government intends to implement a system of quotas for imports and the rationing of food and fuel. This is the latest in the long list of interventions over the last two years to address the growing balance of payments problems. Similar to previous measures this too only addresses the outward manifestation of a larger problem in the economy, but not its origin. Therefore, this policy measure too will ultimately prove futile.

The government took the right step a couple of months ago when they withdrew price controls on a few selected goods in the markets. Instead of further quotas and controls, what is needed now is to withdraw from further interventions in the financial and foreign exchange markets.

Sri Lanka has imposed an ever increasing web of controls on imports since April of 2020 but the trade deficit remains stubbornly high. In the period January-October 2021 imports rose by 26.5% and the overall trade balance grew by 34% to $-6,498m. This is despite a strong performance by exports, which rose 22.1%. The issue is not with exports but with imports caused by excess demand within the economy.

The government is running an extremely loose monetary policy, artificially holding down interest rates through interventions by the Central Bank. They are also running a large fiscal deficit, financed by Central bank credit or money printing. It is these two factors that are fueling domestic demand and as a result the spiral in imports. Curing the malady requires addressing its root, any other solution will at best only provide temporary relief.

Quotas and rationing – this is what a coupon system entails are cumbersome and costly to implement. They are also prone to corruption. Rationing will inevitably create black markets as coupons obtained by those best placed to acquire them are traded.

Existing import restrictions are hurting domestic trade, exports and consumers who face rising prices as a result of the shortages. People often characterise movement towards a larger trade deficit as "worsening," this terminology is flawed and reflects a failure to appreciate that both imports and exports are beneficial for the smooth function of an economy.

Buying goods and services more cheaply than it costs to produce them at home, the nation benefits from imports. By selling goods and services in world markets, at higher prices for them than it could earn by selling only at home it benefits from exports.

What a country can produce is determined by the available resources. This also determines the standard of living of a country. Given the limitation of a fixed set of resources, if a country attempts to produce every single item that it needs it may not be very efficient in the way it utilises scarce resources. Shutting itself off from imports restricts the available inputs to local production.

There may be some things that can be produced efficiently while there may be others that do less well. It makes sense to allow a country to produce the things that it has a relative advantage at producing, and import what it does not. Thus imports are necessary for the growth of exports.

The proposed imposition of quotas will damage the economy even further and increase the suffering of citizens. The government needs to address the fundamental problem; tighten monetary and fiscal policy, free the currency and draw up a proper recovery plan that can prevent even further deterioration.

This will undoubtedly cause a shock - but will then allow trade and economic activity to resume. The alternative however is far worse; suppressing the symptoms of the disease will also stifle economic activity resulting in a slow, certain impoverishment with no hope of growth.

Advocata is an independent policy think tank based in Colombo, Sri Lanka. We conduct research, provide commentary and hold events to promote sound policy ideas compatible with a free society in Sri Lanka. Visit advocata.org for more information.