Democratic Capitalism and Developing Countries — As Applied to Sri Lanka

The word “capitalism” in today’s world, particularly in the developing world, conjures a vision that is not quite welcome. It somehow evokes a sense of distaste for an economic system that prevailed in Europe from the time of the Industrial Revolution, and subsequently in the USA, and it has become the fashion to decry it as the system that sustained colonial empires with the colonial power enriching itself at the expense of the colonized. The “bible”, as it were, of capitalism Adam Smith’s An Inquiry into the Nature and Causes of the Wealth of Nations, published in 1776, gave the impetus, among other things, to the exploitation of colonies as the suppliers of raw materials for the industries of the colonial power and as markets for the manufactured goods produced back home. Hence the dynamism of the spirit of adventure and of the entrepreneur in the nineteenth century whose prime concern was the generation of wealth by the entrepreneurial class. And this, in turn, led to the exploitation by fair means or foul of the subject peoples with a somewhat a-moral justification of the exploiter. The laissez-faire concept which resulted in a free-for-all competition meant the survival of the fittest and elimination of the weak. Indeed the very mention of the word capitalism is distasteful to the liberal, to the socialist, and to the newly emergent states of the developing world.

This, then, is the scenario that we in the developing world have been nurtured upon particularly since the end of the Second World War and more so in the 1960’s when more and more Asian and African countries emerged into independence. I am no academic but an official who for over a quarter of a century has been in the business of representing his country both in the West and in the East. At the end of this career I have arrived in the USA and have been fortunate to have had the opportunity of re-thinking some of the basic concepts that officials from developing countries take as axiomatic. While still far away from the learned treatises that scholars and professors write with such scholarship and many footnotes, this essay is an effort by one who was very much a bureaucrat benefiting from exposure to a world of thinking hitherto closed to him. This has, indeed, thrown open an entirely new world to me and it is my endeavour in this essay to consider how best the positive elements in democratic capitalism can assist developing countries to emerge from the morass of helplessness they find themselves in after chasing the ephemeral shadow of socialism. These nations want to increase their wealth for the greater good of their people. This task can best be performed in the light of the knowledge I have of my own country, Sri Lanka, whose future rests on an experiment in democratic capitalism.

Michael Novak distinguishes the old capitalist system, essentially an economic system, with its emphasis so much on the individual and his freedom to accumulate private property, usually at the expense of his fellow men, from the new democratic capitalism which he formulates as being more than a mere economic system — it is governed by a political and a cultural system, both of which aim at “an open society, respect for the rights of individuals and the vision of justice and equity.” Of course, without proper guidance and planning, democratic capitalism can result in shortages in some places while others have excesses until the market situation brings about the desired balance, that is, if it works as it should. Hence wastages and imbalances continue but the fact that under this system plenty can be achieved and this plenty can be distributed for the social good of the people makes this system preferable to the inefficiencies and bureaucracy of the socialist system.

Democratic capitalism while eliminating the obvious evils of the old capitalist system nevertheless is not a perfect system. Some of the hangovers from the old system of being selfish and seeking wealth for its own sake still tend to injure the spiritual element and leaves the democratic capitalist, however successful, spiritually unsatisfied. Furthermore, competition to meet the market’s demands means the satisfaction of the immediate desires of the consumers and to this extent the spirit of discipline and restraint is undermined. Selfishness which was the hall-mark of the old capitalist system is not eliminated even in democratic capitalism so that inequalities continue to remain, thus making possible the a-moral attitude that was so characteristic of the old capitalist system.

Having tried to distill the few essential characteristics of democratic socialism from the wealth of literature that has been my fortune to discover and read, it is refreshing to note the assertion made by Michael Novak that the “corporation is an invention of law that made democratic capitalism possible. Neither participatory democracy nor capitalism could exist without the corporation”. The International Encyclopedia of Social Sciences describe the nature of a corporation: That it is “a body chartered or recognized by the state; that it is a formal agreement, in the nature of a contract, among people joined in a common purpose; that it can hold property, contract, and sue and be sued in a common name; and that it has a length of life not subject to the lives of its members.”

Multinational corporations, as the developing countries have come to know them, are large impersonal bodies which have sought to exploit them by setting up manufacturing and other facilities and operating them in a manner in which the profit motive alone appears to be the predominant factor, thus, evoking the oft-repeated fear that the multinational corporation milks the receiving country of most of what should rightfully belong to it. This, indeed, is unfortunately the impression created in the developing countries. Yet we must also take into account the fact that the corporation is bringing in hither-to non-existent capital, the technical know-how which is transmitted to the locals; that it opens out opportunities for the local entrepreneur to invest and to learn the economies of large-scale production; eases the burden on imports which would otherwise have been necessary; and with the export of the manufactured items earns the foreign exchange necessary to put the balance of payments of the country on an even keel. The return the corporation takes away is its recompense not only for its capital, but also for the employment engendered and the service it has rendered, together with the risks involved in entering unknown territory. Is this bargain fair?

With this background, I will now endeavor to take the case of Sri Lanka, a developing country, and consider its economic performance in the light of the choice between democratic capitalism and democratic socialism. Sri Lanka is a small island of 25,000 square miles and a population of 14.5 million compared with the huge land mass of India with a 700 million population to its north. Even though it was granted independence by Britain, the colonial power in 1948, universal franchise was enjoyed by its people since 1931. This together with the fact that education from childhood to the university and health services to this day have been provided free by successive governments, has ensured the emergence of a highly articulate, educated; political people. The rate of literacy among the entire population has been established at 80%.

The fortunes of Sri Lanka immediately after independence were not very different from those of the preceding colonial era. This was because practically the same ruling elite, elected under universal franchise in 1931, 1936 and 1947 (there were no elections during the years of the Second World War) continued to exercise power in Sri Lanka up to 1956. The parliamentary party system of government resulted in a conservative, propertied class holding power with Marxist parties forming the opposition. This enabled the continuation basically of pre-independence economic policies which were, fortuitously, blessed by the boom conditions that obtained in the world at the time. The Korean War in the late 1960’s had ensured high prices for Sri Lanka’s primary commodities: tea, rubber and coconut. All this enabled Sri Lanka to have a standard of living above the average among the South and S.E. Asian countries. Although figures do not lend themselves to exact comparisons, the economic situation of the Sri Lankan can be gauged by the fact that the per capita income in 1948 was Rupees 400 whereas today it is only Rs. 200. Apart from the fact that these figures provide a stark contrast, it is well to remember that at that time the US dollar was equivalent to under Rs. 5 (and had much more purchasing power), whereas today it is over four times that amount. Economics in those days were not so complicated — the exchange nexus of exporting primary commodities and importing practically all of Sri Lanka’s needs to the advantage of Sri Lanka did not call for any major policy effort. It was recognized that all that the Government had to do was to sustain a steady growth rate, continue to provide the social services free to the people and to improve conditions by investing in the basics — transport, harbors, agriculture and education. Small industries were also encouraged. Existing expatriate companies were allowed to flourish much in the old colonial way. The boom-time, however, had to come to an end and prices for primary commodities plummeted bringing in their wake, from 1952 onwards, balance of payments difficulties as imports and social services continued as before with export incomes progressively falling far below the amounts needed to service the imports. Welfare measures had to be curbed — they could not be abolished altogether as they were live political issues. The need for assistance from abroad was recognized and became an issue. The Marxist parties were as vehemently opposed to the conditions laid down by the World Bank and the IMF for assistance as well as to foreign investments which were being increasingly felt as necessary for Sri Lanka to climb out of her economic morass.

At this stage, coincidentally, the Sri Lanka electorate was presented with a democratic choice. The United National Party (UNP), which was the ruling party, split with Mr. Bandaranaike, breaking away and forming the Sri Lanka Freedom Party (SLFP) which sought and obtained its support not from the existing power structure but from the Buddhist monks and the indigenous teachers and physicians. It pledged itself to democratic, parliamentary government but posited a socialist approach so that the electorate did not have the invidious choice it hitherto had — to choose between a democratic party and Marxist parties.

What is interesting for the purpose of this essay is that these two parties alternately formed governments, at times with the assistance of Marxist parties which, however, played a relatively minor role. The UNP formed the government from 1947 to 1956, from 1965 to 1970 and from 1977 to the present time and has assured itself of remaining in power till 1989. The SLFP formed the government from 1956 to 1965 (except for a brief period of 5 months in 1960) and from 1970 to 1977. Although it would not be unfair to characterize the UNP governments up to 1970 as “capitalist” in approach and the SLFP governments as “socialist” in intention, all the governments recognized the need for foreign investment and this was dramatically brought to the fore by the economic crises since 1952. These were aggravated by the socialist welfare measures that the SLFP government persisted with in the late 1950’s and early 1960’s. The need for foreign aid became imperative and whatever assistance that was proffered by friendly countries in the form of grants and loans, and loans from the World Bank was simply not enough. Hence the need for private foreign capital for investment was recognized by all parties but somehow the ideas prevalent of the “evils of capitalism” seemed to predominate, less in the eyes of UNP governments till 1970 and more in the eyes of the SLFP governments. But the worsening economic crises, the increase in population and consequently of unemployment and the ever widening balance of payments deficits compelled the governments of both hues to resort to private foreign investment to resolve their economic problems.

The first official statement recognizing the need for private foreign investment was in March 1966 when the UNP Government published its White Paper in which it stated that it “welcomes private foreign investments on terms and conditions advantageous both to this country and to the overseas investor” and set out the incentives: free remittances of profits and dividends, eventual repatriation of capital after the sale or liquidation of investments. Assurances were given regarding the security of investments against nationalization by the Government. In November 1971 the SLFP Government with a Marxist Finance Minister issued its Five Year Plan for the period 1972-1976 and in it acknowledged the function of private foreign capital: “The capital contribution of foreign investors will help augment the country’s foreign exchange resources available for development. Even more important are the opportunities that foreign investment affords for Ceylon to acquire new technologies, modern managerial skills and export outlets”. This was followed by a statement of policy in which the incentives given earlier were enhanced: remittances to be tax free, tax holidays and guarantees against nationalization. Investment Guarantee Agreements with countries that could provide such investors were to follow.

Till 1977, therefore, the efforts of governments by both parties to attract private foreign capital to Sri Lanka were tentative and were forced upon them by the circumstances. While the “Theory” of the Marxists that the private investor was the fore-runner of a possible neo-colonial, imperialist grip on the economy and subsequently on the political life of the country still seemed to linger in the minds of governments, the fact that other countries in the region were resorting to it and their success stories left the governments with no choice. The incentives, it was found, were not sufficiently attractive and somehow the foreign investors could not be lured in great numbers. In the early 1970’s, however, the wary foreign investors came in as partners with local industrialists and some progress was achieved.

But most of these industries concentrated on producing items that were being imported into the country and this program of import-substitution had to be protected behind tariff barriers. There were very few indeed that could export their finished products.

The year 1977 marked a distinct breakaway from the welfare policies of all previous governments. The problem of unemployment, particularly of the young unemployed, had become worse: in 1970 the problem had been bad enough with 550,000 (12% of the work force) being unemployed; in 1977 the figure had more than doubled itself to 1,200,000. The economic situation with the steep increase of world prices of oil and industrialized goods, the steady fall in the economic growth due to these and due to the effects of various nationalization measures that were adopted in the 1970-1977 period, all demanded a new strategy if Sri Lanka were to stimulate economic growth, let alone survive.

The old shibboleths had to be buried if Sri Lanka were not to be totally defeated by the magnitude of its economic problems. Hence the manifesto of the UNP proclaimed the total failure of the SLFP government under which economic growth had practically ground to a halt while unemployment and the cost of living soared. Repeatedly it held out to the people the need to have a drastic change in direction and in policy. State control in practically all aspects of life had to go. It sought “the establishment of a free and just economy after more than 20 years of controls and restrictive practices which hampered and hamstrung economic growth and development”. A new spirit, one that could blend with the concept of democratic capitalism was consciously evoked. The UNP election manifesto declared that “industrial development through foreign collaboration or direct involvement will be encouraged and promoted by way of free trade zones geared to export, to increase employment, to earn foreign exchange and obviate the dependence on foreign aid”. No clearer indication of a new approach to the economic problems of the country could have been given and certainly the UNP (which was in the Opposition) could not have been given a clearer mandate than the five-sixths majority at the general election of July 1977, winning 140 out of the 168 seats in Parliament. Hence the Finance Minister in his first Budget Speech spoke of his “budget that seeks to put the country on a new course”.

The new economic policy that followed saw the dismantling of almost all economic controls by the Government, freeing the currency to find its own true value in relation to foreign currencies, abolition of artificially imposed price controls, removal of the most obvious of the subsidies (except food stamps for the really poor) and allowing market forces to determine price levels. All conditions favorable to an open, supply-oriented market so characteristic of democratic capitalism became prevalent. It was not the freedom of the known predatory capitalism but a democratically acceptable capitalism in which the State played the constructive role of encouraging participation by entrepreneurs, both local and foreign, while investing in and developing the basic infra-structure of the economy. The dams required for the multi-purpose irrigation and hydropower schemes had to be undertaken by the Government on an accelerated basis to provide the atmosphere for the economy to take off.

For the foreign private investor and the multinational corporations to invest in Sri Lanka the potential had to be demonstrated and what better way to do it than to obtain governmental support of those countries that had the investors. Through the aegis of the World Bank, the Aid-Sri Lanka Consortium grew in numbers and their pledges of foreign aid for the Government to carry out its economic development programs, particularly the multi-purpose Mahaveli accelerated program, increased significantly, thus underscoring the effectiveness of the new economic path. Aid commitments from these countries increased from $250 million in 1977 to $400 million in 1978 to $627 million in 1980 and to $814 million in 1981. This, therefore, provided the right climate for private foreign investors concerned about the political stability of the countries they invest in, to be attracted to Sri Lanka. The incentives offered by the Government in addition to the open, liberal free economy far exceeded any of the incentives by previous governments and compared favorably with those offered by other developing countries. In the first instance, a specific area adjoining the International Airport in Colombo was designated a Free Trade Zone administered by the Greater Colombo Economic Commission with wide powers to grant facilities for investors and directly supervised by the President of Sri Lanka himself. The ultimate guarantee that can be given by any government was given: it was embodied as an article in the Constitution or the country — Section 157 of the Constitution specifically refers to the inviolability of foreign investments.

In addition to all the other incentives given earlier, in order to encourage employment specifically, the tax incentives offered were related to the numbers employed. Hence tax holidays for two years for those employing up to one hundred persons, three years for those up to 300 employed, four years for 500 employed and five years for those employing over 500. At the end of the tax holiday period, concessionary tax periods are to follow in proportion to the number of years of tax holidays enjoyed. There are no restrictions at all on the free transfer of shares, remittances of dividends, exemption from all customs duties and exchange control regulations. The response by private foreign capital was encouraging. In his Budget Speech for 1981, the Minister of Finance while expressing his satisfaction at the progress up to, then, saw in it striking evidence of “the confidence reposed by the international community in the stable economic and political environment that has been created by this Government”. By the end of 1981, 154 projects with a total investment potential of Rs. 5.4 billion (US$ equal RS.20) has been approved. Most of these industries are for the manufacture of garments, glass, light bulbs, textiles, batteries, tires, shoes and fishing nets. The Government has made it known that the following industries would be given priority in consideration: electronic industries, the processing of rubber, graphite, • mineral sands, phosphates and coir. It is now expected that multinational corporations will invest in these industries. Outside the Free Trade Zone private foreign investment has gone into tourism and the building industry. As a result of these developments and the development programs of the Government, GDP has increased by an average of 6.3% per annum since 1978. Unemployment, which had reached a peak of 25% of the working population in 1977, has been brought down to about 12%.

I have in the foregoing paragraphs given a somewhat detailed account of Sri Lanka’s economy and how it has been governed by the political developments of the country which progressed from mere welfare-based management to an open market economy governed by market forces but not entirely at their mercy as under the old capitalist system but with adroit management by the State which controls the infra-structure and the basic industries and in this context allowing market forces to bring about that momentum so necessary for economic growth.

Democratic capitalism, as known in the West, has still to move in to Sri Lanka in a meaningful way. The majority of investments has been in the garment industry which does not bring with it technology of any high order. Moreover, most of the entrepreneurs have come mainly from the Asian region. Perhaps, what the democratic capitalists have been waiting for, namely political stability has arrived in Sri Lanka for the incumbent President has been re-elected with the same Parliament up to 1989. The opportunity, therefore, has arrived for democratic capitalism to demonstrate its social and cultural dimensions by moving into developing countries that have themselves consciously moved away from the socialist or centrally planned economies which at one time appeared to be the panacea for their economic ills and the magic wand, as it were, to promote economic growth and improve the conditions of their peoples. The bureaucratization and the controls have instead, proved to be millstones on which economic progress has been wrecked. Henceforth, with those countries that have boldly cut the rope to this millstone, in favor of democratic capitalism, which appears to be the way to economic growth and development, would it be too much to expect democratic capitalism of the West to join hands?

A new experiment is being made. Its issue is still in doubt.

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