Nationalization caused highly skilled workers and experienced executives to leave the country in droves. Many nationalized businesses also recorded frequent incidents of undisciplined behaviour and absenteeism.
by M. Rizwan Muzzammil
Introduction
The production of goods and services can be either through the method of supply and demand in the market economy (called the free-market), or through central planning by governments (called a planned or command economy). The two methods are polar opposites of each other and require substantially different government policies.
This article provides some examples of outcome where both methods have been tried. The information and historical evidence presented herein may be useful to rethink the programs towards restoring the Sri Lankan economy.
The material in the following sections has been condensed and reproduced from the book “The Power of Capitalism” by Rainer Zitelmann. The reader is encouraged to refer to this book for more details and factual references, as well as to learn about other economies not mentioned in this article.
Post War Germany
The situation of Germany after the Second World War is described for the reader to consider.
Prior to being split into the East and West, the German society shared much of the same values, culture and religion. Thus the difference in quality of life can mainly be attributed to the method of governance.
The Economy of East Germany
For 40 years after the Second World War, Germany was split in two. East Germany became known as the German Democratic Republic (GDR) as the governance was taken over by the Socialist Unity Party, while the west was known as the Federal Republic of Germany.
The government was heavily influenced by a central planning ideology. Industries were progressively nationalized such that by 1955, or 10 years after the war ended, 80% of production was by public enterprises.
By 1960 all districts across the country reported complete collectivization. The collectivization caused food shortages resulting in long queues outside butchers and greengrocers all over the country. Without the help of additional imports from the Soviet Union, East Germany’s food supply would have collapsed entirely.
During the 1960s, the supply of goods available to the general population deteriorated. Everything was in short supply, from meat and dairy to shoes, laundry detergent and all kinds of textiles. Shelves were often empty.
The living standards worsened due to the drops in production that were a result of the mass exodus of East Germans to the West. In 1961 the GDR leadership built the Berlin Wall to stop people from leaving. By this time the economy had lost about 13% of its workforce.
In order to afford the facilities and equipment required to modernize manufacturing, the GDR started borrowing money from West Germany and other Capitalist countries.
During the 1970s, and due to social unrest, the GDR implemented economic reforms which included repeatedly raising minimum wages, annual leave allowances and pension rates, while mothers of several children had their mandatory working hours reduced. A housing development policy was also launched. 1972 saw a further nationalisation of around 11,000 businesses.
These changes failed to improve the standard of living. One husband and father sent the GDR leader Honecker a dessicated orange while saying the following:
“When my wife was at our local sales point this week, she was lucky enough to receive an orange for our daughter because the delivery had been so ‘large’ as to include exactly one orange for every child in the town. Today we were going to give the orange to our daughter but were dismayed to notice that it was almost completely dessicated and inedible… Every day, like many workers in our country, we work for the common good of the people and deliver a high standard of quality. In exchange, we would really appreciate being able to buy QUALITY for once!!!”
The debts were no longer sustainable and brought GDR to the brink of insolvency. It was only through the guaranteeing of two loans by West Germany that a crisis was averted.
Despite investments in microelectronics and cars, the East German industries lagged many years behind the state-of-the-art and when compared to their West German counterparts.
During the 1980s, East Germans were able to watch TV shows from West Germany (even though it was illegal), and received parcels from family and friends over the border. West German goods were also available in the state-run Intershop outlets, although they could only be bought by those with foreign currency. This increased discontent and threatened social unrest.
The Economy of West Germany
The adoption of free-market principles in West Germany was mainly due to the efforts of Ludvig Erhard, who came from a family of entrepreneurs. Erhard firmly believed that economic freedom was the route to greater social welfare.
In 1949, Erhard floated the currency, and abolished the production and price controls that had previously existed. After these changes had been done the shop windows quickly filled with goods.
Between 1948 and 1960, the GDP of West Germany grew at an average of 9.3%. Unemployment had reduced giving way to full employment. The economy had also acquired a resilience which shrugged off several recessions and a global oil price shock in 1973.
West German manufacturing became well known globally for quality. BMW, Mercedes and Volkswagon were of significantly higher quality compared to the East German Trabant and Wartburg. While West Germans were able to visit the dealership at any time to buy a car, East Germans had to wait at least a decade.
In 1989, 12% of East Germans owned a computer while in West Germany it was 37%. Telephone coverage was 16% for the East vs 99% for the West.
In 1990, following the introduction of free-markets in East Germany, the gap between the East and West began to close rapidly. By 2006 the differences had shrunk to negligible levels.
The Social Market Economy - A Misnomer
Erhard’s economy was called a social market economy. This naming is frequently presumed to mean large-scale redistribution of wealth by an all-encompassing welfare state.
However this understanding is incorrect, Erhad, in a book published in 1957 titled Wohlstand Für Alle (Prosperity for all), said as follows:
“The ideal I have in mind is based on the individual’s strength to say”I want to prove myself by my own devices, I want to bear the risks of life myself, I want to be responsible for my own fate. It’s up to you, state, to ensure that I am able to do so“. The individual’s appeal to the state must not be:”Come to my aid, protect me and help me“, but the opposite:”Stay out of my affairs, but give me so much freedom and leave me enough of my earnings that I am able to shape my own existence, my fate and that of my family".
The Similarities between Venezuela and Chile
The reader is also invited to consider the economies of Venezuela and Chile. The people from both nations speak Spanish, and were culturally and traditionally similar before they each followed different economic policies leading to different outcomes.
The Economy of Venezuela
The reversal of Venezuela’s fortunes began in 1970, at which point the country ranked among the 20 richest countries in the world with a higher per-capita GDP than Spain, Greece and Israel, and only 13% lower than the UK.
A prime suspect for this reversal was the unusually high government regulation of the labour market, which was unprecedented in the world. The non-wage cost of employment rose from 5.35 months’ wages in 1972 to 8.98 months in 1992.
Chávez was elected to deliver the country from corruption, poverty and economic decline. Thanks to an oil price explosion early in his presidency, Chávez managed to fill the government coffers to the brim.
The oil and natural gas industry was nationalized in 1976 with the formation of the Petroleos de Venezuela, SA (PDVSA), for which operations were continued as a for-profit business. However Chávez disliked the independence of the company and stuffed the board with political allies and generals without business experience.
PDVSA profits were used for cash transfers to the poor, subsidies for food, housing, water, power and phone services. Filling up petrol cost next to nothing (tipping attendants would often cost more). The company even paid for welfare programmes for several cities in the US, Cuba and other allies.
The oil price increasing 10 times during the Chávez presidency seduced the government into enlarging the welfare program, rather than creating cash reserves to safeguard against future slumps.
The agrarian and industrial production decreased to a four decade low. In 2006 the government nationalized iron, steel, cement, food sectors, power utilities and ports. Between 2007 and 2010, 350 businesses were moved to the public sector. With one in three workers employed in the public sector the government payroll ballooned.
When the government offered tax and financial incentives to companies run by workers cooperatives, their number increased from 820 in 1999 to 280,000 in 2009. The majority were unproductive shell companies which existed only to access subsidies and cheap loans.
Chávez’s successor Maduro nationalized dairies, coffee producers, supermarkets, and fertilizer and shoe manufacturers. Production stopped entirely as a consequence, and when the oil price collapsed in 2013 the entire system fell apart. Inflation reached 225% in 2016, worse than anywhere else in the world except for South Sudan. In 2018, it ballooned to 14,000%.
Because many goods were subject to price controls, while raw materials and production goods had to be paid for in USD, the decline in currency led to severe shortages.
Shortages caused production to be suspended, but workers still had to be paid because of the ‘immunity decree’ - a Venezuelan labor law preventing worker dismissal without government approval. This labour law proved calamitous for companies that were trying to restructure. Badly managed public enterprises continued to receive generous subsidies which enabled them to retain more employees than needed.
Feminine hygiene products also disappeared from shops. Venezuelan women were urged to watch the state television channel which aired a tutorial on how to make your own washable and reusable sanitary pads. The demonstrator proceeded to also say: “We avoid becoming a part of the commercial cycle of savage capitalism. We are more conscious and in harmony with the environment.”
In July 2016, 500 Venezuelan women crossed into Columbia via a closed border for food. One woman told Columbian station Caracol Radio “We are starving, we are desperate”. There was nothing left to eat in the country.
A care worker in a retirement home told German reporters about her own desperate situation. Only 9 of 24 residents were left. The others had either died or been sent away because there wasn’t enough to eat or supplies of essential medication for diabetes or hypertension had run out.
A doctor, while subverting a ban, showed reporters around a public hospital where the only X-ray machine had been broken for a long time, and the lab was unable to process urine or blood samples. There was no running water in toilets and lifts were out of order. In general, hospitals were short of everything from painkillers to cancer treatment drugs.
In 2016, child mortality rose by 33%, women dying during childbirth rose by 66%, and infant mortality reached levels above UNICEF estimates for war-damaged Syria. 73% of the population experienced weight loss at an average of 8.7kg.
In 2016, four of five Venezuelan households were estimated to live in poverty with 52% of the entire population living in extreme poverty.
The Economy of Chile
Salvador Allende was elected to power in 1970. In his first official act he nationalized the copper mines, which were Chile’s most important source of income. Banks and other companies were also subsequently nationalized. By 1973, 80% of industrial production had moved to the public sector. Rents and food prices were fixed by the government, which also provided free healthcare.
To increase popularity, the government increased employment within itself and the public sector by 50% and 35% respectively. The increase in expenditure was financed by debt and money printing. A 10.3% increase in public sector investment counterbalanced a 16.8% drop in private-sector investment.
Nationalization caused highly skilled workers and experienced executives to leave the country in droves. Many nationalized businesses also recorded frequent incidents of undisciplined behavior and absenteeism.
16 million acres of land were expropriated, and the former farm owners were forced to work in agricultural collectives as public-sector employees. Productivity dropped and by 1972 Chile had to spend a large share of export revenue on food imports.
Inflation, which was 36% in 1970, skyrocketed to 605% in 1973. In 1971, thousands of Chilean women joined a ‘March of the Empty Ports and Pans’ on the presidential palace. In October 1972, half a million small business owners, farmers and self-employed professionals took part in anti-government protests.
In September 1973, General Pinochet took over power. Despite abolishing press freedom and democratic rights, the new government implemented a liberal, pro-market economic agenda. This agenda was masterminded by a group of economists subsequently called the ‘Chicago Boys’, as they were admirers and former students of Milton Friedman of the University of Chicago.
The Chicago Boys determined that the state and all enterprises linked to the public sector were the central cause of problems, and the less these interfered with the economy, the faster social welfare will grow. This understanding formed the background to the numerous economic reforms under Pinochet.
The government reduced public spending, deregulated the finance industry while reducing Central Bank autonomy, privatized state-owned enterprises (except for copper) and opened the economy to foreign investors.
The state-controlled enterprises dropped from 400 in 1973 to 45 in 1980. Government influence was minimized by abolishing price controls, wealth and capital gains taxes and reducing income tax. VAT became the main source of government revenue.
This resulted in an ‘economic miracle’ with Chile going from having chronic fiscal deficits to a surplus between 1979 and 1981. Inflation dropped from 605% in 1973 to 9.5% in 1981. GDP recovered from -4.3% to 5.5% and exports tripled from 1.3 billion USD to 3.8 billion. Non-traditional exports (i.e. excluding copper and natural resources) rose nearly 14 times from 104 million USD to 1.4 billion. Real wages, which had dropped 25% in 1973 grew by 9% in 1981.
The economic reforms had short term consequences, such as a rise in unemployment, but positive long-term effects. The standards of living improved as evidenced by the dramatic increase in car ownership registrations between 1976 and 1981.
Between 1982 and 1983 Latin America was plunged into a general recession that began with Mexico defaulting on its sovereign debt. While the reasons for the recession is subject to ongoing debate, it is clear that Chile was able to overcome the crisis much faster than its neighbours.
Long after Pinochet’s death, successive governments have persisted in low market regulations. In 2010 Chile, became the first South American nation to join the Organization for Economic Co-operation and Development - a clear sign that it had joined the ‘First World’. The 6% unemployment is about as low as Germany, and inflation is almost non-existent.
Chile has a functioning infrastructure, solid rates of construction and investment, and well-organized transport networks. The country experienced one of the highest economic growth rates in the world while at the same time privatizing infrastructure assets such as public transport, hospitals, prison, telecommunications, water and sewage management.
Despite accusations of inequality, the increased standards of living has benefited even the poor. Chile’s 18 million population has a per-capita income twice as high as Brazil, and poverty dropped from 20% in 2010 to 7% in 2014. During this period the poorest 40% saw incomes rise faster than the national average.
According to the Global Competitiveness Report compiled by the World Economic Forum, Chile currently has the most stable banking system in the region and some of the best conditions for private enterprise worldwide.
A Characterisation of the Sri Lankan Economy and the Way Forward
It is evident from the historical examples of centrally planned East Germany and Venezuela that Sri Lanka suffers much of the same ailments.
On the other hand, West Germany and Chile serve as good examples of the spirit and character of reforms necessary to bring about improvement.
It can therefore be concluded that a change to the policies of the free-market is essential to solving the serious economic problems of Sri Lanka.
It should be strongly emphasized that the free-market economy is a system that grows organically and spontaneously in the absence of government planning. The interpretation here is not that the government does too little, but rather it does too much!
This means the government must “let go”. It must relax its suffocating hands, liberalize and abolish laws that interfere with business. It must take determined steps to decouple itself from business affairs.
Government disinvolvement will allow free-markets to take over and entrepreneurs to do what is necessary to grow the economy. Entrepreneurs arrange resources to create resource increasing businesses. This can be anyone from three-wheeler drivers to the owners of large corporates.
References and Further Reading
- The Power of Capitalism by Rainer Zitelmann
- Entrepreneurship is the Key to Improving the Economy by M. Rizwan Muzzammil
(The writer can be reached via email at write2rizwan.m@gmail.com)
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