Economics and Economists:

Wide gap between textbook economics and business management

By Lloyd F Yapa

Ronald Coase, a Nobel Laureate in economics, writing in the Harvard Business Review, December, 2012 edition on 'Saving Economics from Economists' says, "Economics as presented in textbooks and taught in the classroom does not have much to do with business management and still less on entrepreneurship".

We, economists must examine whether this is true of Lanka as well. If not, the future generations of students studying the subject might ultimately realise that it helps neither them nor others especially, entrepreneurs to understand why it is being taught and give up the subject altogether.

The reason for this is that it has ceased to be a study of the "nature and causes of the wealth of nations" as Adam Smith, perhaps the originator of modern economics, introduced his work, 'The Wealth of Nations', which according to Coase was read by businessmen and politicians at the time, well no longer.

Paradigm shift

He says in the article, "the field (economics) experienced a paradigm shift, gradually identifying itself as a theoretical approach, giving up the real world economy as its subject matter". At present the subject is not only theoretical but technical with mathematical calculations which the ordinary person or the businessman will not understand. So they will run to the politicians for solutions and not to the economists.

In fact, Coase says, "In times of crisis, when business leaders lose their confidence, they often look to political power to fill the void".

Sri Lankan situation

How true, when considering the Sri Lankan situation? Lanka's businesses usually demand import duty, tax and tariff protection from the politicians and get it readily (the trade weighted tariff rate for Sri Lanka was 124, versus 2 for Singapore, Global Competitiveness Index 12/13,) to serve the small domestic market; both parties do not seem to know or ignore the fact that a small market cannot continue to drive economic growth in the future, unlike exporting to global markets which would allow large scale production, to realise economies of scale i.e. for unit costs to come down and induce innovation.

The protection and other barriers like 'red tape' (Ease of Doing Business Index 2013 ranks SL at 85 out of 188 countries) create an export bias, (though duty and tax imposed on export inputs are exempted or withdrawn by other means, which also involves some 'red tape'). So much so that exports have started to decline (from a high of 33% of GDP in 2004) to 17.7% and 16.6% of GDP in 2012 and 2013.

The signal from South East Asian nations such as Hong Kong, Singapore, Taiwan and Malaysia however, is different. It is exports or an emphasis on export promotion, (with a certain degree of protection for domestic market-oriented industries as in the case of the last two countries) can in fact speed up economic growth and alleviate poverty.

Have we economists, succeeded in highlighting the danger of a high degree of tariff protection for domestic market-oriented activities versus a reduction of tariffs to a reasonable level so that the competition and rivalry among firms will compel them to invest more, innovate and become export competitive?

Or is the failure due to the absence of understanding of the subject by the politicians and policy makers? It could be both.

To make matters worse we are here engaged in a 'socialist' versus 'neoliberal' theoretical argument without being practical like the Chinese and opt for export growth to earn scarce foreign exchange.

"What does it matter whether the cat is black or white as long as it catches mice?" ( Deng Xiaoping)

Production marginalised?

Coase also says, "today, production is marginalised in economics and the paradigmatic question is rather a static one of resource allocation". Capacity for production of goods and services in these countries have been created by high levels of investments, particularly of the foreign direct type (due to the confidence they had in the stable business-friendly climate in the countries) which have increased production capacities, while bringing in developed technologies, management skills and market access.

This was accompanied by significant improvement in productivity (let us define it as more output and returns from lower inputs and costs) due to trading with the bigger external markets and investment and development of key factors of production such as human resources to create technical and behavioural or soft skills (like creativity to undertake innovation, communication, ability to work in a team to achieve targets).

Other factors of production liberalised and developed by them to improve productivity included land, labour, capital, physical infrastructure and value chains. In Sri Lanka, however, import substitution and development of services have taken the place of increasing production of goods, particularly value-added manufacture for export, and the creation of skills.

Is this on account of the 'marginalisation of production' and as Coase adds, due to "the reduction of economics to price theory" (body of theory concerned with the determination of prices on the basis of supply and demand) on the part of economists the world over and us in Lanka.

Personal judgments

Coase continues that "since economics offers little in the way of practical insight, managers and entrepreneurs depend on their own business acumen, personal judgments and rules of thumb in making decisions".

This might be correct as we economists in Lanka too might take it for granted that as long as the State gets it correct e.g. where the enabling business environment and policies are concerned for investment and production, the firms will do the right thing in management and profitability of earnings.

But the problem is that Lanka had not been getting it right almost from gaining independence, for short-term political gain and most of the firms (least of all the State-owned enterprises) too have not fared well in business management.

Thus for instance, according to the Global Competitiveness Index, 2014-15 Lanka's ranking in respect of Institutions is 75 (77), Macroeconomic Environment - 114 (120), Higher Education and training efficiency - 72 (62) Goods Market Efficiency - 39 (37), Labour Market Efficiency - 135 (135) and Business Sophistication 39 (34), out of 148 countries (previous year within brackets).

One of the reasons for this could be that we economists may have in addition avoided the study of micro economics (or 'the study of the behaviour of consumers and firms along with price determination of factor inputs - such as labour and land, 'goods and services'), besides being unsuccessful at conveying the seriousness of the macroeconomic situation (though it has somewhat improved in recent years).

Coase says, "The tools used by economists to analyse business firms are too abstract and speculative to offer any guidance to entrepreneurs and managers in their constant struggle to bring novel products to consumers at low cost".

Competitiveness

The last few words, "bring novel products to consumers at low cost", obviously refers to the ability to do so due to the improvement of global competitiveness, which involves investment in production, a high level of productivity and innovation for differentiation of operational activities, (including motivation of workers) and goods and services marketed, to satisfy the needs of customers.

Lanka's competitiveness at present does not seem to be good as attested by the latest Global Competitiveness Index (GCI) of the World Economic Forum. The rank of Lanka's competitiveness according to the GCI in 2014/15 is 73 out of 148 countries (2011/12 rank 52 out of 142 countries), while it is 2 for Singapore, 7 for Hong Kong, 14 for Taiwan, 20 for Malaysia and 26 for South Korea. This is one of the reasons for Lanka's poor performance where exports are concerned.

Rural agriculture

This neglect of micro economics by all parties could be true where Lanka's rural agricultural enterprises are concerned as well, though the sector (on which about 17 million people depend directly or indirectly) has much potential, (since value added per worker in agriculture in Sri Lanka had been only US $965 in 2010 compared to Malaysia's US $ 6680 in 2010 and Japan's US $43,000 in 2011).

This is apparent from a number of facts. More than 80% of the land is State-owned and Governments have been parcelling out land at the rate of about three acres per rural farmer under the Land Development Ordinance (LDO).

The average extent of a holding has become too small (about 50% of holdings being below 1/4 acre due to uncontrolled fragmentation) for obtaining economies of scale and improving productivity. This is subsistence farming and since the farmers do not own the land under this system most are not inclined to invest in farming as a business.

Even if they wish to do so, they will not be able borrow any capital, as banks usually do not accept the LDO permits as collateral for loans. In the case of privately held land, the situation is no better as in most instances, there is acute fragmentation of holdings. The titles of the land they hold are not clear and the owners waste their energies on interminable litigation.

Policy makers and economists like us have ignored the obvious solution, that is to undertake land reform and grant of freehold possession of State land to the LDO farmers and the clarification of the titles of the privately held farming land to get a land market functioning, while investing in expansion of manufacturing to absorb the excess employment in agriculture (32% of total employment).

Systematic investigation

Perhaps we economists may not have highlighted these problems not only because of a neglect of micro economics and diffusion of the information among firms but also due to the fact "production is marginalised" according to Coase.

It may also due to the fact that we tend to specialise in specific and narrow areas of economics rather than looking at the whole as well, (as Coase says " systematic investigation of the working of the economy") and focusing on key result areas for formulation of development strategies.

Coase rounds up by saying, "Economics thus becomes a convenient tool, the State uses to manage the economy, rather than a tool the public turns for enlightenment about how the economy operates".

This is, therefore, a signal for us economists to take a look at the subject, answer the questions raised and indicate how it could be studied and analysed and to determine how the resulting information could be diffused for making the public and businesses aware of the operation of our economy and of the firms so that they could use the knowledge to pressurise politicians and policy makers to take the right decisions regarding development.