Liberalising air links

By Ravi Ratnasabapathy

According to news reports, Sri Lanka's President Maithripala Sirisena has asked Qatar to partner with the island's troubled national carrier SriLankan Airlines. The President’s move is to be commended: the airline has racked up billions in losses, getting rid of it will allow the Government to focus its limited resources on priorities such as health and education.

The argument about the airline has been muddied by emotion, the people; for it is ultimately the people who pay for this; must ask if this is the best use of taxpayers' money.

The annual report for 2016/17 reports that the Srilankan Airlines Group recorded a loss of LKR 28bn (2016 – LKR 12bn) with an accumulated loss of LKR 170bn (2016 – LKR 141bn) as at March 31, 2017. The Company’s current liabilities exceeded its current assets by LKR 99Bn (2016 – LKR 73Bn) and the total equity of the Company as at Reporting date has declined to a negative LKR 116, Bn (2016 – negative LKR 88 Bn).

The Group is technically insolvent and the Auditor General has warned that “a material uncertainty exists that may cast significant doubt on the Group’s ability to continue as a going concern”. The Auditor General has relied, inter alia, on two letters of support: a letter issued by the Secretary to the Treasury on December 23, 2016 and Cabinet approval on July 18, 2017 as notified by letter dated July 26, 2017 confirming the support of the Government of Sri Lanka (GOSL) to the Company to continue its operations as a ‘Going Concern’. In a layman’s terms, unless the Treasury (read taxpayers) is willing to underwrite the activities of the airline it will go bust.

The airline is in debt to the Bank of Ceylon and People’s Bank to a total of Rs.49 bn as at March 31, 2017. The banks have extended support to the airline on the basis of letters of comfort issued from the Ministry of Finance. Further, the airline owes Rs.26.5 bn to international bondholders which are secured on the basis of a Government Guarantee of USD 175 mn. The guarantees extended by the Government to banks and bondholders represent additional potential losses of public funds.

The airline last reported a profit only in 2008, when under the management of Emirates. It has failed to report a profit in any year since then. The airline industry is a high risk, low profitability business. A study by Oliver Wojahn for IATA published in 2012 shows that the overall airline industry has failed to cover its cost of capital in all years except six, since 1981. The study covered 69 public listed airlines worldwide, covering roughly 70% of the airline industry.

Future losses

Sri Lanka has obtained a loan from the IMF a loan US$1.5 billion (the second since 2009, the previous administration borrowed US$2.6 bn) to attempt to put public finances in order. It is sobering to note that the accumulated losses of the airline (just over a US$1 billion) are 65% of the IMF loan. Sustaining further losses is suicidal and tax increases to fund these and future losses represent an unacceptable burden the public.

Sri Lanka does need air connectivity but this is best provided by liberalising air services, not by running an airline. A good example is an extensive liberalisation with India which took place in 2003. Prior to deregulation, only the national carriers of the country were allowed fly, the number of flights was restricted, the pricing was regulated and the destinations controlled.

The liberalisations were in the areas of pricing, competition, capacity and new routes. Market forces were allowed to determine prices as opposed to being set by the two governments. A report by Raveen Ekanayake of the Institute of Policy Studies in January 2016 notes that:

“The benefits of liberalization are clear... passenger traffic between the two countries more than doubled in the immediate wake of liberalization in 2003 and has since increased. The bulk of the new traffic being generated is a result of the relaxation of capacity constraints on metropolitan destinations.

The improvement in air connectivity has facilitated the movement of people to forge trade, investment, and cultural linkages between the two countries. The tourism industry in Sri Lanka, in particular, has been a major beneficiary….. During the early 2000s, India in terms of volume was the 3rd top source of tourist arrivals to Sri Lanka after the United Kingdom and Germany. By 2004, India had jumped to the second place and by 2005, India became the top source of tourists to Sri Lanka, surpassing the United Kingdom by as much as 20% in terms of tourist numbers. Since then India stands as the top source of tourist arrivals to the island.”

This is not an isolated experience, it is confirmed by numerous studies including one by IATA which showed that traffic growth subsequent to liberalisation typically averaged between 12% and 35%, directly benefiting economies by increasing GDP, employment, tourism, and exports. According to the IATA report, the creation of the Single European Aviation Market in 1993 led to average annual growth doubling between 1995-2004 compared to growth in the years 1990-1994. The US-UK agreement lead to an almost 29% increase in traffic.

Aviation hub

Singapore’s liberal aviation policy has been a key factor in the growth of Singapore’s Changi International Airport, where air transport contributed nearly S$20 billion of value-added to the Singapore economy or about 6% of the Singapore GDP in 2011.

A national carrier is a source of pride but it is not a priority for cash-strapped Government. The airline should be disposed, or even closed and a liberal air services policy adopted instead.

This could boost growth and truly turn Sri Lanka into an aviation hub, freeing taxpayers’ money to be used for health, education and other priorities. 

Liberalising shipping agencies the first step to transform Colombo into a maritime hub

The article was published on - FTDaily MirrorCeylon TodayThe IslandDaily News

 

Last week’s budget contained important proposals around the liberalization of the shipping sector.

The port played a significant role in the development of  maritimes hubs such as Singapore, helping the country become a first world economy in a generation. With the right reforms, Sri Lanka’s ports could do the same.

Singapore’s domestic market is small-but its trade volumes massive: trade value is 3.5 times its GDP. Transshipments make up 85% of Singapore’s port’s volumes. Sri Lanka has 750 local shipping, freight forwarding and clearing agents but Singapore open market has over 5000.

The availability of frequent and reliable connections via sea and air (thanks to liberalisation) encourages companies across the logistics chain to operate from Singapore. High-frequency connections sometimes allow goods to reach their destination faster via Singapore than they would through direct shipments.

A foreigner-friendly regulatory environment has attracted investors to Singapore.  Around 20 of the world’s top 25 logistics companies have based their global or regional operations in Singapore. The presence of these big firms drives local companies to emulate international standards

The Colombo port starts with a number of advantages; well situated on the trade routes, it has a deep enough draught to accommodate post-panamex ships.

With a limited internal market Sri Lanka, like Singapore, cannot depend on traffic from its hinterland to develop its port. It must depend on transshipment traffic. Colombo already handles a significant amount of transshipment – 75% of volume; but mostly to India. The expansion of Indian ports poses a threat to this business, but to truly become a hub Colombo needs to look beyond our largest neighbor.

Transshipment is a service that does not add any value to cargo. To grow this service lower business costs and productivity are critical. Fast turnaround times and competitive rates are needed but Sri Lanka’s restrictive ownership rules and fixed fee structures result in higher costs.

Unlike other major ports where cargo handling rates are determined by market conditions, Sri Lanka’s are set by the Central Bank which decides on agency and transshipment tariffs to local agents. The current fee structure is complicated, encourages malpractice, is determined arbitrarily and adversely affects port and logistics industry competitiveness.

To shipping lines working with very thin margins this fixed fee structure represents a significant additional cost. This limits transshipment volumes to the essential-those that flow naturally due to location. Shipping lines have little incentive to route cargo from further afield.

The budget proposes to lift restrictions on foreign ownership of shipping agencies and the creation of a port regulator. This is the first step towards attracting the interest of  large global shipping lines.

Sri Lanka will not  become a logistics hub without significant participation of global players. Substantial investments and presence of global firms active on ground is essential toward making the hub ambitions a reality.  

With the right reforms in place,  Sri Lanka could look to attract attract Maersk or another leading shipper to establish its South Asia hub in Colombo. That would go well beyond its limited activity with its present JV arrangement with a local agent.  Sri Lanka can use this anchor investment, to  attract other leading shippers to do the same, thereby creating critical mass.  This would result in a larger industry, more jobs and more opportunities for the industry as a whole.  

This would make Sri Lanka fertile ground for the top freight forwarders.  It might persuade DHL or others to look at Sri lanka sa a regional hub and  large e-commerce companies such as Amazon  to use Colombo for warehousing.

This is why the liberalization is needed.  To develop, the logistics sector should be open to foreign participation and restrictions (eg Sri Lanka Ports Authority monopoly on destuffing local loose cargo), regulations on terminal handling charges etc. should be removed. Foreigners should be permitted to invest in freight forwarding and the minimum investment thresholds and export revenue requirements imposed to be eligible to invest in declared free ports should be eliminated.

Warehousing space available within the port is limited and outdated. To support the growth of the logistics business, private investment should be permitted within the port; to build and operate new, upgraded warehouses. Alternatively, there should be zoning of a warehousing district outside the port but in close proximity to it (like Singapore).

Other investments include creating logistic networks between producer and consumer areas, markets and transport nodes that connect to the Colombo port, industrial zones and Inland Container Depots (ICD) that speed port access and support a modern logistics corridor.

The presence of global third party logistics firms in Sri Lanka will enhance the confidence of multinational manufacturers who will be more willing to use Colombo as a destination for value added logistics functions (e.g. packaging, labeling, quality checking, simple assembly) etc.

These firms will bring new technology, new knowledge about logistics and supply chain management and are experienced in managing highly sophisticated and complex supply chains for their clients. It is the trust the global firms have in their logistics companies that make them outsource key logistics and supply chain functions and their presence firms will be a huge value add to the location advantage of Sri Lanka.

These firms will also help market Sri Lanka as a destination for logistics- which is needed to get business. This is far easier for such firms with their global presence and networks, than for local businesses.

This would form the core of a maritime-cum-logistics hub as these anchor investments create an ecosystem of supporting services -- financial, legal and other professional services. A maritime-cum-logistics hub would be a boon to competitive local companies with relevant service-support skills, and allow some of the bigger competitive companies to go global.

The Colombo International Financial Centre, a financial hub between Dubai and Singapore, is underway within the Port City. Along with the proposed National Logistics Policy for Shipping and Air Transportation, and the Telecommunication Connectivity Policy it will establish Sri Lanka as the hub of the Indian Ocean.

Production and service standards would improve massively from their present woeful state, with more transparency and less corruption.

This aligns with the Port City, linking up the port and airport, a hub around the airport as part of bigger Vision 2025 plans and would be the beginning of Sri Lanka's insertion into global value chains beyond garments. The big prizes are in services, not manufacturing, especially with the "servicification" of Global Value Chain.

The lower cargo handling costs and greater efficiency will create spillover benefits to local exporters who will increase their competitiveness, further driving volumes.

Opening up the agency business does not necessarily mean the end of the local agents; Singapore has over 5000 agents and sub agents working for ship owners/operators in numerous support businesses.

The shipping and logistics business is continuously evolving and new competition is emerging. An ADB working paper opined that “Slow implementation of the Colombo outer harbor development plan has already caused significant damage to Colombo as a transshipment hub. This damage may be repaired but it is unlikely. Further threats to its current role exist, not least the further development of ports in India”

Sri Lanka has been lucky for a long time, because we still retain our advantage in terms of serving the Indian Sub-Continent cargo but it is naive to imagine that this will last. Sri Lanka is operating far below its potential, especially in terms of logistics. Therefore, it is important to remove all constraints which prevent us from reaching our potential.

The budget proposals are a good start but full reform package of port, shipping and warehousing services is needed. This presents much greater opportunities for existing players in the long term and they should seize the challenge. Unless reforms take place we may well find ourselves stagnating while traffic moves to competitors.

Competition is the long-term answer to the fuel crisis

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Originally appeared on FT

One shipload of refined petroleum was rejected because of quality issues. Another was delayed due to rough seas. Rumors and ill-considered ministerial statements caused consumers to want to stock up.  Day-to-day activities were affected and livelihoods were harmed.  

Conspiracy theories abound. Some see an effort to benefit from emergency fuel purchases. Others speculate about efforts to dump poor-quality fuel. Even if we eschew conspiracy theories and speculations, we still have a problem: it’s difficult to get petrol for vehicles and vehicle queues are causing traffic jams. What caused all this?

How can recurrences be avoided?

The larger problem is how we manage risk. In any industry, bad things happen. Suppliers do not deliver; supply lines get disrupted. Every commercial organisation analyses its risks and makes plans to mitigate them.  Infrastructure services, which are provided directly by the state or under state authority, pose additional problems.  They are essential for the smooth functioning of many other activities.  Failure has enormous knock-on effects.  One of the biggest challenges facing modern states is how to manage increasingly complex forms of risk.  What we are seeing now is how bad we are at this.  

The facts

The fuel-distribution market (defined as starting from the gate of the storage facility to the pump) is a lopsided duopoly.  The market shares are 85% for the state-owned CPC and 15% for LIOC.  For the major markets on the west coast of the country, both companies use a Common User Facility (CUF) to store refined petroleum.  

The fuel is in the same tanks, but in the books, each knows how much stocks belongs to each.  To illustrate, the Kolonnawa facility can store 50,378 MT of 92 Octane petrol and 18,647 MT of 96 Octane petrol. If this were allocated by market share, 43,000 MT of 92 Octane capacity would be for CPC and around 7,000 MT for LIOC. In the case of 95 Octane, around 16,000 MT would belong to CPC and the rest to LIOC.

The CUF is operated by Ceylon Petroleum Storage Terminals Limited (CPSTL), a majority state-owned company. In Trincomalee, LIOC has its own storage facilities. There have been moves to increase storage in Trinco through a joint venture and also to expand capacity in Kolonnawa and Muthurajawala to serve the high-demand markets on the west coast. There are costs to moving fuel from Trinco to the west coast.

Each distribution company purchases its own petroleum products and arranges transportation. But because all the fuel goes into common storage tanks, the Ministry ensures that every shipment meets quality standards. 

A shipload of fuel supplied by Total S.A. to LIOC was rejected in October 2017. Total is a French integrated oil and gas company that is one of the seven “Supermajor” oil companies. Once the shipment was rejected, it became the responsibility of Total to fulfill its contractual obligations to LIOC. An offer had been made to filter the fuel in a ship-to-ship operation, with the filtered product still having to meet the quality standards.  This offer was rejected by the Ministry.

A ship that was scheduled to arrive in Colombo with fuel supplies for CPC was delayed, reportedly because of bad weather. The delay of two shipments within a short time caused concerns that supplies would not be adequate. Supplies from LIOC’s parent and emergency purchases in the spot market by CPC would still take time to arrive. Demand surged because of rumors and perceptions of the Minister’s statement. Supplies to both CPC and LIOC were rationed at the CUF. Reduced supplies and increased demand led to queues at the retailing points.

How can a recurrence be avoided?

An obvious solution is to increase buffer stocks. Much of the discussion around the Trinco tank farm centered on this solution. But keeping stocks is expensive. The Petroleum Ministry has budgeted Rs. 495 million for the construction of a new 15,000 cubic meter tank in Kolonnawa.  In addition to capital costs, there are the costs of holding stock instead of selling. It may be expected that CPC’s already high debt levels (Rs. 308.5 billion in 2016 and Rs. 382.5 billion in 2017 Q1) will rise even further if it were to engage in stockpiling.

Given increased motor vehicle imports since 2015 and the resultant increase in fuel consumption, it is understandable that the quantum of stocks should be reassessed.  Imports of refined petroleum increased by 17% from 3,321 metric tons in 2015 to 3,885 MT in 2016.  

Should the government decree the levels of buffer stocks to be maintained, or should it leave it to the market?  

Sri Lanka does not have a competitive petroleum market.  State ownership and involvement pervade the entire sector.  The dominant supplier, holding 85% of the distribution market also controls the upstream storage and transmission facilities through majority control of CPSTL. The Ministry is policy maker and price setter. There is no independent regulatory authority. 

If the market were to be made workably competitive, for example by allowing at least two more additional distributors to reduce CPC dominance and by restructuring CPSTL, decisions regarding buffer stocks and quality may be left to individual distributors under the oversight of an independent regulator.  In such a scenario, where the consumers have choice of alternative suppliers, no distributor would want to run out of fuel. There would be no crisis, because customers would simply obtain supplies from competitors. They may come back when supplies return to normal, or they may not.  

Given the market power of the operator of the Common User Facility it may be wise to mandate buffer-stock levels. Of course, there is no requirement that all retailers must draw from a CUF. If they are given a ‘build or buy’ option, the market will decide on the most economical solution.  Where all retailers of fuel have their own storage facilities, it is common practice in other countries to engage in various kinds of swap arrangements, in normal times but especially in times of supply problems such as we are experiencing now.

In conclusion

Risks cannot be eliminated. But they can be managed well or poorly. Building in redundancy is a solution, but it has to be balanced against cost. With highly centralised operations such as those that exist in the petroleum distribution market, state involvement in mitigating and managing risk is essential. But the costs will have to be borne by the tax payers because the government does not have money of its own. In a workably competitive market, the risks can be distributed and there would be less need for government involvement.  

In the short term, the government should ensure that CPSTL maintains buffer stock adequate to avoid disruption of the kind experienced this week. But the long-term solution is to permit more suppliers to enter the market which will allow decentralisation of risk. 

 In a competitive market, the costs of poor management that results in expensive spot-market purchases will be borne by private companies. In the present centralised market which is pervaded by state control, the costs of emergency purchases will be borne by the taxpayer, who is already looking at Rs. 3.8 billion in losses by CPC just for the first quarter of 2017.


Rohan Samarajiva is the chair of Lirneasia and an advisor to Advocata Institute.

How we eat now and then

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As the prosperity of a country (or a household) increases, it has been observed that protein consumption goes up. This appears to happening in Sri Lanka as demonstrated by the findings of the last three Household Income and Expenditure surveys, as shown in Figure 1. 

Chicken, it is well known, is one of the most popular protein sources among Sri Lankans. It has increased from an average of 233 grams per month per household to 387 grams by 2016. This was a 66% increase over six years. 

Dry fish was for a long time a major source of protein for Sri Lankans. It is the only one which shows a small decrease over the past six years. It’s possible that it is being substituted by fresh fish, but unfortunately information on fresh fish consumption has not been provided in the recently issued summary report. For that, we will have to wait for the final report.

Consumption of dhal, another major source of protein, has also increased over the three survey periods, though not by as much as chicken. 

Because we are marking the 40th anniversary of the 1977-78 economic reforms, it would be interesting to compare the protein consumption patterns prior to the reforms and now. A direct comparison is not possible because the data are taken from a report prepared by Dr. Brighty de Mel in 1978 using different units (daily per person, rather than monthly per household) based on an official socio-economic survey. 

But the overall picture that she painted was a grim one, where protein consumption was more than halved during the socialist experiment of 1970-77. During that period, food imports were rigidly curtailed. For example, the import of dhal was altogether banned. Dry fish was only available through the State-controlled ration shops (cooperatives), through unofficial back markets flourished. The government decided what people ate, issuing dried sprats one week and a different kind of dried fish another week.

Dr. de Mel reported that the calorie and protein consumption of the poorest 43% of the population fell below the minimum levels of 2,200 calories and 40 grams of protein. Physicians active during that period have recounted that they observed cases of Marasmus and Kwashiorkor even in the city of Colombo. 

So it appears that people are eating much better under the open economy than under the closed one. The numbers should be educative for those who still hanker for State control of the economy.


Rohan Samarajiva is the chair of Lirneasia and an advisor to Advocata Institute.

Sri Lanka needs specialist skills from abroad to grow faster

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State Minister for Finance Eran Wickramaratne’s comments that the Government will cut red tape in issuing visas to fill critical skill gaps is a welcome development as it will help Sri Lankan businesses grow faster, win bigger contracts and employ more people.

Shortages are apparent in several sectors as Sri Lanka’s labour market with unemployment falling to 4.4% in 2016 from 6.5% in 2006. Tourism, agriculture and construction sectors are among those complaining. The leisure sector not only needs well-trained workers until domestic training catches up, but also specialists with Chinese language and cooking skills to cater to a sudden influx of tourists from China.

Firms in Information technology and business process outsourcing (IT/BPO) sector are also finding it difficult to get specialist workers in particular.

The difficulty in getting specialist skills has stifled an entire eco-system of small, medium and start-up companies that are emerging, preventing them from winning bigger contracts and growing faster. A growing information technology sector, where more small companies expand rapidly, or which drawn outside investments, can also help retain some of the most talented IT professionals who are now migrating due to lack of upward career growth. 

The tech entrepreneurs who are complaining of skills shortages are also IT professionals. 

Fear psychosis

The proposal to streamline the process of sourcing labour from overseas has triggered a protest from one group of information technology workers. 

Though it is understandable that these workers fear that they may lose jobs, IT workers-turned SME entrepreneurs say there is not enough awareness in the country about the dynamics of the market, which are fast changing and how cutting red tape will bring benefits for everyone including workers themselves.

Those chasing short term gains and protection, will not only deny an opportunity for Sri Lanka to grow, but may also hurt themselves in the long term, by denying opportunities for career growth.  Meanwhile other countries are not standing still. Countries like Vietnam, which are more open in multiple ways, is already ahead of Sri Lanka in the BPO game, is overtaking others.

Past experience has shown that clearing bottlenecks and removing roadblocks can unleash growth and employment.

Sri Lanka’s IT service sector got a firmer foothold in the global market 1990s when the then telecom minister broke a monopoly held by Sri Lanka Telecom by introducing competition. An international voice and data monopoly was broken a few years later, ending another protection afforded to SLT, cutting costs and making the IT sector competitive. 

Though Sri Lanka Telecom lost market share, its business is now part of a bigger pie and the firm is better positioned deal with competition from services such as Viber and WhatsApp. The entire country also has access to cheaper telephony and faster data services. Many people have found work in businesses connected to the telecom sector.

The fee levying Sri Lanka Institute of Information Technology (SLIIT) was also set up in the late 1990s, partly with the intermediation of the Board of Investment, giving economic freedoms to many students who would otherwise have been hurt by a road block in the form of a tax-payer funded state monopoly in IT degrees.

At the time there was no Government IT Officers Association, like in the medical sector or any such body to prevent these freedoms from being given to the students and the country, after resistance from Sri Lanka Telecom was dealt with.

It is therefore important to understand the issues and dynamics at play in the software and information technology market, particularly in the small, medium and start-up sector, and why tech entrepreneurs want foreign specialists to grow faster.

The skills gap

The Sri Lanka Association of Software and Service Companies (SLASSCOM) says about 3,000 students qualify from State universities each year. Reliable estimates are unavailable of private sector output or migration.  The best graduates are snapped up by the largest players. Some are also absorbed by firms catering to the domestic market. Some qualify in hardware and networking areas.

But it is a fact that large companies like Google and Microsoft who employ a 1,000 or more workers in a location are not coming to Sri Lanka. The IT/BPO industry is estimated to employ around 80,000 people of various disciplines. Understandably existing industry players may also be comfortable with this situation as the entry of any big name can lead to poaching and a steep rise in wages. 

The problem of attracting large tech companies who need a large volume of labour is one side of the coin. The lack of specialist skills is another one.

Given that Sri Lanka is a small market students tend to go on a more general route. It may not make economic sense to go for additional qualifications especially when it is quite easy to get a well-paid job with expertise in general areas.

But the industry is changing fast and new skills are needed. At one time a programming language like Python may be ‘hot’. At another time there may a shortfall of good User Interface and User Experience (UI/UX) specialists, who will design and build the front end of an application so that users can do their work easily and with as less training as possible. 

The list goes on, and it changes rapidly.  

Unleashing the SME ecosystem

Industry watchers say there is a trend where entrepreneurial software engineers with several years of experience under their belt, are setting up small outfits to cater to the international market.  They have know-how, some management skills and customer relationships to work with foreign clients.

For a small company, getting the right mix of specialist skills is not easy, especially when requirements change rapidly.

For example a Sri Lankan SME bidding for a contract in Europe may require a 30 software engineers, but the client askes for five certified usability testers. Another deal may require five qualified data scientists. The company may have 25 staff, but lack the five specialists. They will have to give up the job, when specialists are not available even if the client firm is willing to engage them.

Sometimes such talent may be available from a larger company, but poaching them at high prices may make the bid unviable.  Due to the lack of specialist skills, many SME founders say they are now hitting a roadblock.

IT entrepreneur say that Indian or Filipino developers are not necessarily cheaper to employ than Sri Lankans, with living costs in Sri Lanka being higher than in countries like India.

Migration and lack of career growth

A fast-growing industry will also help reduce the migration of seasoned professionals, which is a big problem dogging the industry.

Currently IT professionals who gain experience and reach lower management level find that there is not enough opportunities for career growth due to the slow expansion of the industry.

By the time a tech professional gains mid-level experience, the salary gap between Sri Lanka and other markets widens. With limited options at home, these professionals migrate. 

If the industry grows faster, more experienced IT professionals will remain in the country. By opposing measures that may make an industry grow faster a section of IT workers may be denying themselves and their colleagues’ opportunities for career growth.

Lagging behind

As it happened with products exports, there are fears that Sri Lanka is lagging behind, though the country may have been a pioneer in removing the first state controls.

In the Global Services Locations Index compiled by AT Kearney, Vietnam was ranked 19th in the world in 2007, with a People Skills and Availability score of 0.99 points.  Sri Lanka was only slightly behind with a score of 0.96.By 2017, Vietnam had moved to 06th place, overtaking the Philippines. Vietnam had radically improved its score in People Skills and Availability to 1.39.  Sri Lanka’s score in the People Skills and Availability sub-index had only improved to 1.07 points.

Philippines had been a leader in East Asia due to its English ability. Vietnam had an early start serving the Japanese market but big Western firms are now moving in.AT Kearney noted that a “significant percentage of the predominantly young Vietnamese population is now fluent in English”. 

Young Vietnamese are learning English quickly due to a booming formal and informal private education system staffed with teachers from the US, UK and Australia who are moving to the country easily.

Clearing roadblocks

The start-up boom and the wide adoption of software in the local market offers hope. But it can be realised by being open to investment and talent. 

When more Sri Lankans work with specialists, they will also acquire some of the know-how as knowledge diffusion occurs faster when people move. 

SLASSCOM, the industry body, has recommended that a program be launched to attract diaspora and international knowledge workers, a non-resident type dual citizen scheme be introduced and easier visa and work-permit process for knowledge workers similar to an existing program to attract regional headquarters of global companies to Sri Lanka be offered.

Sri Lanka should not just think about clearing red tape for easier sourcing of specialist skills as the Government plans, but move beyond and think about a structured skilled visa programme along the lines of other countries that are technology hubs.

Other countries are moving even further. Thailand recently announced a four year ‘smart visa’ for business professionals without the need for a work permit. 

Sri Lanka plans to be a service hub for the Indian Ocean. These lofty goals cannot be reached without quick access to knowledge workers who will in turn impart their knowledge to Sri Lankans.

Sri Lanka ranked 92nd in Economic Freedom of the World Index; it can do much better

By Fred McMahon

Originaly appeared in Daily FT

As Sri Lanka celebrates the enormous benefits brought forward by four decades of the open economy, Advocata Institute looks back at the economic progress of the country and the benefits that have been passed onto the man on the street. 

From 1977 to date Sri Lanka’s economic growth over the last 40 years has expanded four-and-a-half fold on a person basis on an inflation-adjusted term. However, despite Sri Lanka opening its doors 40 years ago, the benefits and prosperity would be much greater if the economic freedom of Sri Lankans was increased. In the just released 2017 Economic Freedom of the World Report, produced by Canada’s Fraser Institute, Sri Lanka ranks 94th out of 159 jurisdictions.

Sri Lanka’s Advocata Institute studies and promotes sound economic policy for the nation. Starting 11 October, Advocata will hold an innovative conference – Economic Freedom Summit – which I am honoured to attend, to help build increased economic freedom for the people of Sri Lanka.

Sri Lanka’s growth may sound impressive, but consider Taiwan, which has long had a high level of economic freedom and ranks 32nd in the world. Its economy on a per person basis is eight times larger than it was in 1977, almost double the growth of Sri Lanka.

The longer-term effects of economic freedom are even more impressive, leading to greatly increased prosperity. Consider Hong Kong and Singapore, two tiny resource-poor places, but now number one and two in the world for economic freedom.

Singaporeans, averaged over the population, produce 14 times as much wealth per person as Sri Lankans; for Hong Kong, it’s 10 times as much. Taiwanese, with a lower level of economic freedom than Singapore or Hong Kong, but much higher than Sri Lanka, produce nearly seven times as much per person.

Why does economic freedom create such prosperity? Economic freedom is the ability of individuals and families to make their own economic decisions—what to buy, whether to set up a business, where to work or whom to hire, and so on—without interference from government or powerful interests of its cronies.

More than a century of experience has shown that the drive and ingenuity of individuals beats government planning or cronyism hands down in growth and prosperity.

With economic freedom, businesses can freely enter the market and consumers have choices. With a world of choice, every exchange must benefit both parties or the party that would come up short would reject the exchange and go elsewhere. This forces producers to constantly improve price, quality and innovation, driving productivity and economic growth and creating jobs.

The results are amazing, and not just for the rich. In the quarter least free nations globally, the average per capita income of the poorest 10% is $1,100; in the quarter freest nations, the income of the poorest 10% is $12,000, more than 10 times greater. Life expectancy rises from 64 years in the least free nations to 81 years in the freest nations.

The list could go on—over 600 studies have looked at the impact of economic freedom and found improvement in virtually all aspects of life. When people are free to look after themselves and their families, they do a good job.

The Fraser Institute studies economic freedom in five dimensions:

1.Size of government: When government taxes or spends too much, it reduces the space for free exchange and thus economic freedom. This is the one area in which Sri Lanka does well, but Sri Lankans should still ask whether the money they give the government by the way of taxes is well-spent.

2.Rule of Law and Property Rights: Everyone, not just the rich and powerful, should be able to depend on the rule of law to protect their property, ensure contracts are fairly enforced, and receive equal treatment in the courts.

3.Sound Money: Without sound money, inflation eats away at the value of your money and pay.

4.Free Trade: Sri Lankans should be able to buy from and sell to anyone, anywhere in the world. A small nation like Sri Lanka needs the world as its marketplace.

5.Regulation of credit, labour and business: Sri Lankans should be able to borrow from and lend to whom they wish; work for and hire whom they wish; start a business, or close it, as they wish.

Sri Lanka scores worst in sound money and freedom to trade, 135th out of 159 jurisdictions in both. Lack of sound money creates uncertainty undermining economic growth, an area to be looked at seriously. 

The country’s score in Freedom to Trade is inexcusable. Trade has been the path to prosperity for scores of nations. Sri Lanka must be open to sell to the world. The task of 1977’s opening remains incomplete with such barriers in place such as para tariffs that makes Sri Lanka’s trading regime complex to navigate compared to other economies.   

Sri Lanka ranks 92nd in regulation. To create economic dynamism, obstacles to work, business and credit must be removed.

In Rule of Law and Property Rights, Sri Lanka ranks 73rd. This may sound good compared to other areas, but it’s a huge problem because of its key importance to economic freedom. Freedom is not safe unless protected by the law. No nation has reached a high prosperity unless its citizens and their property are protected equally by an efficient and fair rule of law.

The challenges are great for Sri Lanka. Advocata, through research and advocacy, is seeking the solutions to provide a better, more prosperous life for the people of Sri Lanka. Stay tuned.


(Fred McMahon is a Fraser Institute resident fellow and holder of the Dr. Michael A. Walker Research Chair in Economic Freedom.  Mr. McMahon will deliver a talk on state of Economic Freedom in Sri Lanka on 12 October at Advocata Economic Freedom Summit.)

How should we think about the e-NIC program? Prof Mehta offers insights from India's experience

With the recent passing of regulations, the Sri Lankans government to issue new digital id cards with a central database of citizens have come under scrutiny. When Advocata hosted Indian political analyst Prof Pratap Bhanu Mehta earlier this year we asked what lessons Sri Lanka can learn from India's digital ID project Aadhar

 

Q: Sri Lanka is planning to introduce a digital Id called the e-nic project. In India, you have experience with the Aadhar project that’s digitized millions of identity data. What can we learn from this in Sri Lanka

A: This is something that is going to be a big challenge for the future. There is no question in terms of ease and convenience. Some form of digital ID is very attractive. There’s almost a kind of utopian romance people associate this notion of, one ID, one authentication and all services open up- you don’t need multiple cards, multiple agencies.  Certainly we want a way of redeeming the promise. You can’t roll back the tide of technology and in any case we’re doing that with private companies, Google, Facebook all the time, so why not harness for a public purpose?

I think the real danger is that these are tools of surveillance and and these are also tools of control and you need to see new, robust privacy legislations. You need a consent architecture for it- how is this information is going to be used? and what are you consenting to when you use this ID. You need an information architecture -- who is allowed to share what and with whom? Because with that digital ID, depending on how it is designed, can potentially reveal a lot of information about a person. It has to be embedded in deep institutional safeguards.

In India, the worry is that -- and most of us were moderate proponents of Aadhar -- we are rushing into the ease and convenience part, but frankly there is very little protection on privacy and almost no protection on surveillance. And as the experience of democracy is globally showing you have to safeguard against the possibility that authoritarian elements within our societies might use this information and data to control and surveil populations, and you need safeguards against that.

Prof Mehta who was an earlier a moderate proponent of Aadhar wrote a hard hitting Column on the project arguing the project has gone too far.  Sri Lanka’s e-NIC project is even more casual on concerns around privacy and transparency.

The video of the exchange is below

Sri Lanka’s absence from Asia’s big FTA game

Dr. Ganeshan Wignaraja

Dr. Ganeshan Wignaraja

Sri Lanka is pursuing a more proactive free trade agreement (FTA) strategy to reduce trade barriers with major Asian economies. FTA negotiations are on-going with China, India, Singapore and there is talk of FTAs with Bangladesh and Thailand. However, Sri Lanka is absent from Asia’s big FTA game – the Regional Comprehensive Economic Partnership (RCEP).

Concerns about losing sectors and unemployment have made trade agreements unfashionable in the post global financial crisis era. Unilateral trade liberalisation has slowed. The WTO Doha Round has effectively ended after years of negotiations. The US has left the ambitious Trans-Pacific Partnership (TPP), signed early last year. Brexit has made EU trade uncertain.

Yet negotiations are proceeding in Asia on its own mega trade agreement – RCEP. While there have been some contentious issues during the negotiations and afterwards, an RCEP agreement could be reached by 2019, with significant economic implications for Sri Lanka and Asia. Some of the difficult issues in the talks include tariff elimination in sensitive goods sectors, non-tariff measures, and movement of skilled professionals.

Although many are pessimistic about trade policy outcomes, RCEP offers hope for continuing preferential trade liberalisation in Asia in challenging economic times.

Background

RCEP negotiations began in late 2012 in Cambodia. The end-2015 deadline for concluding the negotiations has passed but talks are intensifying following the TPP’s apparent demise. The 20th round of RCEP negotiations are in Songdo, Korea on October 17-28.

RCEP parties aim to achieve a modern and comprehensive trade agreement, and the agenda covers trade in goods, services, investment, economic and technical cooperation, and dispute settlement. Compatibility with WTO trade rules on goods and services is also a principle for RCEP negotiations. The RCEP is likely to be less ambitious than the TPP (with high standard trade rules geared more toward advanced economies), and the prospect of development assistance for adjustment means developing countries will find it easier to join.

The RCEP seeks to reconcile two long-standing proposals into a large, region-wide trade deal: the East Asian Free Trade Agreement, which includes the Association of Southeast Asian Nations (ASEAN), China, Japan, and Korea, and the Comprehensive Economic Partnership for East Asia, which adds Australia, India, and New Zealand. The RCEP bridges the two proposals by giving ASEAN a central role in coordinating regional trade, and adopting an open accession scheme.

Value of RCEP

The RCEP can help regionalise the sophisticated global value chains that make Asia the world’s factory. It will also reduce the overlap among Asian FTAs and the risk that Asia becomes a confusing ‘noodle bowl’ of multiple trade rules. If a comprehensive agreement can be reached, trade barriers in Asia will come down and the new rules will be consistent with WTO agreements. Rules of origin could be rationalised and made more flexible, and be better administered through electronic means. In investment rules, where no WTO agreement exists, RCEP will promote easier foreign direct investment (FDI) flows and technology transfers by multinational corporations.

Since RCEP will contain three of the largest economies in the world — China, India, and Japan—it is globally important. The RCEP bloc represents 49 per cent of the world’s population and accounts for 30 per cent of global GDP. It also makes up 29 per cent of global trade and 26 per cent of global FDI inflows. Our conservative estimates, using a computable general equilibrium model, suggest that if RCEP was implemented it would bring income gains to the world economy of at least US$260 billion within a decade. Other estimates suggest an even higher figure of around $600 billion. India – the only South Asian economy in RCEP – is projected to gain from the agreement, while outsiders to RCEP like Sri Lanka and the rest of South Asia would lose from trade diversion.

Potential drawbacks

However, there are some challenges to the RCEP negotiations and their aftermath.

First, smaller ASEAN economies may find it difficult to stay in the driving seat of RCEP amidst China’s economic dominance. Second, RCEP may only achieve limited trade and investment liberalisation if parties with different levels of development and interests negotiate exclusions to protect sensitive sectors. Third, there is a risk that businesses, particularly small and medium-sized enterprises (SMEs), may underuse the RCEP tariff preferences and other rules due to a limited understanding of its legal provisions. Fourth, many countries will find it difficult to finance physical infrastructure and improve trade facilitation so goods and services can be transported smoothly across RCEP member countries.

RCEP negotiations should focus on a template with the best features of existing Asian FTAs, including ASEAN+1 FTAs and the Korea-US FTA. On difficult issues, the minus-X formula should be used to permit an RCEP member to opt out of agreed commitments until it is ready. Afterwards, significant outreach and business services are needed for SMEs to lower the costs of using RCEP. Expanding the Asian Bond Market Initiative and supporting public–private partnerships can also help increase regional infrastructure financing.

Once RCEP is eventually in force, it is envisaged that new members may join the agreement and reap economic benefits. Joining RCEP offers Sri Lanka the prize of simultaneous access to an enormous regional market and dynamic Asian FDI. It is also arguably simpler to attain, and is less draining on Sri Lanka’s scarce negotiating capacity than separately negotiating bilateral FTAs with each of the sixteen members. Through its membership of the ASEAN Regional Forum, Sri Lanka is involved in informal multilateral discussions on security issues in Asia and the Pacific but not on economic issues. Observer status of ASEAN is an important first step in Sri Lanka’s quest for RCEP membership and should be pursued through enhanced diplomatic efforts with ASEAN economies. Furthermore, think tanks in Sri Lanka should study the economic effects of RCEP on Sri Lanka.


Dr Wignaraja is the Chair of the Global Economy program at the Lakshman Kadirgamar InstituteHe spoke at Advocata recently on export-led growth.

Food taxes in Sri Lanka are detrimental to food security

HIGH FOOD COSTS IN SRI LANKA, AND GOVERNMENT POLICY

Article originally appeared on ECHELON

Food costs make up a significant portion of household expenditure in Sri Lanka. According to the last Household Income and Expenditure Survey carried out by the Department of Census and Statistics in 2012/13, the average household spent 34% of its income on food. Although this proportion fell from 46% in 2001/2, it’s still significant.

In general, households spend more money on food when incomes rise, but food represents a smaller portion of income, as they allocate additional funds to other goods. In the UK and the US, food takes up less than 10% of household income. The common complaint of the high cost of living in Sri Lanka has some grounding in policy, particularly taxes on food.

Sri Lanka heavily taxes imports, everything from cars to cereal. Basic food items are no exception. The government claims the reason for high taxes is to protect domestic farmers for reasons of food security.

Early concepts of food security focused on food supply problems like assuring availability and, to some degree, the price stability of basic foodstuff. The current view of food security focuses on access rather than availability of food.

The FAO says food security is achieved “when all people, at all times, have physical, social and economic access to sufficient, safe and nutritious food”.

Access is dependent on physical availability and affordability. If food is available but unaffordable, there is limited food security.

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Taxes, which raise food costs, are thus detrimental to food security. The Global Food Security Index ranks Sri Lanka 65 out of 113 countries, with low affordability (Sri Lanka is ranked 69 on this score) being one of the reasons for the low ranking. Singapore, which has minimal domestic food production, ranks 3rd overall and 1st in terms of affordability. Singapore imports 90% of its food, but the Agri-Food and Veterinary Authority of Singapore, which is charged with ensuring food security, has diversified its sources of imports to spread the risks associated with high levels of food imports. Therefore, it is not necessary to produce food in order to achieve food security, but food must be available, cheap and safe.

Taxes on food generate substantial revenue for the state. The Special Commodity Levy (SCL), which usually applies to food, earned the Government Rs55.8 billion in 2016. In the period January to April 2017, revenues from SCL rose 14.1% to reach Rs24.1 billion due to increases in rates. To give an example, the SCL on potatoes increased progressively from Rs15 to Rs35 to Rs40 just over last year. Similarly, the SCL on Bombay onions rose from Rs5 to Rs25 to Rs40 per kilogram. The SCL contributes around 4.3% of total tax revenue. The end result is higher prices for consumers, rich and poor alike. Nowhere is this more damaging than in food prices, which hits the poorer sections of society the hardest. Most Sri Lankans are unaware of the extent of the tariffs. Consider the following items: Import taxes add Rs130 to a bottle of cooking oil, Rs880 to a kg of butter, Rs300 (or 30%, whichever is higher) to a kilo of cheese and Rs625 to yogurt. This means that taxes make up almost 40% of a slab of butter you buy at the supermarket.

Sri Lanka’s public finances are in disarray, with public debt reaching Rs9,387 billion, around 79% of GDP in 2016. There is a real need to balance the budget to prevent the debt ballooning even further, but the state chooses to do so simply by increasing taxes and the cost of living. Government revenue rose 24.6% in the period January to April 2017, with collection from consumption-based taxes (mainly VAT/PAL/NBT) increasing 32.3%. Unfortunately, little attempt seems to have been made to curb government expenditure, which grew 16.5% during the same period.

Increases in government revenue are welcomed by analysts, but not by consumers, especially if they understand the extent to which they impact the cost of living. There is plenty of room to cut government expenditure by reducing the size and scope of the government with no significant impact to public services. To improve public welfare by cutting the tax burden, a programme to reduce expenditure must be pursued aggressively.

For example, the largest loss-making state enterprises lost Rs54 billion in 2016, with SriLankan Airlines alone losing Rs28 billion. The entire revenue earned in 2016 through the Special Commodity levy was Rs55.8 billion in 2016. Taxes on food basically covered the losses of the largest loss-making state enterprises. Theoretically, food taxes could have been cut to zero if these losses had been avoided.

Privatising loss-making state enterprises has the double benefit of both eliminating losses and raising revenue that can be used to reduce government debt, which in turn leads to permanent reductions in interest payments. Interest payments consume around 36% of government revenue. The sale of idle or underutilised land and other assets can serve the same purpose.

There are innumerable instances of corruption, waste and extravagance, a lot of which is hidden in state enterprises that are being paid for by taxpayers; one well-documented instance is the loss of Rs15 billion in a scam involving imported rice at Sathosa.

 

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The bloated public sector, which employs 1.3 million people whose pensions and salaries consume 50% of government revenue, needs to be downsized. The country employs 272,000 in the military, an unfortunate consequence of the war, but in peace, do we need to maintain a force larger than the combined forces of Britain and France? Even if the military is ignored, how are public services improved by employing 166,588 peons, 72,034 semi-skilled labourers and 25,645 driver/semi-skilled labourers? To put this into context, we only employ 19,612 medical officers, 32,399 nurses and 230,525 teachers. Why does the government need to run 100+ commercial businesses? Does Polipto Lanka, which supposedly turns plastic into petrol, actually have proven technology to do this? If they do, why is this not being exploited fully? How does the Cashew Corporation or Lanka Ceramics benefit the ordinary citizen?

The public needs to hold the government to account. To do this, we need information—this is why transparency is important. We need to ask what our tax money is being spent on, what services are being delivered and how public welfare is being increased.

The next time politicians offer something “free” or “subsidised”, or offer to build infrastructure, we must ask ‘How much does this really cost? How is it being paid for? Does the government really need to do this, and who does this really benefit?’ Unless we get the government to control its expenses, and eliminate waste and corruption, we will be saddled with high taxes and a high cost of living.

 

References
*Dept. of Census and Statistics, Household Income and Expenditure Survey 2012/13, pp 6, 23
*Dept. of Census and Statistics, Household Income and Expenditure Survey 2002, pp 5, 13
*CBSL Annual Report 2016,
*Mid-Year Fiscal Position Report 2017, Ministry of Finance
*Ministry of Finance and Planning Sri Lanka, Annual Report 2015 pp 204, 207
*Ministry of Finance and Planning Sri Lanka, Annual Report 2016 p 187

Why sell Srilankan Airlines?

By Ravi Ratnasabapathy

This article originally appeared on the Echelon

STATE-OWNED ENTERPRISES CARRY INHERENT STRUCTURAL WEAKNESSES IN GOVERNANCE. STATE AIRLINES ARE PARTICULARLY PROBLEMATIC AS THEY ARE COMPLEX BUSINESSES AND FACE DYNAMIC MARKETS.

According to reports in the press, the government will take a final decision on the future of the country’s national carrier, SriLankan Airlines, by July 2017. Coincidentally, the Indian Government is about to decide on the sale of Air India, so the timing may be opportune.

The Indian Government is exploring three options: A full 100% sale, or the sale of a 74% or 51% stake. Like SriLankan, Indian Airlines is staggering under a mountain of debt, so a part of the restructuring may involve the creation of a special purpose vehicle (SPV) to get rid of a major portion of its debt, which is in excess of INR500 billion. A similar arrangement may be necessary for SriLankan, whose had debt of Rs67.9 billion as at March 2016. The government has infused funds regularly to keep it running; recent injections include Rs14.28 billion in 2012, Rs12.6 billion in 2013 and Rs19.58 billion in 2014.

Citizens may be comforted to learn that the drain on public funds has a long international tradition; Sri Lanka and India are not the only governments that keep rickety state airlines in flight. Malaysia, Italy and Poland are among the countries that have bailed out state airlines in the past few years. Why is it so?

I T ’S DUE TO THE FOLLOWING T WO REASONS:

1 . Airlines are complex businesses to manage.
2. Governments cannot fully shield state airlines from competition.

Businesses must risk their own money when they go into trade, but governments risk other people’s money

Airlines are unlike many other businesses that a state gets involved in. They are big and complex: Aircraft leases are expensive and the support infrastructure is large. They are much more complex than, for example, running bus or train services. Given their size, even minor mistakes carry major consequences.

Crucially, they must also compete on an international level. Airlines, by definition, are not local businesses. Wherever they are located, they compete with other airlines to their home country; they cannot be insulated from competition.

State-owned enterprises (SOEs) tend to play in protected or semi-protected domestic markets. Some are monopolies; others find various ways to restrict competition. A business that faces limited competition will find it easier to make profits. Even where state businesses face competition, the government may grant SOEs preferential tax or other benefits that prop up its business model. As the state is the owner, it has incentive to tilt the playing field in its favour.

Shielding airlines from competition is harder to do, which is probably why losses are a recurring problem the world over. It is a combination of these two factors that make state airlines prone to failure.

Competition exposes the weaknesses in management, and the scale of the business usually means that the losses are spectacular. Admittedly, some do run well, Singapore Airlines being a notable example. People may wonder as to why this is so. Surely if one country can do it, why can’t another?

Profitability depends on good management, and ensuring that management is good is dependent on the governance that the owners can exercise. Herein lies the second challenge. Let us digress to understand the fundamental problem of governance in corporate entities: the problem of agency.

Let’s look at a small business, a shop or restaurant run by its owner. The owner puts down the money to start his business and is involved in the daily running of it. He can see if there is waste and can control it. His interest in the business is personal; naturally, he will try to do everything in the best interest of the business.

In the case of a company, things become more complex. Companies have many shareholders, so they cannot all be involved in running the business. They appoint directors who must act on their behalf. The owners are no longer running the business. The shareholders (owners) must trust the directors (agents) to do the best for the business.

This is not an easy thing to achieve. The Companies Act provides some safeguard such as the need to publish accounts (which must be independently audited) and face the shareholders at an annual meeting. For listed companies, the CSE and the SEC provide additional oversight, but it is not always certain that the shareholders are getting the best from the management. This is an inherent risk they must run, but it’s their choice to do so.

Investors in private companies take a risk when they put money down, but it is done by their own volition. Shareholders subscribe voluntarily to shares; they are not compelled to invest. Generally, people only invest in private companies if they know and trust the management.

If the business goes down, the shareholders will lose, but it is their own money, voluntarily invested, that is lost.

THERE ARE THE FOLLOWING TWO IMPORTANT DIFFERENCES WITH SOES:

Airlines are unlike many other businesses that a state gets involved in. They are big and complex: Aircraft leases are expensive and the support infrastructure is large

1 . Unlike in a company, where willing investors are taking a calculated risk, the investment in an SOE is by taxpayers who contribute involuntarily and unwittingly.
2 . There is an extra level of agency. The SOE is owned by the citizens and run by managers, but controlled by politicians. It is politicians who decide who to appoint to manage the business and who must hold the managers accountable. Unlike shareholders, politicians have not invested their money and have no stake in the business, and therefore no particular interest in ensuring its proper functioning. The real owners, the citizens, have absolutely no voice in how the business is run.

Businesses must risk their own money when they go into trade, but governments risk other people’s money. If a business does not earn a profit, the owner will need to keep infusing funds, which provides a powerful incentive to improve efficiency. The general public, whose money is at risk in a state venture, do not have the wherewithal or knowledge to hold managers or politicians to account.

This structural problem, an additional agent, means ensuring good governance in an SOE, which is intrinsically harder than in a private company. The lack of oversight in bodies like the SEC/CSE, the lack of public scrutiny or the pressure to publish accounts compound the problem.

As it is difficult to shield a national carrier from competition, the weakness in management is exposed to the cruel forces of the market, so losses are hardly surprising. Perhaps the correct question to ask here is not why would you sell SriLankan off, but why wouldn’t you? The structural weaknesses with SOEs in general and airlines in particular seem to condemn state carriers, with rare exceptions, to perennial losses. SriLankan’s sorry track record speaks for itself.

It provides no public service that could not otherwise be provided. A potential private buyer would probably continue to operate flights to the country, and if not, an open skies policy will ensure that enough other carriers fly in.

A strategic disinvestment of the airline will free up funds for allocation in areas where they are more needed such as health and education, rather than an industry that is not one of the government’s core responsibilities.

The government must pursue the disposal of Srilankan Airlines aggressively. A potential investor was found earlier, but backed out claiming that allocating the human and financial resources to make the airline profitable will not realise sufficient returns; all the more reason for taxpayers to walk away. The government should put this for open bids; if nothing else, it will give citizens an indication of the real value of the business.

What if no buyers come forth? If no one wants it, then that’s an indication that the existence of the airline serves no purpose and the correct solution is simply to close it down.

Lee Kuan Yew recounts in his memoirs the advice he gave JR Jayewardene when he wanted to start an airline. He says Mr Jayewardene wanted an airline because he believed it was a symbol of progress.

As it is difficult to shield a national carrier from competition, the weakness in management is exposed to the cruel forces of the market, so losses are hardly surprising

L E E KUAN YEW SAYS:
“I advised him that an airline should not be his priority because it required too many talented and good administrators to get an airline off the ground when he needed them for irrigation, agriculture, housing, industrial promotion and development, and so many other projects. An airline was a glamour project, not of great value for developing Sri Lanka.

But, he insisted. So, we helped him launch it in six months, sending 80 of Singapore Airlines’ staff for periods from three months to two years, helping them through our worldwide sales representation, setting overseas offices, training staff, developing training centres and so on.

But, there was no sound top management. When the pilot, now chairman of the new airline, decided to buy two secondhand aircraft against our advice, we decided to withdraw. Faced with a five-fold expansion of capacity, negative cash flow, lack of trained staff, unreliable services and insufficient passengers, it was bound to fail. And it did.”

We never tire of claiming to want to emulate Singapore. Perhaps we should start by taking the advice of its founding father?

Reviving Sri Lanka’s exports and attracting FDI to the export sector

By Ravi Ratnasabapathy

This article originally appeared on the Echelon

Sri Lanka’s export performance since 2000 has been dismal. As a percentage of GDP, exports have fallen steadily from a high of 33.3% to about 12.7% of GDP in 2016, a level last seen during the protectionist era of 1970-1976.

Not only are exports making up a declining proportion of GDP, they have started to contract in absolute terms. Exports shrank in 2016 for the second year in a row, declining to $10.3 billion from $10.5 billion in 2015 and $11.1 billion in 2014. In dollar terms, exports are now at a slightly lower level than they were in 2011 ($10.5 billion).

Sri Lanka’s share of global exports has also declined. The country’s share in world manufacturing exports increased from 0.05% in the mid-1980s to about 0.11% in 1999, but has since declined, reverting to the level in the 1980s.

On their own, these figures would be a cause for concern; however, in comparison to those of our peers, they are positively alarming. Our peers have grown rapidly, while Sri Lanka has stagnated.

Not only are exports making up a declining proportion of GDP, they have started to contract in absolute terms

In 1990, Sri Lanka’s exports were around $2 billion, roughly on par with Vietnam and slightly ahead of Bangladesh ($1.7 billion). Sri Lanka’s exports have since grown to $10.3 billion, which looks respectable; but in the same period, Bangladesh’s have grown to $34 billion, while Vietnam’s is at $170 billion.

To be overtaken 230% by Bangladesh and 1,550% by Vietnam is evidence that something radical has gone wrong for Sri Lanka.

Sri Lanka pioneered trade liberalisation in 1977. Vietnam and Bangladesh followed much later; but while they continued the programme, Sri Lanka’s reforms stalled and were then reversed.

In 1977, Sri Lanka was the first country in South Asia to move decisively away from protectionist import-substitution trade policies that for many years had damaged economic efficiency and hobbled growth. Exports and the economy responded rapidly to the reforms. In particular, the export of manufactured goods responded immediately and grew rapidly, at around 20% annually, between 1976 and 1984. Following the outbreak of the civil war, growth slowed drastically over the next five years, but accelerated to an average rate of 16% between 1989 and 2000. Despite a change in regime in 1994/5, trade policy reforms, especially reductions in the average level of import tariffs, were broadened and extended over the following 23 years until 2000.

Protectionist pressure began to build in 2001, and from 2004, the relatively open trade policies of the past were explicitly and systematically reversed. A policy paper by the World Bank titled “Increase in Protectionism and Its Impact on Sri Lanka’s Performance in Global Markets” shows that, today, through the proliferation of a variety of para-tariffs, Sri Lanka’s tariff policies are just as protective as they had been more than 20 years earlier.

Taxes on imports were increased with the imposition of a plethora of new taxes, as well as increases in the rates of existing tariffs. The Customs Surcharge was introduced in 2001, the Ports and Airports Development levy imposed in 2002, and the Regional Infrastructure Development Levy (RIDL) introduced in 2007. Rates of the Commodity Export Subsidy Scheme (Cess), Nation Building Tax (NBT), Social Responsibility Levy, Special Commodity Levy (SCL) and VAT were progressively increased.

Sri Lanka pioneered trade liberalisation in 1977. Vietnam and Bangladesh followed much later; but while they continued the programme, Sri Lanka’s reforms stalled and were then reversed

By 2009, Sri Lanka had a highly complex tariff system, which included up to nine other import taxes (in addition to Customs duty, referred to as “para tariffs”) that were imposed or potentially imposable on imports of products; this was a major reversal of the broadly liberal trade policies of the past. Some of these were later repealed or reduced, but the damage had already been done.

Despite minor reforms since, the import tax system remains highly protectionist, non-transparent, complex and likely to deter long-term business commitments, both in production and trade.

Imports and exports are closely linked; many exporters must import some of their raw materials, intermediate goods or components. Although many exporters have exemptions on Customs duty, they are liable to pay other tariffs. These tariffs are thus a tax on exports, making Sri Lanka relatively uncompetitive vis-a-vis its peers, which explains the relative decline of exports and failure to attract export-oriented FDI.

Apart from dissuading exports, high tariffs also protect some segments of the local market. This has had the effect of drawing investment to high-cost and highly protected import substitution farming and agricultural processing activities with low or negative economic rates of return. Diverting investment into these low-yielding activities drags down overall economic growth.

Given this tax structure, it’s hardly surprising that the FDI that does come in tends to cluster in the non-tradable sectors, particularly real estate, infrastructure and tourism.

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If we are to regain our position in export markets and attract investment to the sector, we need to return to the liberalisation agenda that was abandoned in the early 2000s: Cut import taxes, simplify the tariff structure and improve facilitation of investments. Some suggestions are as follows:

Broad Policy Reforms

SIMPLIFY AND REDUCE TARIFFS
1. Announce a simplification of tariffs and an intention to move towards a single flat tariff. This gives some reforms and sets the direction for future reforms.

2. Initially, for raw materials and components for industry, move to a low, single flat tariff. Unify the existing Customs duty and the plethora of para  ariffs (PAL, VAT, CESS, Customs Surcharge etc.) into a single Customs duty OR Special Commodity Levy (if administratively simpler) at the individual customs code level.

A study needs to be carried out to identify the specific HS codes/current tariff structure/revenue collected, but moving towards a low uniform tariff structure has the potential to increase tariff revenues as increased volumes compensate for the lower rate. This would also speed up Customs clearance and reduce the potential for corruption as it reduces the discretion of customs officials and makes the trade regime predictable.

3. On the export side, remove all cess as it reduces the effective price received by exporters, and thereby discourages exports. (There is no evidence to suggest that these cess promote local downstream processing of primary products that are now exported in ‘raw’ (unprocessed) form.

4. Join the Information Technology Agreement of the WTO to create free trade in electronics, which will attract FDI to this sector.

IMPROVE FACILITATION OF FDI
Restore the role of the Board of Investment as the ‘one-stop shop’ for investment approval/promotion (as envisaged in the BOI charter). The role of the BOI has been undermined, for example, by the Strategic Development Projects Act, which gives wide ministerial discretion in investment approval to the Tourism Development Authority, which seems to play a parallel role  in tourism projects. This also requires repealing the Revival of Underperforming Enterprises and Underutilized Assets Act (2011) and the Strategic Development Projects (2011) Act, or passing new legislation to supersede these two acts.

It is, of course, necessary to rationalise the fiscal incentives offered to investors, but there is a strong case for providing export- oriented foreign investors with time-bound tax holidays and investment tax allowances beyond the tax-holiday period. There is evidence that tax incentives play an important role in influencing location decisions of export-oriented (efficiency-seeking) FDI, especially where competing countries still offer them, provided other preconditions are ‘reasonably’ met. Removing all tax incentives, other negatives that continue to weigh on the overall competitiveness in investment and trade may be counterproductive. Sri Lanka has to improve property rights to draw investment. The guarantee against the nationalisation of foreign assets without compensation provided under Article 157 of the present Constitution needs to be maintained under the ongoing constitutional reforms.

Avoid the current practice of ‘domestic value added’ [which is defined as the per unit domestic retained value (wages + profit + domestically procured intermediate inputs) as a percentage of growth output] as an evaluation criterion in approving investment projects.

Protectionist pressure began to build in 2001, and from 2004, the relatively open trade policies of the past were explicitly and systematically reversed

FACILITATE TRADE THROUGH SIMPLIFYING CUSTOMS PROCEDURES
1. Move to fully electronic Customs processing.
Customs entries are currently being filed electronically. We now need to move to getting the appraisal/verification of Customs entry to be done electronically on the system. This obviates the need to visit the Customs office, and will greatly speed up and simplify the processing of documents.

2. To facilitate moving to full online processing, a generous incentive scheme to reward Customs officials for speed in processing documents should be considered. Basically, a reward scheme based on the number of applications approved per day, to align the interests of the importer and the Customs staff.

3. Allow pre-documentation as standard, not only for perishable goods. Importers should not have to wait for the vessel to arrive to file documents. Currently, this facility is available only for perishable cargo; it should be extended to all cargo, to minimise bottlenecks when vessels arrive.

4. Valuation by Customs. This is usually a time-consuming process. A fast-track option is available for a few firms only. Expand this fast track option to all export firms. All new investors should be eligible for fast-track processing.

5. Automate Customs inspections by installing scanners. Replace physical inspection with electronic scanning as a standard procedure. Physical inspection should only take place where there is some doubt.

These reforms should send a clear message to investors that Sri Lanka is once again open for business. Together with the GSP+ concession, this should make Sri Lanka an attractive investment destination. This should be followed up with an extensive promotion campaign to market the country to investors.

Keep the state out of sports

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It is not very difficult to explain our nation’s mentality. We are a country misled by wrong definitions and misperceptions. Our definition for patriotism, friendship, love, religion, education, sports and many other perspectives of life has been off track since the beginning.

Our independence stops at hosting the national flag on the day of independence. Rest of the days in the calendar we lose our independence by over depending on the government. We prefer the government to be our guardian angel and get ourselves disappointed often. Sri Lankans request the state to intervene at every single point of life. And we expect the state to play an almighty god role, who has a solution for everything and everyone.

The Sri Lankan students look for the state to intervene in their employment. Farmers and local entrepreneurs envisage to protect their livelihood by the likes and means of the state. Doctors require intervention from the state to run their medical cartel and the list goes on and on.  

The only topic Sri Lankans do not want to see the state and political intervention is ‘sports’. At least let’s try to protect sports from state interference. If life is a game of cricket, the state should act the role of an umpire. Sri Lanka is in a situation where the players expect the umpire to intervene the game and be the deciding factor. Those who have a basic understanding on any game know how tragic it is when the umpires become the decider of the output of the game. 

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While many Sri Lankans having higher expectations on the state to intervene at every stage of life, let’s, for a moment, look at the composition of the state, in other words, the current state of our umpire. 

We have a legislature, where more than 80 percent of the members have not even passed the advance level examination – in other words, an umpire who is not intelligent enough to comprehend the rules of the game. 

Another 1.5 million state workers, who are the second layer of the state, of which the majority are henchmen or family members of the political class. Most of the state workers/bureaucracy have come to the state sector from the back door. According to Policy Planning and Economic Development Deputy Minister Harsha de Silva, the entire government sector carder requirement is 800,000 (current carder is 1,500,000), so no explanations needed. We are almost overstaffed by 100 percent. 

The private sector and entrepreneurs are working hard and pumping tax money to pay the state bureaucracy pensions. On certain days of the year, the state worker bureaucracy (most of them) wakes up from their slumber when their palms are oiled and think how they can curtail the private sector and enlarge the state footprint.

To elaborate on cricket terms, the umpires are given decisions based on self-interest but not complying to the rules of the game. The legislature and bureaucracy are genetically interconnected and the information systems they refer to make decisions are equally corrupt. For an instance, the third umpire switches on the green light instead of red when the batsman is clearly out of the crease. The umpires behest the spectators like you and I to cover their cost and we were asked to watch the game in awful conditions. 

At taxpayers’ cost

Let me not comment on the judiciary and legal system. The donkey’s years taken in resolving a land case at courts and the impeachment motion against the former chief justice attest how good our legal system is. If the chief justice was given an unfair impeachment, there is nothing left to comment indeed.

Since independence, we have tried this model and failed over and over again. A hope of relief, open economy in 1977, but since then, nothing has happened and we have already lost our competitiveness in the global markets. Our exports are dropping as a percentage of gross domestic product (GDP).

If you need further evidence on how good our state sector is, just see the figures of the enterprises they manage - the so-called state-owned enterprises (SOEs). For a decade they slurped Rs.605 billion of taxpayers’ money only on five SOEs, which is equivalent to 5 percent of GDP in 2015. 
Even the profit-making SOEs are mainly state monopolies and the taxpayers are paying the inefficiency. 

The state is exceptionally capable in converting the profit-making enterprises to loss-making. SriLankan Airlines is just one case and the chart says it all. If I go back to my cricket anecdote, this is how they convert the winning games to a series of whitewashing.

The latest topic on state intervention is in sports. Now it seems the state is interfering the sportsmanship of the game challenging the freedom of individuals and athletes. For Sri Lankans, cricket is a religion and a thread that connects all beads of ethnicities together into a beautiful necklace. Kumar Sangakkara said it better than anyone else in his MCC Spirit of Cricket Cowdrey Lecture. 

“Cricket became an integral and all-important aspect of our national psyche. Our cricket embodied everything in our lives, our laughter and tears, our hospitality our generosity, our music our food and drink. It was normalcy and hope and inspiration in a war-ravaged island. In it was our culture and heritage, enriched by our myriad ethnicities and religions. In it we were untouched, at least for a while, by petty politics and division.”

The state-affiliated politicians intervening sports is not new in the Sri Lankan context but now it has reached to an extent unbearable anymore. In fact, a few days post the lecture by Sangakkara, the then Sports Minister Mahindanada Alutgamage had called an investigation report. Since the distance between international imagery between Sanga and the minister is a little far than the sky and the earth, Sanga was rescued before getting into hot waters. 

Now after many years later, the top faster bowler Malinga is on the spotlight. It is not at all the objective of this article to discuss whether the disciplinary actions are fair or not or the appointment of Dinesh Chandimal and Upul Tharanga as cricket captains in Sri Lanka is right. We need to ensure freedom of expression of athletes. 

Of course the athletes need to be disciplined and a brand of true qualities of sportsmanship. The freedom of expression was what rescued Murali when he was accused of chucking in his bowling action. Arjuna stood ramrod rigid and fearless in expressions and had a spine to stop the match on a land not in favour of him.

Arjuna was fit to pick the battles to take on the ground and to decide which battles to take on the boardrooms. Things seem heated again now. The two men of highest integrity and credibility so far are on a battle. We, the spectators, need to patiently watch carefully and see where the game is turning now.  

Private vs. public property

The only Olympic medallist in our generation, Susanthika Jayasinghe, has also connected to a different side of the story.  On Susanthika’s matter, the sports minister attempting to pass a law avoiding selling or auctioning medals won by athletes is far more catastrophic. 

Susanthika’s Silver medal won in Sydney Olympics is a moment of pride indeed for Sri Lankans. True, we were the cheerleaders and she was contributed by the taxpayers’ money. But we need to agree the medal she won is a private property owned by her and we do not have any ownership. It is simple as a young kid winning a medal in the annual sports meet in a government school. Studying through free education doesn’t mean the medal the kid won is owned by the Education Ministry. 
Susanthika is someone who proved herself on the track in the pet event 200m in Olympics to be the second fastest iron lady on the planet. 

In her own words: “The minister of sports will change; the governments will change but my achievement as an Olympic winner will always be in history. It is inerasable. I was the only woman to do it in entire Asia and my feet were able to vanquish strong women who came on the track from over 200 countries, which no one can deny.”

Not that we encourage her to auction the medal but it is her call. Whether Susanthika needs to be appointed as a coach at the Sports Ministry and her personal life is a different question but the property rights should not be allowed to be challenged by the state, which defends in inaction on the ministers who sell the vehicle permits over taxpayers’ money. 

The ownership of the medal is a private property owned by Susanthika is a clear cut fact and similar occasions have occurred in Olympic history. 

Let’s look at the history of Olympic medal auctions before we jump the gun. 

Wladimir Klitschko won a Gold medal in boxing for Ukraine at Atlanta Olympics in 1996. He decided to auction the medal to help the Ukrainian children in getting involved in sports. Surprisingly, a mysterious bidder who bought the medal for US $ 1 million, returned the medal back to Klitschko.
Anthony Ervin, a United States swimmer, donated money to tsunami victims in Indonesia by auctioning his medal he won when he was at the age of 22 in 2000, the same Olympic Susanthika won the Gold medal. 

Polish swimmer Otylia Jedrzejczak dedicated her medal to the kids suffering from leukaemia in Poland. She said, “I don’t need the medal to remember; I know I’m the Olympic champion. That’s in my heart.”

The history of Olympic medal auctions teaches us lessons on what kind of athletes we need as a nation and the real meaning of sportsmanship. Those examples provide answers from Sydney Olympics to IPL. 

The reasons of auctioning the medal by Wladimir Klitschko, Anthony Ervin and Otylia Jedrzejczak are undoubtedly harder than winning an Olympic medal itself. That was only possible in history because they had the property rights to do whatever they want to do with the medal the respective athletes won. 

Although Susanthika may have her reasons to auction out her hard work encompassed in the form of a Silver medal, the government has no right imposing such a law, banning the auctioning of medals. The discussions on the law were diluted but we need to ensure no such laws for the betterment of sports.

After all, a medal or trophy won is private property. These medals or trophies won by the athletes must be perceived as a gateway for the greater good and unselfish gains. A medal may succumb to the wear and tear and may fade away, however the memory of the act will live on for a lifetime. 
The reason Susanthika claims she had to give up the medal is indeed sad. But we should not forget there were sports men and women who had bigger hearts to give up a lifetime of achievement for better causes. That was only possible because of the protection of the property rights. This is similar to a sport – the umpire introduces a rule on what the players of the game should do with their medals, trophies and awards post the game.  

The fate of Sri Lankans is not different to Lasith and Susanthika. The state intervention is coming to handicap every citizen’s freedom sooner if we fail to understand the calamitous of the state. It may be on sports or in life. This is not only valid for Sri Lanka but across the orb. 

The Nobel laureate Milton Friedman justifies how bad is state intervention. “If you put the government in charge of the Sahara Desert, in five years there’d be a shortage of sand.”

 

Sri Lanka's sugar tax -- An unsweet deal for the consumer

By Ravi Ratnasabapathy

This article originally appeared in the Daily News.

Taxes on imported sugar were increased recently to Rs.25/kg. Consumers will be shocked to learn that the tax is almost 50% of the import price, small wonder that sugar retails for over Rs.100/kg. Strangely, sugar is also subject to price control.

On one hand hefty taxes are imposed to protect the industry which cause prices to rise. On the other hand prices controls are imposed to “protect” consumers. This does not make sense.

Is protection necessary?

Sri Lanka has a small sugar industry that produces around 50,000 mt of sugar, while consumption is around 550,000 mt.

In economics, what is called the infant industry argument is often cited as the rationale for protection. Poor nations, the argument goes, benefit from having high-tech, high-value industries that produce positive spillovers -local supply chains, an expert workforce, innovative ideas. But because poor countries have little capital, their high-tech industries can’t compete with huge multinationals. So it makes sense to shield these young, promising industries behind protectionist walls for a while, letting them play in the sandbox of the domestic market until they gain the size and know-how to go out and compete in the world.

If the argument was cited in favour of protecting an industry based on advanced technology it may make some sense, but does it apply to basic agriculture?

Top sugar producers

Sri Lanka’s sugar industry has been protected for the better part of forty years, the infant industry is now well into middle-age! If it has not reached the level to compete in the global market after several decades under protection it seems highly unlikely that further gains in productivity will materialise. According to data from the Department of Census and Statistics, sugarcane yield per hectare in Sri Lanka was stagnant at around 59 mt/ha between 1993-2012 before plummeting to an average 42mt/ha between 2013-2015. This is well below those of the top sugar producers.

Strangely, the data indicates that between 2009-15 while sugar cane was harvested no sugar was produced except in one year (2012). Presumably the crop was converted to ethanol, which is even more profitable.

FAO data indicates that average sugarcane yields worldwide are close to 60mt/ha but some countries produce mean crop figures of 100mt/ha and above. Of those major producers who grow in excess of 20 million tons every year, Colombia, Argentina, Australia, Philippines and Brazil usually have mean yields around 80mt/ha or more. Advantages of scale, weather, agricultural practice may all contribute, but for whatever reason the major producers do seem to have a clear advantage over Sri Lanka.

A local producer however enjoys an advantage in being close to the home market; that an importer can ship sugar halfway across the world and sell it cheaper in Sri Lanka is indicative of the extent of the efficiency of the major producers. Unfortunately the tax system prevents Sri Lankan consumers from benefiting from this greater efficiency.

Consumers are forced to pay much higher prices than they should which in effect subsidises the local production. Currently the transfer from consumers to producers is worth about Rs1.25bn rupees a year (at the new rate of tax and assuming a production of 50,000mt) which from the point of view of the sugar industry is a very handsome sum. With such riches on offer it is hardly surprising that the protected domestic market is attracting new interest.

In February this year the press reported that a foreign firm would invest US$152 m in a sugar cane project in the Uva Wellassa region of Sri Lanka. The proposed plantation will occupy about 15,000 ha which is almost double the current extent cultivated and produce 80,000 mt of sugar. Based on current tax rates it will earn a ‘subsidy’ of Rs.2 bn from Sri Lankan consumers. To put things in perspective, the annual subsidy alone would return 8.5% on the proposed investment of USD152 m.

The subsidy (and profits) will increase further if the tax rate rises, creating the incentive for further lobbying to increase the rate in time to come, burdening consumers further.

Foreign investment is a good thing but there is no good reason why Sri Lankan consumers should subsidise such a project.

Domestic industry consumers

The foreign investor in the new project presumably has access to all the latest technology, plant varieties and skills to be produce sugar efficiently. The investment should not be dependent on continued import protection. If they do not have the technology to compete with world markets should they be investing in the first place?

Having fruitlessly spent several decades enriching a domestic industry consumers should not expect to spend several more decades protecting it further. Let the investment come in by all means, but the market for sugar should be free. If there is a tax to be imposed it must be imposed equally on both domestic and imported sugar. The tax system should not create cushy markets for selected industries, who earn easy money at the expense of consumers. This behaviour is termed “Rent-Seeking” in economics.

There is nothing wrong with a business making profits, but Rent-Seeking (also called crony capitalism), which what happens when selected firms have preferential treatment is bad.

Rent-Seeking is a concept used to describe the activity of individuals or firms who attempt to obtain or maintain wealth-transfers, primarily with the help of the state. More specifically instead of making a productive contribution to an economy, a rent-seeker attempts to obtain benefits for themselves by manipulating the political environment, in this case by ensuring larger margins by taxing competing products from overseas. An activity that is otherwise not viable can suddenly become very lucrative when shielded from competition.

Competitive markets allow a nation’s resources to be used to best effect in the production of goods and services. For private investment to be a true catalyst for growth markets must be efficient and open. Distorting the market through government policy creates the wrong incentives for investors, opens the door to corruption and leaves consumers worse off.

As they do not create any value, rent-seeking activities impose large costs on an economy that may include unintended consequences such as damaging the environment or destruction of historic sites.

Environmental problems

Prof Gananath Obeysekere in a recent article the sugar project has claimed that the Uva Wellasa region where the new sugar project is proposed will be “raped”. He says that the “area is studded with archeological remains, such as Brahmi inscriptions, drip ledge caves where monks meditated and more developed meditational complexes, ruined viharas and Buddha statues”.

Elephants are attracted to certain crops and have a particular fondness for sugarcane. The project will almost double the area under cultivation of sugarcane probably with a multiplier effect on the elephant problem.

Dr. Sumith Pilapitiya onetime leading environmental specialist for South Asia in the World Bank and the former Director General Wildlife maintains that the Pelawatta and Sevanagala sugar projects have encroached into prime elephant habitat and are a source of the human-elephant conflict. Thus protecting an uneconomic local industry at a huge cost to consumers is also harming the environment. If the tax on sugar was rationalised, with local sugar taxed at the same rate as imported sugar the distorted incentive to expand the industry would disappear, solving the associated environmental problems with it.

Considerations for formulating a trade policy for Sri Lanka

A PRESENTATION TO THE “PEOPLES’ COMMISSION FOR NATIONAL POLICY ON INTERNATIONAL TRADE”
BY ROHAN SAMARAJIVA

This article originally appeared on the Echelon

We must look to the future, not the past. We must be realistic about where we are at present and what our potential is. We must always take into consideration our external environment, especially the actions of competitively positioned countries. We must give priority to the broad public and national interest, not those of narrow interest groups. My brief comments are organized around the above principles.

1.0

The future is Asia. Most models of international trade assume that greater trade will occur with nearby countries than with those which are distant1. At present, Sri Lanka’s goods exports violate this assumption, going primarily to the US and Europe2. This was also the case with Mode 2 3 service exports in tourism, until recently. But, things have changed in tourism service exports, with India and China becoming the principal sources. We must make active efforts to re-orient goods exports to Asia because that is where the highest growth is occurring. With turbulence in trade policy caused by the failure of the Doha Round of World Trade Organization (WTO) negotiations and the US withdrawal from the Trans-Pacific Partnership (TPP), we must focus on plurilateral agreements within Asia, giving primacy to the emerging single market of ASEAN, India and China. Joining some form of ASEAN plus agreement such as the Regional Comprehensive Economic Partnership (RCEP) would be optimal. A comprehensive goods, services and investment agreement among BIMSTEC (Bay of Bengal Initiative for Multi-Sectoral Technical and Economic Cooperation) countries would also be desirable. But, bilateral agreements with willing countries are a necessary step for a small economy such as ours to get to the negotiating table where these plurilateral agreements are reached. But the immediate impact of completing the ongoing negotiations will be substantial. Firms located in Sri Lanka which satisfy the preferential rules of origin4stipulated in the various agreements will have access to a market of 3 billion people. These firms may be fully owned by Sri Lankan citizens, joint ventures or foreign investors.5

● 1.1 Both India and Vietnam have entered into multiple bilateral agreements,6 which are yielding them good results, but also giving rise to the “noodle bowl effect”.7 But, these complications are likely to be reduced when they join RCEP or a similar plurilateral arrangement. The good results are illustrated by Table 1, which compares Sri Lanka’s and Vietnam’s investment and trade performance. The increase in FDI was in the same range (7 times and 9 times); but Vietnam increased exports by 9.5 times versus Sri Lanka’s paltry doubling.

2.0

Trade policy in the 21st Century is not a zero-sum game, where scores are kept in terms of positive/negative trade balances. In the context of global production networks (GPNs), components of end products (including services) cross and re-cross borders. Here is what the economists at the Central Bank of Sri Lanka say about our failures to catch this wave: “Regional competitors, particularly East and South East Asian countries like China, Taiwan, South Korea, Thailand, Malaysia, Vietnam and Indonesia, have dramatically increased their manufacturing exports through global production networks. India, which traditionally focused on labour-intensive manufacturing exports, has integrated successfully with global production networks, producing technology-intensive parts and components for data processing machines, electrical machinery and semiconductor devices. Conversely, only a fraction of Sri Lanka’s manufacturing exports moved through global production networks during this period.”8

● 2.1 GPNs are highly efficient, but they are vulnerable to disruption, as evidenced by worldwide problems caused by the Bangkok floods of 2011.9 Therefore, firms active in GPNs pay special attention to managing risks, both natural and human in origin. Trade agreements that cover services trade including clear provisions regarding Mode 4 movement of natural persons are important in this regard.

● 2.2 Sri Lanka’s more-efficient logistics and port facilities (relative to South Asia, but not South East Asia)10 may give us an edge in participation in GPNs. That this has not materialized indicates that legal and regulatory risks are washing out the logistics advantages.

3.0

Services are becoming increasingly important in the economy as a whole and within international economic relations. The first trade agreement to include enforceable provisions on services was the Canada-US Free Trade Agreement of 1987. Sri Lanka is party to the General Agreement on Trade in Services (GATS), which came into effect in 1995. Now, every trade agreement includes services. Of the Sri Lankan labour force, 46.5% are employed in the services sector, in activities ranging from plucking coconuts to retail trade, to software work. This is considerably larger than the 27.1% employed in agriculture and the 26.4% in manufacturing.11 Mode 4 service exports in the form of labour exports yielded earnings (remittances) of $7.2 billion in 2016. While labour exports slowed, earnings grew 3.7% in 2016.12 Earnings from exports of services recorded growth of 11.6% to $7.1 billion in 2016. About half came from tourism service exports (Mode 2), which yielded $3.5 billion in earnings in 2016, an 18% growth over 2015. Earnings from telecommunications, computer and information services increased from $805 million in 2015 to $858 million in 2016. The combined service-export earnings were larger than the $10.3 billion earned from the export of goods. Services are critical inputs for all economic processes, including goods exports.

For the overall efficiency of the economy and for improved competitiveness in exports, it is important to enhance competition in services industries, which is best done by opening them to international competition.

● 3.1 Because service trade across borders requires movement of juridical (Mode 3) and natural persons (Mode 4), there is an unjustified opposition to services trade in general, and services agreements in particular. The usual harms associated with protectionism result when domestic suppliers use political pressure to inhibit competition and extract rents in service industries. When protectionism is extended to services that are critical inputs to other economic processes, the overall economy suffers.

● 3.2 The positive-list method used in services trade agreements allows for a highly calibrated opening up of sectors and Mode 4 commitments. Unlike in goods agreements, a sector is brought within the scope of the agreement only when it is specifically included and schedules of commitments are offered. Sri Lanka made commitments only in tourism and travel-related services, telecommunication services, and financial services in the case of the only services trade agreement it is party to, the GATS.13 They too were very conservative and even so, not fully adhered to.14 Usually, Mode 4 provisions in services trade agreements affect only professionals, senior managers, etc, quantitative limits, minimum salary requirements, etc. can be imposed.15 This enables government to assuage the protectionist concerns of organized groups even to the detriment of the overall economy and the interests of the consumer.

● 3.3 However, given the importance of Mode 4 service exports in the form of expatriate workers traveling to West Asia and elsewhere, we should consider building in safeguards for even non-professionals in the trade agreements that we negotiate. With Sri Lanka now facing labour shortages in critical sectors such as construction,16 it is time to consider well-designed labour contracts articulated with improved enforcement of immigration laws, as indicated by the proposal to establish an Immigration Police in the 2017 Budget Speech.

● 3.4 The Central Bank says, “Given stagnant earnings from merchandise exports, the importance of non-traditional service exports has grown significantly, although focused efforts are required to tap their full potential.”17 To tap the full potential of the services sector, it is necessary to liberalise rules, encourage investment and enable easy movement of professionals across borders. Today, these facilities are available in some form to BOI companies only. Officials have excessive discretionary authority. Workarounds abound.

4.0

Agriculture, where 27% of the workforce produces a mere 7.1% of GDP, requires serious attention. The primary focus must be on supporting the initiatives by private firms to increase high-value fruit and vegetable exports that are already underway. This will result in the improvement of standards throughout the sector and, of course, the earnings of smallholders now connected to export supply chains. Good agricultural practices, including low/no use of chemicals and traceability, will increasingly define what is acceptable in export markets. Our trade policies must, on one hand, strive to prevent the use of phyto-sanitary rules as non-tariff barriers.18 On the other hand, we need to encourage good agricultural practices among suppliers.19

5.0

Given China’s success in becoming the factory of the world, many fear that a manufacturing-based path for climbing out of developing country status is no longer available.20 Energy and labour costs that are high relative to competitor economies are significant constraints in Sri Lanka. That is why only 26.4% of our workforce is in manufacturing. Therefore, Sri Lanka’s manufacturing option must focus on high-value rather than high-volume manufacturing. This leads to the GPN solution discussed above, and the need to reduce legal and regulatory risks that GPNs are sensitive to, by embedding ourselves in plurilateral or bilateral trade agreements.

● 5.1 Effective participation in GPNs requires flexibility, and certainty about importing and exporting. Old-style import-substitution thinking, which seeks to encourage exports while discouraging imports, is inimical to effective participation in GPNs. Indeed, some scholars argue that unilateral investment and trade liberalisation is superior to bilateral agreements, with rigid rules of origin provisions in terms of promoting GPNs.21

● 5.2 Manufacturing enterprises find it difficult to scale up to meet the requirements of GPNs and of regional markets because of labour market constraints. These constraints need to be addressed through labour contracts, rather than opaque workarounds as at present.

6.0

When one looks back at Sri Lanka’s first-generation reforms undertaken in the late 1970s, one sees a form of shock treatment where the domestic market was suddenly opened up with few safety nets established for those negatively impacted. The reforms that need to be undertaken now are not of the same magnitude. But, it is good that the government is considering trade adjustment facilities to help specific firms retool and adjust to increased competition when tariffs, para-tariffs and barriers are brought down.22

 

 

1 The gravity equation of international trade states that bilateral trade between two countries is proportional to size, measured by GDP, and inversely proportional to the geographic distance between them — Chaney, T. (2013, August). The Gravity Equation in International Trade: An Explanation, NBER Working Paper No. 19285. http://www.nber.org/papers/w19285
2 In the case of imports, China was the largest source (21.7%), followed by India (19.7%), in 2016. India was the largest source before 2016: Sirimanne, B. (2017 May 14). China emerges as Sri Lanka’s main import source replacing India, Sunday Times. http://www.sundaytimes.lk/170514/business-times/china-emerges-as-sri-lankas-main-import-source-replacing-india-239808.html
3 For explanation of the four modes of services trade, see: https://www.wto.org/english/tratop_e/serv_e/cbt_course_e/c1s3p1_e.htm
4 Preferential rules of origin are applied by countries that offer certain trade partners zero-duty or reduced-duty access for their imports as a means of determining the eligibility of products to receive such preferential access. — Brenton, P. (n.d.). Preferential rules of origin, http://siteresources.worldbank.org/INTRANETTRADE/Resources/C8.pdf
5 An example of investments being attracted by market access (in this case, GSP+) is the Hero bicycles investment of $20 million in BSH Ventures, a bicycle manufacturer located in Biyagama: Sirimanne, S. (2016 April 4). Hero Cycles to make Sri Lanka bicycle hub in South Asia, Ceylon Daily News, http://dailynews.lk/2016/04/04/business/78194
6 India has entered into agreements with Finland, SAARC (multiple, inactive), Singapore, Malaysia, multiple countries in Africa, Chile, Afghanistan, ASEAN, Bhutan, Japan, Korea, MERCOSUR, Nepal, Sri Lanka and WTO (GATS, GATT). Vietnam has directly entered into agreements with Chile, Japan and South Korea, and through ASEAN with Australia, New Zealand, India, Japan, China and South Korea.
7 http://www.unescap.org/resources/asia-pacific-noodle-bowl-trade-agreements
8 Central Bank of Sri Lanka (2017). Annual Report 2016. Colombo: CBSL, p. 29.
9 E.g., Fuller, T. (2011 November 6). Thailand flooding cripples hard-drive suppliers, New York Times, http://www.nytimes.com/2011/11/07/business/global/07iht-floods07.html
10 Dappe, M.H. & Suarez-Aleman, A. (2017). Competitiveness of South Asia’s ports: A comprehensive assessment of performance, drivers and costs. Washington DC: World Bank.
11 Sri Lanka Labour Force Survey, Annual Bulletin 2016.
12 Central Bank of Sri Lanka (2017). Annual Report 2016. Colombo: CBSL, p. 12.
13 GATS/SC/79, GATS/SC/79/Suppl.1, GATS/SC/79/Suppl.2
14 Samarajiva, R. (2007 July 31-August 1). Sri Lanka’s telecommunications commitments under GATS: Assessment and issues for the future, Conference on the Doha Development Agenda and the Future of the Multilateral Trading System organized by the Sri Lanka Law College, Colombo. http://www.lirneasia.net/wp-content/uploads/2007/08/rstelecomtrade1aug07.pdf
15 Bandara, K. (2016 August 24). Interview with Rohan Samarajiva: If we sign ETCA, it will become more attractive for other trade agreements, Daily Mirror, http://www.dailymirror.lk/114618/If-we-sign-ETCA-it-will-become-more-attractive-for-other-trade-agreements
16 Warakapitiya, K. (2017 April 30). Acute labour shortage in Sri Lanka; 200,000 foreigners working here, Sunday Times, http://www.sundaytimes.lk/170430/news/acute-labour-shortage-in-lanka-200000-foreigners-working-here-238900.html
17 Central Bank of Sri Lanka (2017). Annual Report 2016. Colombo: CBSL, p. 28.
18 Verite Research is doing excellent work in this area.
19 LIRNEasia is working with the Department of Agriculture and the Sri Lanka Fruit and Vegetable Producers, Processors and Exporters Association to address these issues using modern technology.
20 E.g., Roderick, D. (2015 January). Premature deindustrialization. Economics Working Papers 107, IAS School of Social Science. http://drodrik.scholar.harvard.edu/files/dani-rodrik/files/premature-deindustrialization.pdf
21 E.g., Athukorala, P. (2010 August). Production networks and trade patterns in East Asia. ADB Working Papers on Regional Integration 56. https://www.adb.org/sites/default/files/publication/28530/wp56-trade-patterns-east-asia.pdf
22 Samarawickrama, M. (2016 October 14). Sri Lanka is ready for business. Daily FT, http://www.ft.lk/article/573733/Sri-Lanka-is-ready-for-business

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Selected trade-related publications
Bandara, K. (2016 August 24).  Interview with Rohan Samarajiva:  If we sign ETCA, it will become more attractive for other trade agreements, Daily Mirrorhttp://www.dailymirror.lk/114618/If-we-sign-ETCA-it-will-become-more-attractive-for-other-trade-agreements.

Samarajiva, R. (2016 March 16). Trade agreements as opportunities:  How to make best use of them, Daily FThttp://www.ft.lk/article/531261/ft [1]

Samarajiva, R. (2016 January 4).  Global value chains: A bridge too far? Daily FThttp://www.ft.lk/article/515531/Global-value-chains–A-bridge-too-far

Samarajiva, R. (2015 October 21).  The significance of TPP for Sri Lanka, Daily FT.http://www.ft.lk/article/485931/The-significance-of-TPP-for-Sri-Lanka

Samarajiva, R. (2015 September 14).  Plug pulling politicians should not be allowed to override mandate for trade agreements, Daily FT.  http://www.ft.lk/article/469687/Plug-pulling-politicians-should-not-be-allowed-to-override-mandate-for-trade-agreements

Samarajiva, R. (2015 March).  A new page in India-Sri Lanka relations? Diplomatist.

Samarajiva, R.; Amaratunge, C.J. (2012).  අපට ගැළපෙන ආර්ථික ක්‍රමවේද [Economic strategies appropriate for us].  Maharagama, Sri Lanka:  Ravaya Publishers.

Samarajiva, R. (2012 May 30).  International Trade:  Is Sri Lanka sleeping at the switch? LBO.  http://www.lankabusinessonline.com/international-trade-is-sri-lanka-sleeping-at-the-switch/

Samarajiva, R.; Herath, P. (2012).  1.2 trillion dollar GDP, 1.1 billion people:  How best can we grow with India?  Report for Pathfinder Foundation.

Samarajiva, R. (2010).  Enhancing the status of Colombo as a regional container shipping hub.  Economic Review, 37(3&4):  10-13.

Samarajiva, R. (2007 July 31-August 1).  Sri Lanka’s telecommunications commitments under GATS:  Assessment and issues for the future, paper at Conference on the Doha Development Agenda and the Future of the Multilateral Trading System organized by the Sri Lanka Law College, Colombo.  http://www.lirneasia.net/wp-content/uploads/2007/08/rstelecomtrade1aug07.pdf

Samarajiva, R. (2000).  The role of competition in institutional reform of telecommunications: Lessons from Sri Lanka, Telecommunications Policy, 24(8/9): 699-717.

Hadley, P.D.; Samarajiva, R. (1997).  Regulation of on-line content in the new trade environment:  NAFTA and communication policy, The Communication Review, 2(2): 207-33.

Samarajiva, R. (1993).  Down dependency road?  The Canada-US free trade agreement and Canada’s copyright amendments of 1988, in J. Wasko and V. Mosco eds., Illuminating the blindspots:  Essays honoring Dallas W. Smythe.  Norwood NJ:  Ablex, pp. 152-180.

[1] Recent Daily FT op-ed articles also published in Sinhala in Ravaya.

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Rohan Samarajiva is founding Chair of LIRNEasia, an ICT policy and regulation think tank active across emerging Asia. He was Chief Executive from 2004 to 2012. His most recent co-authored book (2013), Information lives of the poor: Fighting poverty with technology, was published in Burmese, English, French and Spanish.

He was also Team Leader at the Sri Lanka Ministry for Economic Reform, Science and Technology (2002-04), which is responsible for infrastructure reforms. He was Director General of Telecommunications in Sri Lanka (1998-99), a Founding Director of the ICT Agency of Sri Lanka (2003-05), Honorary Professor at the University of Moratuwa (2003-04), Visiting Professor of the Economics of Infrastructure at Delft University of Technology, Netherlands (2000-03), and Associate Professor of Communication and Public Policy at Ohio State University, US (1987-2000).

He was a member of the intergovernmental Joint Study Group on the India-Sri Lanka Comprehensive Economic Partnership Agreement (2003), and chaired the GATS Advisory Committee of the Department of Commerce (2002-2004).

More at http://lirneasia.net/about/profiles/rohan-samarajiva/

 

Task of new Finance Minister : Turning the tide of public displeasure

By Ravi Ratnasabapathy

This article originally appeared on the Daily News

Following the Cabinet reshuffle, Sri Lanka now has a new Minister of Finance. The reshuffle was timely, there is widespread disillusionment amongst the public who keep repeating that “nothing seems to be happening”. The Government now has the opportunity renew itself in the public eye, what should our new Minister of Finance do?

The macroeconomic indicators are improving: government revenues are up, expenditure is stable and the fiscal deficit targets look likely to be achieved for the current year.

Growth has slowed a little to around 4-4.5% but this is only to be expected and caused by the drought and tax increases, which are also the factors that have pushed up inflation. The impact of the floods will add to these pressures but macroeconomic fundamentals are stabilising and things should improve.

Yet why is there such intense annoyance amongst the public and the business community? This is partly a problem of perception and partly due to the painful measures imposed to sort out the fundamentals.

Business community

 

Public anger is driven by the cost of living while the business community is left bewildered by the perceived instability in the tax and policy environment. It is a tall order, but if both can be fixed he will be hailed as a success.

For the public, the problem is that the Government has achieved its macroeconomic stability at a cost: by imposing a huge tax burden on the public. Getting the macro fundamentals right is necessary and some tax increases are unavoidable but this cannot be a one-way process. The Government cannot expect to tax punitively, spend ostentatiously and expect the public to grin and bear the spectacle of ministers living in luxury while they are cutting back on staples.

The cost of living has risen sharply over the past two years because of taxes (VAT, excise duty, PAL and others) and the depreciation of the currency. Over the past two years the combined impact of VAT, PAL and the currency has added around 25% to the cost of imported items. Considering most of our basics are imported the impact on household budgets is heavy.

This is excluding the impact of any increases in duty and excise. While some duties have been cut others have risen, adding to the burden. Naturally, there is unhappiness when people have to cut back on their lifestyles; when ministers are seen to be living luxury this unhappiness morphs to real anger.

What should the minister do?

The Government has no room to cut tax – yet, but they do need to send a strong message that it is serious about controlling expenditure.

It cannot be only the public who bear the burden of closing the deficit, the Government must be seen to be doing something about cutting their own expenditure. This cut back needs to be visible and lead from the top: which means no new vehicles, no fancy offices, fewer overseas jaunts, no large entourage of security/staff. It must be visible, even if the impact on cutting back on ministers privileges yields comparatively small savings, they need to be seen to be tightening their belts to win public support.

Corruption and waste

Citizens are wearied by the sight of ministers scrambling for plum positions leaving a distinct impression is that their sole interest is in feathering their own nests and enjoying the perks of office.

The minister should launch an economy drive eschewing extravagance, the elimination corruption and waste through increased transparency and open processes. Sri Lanka’s leaders frequently cite the example of Singapore. Fiscal prudence has been a hallmark of Singapore’s governing philosophy and successful management of the economy; an ethos that must become a watchword for Sri Lanka’s rulers.

When faced with a crisis Singapore set up a “Cut Waste Panel” headed by members of the public and private sector, to receive suggestions from the public on where the government can cut waste, remove frills and make savings in the delivery of public services. The minister could set up a similar panel and in addition to suggestions from the public actively seek other opportunities to reduce costs.

For example, moving to daylight saving time will save money for the CEB and reduce household electricity bills. It is a simple measure that can bring benefits at almost no cost and should be implemented immediately.

There needs to be a tightening of belts but we must all be seen to be doing it together.

In parallel, there needs to be a comprehensive review of spending, reviewing not only the scale of spending but also the scope of Government. The Government should not expend any further funds expanding the SOE’s and should restructure these to cut waste and losses. Privatisation can have a threefold benefit:

a) raise revenue which will supplement tax revenues,

b) obviate the need to fund losses (in the case of loss-making entities), and

c) open new opportunities for private sector participation in the economy.

For example, plans to add 500 new outlets to the loss-making Lanka Sathosa chain at a cost of a billion rupees need to be shelved. Many SOE’s serve as vehicles for patronage and are dens of corruption. Lanka Sathosa which is mired in corruption scandals (one involving a Rs.15bn consignment of rice) and has not submitted an annual report since 2012 is a prime example.

Illiberal trade policies protect businesses close to politicians and raise the cost of living. There are many such instances but to cite just one example, the import of wheat flour is taxed, ostensibly to support paddy farmers but increases the price of bread. Bread is subjected to price control – to “protect” the consumer but why the local price of bread is rising even while world wheat prices have collapsed by 50% since 2013 is a question that needs to be asked. Liberalising the import of wheat flour could reduce prices significantly and thus the cost of living.

There are other sectors such as dairy, (milk powder attracts a duty of Rs.225/kg, butter Rs.880/kg), fruit (oranges Rs.65/kg, grapes Rs.130.kg, apples Rs.45/kg), cooking oil (Rs.130/kg) sugar (Rs.30.kg) and meat (taxed at 30%). The cost of living can be brought down if more sectors of the economy are liberalised.

New opportunities

These are short-term measures that can bring relief to the public while the private sector will welcome the new opportunities for trade that this opens.

The government’s fiscal position must sustainable over the medium and long term.

If this is not properly planned periodic fiscal crises will recur pushing the Government to resort to ad-hoc, short-term measures to deal with them creating the volatile business environment that destroys confidence.

The Prime Minister has already announced a medium-term economic framework. This, a good starting point. Budgets and policies must now fall within this framework. Policy making must be evidence based, with adequate consultation through the use Green and White papers, as in the UK.

Green Papers set out for discussion, proposals which are still at a formative stage. These detail specific issues and point out possible courses of action in terms of policy and legislation. Once an issue is debated, White Papers are issued as statements of policy, and often set out proposals for legislative changes, which may be debated further before a Bill is introduced.

The process of consultation minimises the need for later changes and results in stability in the policy environment which means business confidence will rise.

The minister has a huge task ahead of him, these are only a few preliminary ideas to explore and we wish him all success.

Cheap footwear imports benefit ordinary Sri Lankans

Sri Lanka's footwear industry has written to the Director General of Customs requesting a crack down on illegal imports of footwear.

The industry claims that Sri Lanka is losing over US $112.5 million annually in foreign exchange as a result of cheap footwear imports from China and India. The industry estimates that the state should have gained revenue of around Rs. 9 billion if proper taxes had been paid on the import shoes

Local manufacturers are supposed to be on the verge of collapse as they cannot compete.

The industry has made repeated calls for protection following the reduction of duties on imported sports shoes in the 2011 budget. Successive governments since 2002 have introduced tariff barriers to protect the local footwear industry but some duties were reduced in 2011.

Shoe makers claim that illegal imports are mainly factory overruns, stock lots and inferior quality products and are available in the market for less than Rs. 750 which is below the minimum total custom tariff on footwear (CESS Rs. 600 +PAL + VAT and NBT). Consumers who were befuddled as to why shoes are so expensive in Sri Lanka now know why.

Yet, only last month the Minister of Industry and Commerce Rishad Bathiudeen, speaking at the Footwear & Leather Fair remarked that Sri Lanka's footwear and leather exports have increased by 28% in 2016. "Our footwear and leather exports in 2016 increased by 28% in comparison to 2015 revenues to $140 Million showing strong growth trends”.

It is clear that the problem is not as straightforward as the industry claims. The local shoe industry seems to succeed competing, at least on some level in the global market. If they compete abroad they should be able to compete in the domestic market, why is there a need for protection? 

Let us try to assess the relative benefits and costs of protecting the local shoe industry.

The industry maintains that letting consumers buy cheap imported shoes threatens the jobs of 40,000 people employed in the industry island wide.  The producers have requested that the duty structure that prevailing before 2011 be reintroduced. Duty on shoes was 30 per cent or Rs. 1000 per pair whichever was higher. Addition to duty, a CESS of Rs. 500 was levied per pair. 

This is a significant additional cost that consumers are burdened with. Additional costs will be a source of particular anguish to the parents of the four million children who attend school and whose shoes would need to be changed almost every year. All children have in common a constant need for new clothes and shoes as they grow. Kitting out youngsters for school can be expensive; those who participate in sports may require several different types of shoes, placing a heavy strain on family budgets.

The effect of import duties is to raise the price of both foreign products and domestic goods. These policies may “save” the 40,000 jobs in the industry, but only at the expense of the overall welfare of consumers. The annual shoe requirement locally is around 40 million pairs; a greater part of the population needs to pay higher prices on shoes in order to support the footwear industry.

Trade protection temporarily helps some producers, but it cannot do this without harming others. Who is affected by higher import duties? First consumers who either buy an imported shoe or a local shoe sold at a high price. Remember it is not just a case of an imported shoe being sold at a high price and consumers turning to local shoes instead. The purpose of the duty is to enable local products to be sold at higher prices (benefiting manufacturers) than would otherwise be possible.

Since they pay higher prices, consumers would have less money to spend on other goods, indirectly hurting various other trades. Due to high prices people will buy less; they will manage with broken or worn out shoes without replacement. Shoe traders and retailers, who sell imported shoes, will also suffer from reduced business.

Various arguments are put forth to support protectionism; to protect sunrise (infant) industries, sunset (declining) industries, strategic industries (energy, water, food etc.), save jobs or deter unfair competition.

When firms within certain industries call for protection, for whatever reason, policymakers must view the issue from the perspective of the consumers as well and weight the relative merits of the claim. Consumers do not form associations and lobby for their interests, unlike businesses, so Governments are under little pressure to look after consumer interests. Yet, in most instances the number of consumers far outweighs the number of producers or the number of jobs concerned. Often, the real goal of the industry is to gain security through the removal of competition.

Certainly, if duties are lowered, some workers in the footwear industry may lose their jobs and some or all of the firms may be forced to close by the foreign competition. The indsutry claims that 2000 cottage type businesses may have to close.

Workers will have to look for employment elsewhere. However, other job opportunities will be made available since the money that consumers previously had to pay for duties could be used to buy new products or services or consume more of already existing products and services. Employment is created in other sectors because resources will flow to areas that consumers consider being of highest value to them. 

It is rather ironic that while the industry focuses on opening markets abroad it is keen to keep the domestic market as protected as possible, in the interest of maximising exports and minimising "harmful" imports. It is fortunate that the export destinations for Sri Lanka's shoes are more open than Sri Lankas' home market.

In general, tariffs promote the production of items in which a nation is inefficient and deter other production lines in which the country has a comparative advantage. By reducing tariffs, things that could be produced more efficiently in one country would be made there and items that could be purchased less expensively abroad would be imported.

In the 1950’s, Britain attempted to protect its famed Lancashire textile industry through restraints on imports.  At best, this may have prolonged its decline, but it did nothing stop it.  Low-cost textiles were being made on a mass scale by foreign competitors.  Eventually the Britain’s textile industry moved to high added value luxury and designer products that sold at a premium in both domestic and foreign markets.  Some UK textile products have become world-beaters, without the need for subsidies or tariffs to protect the jobs they sustain.

Some of Sri Lanka’s shoe exporters are already competing effectively in the world market. Reducing import duties on shoes would benefit consumers and would spur the local industry to improve efficiency and towards greater innovation, to the long term advantage of all concerned.

A version of this article previously appeared in the Ceylon Daily News.


Ravi Ratnasabapathy is a Fellow of the Advocata Institute and a management accountant by Training.