In dealing with disaster, the state has a critical role

By Ravi Ratnasabapathy

Originally appeared on the DailyNews

Sri Lanka braces itself for yet another round of floods; the third in as many years. As floods and droughts become regular occurrences, how should the nation respond?

The impact of this year’s floods is not yet known but likely to be heavy. In May 2017 floods and landslides affected 15 of the 25 districts of Sri Lanka. The drought in 2016 and 2017 affected 1,927,069 people across 17 districts, many of them poor.

“Approximately 12 per cent of those affected were poor, nearly twice the national average of 6.7 per cent. In the case of the landslides, this is because the 11 affected Divisional Secretary (DS) Divisions tend to be poorer than the national average. Those affected by the floods overall were also disproportionately poor, with an estimated poverty rate of 8.7 per cent.” (World Bank)

If the poor are disproportionately affected by natural disasters it has a negative impact on poverty and therefore has the highest level of priority for policymakers.

Little can be done about the weather but proper risk management can minimise its impact. The Government needs to move from the unplanned and ad-hoc reaction when disaster strikes to a proactive, systematic management of risk, something that may be illustrated by the example of Chile.

The earthquake that rocked Chile in 2010, one of the largest in history that wiped out roughly 18% of the country’s GDP – a massive impact. (The impact Sri Lanka’s 2017 floods was only 0.4% of GDP.) Yet Chile demonstrated a miraculous recovery. Most countries that suffer catastrophes of that magnitude take years or even decades to recover. Chile did it quickly, how did it do so?

Several factors contributed overall to the low casualty rate and rapid recovery.

The Government had decided to prioritise the role it played in managing disasters. First, in minimising damage, because of its history with natural disasters, Chile’s Government had developed a strong building code and ensured it was properly enforced. In particular, Chile had a law that held building owners accountable for losses in a building they built for 10 years. Furthermore, while not legally required, almost all homeowners in Chile had earthquake insurance because banks required it in order to get a loan to buy a house.

Second, the disaster response had been well-planned- the number of fires after the earthquake was limited due to the immediate shut down the electricity grid and the local emergency response was very effective. The third factor was education: the overall high level of knowledge about earthquakes and tsunamis by much of the population that helped them respond more appropriately after the event.

After the disaster, any government faces the question of how reconstruction will be paid for. Did Chile wait for aid to arrive? No.

Following the quake, because of the sheer size of the disaster, Chile was compelled to increase taxes temporarily. But the policies that ensured that a large part of the homeowner market was insured paid off – it minimised the amount the Government needed to finance. Together these contained the financial ramifications from the earthquake and put Chile quickly on the road to recovery.

Although Sri Lanka never experienced anything like the devastation in Chile, natural disasters in Sri Lanka take a heavy toll on resources and people. Apart from the human cost they disrupt agricultural output (which may affect exports) and increase food inflation. The contraction of economic activity negatively impacts government revenue while simultaneously creating new budget pressures in the form of disaster relief. In the four months of 2017, the government reportedly incurred LKR 1,397 million for the provision of disaster relief (World Bank).

How can risk be managed?

Small risks may be managed by households and slightly larger ones at the level of the community but for largest risks governments have a critical role, providing an enabling environment for shared action and responsibility and channelling direct support to vulnerable people.

The problem needs to be tackled across three fronts:

1. Preventive measures that minimise the impact of disasters.

2. Early warning systems and evacuation plans that allow people to leave disaster zones to safer areas.

3. Managing the financial risks from natural disasters.

Preventive measures

1. Floodplain zoning

A flood zoning authority must be created and floodplains (the water channel, flood channel and low land susceptible to floods) must be surveyed. The survey forms the basis of establishing floodplain zones, including delineation of the areas subject to flooding and classification of land with reference to the relative risk of flood.

Specific activities and uses (settlement and economic) in designated areas should be subject to administrative permits and building/land use codes. Eg. Building and design standards must protect against inundation. Restrictions and prohibitions should be based on risk assessments.

 

 

The public should be made aware of the dangers of floods and the need to restrict use.

Information about restrictions on construction in flood areas should be easily accessible and information about risk assessments should be easily understood, for example, clear flood maps and, where appropriate, information based on geographic information systems (GIS) should be distributed. Mandatory disclosures of risk could be included for property transfer or rental in areas of risk.

2. Conservation of wetlands

Wetlands are natural sponges that trap and slowly release surface water, rain, groundwater and flood waters. They are important in both flood and drought management so as far as possible natural wetlands and retention areas in the river basin should be conserved, and where possible restored or expanded.

3. Modifying the flood flow: Engineering measures

Diversions, reservoirs, channelisation (increasing the capacity of the channel), bank protection (to prevent bank erosion), dams and floodplain restoration (creating washlands that can safely take overflows) will play a role in minimising impact. Engineering measures must be in harmony with the landscape and nature conservation. A holistic approach covering the whole river basin is needed as localised flood protection measures can have negative effects both downstream and upstream.

Early warning systems and education

Forecasting and early warning systems should be established and guidelines issued on how populations are to act during floods.

Education on measures that can be taken at the level of individual households to either limit the damage when flooding occurs or prevent inundation is needed, eg. elevation of structures, elevated curb stones to prevent water entry from smaller events, reinforcement of foundations to avoid structural damage, moving building contents (and particularly electrical installations) above flood water levels (either temporarily or permanently), dry flood proofing to make areas below flood water levels watertight and temporary or permanent flood walls (ranging from sandbags to free-standing concrete barriers).

Forecasts and related information must be easily accessible and real-time media coverage ensured.

Managing financial risks of natural disasters

The GoSL exposure to disaster risk is through the costs of relief/recovery, reconstruction of public assets, compensation and (re)insurance schemes that provide coverage for disasters.

Several tools are available:

i. Insurance, GoSL already has some cover with the National Insurance Trust Fund but premia can be reduced through risk reduction – eg. land-use planning, flood defences etc. which will also support private insurance, which can top-up overall compensation.

ii. Risk pooling - insurance coverage for a pool (or its full portfolio) of Government assets. Insurance arrangements that cover a broader pool of assets facing more diversified risks can have cost advantages over insuring the assets in a flood zone.

iii. Multi-country pooling (done by several Pacific, Caribbean, African nations) provide small countries with improved access to international insurance markets based on their ability to merge a set of (less) correlated risks.

iv. Catastrophe bonds: bonds where the principal or interest payments are delayed or lost to investors in the event of a disaster.

v. Contingent credit lines with multilateral development agencies can bridge short-term shortfalls.

These are some possible options, careful assessment of the relative costs and benefits of different approaches is necessary. Once zoning is complete, the Government could lead the way in the relocation of some public assets away from areas of risk.

Rethinking agricultural policy

Agriculture is being affected by social, economic and environmental pressures. Current policies which encourage domestic agriculture need to be reviewed in the light of changing the climate, society- fewer people wish to take up agriculture, labour shortages and pressures on land use.

Policies that encourage risky production choices in flood zones or increase vulnerability to droughts and floods should be avoided. Allocation of water rights should reflect sustainable use and will help mitigate the impact of droughts. The Government must understand the impact that disasters have on poverty and recognise the proper role it must play in managing these risks. Ad-hoc responses grab headlines but working strategically to minimise long-term risks-a harder and thankless task, is the way to go.

The author is a resident fellow at the Advocata Institute.

Sri Lanka can create jobs, boost exports, by moving brains: Hausmann

  Harvard University’s Center for International Development Director Prof. Ricardo Hausmann

Harvard University’s Center for International Development Director Prof. Ricardo Hausmann

Many advanced nations from Singapore to the US have open policies that allow people to migrate easily bringing knowledge and skills to transform economies and create new jobs, a top Harvard economist said.

Allowing brains to move brings skills in faster, and tends to have a multiplier effect in jobs and economic activity, Ricardo Hausmann, from the University of Harvard, told a seminar organised by Colombo-based Advocata Institute.

In the US, every foreign-born Science, Technology, Engineering and Mathematics (STEM) graduate was found to help create 2.61 additional jobs, Hausemann said.

Technology is not limited to tools and codes/routines/procedures. These can all be easily transferred. What is difficult to transfer is tacit knowledge, knowledge embedded in the human mind through experience. Tacit knowledge includes insights, intuition and personal wisdom gained through experience. This is know-how and something that is difficult to extract and codify.

Know-how takes a long time to acquire, like becoming a skilled surgeon or an anaesthetist. To carry out a successful operation both were needed. 

Producing complex goods requires different types of know-how which a single person simply did not have. In simple agriculture of a different age, a single farmer knew how to grow seed, cultivate, breed and look after buffaloes, make or repair his plough and produce his fertiliser.

But in modern agriculture where genetically engineered seeds, combined harvesters and fertiliser were used, he simply did not have the knowledge. An advanced society possessed a lot of know-how, but it was in the minds of many different people. 

  Harvard University’s Center for International Development Director Prof. Ricardo Hausmann with Moderator JB Securities CEO Murtaza Jefferjee Pix by Ruwan Walpola

Harvard University’s Center for International Development Director Prof. Ricardo Hausmann with Moderator JB Securities CEO Murtaza Jefferjee Pix by Ruwan Walpola

 

Scrabble theory


To produce a good, a team of people had to come together, like making a word out of different letters when playing scrabble. While some letters may be available, others were not.

“So if you are missing a letter, the other letters would become less valuable. So you would give a lot to have this other letter.

“I like to say that an anaesthetist working on his own is not much better than a bad economics lecturer. The only thing he does is put people to sleep.”

“So if you bring different skills, you can make more things. They are complements, not substitutes. There are enormous benefits in different people working together.”

“In some sense the secret of development is to get more letters and express them in different words and longer words.”

He says it is difficult to move know-how into brains. Author Malcom Gladwell had claimed that it took 10,000 hours (about 14 years) to learn, practice and acquire a world class skill.

“So how do you move know-how? How do you get more know-how to Sri Lanka? We know it is difficult to put know-how to brains,” Hausmann says.

“It is much easier to move brains. It is a fundamental intuition.”
 

Moving brains


Brains moved through migration, foreign direct investment and diaspora networks, when people who had originally migrated out, came back.

Moving brains allowed a geographical region to move into entirely new products and keep boost productivity in established sectors, he said.

In Sri Lanka, Camso-Loadstar, now a global solid rubber tyre company was founded by a foreign national teaming up with a local partner.

US car companies Ford, GM and Chrysler were founded by people who worked for Oldsmobile. Oldsmobile was founded by a German who worked for Daimler-Benz.

Silicon Valley founded by 10 people who were hired from AT &T Bell Labs in New Jersey to Shockley Semiconductor. Eight broke away to form Fairchild Semiconductor. 

Ex-Fairchild workers then founded a number of other companies including Intel. About 57% of Silicon Valley workers are now foreign born, 25% were out of state.

“Only 18% were born in California, even though it has a population of 40 million, twice as big as Sri Lanka,” Hausmann said. “Silicon Valley would not exist if it was based on locally grown talent.”

Hausmann himself is originally from Venezuela.

Sri Lanka’s IT sector is small and not growing as fast as countries that had easier access to foreign talent.

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Wage differential
 

Wages were found to be lower in Sri Lanka than in India, he says. 

However IT wages are higher than in other sectors in the island. IT graduates could find work easily suggesting that skills were in short supply.

Sri Lanka a net was exporter STEM workers, Hausmann says. About 23% of engineering and science graduates and 20% of computer science graduates leave the country to work abroad each year he says.

The low inflow of foreign workers does not compensate for outflow, he says.

Apparel manufacture in Bangladesh was pioneered by a Desh Garments in 1977, in a joint venture with Daewoo, who took 126 workers of various disciplines to train in their country. By 1988 ex-Desh workers had set up 56 companies.

Foreigners who move tended to create more jobs though the common perception was that they ‘stole’ jobs.

In Singapore now 45% of the population was foreign born, “People say we want to be like Singapore,” Hauseman said. “But they would not have gotten where they were with only home grown ‘letters’. They had to attract ‘letters’.

The foreign born population of Hong Kong was 40%, he said.

 

Stealing jobs or creating jobs?
 

It was not just obviously technological degree holders that transformed countries, he said.

Albania, an ex-communist state had at one seen large scale migration into Greece. 

When the Great Recession credit bubble broke, hitting the Greece’s deficit spending government and its economy, large numbers returned boosting Albania’s workforce 5%. The people who went to Greece were supposedly low skilled.

The standard argument goes that, if the workforce increased unemployment would rise 5%. Or wages would fall.

“Well, unemployment went down and wages went up,” Hausmann said. “And why? The people who returned were not the same people that had left in terms of know-how they possessed.”

Agricultural workers for example had worked in green houses. 

“They built green houses and hired neighbours,” he says. “And there was a boom in tomatoes and other agricultural exports.”

Panama had seen a spectacular boom in services, which was very skill intensive.

The country had built special economic zones with tax holidays. The country wanted to attract international headquarters. 

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Horrible immigration laws
 

But investors who wanted to come, wanted exemption from immigration laws.

“So Panama has a horrible immigration policy as bad as that of Sri Lanka,” Hausmann says.

“They had closed the door on immigration but they opened two windows. People came in through the windows.

“So foreigners came in and there was a boom in construction and everything else and wages of Panamanians skyrocketed,” he says.

Still only 4.7% of the population is foreign born in Panama.

“It is one foreigner in 27. Not like one is 7 in the US, or one it two in Singapore,” he says. “And everybody complaints about that. 

“It doesn’t matter what level of migration is. Australians are at 27% migration and they think it is too high. Panamanians are at 4.7% migration and they think it is too high. 

“Sri Lankans are at 0.1% migration and they think it is too high.”

Sri Lanka could grow fast with immigration law reform, he says. 

Though board of investment companies were allowed to bring some foreign workers, their spouses are not allowed to work. 

Typically professionally qualified people married qualified people.

They also cannot choose a different job after they come. 

There was no path to permanent residency or citizenship. It was much more difficult for a non-BOI firm to access foreign talent. 


Approving vs Attracting Talent
 

Hausmann’s team had done a comparative study reviewing immigration laws of Hong Kong, Singapore, Indonesia, Thailand and Vietnam. They had also looked at Saudi Arabia.

The more economically advanced have sophisticated immigration systems that have moved from being systems that strictly authorised the entry of foreign workers, talent, and capital, to systems that promote their entry, he says.

They had a wide variety of visas for skilled, semi-skilled, trainees, managers and entrepreneurs. There were talent visas.

He says immigration reform should be part of an overall effort to draw talent, foreign direct investment and export diversification. 

More visa categories should be created. If here is a path to residency more skilled workers will come. 

He says immigration reform is a ‘low hanging fruit’ that can be implemented easily unlike infrastructure which needs lots of money. 

“Sri Lanka may have the talent and the people for the current economy, but does it have the talent and the people for the economy it wants to have?” Hausmann says.

“To get there, Sri Lanka will need to open up for more inflow of foreign know-how the way all prosperous countries have done already. This means more FDI, more return diaspora and higher inflow of foreign workers.”

Sri Lanka is ‘weird’ he say because there is no path to citizenship unlike countries that have become prosperous fast.

Analysts say Sri Lanka’s immigration laws are even ‘weirder’ than people realise.

Solving Sri Lanka’s growth conundrum: lessons from East Asia

Originally appeared on Echelon

By Ravi Ratnasabapathy

Sri Lanka’s economy has lagged its potential for decades. Even nine years after the end of the war, growth remains elusive. Something is wrong, but what? Sri Lanka, like other developing countries, experienced short spurts of growth, but nothing like sustained growth over decades that took place in East Asia.

Between 1965 and 1993, the high-performing countries of East Asia (HPEA) – Hong Kong, Singapore, Taiwan and South Korea – broke the mould of history: they brought about, within a single generation, a process of socioeconomic development that took the advanced economies of Western Europe centuries to achieve. Malaysia, Thailand and Indonesia also experienced rapid progress, although not to the same extent as the others. These nations used a range of policies, from hands-off to highly interventionist, so no single “East Asian model” exists, but economic openness, macroeconomic stability and flexible labour markets were common factors that provided the enabling environment for growth.

DRIVERS OF GROWTH
There is a general agreement that the two principal drivers were as follows:
(a) rapid capital accumulation, both human and physical
(b) superior allocation of physical and human resources among various sectors of the economy

High levels of investment created jobs, which together with ongoing investments in education, improved skills and enabled workers to move into new industries as they opened up.

OPENNESS TO TRADE
Sri Lanka’s educational standards, like India and the Philippines, exceeded those of East Asia in the 1950s. The difference was the environment in which investments in education took place: an openness to trade. While Sri Lanka, India and the Philippines adopted a path of self-sufficiency, closing themselves to outside influences, the rest of East Asia opened up.

After an early phase of import substitution, the miracle economies embarked on a strategy of outward orientation from the 1960s. This outward orientation was reflected in their lowering of tariff rates and export taxes, the removal of quantitative restrictions on trade and reduced barriers to international investment flows (ADB, 1997).

FDI brought new production techniques, quality control and access to external markets. It created competitive pressure on local firms to acquire new skills. An important spillover effect was the demonstration effect to domestic firms regarding feasibility in terms of production and quality, thus heightening demand for new technology and sophisticated skills by local firms. This created a virtuous cycle of accumulation and assimilation: rapid acquisition of new technology went hand in hand with the formation of new skills, some of which took place outside schools; on-the-job-training, informal acquisition of knowledge and learning by doing. Some innovations originated on the shop-floor.

Growing levels of income, in turn, increased both private and public investment in education including, specifically, higher education, and science and technology. The outcome is reflected in the rising shares of exports and imports as a proportion of these economies.

Trade and regulatory barriers make Sri Lanka unattractive for investment, which means lower levels of technology transfer and, in turn, productivity; a cycle that needs to be broken

MACROECONOMIC STABILITY, FISCAL PRUDENCE AND DEBT
Exceptional macroeconomic management created the stable environment essential for private investment. Fiscal prudence is key to macroeconomic stability. Balanced budgets lead to low inflation, low interest rates and stable exchange rates. Some countries did run small deficits: between 1961 and 1996, South Korean deficits averaged 0.86% of GDP, Thailand (0.79%), Indonesia (1.09%) and Malaysia (4.04%), but nothing like Sri Lanka’s deficits, which averaged 8.2%.

Countries that did run deficits financed them prudently, avoiding money printing, which causes inflation and currency depreciation, unlike Sri Lanka.

TECHNOLOGY AND PRODUCTIVITY
East Asia’s extraordinary growth was not only due to superior accumulation of physical and human capital, but also to better allocation of capital. The more easily accessible resources in an economy can move from lower to higher productivity activities, the greater the overall productivity.

Lower-income countries are less developed not only because they have less physical and human capital per worker than developed economies, but more importantly, because firms use their tangible input of labour, capital and raw materials less efficiently – and without combining them with sufficient complementary, knowledge-intensive intangible assets (Dutz & O’Connell, 2013).

Sustainable economic growth is based on productivity growth.

Productivity growth in Sri Lanka increased following reforms in 1977/78, but slowed steadily between 1988 and 1997 mainly due to slower adoption of technology (Bandara and Karunaratne). In an open world, there is always competition from low-wage economies that compete on cost. Established players may start with low wages, but must move up the value chain, redesigning and improving their production systems to increase competitiveness.

Competitive pressure forces firms to improve, restructure or close. Inefficient firms being closed or taken over (by more efficient ones) is not harmful, but increases overall productivity, a process termed “creative destruction”. In common, East Asia did not have high levels of labour protection, making it easier to downsize or close businesses.

Instead of minimum wages or job protection, governments focused on job generation, boosting demand for workers, resulting in rising employment levels, which was followed by market- and productivity-driven increases in wages. Low inflation meant workers experienced real increases in living standards, unlike in Sri Lanka where inflation erodes wage increases.

Resource allocation is also dependent on prices and regulation, prices for energy, raw materials, and indeed all factors of production including labour and capital. For example, mispricing energy may change the relative competitiveness of certain industries, and subsidised credit could end up propping up inefficient firms. Despite some limited intervention, all HPEAs kept price distortions within reasonable bounds. Regulations can create rigidity that impedes optimal resource allocation (e.g. Paddy Lands Act prevents alternative use of land).

SELECTIVE INTERVENTION
Many HPEAs practised intervention to foster development, with variable results. Where guided by political considerations, such as Malaysia’s efforts at heavy industrialisation in the 1980s and Indonesia’s high-tech industrialisation in the 1990s, they did not succeed. (Jumo 2001).

Where selective interventions succeeded, they did so because of three essential prerequisites. First, they addressed problems in the functioning of markets. Second, they took place within the context of good, fundamental policies. Third, their success depended on the ability of governments to establish and monitor appropriate economic-performance criteria related to the interventions (World Bank, 1993). A technocratic bureaucracy, insulated from political pressure with capacity to conceive and implement the policy designs, is essential. This requirement, and the fact that the WTO rules now bar some of these policies, means that this has limited application for Sri Lanka. The World Bank concludes that “the market-oriented aspects of East Asia’s policies can be recommended with few reservations, but the more institutionally demanding aspects, such as contest-based interventions, have not been successfully used in other settings” (World Bank,1993).

CONCLUSION
East Asia’s success was based on set complementary factors that worked in concert. Economic openness is critical, but must go with macroeconomic stability, low price distortions, and a conducive regulatory environment that encourages investment and permits efficient allocation of resources. Sri Lanka retreated from a policy of openness since 2000, raising tariff and regulatory barriers, resulting in a sharp contraction in exports as a share of GDP, which fell from a high of 33.3% to about 12.7% in 2016. Total nominal protection doubled from 13.4% to 27.9% between 2004 and 2009 (Pursell 2011).

Tariffs and policies favour import substitution in agriculture and industry. Domestic industries have thrived, but at the expense of productivity. Low productivity growth means wages rise slowly, but high tariffs from food and household products translate to high costs of living. This prompts workers to seek high wages (which deters some investments) or better paying jobs overseas. Worker remittances support families, propping up consumption and local industries. Trade and regulatory barriers make Sri Lanka unattractive for investment, which means lower levels of technology transfer and, in turn, productivity; a cycle that needs to be broken.

No single “East Asian model” exists, but economic openness, macroeconomic stability and flexible labour markets were common factors that provided the enabling environment for growth of East Asia

KEY RECOMMENDATIONS
1. Trade and commercial policy liberalisation
2. Macroeconomic reforms
3. Investment and regulatory reform Trade reforms

Eliminating the anti-export bias of import protection (resulting in exports being less profitable than domestic sales, propped up by high protection) encourages trade and investment in exports. This overcomes limitations of the domestic market and creates the competitive pressures that drive productivity. This works through three channels.

First, it lowers prices, benefiting consumers by increasing purchasing power (pro-competitive effect); second, it forces less competitive firms out of the market, reallocating resources to more competitive ones (selection effect); finally, it induces innovation to improve productivity (innovation effect). Higher productivity growth produces not just one-off price reductions, but a sequence of reductions over time, increasingly benefiting present and future consumers.

Macroeconomic reforms
There is acceptance on the need for fiscal consolidation and balancing budgets, but adopting a Medium-Term Expenditure Framework; an annual, rolling three year-expenditure plan that sets expenditure priorities; and hard budget constraints increase predictability and credibility of commitment to macroeconomic stability. Creating externally imposed constraints on Central Bank operations based on commitments to the IMF or, more radically, by adopting the German Bundesbank Law as done in some East European nations will enhance this further.

Investment and Regulatory reforms
Broad-based regulatory reform must include agriculture, which contributes about 8.7% of GDP, but absorbs 28% employment. Reforms to seed, planting material and land policy to increase productivity are needed. Incentives should promote the adoption of technology (greenhouses, drip irrigation) and mechanisation. Withdraw price and marketing interventions. Divert expenditures to provision of agricultural insurance, finance, irrigation infrastructure and R&D.

In East Asia, agriculture productivity improvements released labour to work in non-farm employment, and reduced food prices helped increase the value of real incomes (ADB 1997).

Encourage private provision of tertiary education to meet the evolving skills needs of an outward-oriented economy. The impact of policy reforms will be enhanced by investments to eliminate infrastructure bottlenecks. Investments must be characterised by transparency, efficiency and quality, and privately financed to minimise budget strain. These are merely the outline of a large reform process to ease investment and trade. Post-war, the economy experienced a brief spurt of debt-fueled reconstruction and infrastructure-driven growth, but this petered out. Apart from questionable improvements to productivity, it is a path that is closed to a heavily indebted government.

East Asia grew in different circumstances, but openness and trade underpinned by decent macroeconomic fundamentals still offer opportunities for growth, as demonstrated by later reformers like Vietnam. It is the path Sri Lanka should return to.

 


References
1. ADB (Asian Development Bank). 1997. Emerging Asia: Changes and Challenges. Manila.
2. Productivity, Innovation and Growth in Sri Lanka, An Empirical Investigation, Mark A. Dutz Stephen D. O’Connell, World Bank 2013
3. An empirical analysis of Sri Lanka’s Manufacturing Productivity slow-down, Bandara, Yapa M. W. Y. and Karunaratne, Neil D. (2010) An empirical analysis of Sri Lanka’s Manufacturing Productivity slow-down. Journal of Asian Economics
4. Jumo, K. 2001. “Rethinking the Role of Government Policy in Southeast Asia.” In Joseph E. Stiglitz and Shahid Yusuf, eds., Rethinking the East Asian Miracle. Oxford, U.K.: Oxford University Press.
5. The East Asian Miracle, Economic Growth and Public Policy, World Bank 1993.
6. Pursell, Garry and F.M.Z. Ahsan (2011), ‘Sri Lanka’s Trade Policies: Back to Protectionism’, Australia South Asia Research Centre Working Paper 2011/03, Canberra: Australian National University
7. Growth and Poverty: Lessons from the East Asian Miracle Revisited, M. G. Quibria, 2002.
8. Giammario Impullitti and Omar Licandro. 2018.We may be underestimating the gains from globalisation. [ONLINE] Available at:http://blogs.lse.ac.uk/businessreview/2018/03/09/we-may-b-underestimating-the-gains-from-globalisation/. [Accessed 10 April 2018].

Tax Spiral and Government Spending

By Ravi Ratnasabapathy

The new Inland Revenue Act replaces the existing income tax law and comes into effect from April 1, 2018. It’s stated aim is to simplify and modernise the existing code and it does take some steps towards this.

Sources of income have been consolidated and some exemptions removed but it also introduces new complexities with regard to deduction of certain business expenses including interest and repairs. It aims to reduce tax holidays, which is positive; tax holidays go against the principle of equal treatment but the aim to increase direct taxes is questionable. Indirect taxes affect consumption and spending but direct taxes affect savings and investment.

Nevertheless the Government is expected to collect more tax with the burden falling heavily on businesses and higher income earners.

This column will focus mainly on the larger issues from a macro perspective rather than a detailed analysis of tax rates.

Taxation is required to fund government spending but the system must based on sound principles: simplicity, certainty and stability. Simplification reduces costs of administration and brings greater clarity. The government’s pressing need for revenue means that taxes should focus primarily on this aspect; using taxes to regulate activity (eg. bank lending, leases etc.) should be avoided.

Tax transactions

Taxes designed purely to raise revenue are more likely to be simple, as the only design constraints are neutrality and efficiency. The number of taxes and the number of tax rules should be minimised.

Uncertainty can arise at any stage – when identifying tax transactions, valuing them and applying tax law to them. (eg. conflicts between the Inland Revenue and Foreign Exchange Act, uncertainty over application of capital gains tax to old apartments). For this reason it is preferable to alter rates on existing taxes rather than introducing new taxes or changing the basis of application. Ad-hoc tinkering outside the annual budget should be avoided. Retrospective legislation is particularly devastating and its use should be discontinued.

Stability is connected to certainty. ‘Certainty’ is knowing the answer to a given question; stability is about whether the current answer will still be correct in few years’ time. For taxpayers, stability enables better planning and efficient compliance.

People can budget household income more accurately and businesses can make long term investment decisions in confidence. Businesses would far prefer to operate in a slightly more imperfect system than in one where incremental improvements are made every year. Stability also enables more efficient administration; changes in returns, processes or mechanisms of collection create difficulties for the Inland Revenue.

A stable tax system requires greater predictability in expenditure. Unfortunately too much spending is driven by short-term expediency and is often disconnected from policy making, planning and budgets. A medium term expenditure framework incorporating fiscal sustainability and space is essential.

Inflation and currency depreciation

Fiscal Sustainability considers the fiscal balance, evolution of public debt, capacity of the government to finance its budget (borrowing etc.) requirements, refinance maturing debt and fiscal risks. Fiscal Space refers to additional expenditure needed to promote development or stimulate growth.

While taxes are important, it is government spending rather than taxation that ultimately determines the total burden of government activity on the private sector. Although spending may also be financed by borrowing or printing money, all government spending is ultimately a call on resources that have alternative uses or involves transfers from one group in society to another. If a government borrows money, this has to be financed at the time of borrowing and then serviced by future generations of taxpayers with interest. Money printing causes inflation and currency depreciation.

Thus far the Government has focused on achieving fiscal consolidation through revenue enhancing measures. This must change, the level and composition of public expenditure must be reviewed for efficiency. Between 2005-17 total spending quadrupled (from Rs. 584,783 m to Rs. 2,645,300 m). This level of growth in expenditure is difficult to sustain and threatens macroeconomic stability, which is necessary for growth.

The Government needs to conduct a comprehensive review of spending, evaluating the quality and efficiency with a view to reducing waste, inefficiency and improving outcomes. Expenditure needs to be prioritised within a frame of a medium term expenditure plan. There is much scope for further simplification and rationalisation of the overall tax system including para tariffs and excise duties.

People are worried that the rates of tax may increase-quite understandably so. They must pose the next logical question: What does the government do with the money that they collect? Is the public getting value for the money being spent-does the much vaunted public health and education system deliver value? If so why do so many go to private hospitals or fee-paying schools. For the richer sections, lead by the ministers themselves, even the local private hospitals and schools are not good enough - they must go overseas. Why?

Unless the public holds the government accountable for its expenditure we will see a never ending spiral of spending and taxes.

This article originally appeared on the Daily News

 

The COPE Report findings: we need to rethink the role of the State

By Ravi Ratnasabapathy

The last report from The Committee of Public Enterprises (COPE) released in 2016, highlights the government waste.  In this article we highlight some of the worst excesses.  

The Government is entrusted with billions of rupees of public funds, collected from the people. It has a duty to account for them and use them in accordance with the wishes of Parliament, without excess, extravagance or waste.  

Ensuring the money is properly used is the responsibility of Parliament which works through two  Committees, the Committee on Public Accounts (COPA) and the Committee on Public Enterprises. COPA scrutinises the Government, its Ministries, Departments, Provincial Councils and Local Authorities while COPE scrutinises public corporations and business undertakings.   

Summarised are some findings of the 1st COPE report. The COPE, by its own admission, is under-resourced. It lacks staff particularly for audit and legal support. They also lack IT systems and apparently, even a proper office.

Despite these limitations and the fact that the reports are not comprehensive-they have examined a limited number issues in a few institutions, they are a devastating critique on the state of governance. This is only the tip of a very large iceberg and underlines the need for a drastic re-think in the role of government.

A few highlights are presented below.     

The Committee on Public Enterprises

First Report
(For the period from 26th of January 2016 to 08th of April 2016)

Purchase and issue of substandard drugs

  1. Imported pharmaceuticals not properly tested due to lack of lack of laboratory facilities. Drugs later found to be substandard are issued to patients owing to the delays in testing samples prior to the distribution of the same.

  2. Drugs worth Rs250m had been identified for destruction in 2014 & 20 15but only Rs.214.6m were actually destroyed.

  3. Substandard drugs worth Rs.199m purchased between 1996-2014 for sale through Osu Sala outlets.

  4. Substandard drugs worth Rs.1bn purchased between 2011-14, the majority (Rs.867m) for distribution free through the public health system.

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Ceylon Electricity Board

Lack of accountability 20 subsidiaries incorporated under the Companies Act  

The CEB holds a 63% stake in Lanka Transformers Ltd, which in turn has stakes ranging from 50%-100% in 15 of other companies. The CEB also has stakes of 50%-100% in 5 other companies.

  1. LTL and its subsidiaries refused to submit details of operation to the COPE, despite the fact that the CEB effectively owns more than 50% of the shares. They claim to be private companies and need not report to parliament. The accounts of 14 were later submitted 16.3.2016

  2. The subsidiary companies have paid dividends worth Rs.14bn to LTL. The CEB should have received 7.1bn as its share but only Rs.6.9bn was received.

Authors Note: LTL supplies services and products to the CEB. Values and terms of contracts are not known.

Payment of salaries and allowances outside standard procedures  

  1. A sum of Rs. 849 million had been spent to pay 39 allowances of various types to employees without the approval of the Cabinet of Ministers of the Treasury.

  2. Establishing a new salary scale known as “E – scale” for engineers with effect from 01st of January 2015 and making payments in accordance with that without the recommendations of the salaries and Cadre Commission.


Janatha Estate Development Board

  1. Land leased at low rates

Land belong to the JEDB in Vauxhall street had been undervalued and given on long leases of 25,30 or 50 years upon  a cabinet decision.

Click image to enlarge

    2. Unpaid EPF and ETF dues for the period 2011-2015 amounting to Rs.323m (including surcharges).

    3. Operations Loss of the JEDB

2011           2012          2013         2014
Rs.258m    Rs.199m   Rs.501m   Rs.169m


Land Reclamation Commission

1. Information with pertinence to the lands belonging to the Commission not been updated.

Action has not been taken to formulate a register of lands and to maintain it updated.

2. Special Projects for which lease agreements have not been signed

i. 280 acres of Monarakelewatta had been leased out to a private company under 30 year lease in February 2011 without any approval from the subject minister and Rs.1 million has been paid as advances but lease rent had not been recovered for the period from 2011-2016

ii. Out of 12 acres of the Kumbalgoda estate, 06 acres have been leased out to a private Export Crop Project in an illegitimate manner.

iii. Leasing out a plot of land with an extent of approximately 2 hectares of Arkediyawatta in Badulla District. The amount in arrears to be recovered is around one million and without the approval of the Council a loan of Rs.17.5 million has been obtained keeping this land as a security and no action been taken by the Council with pertinence to this matter.

iv. 06 acres of Industrial Zone, Leylandwatta, Homagama has been given to Rosell Bathware Ltd company under 50 year lease and lease rent not been properly recovered.


Elkaduwa Plantation Company LTD

1. Leasing out the Nellaolla estate

i. Leasing out an extent of 125hectares of the Nellaolla estate which consist of 358 hectares to Agri Squad company and the balance forcibly acquired by the residents of the area.

ii. A person as a sub lessee of the Agri Squad Company possessing the estate in an unauthorized manner.

2. Leasing out a factory owned by the company

Leasing out a factory owned by the company to the institution by the name of Pride Tea, the particular institution has completely defaulted paying lease rent to the company and also defaulting the payment due for tea leaves with a value of Rs.30 million provided by the company.


Board of the Sri Jayawardanapua Hospital

Payment of consultants fees

Note: Although this is a state hospital it also runs a paying ward. These payments of fees appear to be over and above the normal remuneration to staff.

  1. 50% of the total income charged from the patients of the paying wards have been paid as professional fees to the doctors and staff of the hospital. PAYE tax has not been deducted on the payment. Unpaid PAYE tax for 2014 and 2015 amounted to Rs.74.7m

Purchase of anesthetic equipment

  1. Four anaesthetic machines had been purchased at a cost of Rs. 29.9m without following a proper procurement process. The purchase of the equipment had apparently gone ahead despite an offer from the Australian Government to provide these free of charge.

  2. The purchase of the equipment had been justified on the basis of three existing machines being defective. No technical evaluation of  is available to support this and no proper procedure was followed for disposal. The Committee was later informed that he disposed equipment had been  given to the Negombo, Kalutara and Monaragala hospitals.

Expired stock

Drugs and other worth Rs.5.1m had been purchased for the Neurosurgical Unit in February 2012.

80% of the stock valued at Rs.4.1m had not been used and expired.


National Secretariat for Elders

Deducting Rs. 100/- without the concurrence of the Ministry of Finance from the elders’ allowance of Rs 2,000 paid to elders as per a budget proposal

The budget for 2015 proposed a monthly payment of Rs.2000/- for elders over the age of 70. Ministry of Social Empowerment and Welfare, the relevant line ministry by way of circular No. 1/2016 has ordered that Rs.100/- be deducted from each payment and the money be retained at the secretariat to set up a welfare fund.

The money is being deducted in spite of the opposition of the management of the secretariat and without the approval of the Ministry of Finance

Note: The Secretariat has issued ID cards for 10,978 elders, although the plan had been to issue 40,000 cards. Assuming the monthly allowance of Rs.2000 was paid only to those registered the monthly payment would amount  to Rs21m and the amount retained for the ‘welfare fund’ would be Rs1m per month.


Bank of Ceylon

Continuous losses at the overseas branch in London. Although the branch in the Seychelles I snow profitable operations are high risk as 62% of the total deposits are owned by only 03 customers.

 

The task ahead for the Government

Originally appeared on Echelon

The Yahapalanaya Government is unpopular, as borne out by the results of recent local government elections. They were elected amid great expectations of change: people wanted better governance, lower corruption, more freedom; in sum, a better life. They have failed, dismally. It is uncertain which party will eventually form a government, but whatever party needs to pay heed to the concerns of the people.

What is the problem?

Sri Lanka’s macroeconomic fundamentals are improving, but to ordinary people, this is meaningless; what matters is how it benefits them: better jobs, higher salaries, lower cost of living. To comprehend the problems of the common man, we must view them from that perspective. Between 2015 and mid-2017, the government imposed a huge burden on the public; the combined impact of tax increases (VAT, PAL) and the currency depreciation added almost  25% to the cost of imported items. This is excluding increases in duty or the impact of extending VAT to previously untaxed items such as healthcare, alcohol and telecommunication; factoring these in would increase the impact even further.

How many average citizens were fortunate enough to receive a 25% increase in income during this period? Anyone who did not would probably face lower living standards.

To add to these self-inflicted woes is the impact of the drought and floods in both 2016 and 2017. Affected people, particularly in rural areas, lost livelihoods and income. With crops wiped out, urban people experienced soaring prices of coconuts and vegetables. When the cost of living rises, the government gets the blame, even when, in this instance, it’s not at fault. The impact is evident in consumer spending; one only needs to glance at the published accounts of companies such as Nestlé and Elephant House. Nestlé reported a 5.3% decline in turnover in the half year ended June 2017, while Elephant House reported a 5% decline in the quarter to June 2017. These are both food companies; noodles, malted milk, ice cream and sausages are hardly luxuries. Yet, overall sales revenues have declined; the fact that people have cut back on simple things like this illustrates the depth of the problem.

When people cutting back on basics are confronted by the spectacle of egregious corruption of ministers living in ostentatious luxury and driving around in convoys of vehicles each of which costs more than the house of a common man, the frustration boils over. The government cannot expect to tax punitively, spend lavishly on themselves, and expect the public to grin and bear. How should the government react? In the short term, some relief that does not upset fiscal stability, and reforms to promote growth in the longer term.

 

The First Step: A clear message of austerity starting from the top

The government must show, publicly, that they are concerned about waste, corruption and inefficiency. Mere words will no longer suffice, deeds must follow. A visible cutback in luxury and waste must be led from the top: this 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.

They should launch an economy drive eschewing extravagance, and eliminating 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 from the public and private sectors, 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.Properly executed, with real results, this will help restore credibility.

 

The Second Step: For quick relief, cut protective tariffs

Sri Lanka has a high cost of living, partly due to taxes. The taxes are of two types – protective taxes to benefit local industries and revenue-generating taxes. Protective taxes bring minimal revenue to the government and can be cut immediately, with little impact on the budget deficit.

Local industries have lobbied for protective tariffs on imports, which benefit them by raising the price of imports. These earn little revenue for the state, but increase consumer prices. For example, the import of wheat flour is taxed, ostensibly to support paddy farmers but in reality to protect local wheat millers. Wheat flour is effectively taxed at around 85%, while wheat grain is taxed at around 23%. Local wheat millers pocket the difference.

The net result is high prices of bread. Wheat flour retails in Malaysia for half the price it does in Sri Lanka. Cutting the tax on wheat flour could reduce bread prices significantly, and thereby the cost of living.

This is not an isolated example, it is prevalent across many food items and sectors from building materials (construction costs in Sri Lanka are estimated to be 40-60% higher than in the region) to toiletries (shampoo is taxed at rates between 100% and 200%), to shoes. Local industries create a few thousand jobs to protect these, and millions of consumers pay higher prices. A much larger population loses, while a small group gains, which means negative results on overall welfare. If these taxes are cut, they will bring immediate and significant relief to people, with little pressure on public finances.

 

The Third Step: Resist giveaways, maintain macro stability, facilitate investment

As a result of increased taxes, the primary balance of the budget (all expenses before interest) showed a surplus as at November, the first in 63 years. This means that government revenue meets current expenditure without the need to borrow. This must be maintained to prevent debt from growing, so there is no room for panicked giveaways.

The temptation for salary increases or subsidies must be resisted at all cost: it will buy short-term popularity, but destabilise the budget in the long term. Indeed, it was the public sector salary increase in 2015 that ultimately forced the government to increase taxes. The government initially financed the increased salary bill in 2015 by printing money, the impact of which came later in the form of currency depreciation. Forced to contemplate either further currency depreciation or tax increases to pay for salary hikes, they chose the latter and the currency stabilised. The cost of increased salaries for 1.3 million public servants was ultimately borne by 20 million people. A minority experienced an increase in welfare, but ultimately the vast majority suffered.

Politicians and the public must understand that a government has no resources of its own to distribute, and what it can distribute is ultimately only what it can collect in taxes. Short-term giveaways will simply repeat this destructive cycle.

The solution to jobs is not to grant public sector salary increases or recruit more into service, but to enable new investment that will create new jobs and increase demand for workers, which will lead to higher salaries. A simple illustration of this is the sudden increase in demand for workers in Colombo hotels following the opening of Shangri-La Colombo – city hotels are competing actively, and overall salaries in the sector have risen. To do this, they need to facilitate investment by simplifying regulations and removing tariff barriers, while maintaining policy stability. A limited domestic market means the path to growth is through exports, not protected, import-substituting local businesses.

 

The Fourth Step: Pruning of debt, reducing expenditure

Around 50% of government revenue is spent on salaries and pensions, and a further 36% on interest. With 86% of revenue eaten up with these two items, the country is effectively borrowing to consume, and debt keeps growing. A primary surplus on the budget means that fresh debt is not needed for current expenditure (although it may be needed for capital expenditure). If expenditure is cut, then the surplus will grow and more debt repaid, leading to long-term reductions in interest. Fortunately, there is plenty of scope for this: simply, cut waste and reduce corruption. A key area is State-Owned Enterprises (SOEs), which have become little more than vehicles for corruption.

Corruption is endemic and deep-rooted, and can only be controlled at the source – government procurement. Politicians love to spend other people’s money, whether on capital expenditure or in procurement of ministries and state enterprises. The Auditor General (AG) has revealed a Rs15 billion scam in rice imports by Lak Sathosa – purportedly imported to reduce the cost of living, but in reality, for the purpose of making money. The AG also revealed a Rs4 billion scam in coal imports.

Spending presents opportunities for theft; the less the government spends, the less politicians can steal. Scaling back state involvement in economic activity will automatically lead to a reduction in corruption in absolute terms, even if the proportion stolen never changes.

Recall that the high taxes are what angered people, the taxes that fund government spending. Control spending to keep taxes low. 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 SOEs; these should be restructured to cut waste and losses. As many as possible should be sold or closed down. Privatisation can have a fourfold benefit:
a) raise revenue that may be used to repay debt,
b) obviate the need to fund losses (in the case of loss-making entities),
c) reduce opportunities for corruption, and
d) open new opportunities for private sector participation in the economy.

For whatever procurement that does take place, open and transparent processes must become the norm. Infrastructure can either be developed privately or in partnership with the government to minimise additional borrowing. Where corruption is detected, action must be taken, starting from within the government’s own ranks.

Conclusion
There are no quick and easy solutions, but measures described above will bring some immediate relief, while setting the foundation for sustainable growth. Enough benefits will flow to ensure re-election of whichever party implements this in full by 2020. There will be stiff opposition by politicians and businesses who benefit, but they are a minority. The vast majority, particularly the poor, will benefit.

#Lka70. Independent. Not free.

  Photo Credit : Nazly Ahmed

Photo Credit : Nazly Ahmed

By Ravi Ratnasabapathy 

Sri Lanka achieved ‘independence’ seventy years ago. What does this mean? What we achieved was self-government – the ability to elect our own rulers; but as a society did we become freer? We are no longer administered by rulers appointed from afar but is the citizenry free?

Representative, constitutional democracy is the best means known for keeping rulers accountable. Contrary to popular belief its real benefit is in removing bad leaders, not in choosing good ones.

To get elected politicians may lie or may make meaningless appeals to emotion, only a handful truly understand the problems or have real intent on solving them. Citizens have to sift truth and assess ability with minimal information. There is no way to know how a politician will perform once elected.

As a system for choosing leaders, it fares poorly but citizens can remove the really bad ones. This is the most important, maybe even the only real check that citizens have on power.

Thus while democracy is an improvement on colonialism, it does have its limits. Power remains in the hands of fallible human beings but at least the bad can be booted out. It is a good way to make a few big decisions-once elected the politician has little concern with the citizen until the next election-but it is best to leave smaller ones in the hands of citizens themselves.

What matters in daily life is personal freedom.

The Government intervenes heavily in the economy, its motives driven by corruption and the protection of special interests. They benefit a few to the detriment of the many. Fiscal prudence must be restored and cuts made to the size and scope of Government spending. This regime was elected on mandate of good governance, so they should use the mandate to restore the personal freedom of the citizenry in all spheres of life

Freedom is about not being limited by in ones actions by threats, coercion or interference of others – specifically, other individuals or institutions, such as government or religious bodies. The only good reason to interfere with people’s freedom is to prevent them doing or threatening actual harm to others.

Freedom is guaranteed by laws that restrain the power to interfere in people’s lives. The role of Government is to uphold the rule of law. As Francisco de Paula Santander (1792-1840), Colombian soldier and statesman said “Weapons have given you independence. Laws will give you freedom”.

Colonial laws

Sri Lanka has no bill of rights and we inherited some colonial laws that intrude into personal freedom.

For example, articles 365 and 365A of the Penal Code are widely considered to criminalise homosexuality and are used to arrest, detain, harass, intimidate, blackmail and shame. The Vagrant’s Ordinance is used to harass, arrest and detain sex-workers, and is also used to criminalise the poor, mentally ill, disabled and other vulnerable people. Abortion is illegal except to save the life of the mother. Half the population, women, are discriminated in the Thesawalami, Kandyan and Muslim laws.

These are questions of morals, customs and ethics, things that concern individual citizens. It is individuals who must tussle with these issues, not the law. In any case the law should apply equally to everyone, regardless of gender, race, religion or language.

We may well detest other people’s morality, religion, political views or lifestyle. We may worry that they are harming their health but these are not valid reasons to interfere in the lives of others. Minors should be protected but consenting adults should be left in peace.

Any regulation should focus on limiting public harm, not protecting morality. Strict laws on drunk driving, prohibition on sale of alcohol to minors or limiting public smoking may make sense but the recent foray of state policy, through punitive taxation and restrictive laws to stop the consumption of alcohol and tobacco is wrong.

There are licenses and taxes that most countries impose but they must be reasonable. The fact that some people disapprove of something is no reason to restrain others. The goal of taxation should be the raising of revenue, not punishment.

It is a fact that individuals disagree on things. What is the interest of one is not necessarily of the other. When one is called to give up some freedom for society what happens in reality is the sacrifice of one set of interests to another, there is no real common interest.

Self interest of politicians, officials

When the state makes laws, a choice will be made over many conflicting sets of interests-a choice in which only one side can win. The process of lawmaking is tainted by the self- interest of politicians, officials and lobbyists. It can lead to minority groups being exploited and their liberties curbed.

Therefore the passing of laws, especially those that curb rights should only be resorted to only when strictly necessary. Calls to curb or ban activities must be viewed sceptically. For example, why is horse racing banned in Sri Lanka? This may not be an important example but the problem is ‘mission-creep’ restrictions start innocuously but then keep expanding.

If freedom is to be restricted it should be up to those who want to do so to show why this is both necessary and sufficiently beneficial to warrant it. Election success does not license the winning majority to treat other people exactly as it chooses.

The philosopher John Locke listed life, liberty and property as basic freedoms: people have a right to live, to do as they please (provided they do not infringe the equal right of others) and to enjoy all that they own.

Locke’s concept of property was not limited to land, he claimed people had property in their own lives, bodies and labour. They deserved to own the things that they had spent personal effort in creating and ownership should be secure under the law.

Sri Lanka’s emergency regulations and the Prevention of Terrorism Act granted the authorities sweeping powers of search, arrest, and detention, which have led to arbitrary detention, torture, and enforced disappearances. The Government has been widely criticised for abuses against political opponents and innocents, particularly minorities who claim to have been targeted purely on suspicion.

These laws remain even nine years after the end of the war. For at least some, the right to life could be under threat. The right to property has also been under attack.

Land, houses and businesses were expropriated by law. Laws were passed limiting what property citizens could own and how they could use it. For example, land classified as paddy land can only be used for paddy, not other crops or purposes. Restrictions apply to the sale of tea, rubber and coconut land. Never mind that people may no longer want to farm or have other needs, such as housing. The colonials also confiscated land but there is no need to repeat the error.

Land reforms

Whether the exercise even benefited society is doubtful, certainly Sri Lanka never became rich as a result.

Land reforms, ostensibly to help the poor, weakened a fundamental pillar of freedom-the right to hold what we own. Once personal property is no longer sacrosanct a precedent is set for future abuse: witness the complaints of the poor evicted from their homes in Colombo or the plight of some of the displaced in the conflict zone, denied access to their land. Laws enacted to reengineer society for the betterment of the weak have created the conditions for their oppression.

Money, lawfully earned cannot be used as we wish. Exchange Controls, introduced in 1953, later expanded and later partially reversed dictate how we spend our own money. At one time it was impossible to travel abroad, spend on overseas education or buy anything imported unless deemed “essential” by the state. Thankfully some rules have been relaxed but try sending money to relatives overseas (for medical or other reasons) or remit the proceeds of property sales and we face obstacles. Are these trivial issues? Perhaps, but even so why? Colonial Ceylon had no restrictions but independent Sri Lanka does. Problems of mismanagement of finances by the Government translate to restrictions on citizens.

If citizens, even if displaced or poor, feel their rights are infringed they should be able to seek justice through the courts. Few seem to try. The system of justice has corroded. The courts exist and the police exist but are they independent enough to uphold and enforce the law? Can an ordinary person hope to win in court against a politician?

A new regime is in power, when they celebrate independence they must reflect on the state of personal freedom.

The purpose of Government should be to expand freedom, not restrict it.

New constitution

A new constitution can help protect natural justice: enshrine the due process of the legal system, ensure equal treatment; and define a personal sphere into which legislation and officialdom can never intrude.

They must recognise that people’s beliefs, lifestyle or morals vary. There is no common agreement on what is acceptable, unacceptable, tolerable or intolerable. As long as no harm is done to others the state should not intervene in such matters, legislation that permits this should be rolled back.

The independence and integrity of the system of justice must be restored.

The Government intervenes heavily in the economy, its motives driven by corruption and the protection of special interests. They benefit a few to the detriment of the many. Fiscal prudence must be restored and cuts made to the size and scope of Government spending.

This regime was elected on mandate of good governance, so they should use the mandate to restore the personal freedom of the citizenry in all spheres of life.

Ravi Ratnasabapathy is a resident fellow at the Advocata Institute.  

After Independence : Reform or Revolution

Originally appeared on FT.LK

It could have been better. Much, much, better. But it was not a disaster. That, in summary, is the story of our country since 1948, when we received independence as a collateral effect of the Indian independence struggle. The atrophying of British military power as a result of the World Wars also contributed.

Institutions

At the top of our society, the institutions appeared strong when we became free from British rule. For example, many talk about how independent our courts were and how we squandered that legacy in recent decades, especially after the appointment of Sarath Nanda Silva as Chief Justice. 

There is no doubt that a strong and efficient judicial system that dispenses justice without fear or favour (and undue delay) is an essential pre-condition for wealth creation and the building of a good society. But there was little depth to what was good about our legal system. Who the litigant was still mattered in Magistrate’s Courts and District Courts.

Fairness in the superior courts was underwritten by the presence of a few truly independent judges, especially those from the Burgher community. Not them alone, but their presence made most of the judge behave better. But after 1956, the Burghers were made to feel unwelcome and departed for Australia. Our institutions gradually deteriorated.

Believing that an independent and professional administrative service was a barrier to their efforts to serve the people, our political class, inspired and led by the socialist parties, subjugated it to their will. Comparison of those at the upper levels of the administrative and foreign services of India and Sri Lanka shows how much damage has been caused. 

Economy

The British did not bequeath us a dynamic economy. It was, as many in my age group learned in school, based on the export of tea, rubber and coconut. Little value addition was done. Most government revenues came from taxing foreign trade. Reliance on commodity exports made the economy vulnerable to economic cycles. In 1952, a dramatic fall in rubber prices by over 30% because of the end of the Korean War led to the Rubber-Rice Pact with China, not some kind of grand gesture of non-alignment.

But today, we are less dependent on commodities. Service exports (if we include remittances from those who work abroad, technically a form of trade in services) yielded Rs. 14.3 billion in 2016, higher than the $ 10.3 billion earned from goods exports, of which agriculture and mining comprised on 23%, according to the 2016 Annual Report of the Central Bank. 

Remittances, which none other than the families that generate them appear to be proud of, brought in $ 7.2 billion. Contrary to entrenched perception, more men than women are now engaged in this form of service export and the proportion of skilled workers is increasing. Tourism was the biggest source of conventional service earnings, yielding $ 3.5 billion. Most of our rubber now goes out in the form of value-added tyres, gloves and such. It is second only to apparel among industrial exports. 

Our economy has diversified and is less vulnerable to external forces than at independence. But the momentum achieved in increasing and diversifying exports was lost as a result of the insular policies of the past decade. Lack of attention to exports and the right kinds of foreign investment has led to greater dependence on borrowing, no longer available at concessional rates, leading to a different form of vulnerability that has to be carefully managed.

Human development

 But from the perspective of citizens, life has actually improved, contrary to those who claim otherwise. Few people know or remember how life was for the citizen back then. These days, we have the Human Development Index (HDI) which was developed by the famed Pakistani economist Mahbub ul Haq. 

“People are the real wealth of a nation,” Haq wrote. “The basic objective of development is to create an enabling environment for people to enjoy long, healthy and creative lives. This may appear to be a simple truth. But it is often forgotten in the immediate concern with the accumulation of commodities and financial wealth.”

However, the HDI which was devised in 1990 does not allow comparison between 1948 and now. Life expectancy is a cruder, but easier to understand, indicator that does.

A male child born in Sri Lanka in 1945-47 could expect to live 46.8 years. A female could expect live 44.7 years, two years less. The life expectancy predictions in 2015 were 72 years for a male and 78 for a female (six years longer), according to the WHO. 

Behind these huge increases are significant achievements in healthcare, housing, education and even working conditions. Obviously, life expectancy could not improve for women if many of them would die at childbirth like they did at the time of independence. If polio, malaria, filariasis and various infectious diseases had not been eliminated with considerable effort and if the housing stock had not been improved, it’s unlikely that that life expectancy for everyone would have gone up by this much. And without people’s incomes and education improving, they could not have stayed alive for that long. 

Revolution or reform?

Those who draw a picture of a country in dire straits tend to do so as part of advocacy of radical change. But in the centenary year of the Russian Revolution, it would be wise to exercise caution with regard to prescriptions of revolution. Revolutionary movements in the 20th Century killed millions worldwide and thousands right here. Reform may be messy. The results may be sub-optimal as has been the case in Sri Lanka. But they carry less risk of unintended consequences. Reforms demand more from us as citizens than the mouthing of grandiose slogans. The less-than-ideal pace of economic growth does call for remedial action. Should it be the replacement of the current crop of political leaders with those promising revolutionary change? Or should it be the hard work of exerting pressure on political leaders and officials through instruments such as the Right to Information Law?


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

High construction costs: Do price controls on cement help?

Originally appeared on Echelon

AN INTERVENTION-EAGER STATE NEGLECTS ITS REGULATORY ROLE

The president of Sri Lanka’s Chamber of Construction Industry has complained that construction costs in Sri Lanka are higher than in the region. Players in the tourism industry have claimed that high construction costs inhibit capacity expansion in the tourism industry. Why are construction costs so high? The government imposes price controls on cement, an important factor in construction, supposedly to keep costs low; but is this working?

Price controls distort markets, causing shortages and creating black markets. But, these obvious market distortions are not visible in cement. This may be because of industry involvement in setting prices, which are based on cost estimates provided by manufacturers. This seems likely, given that cement prices in Sri Lanka are higher than in the region. According to the JUBM & Arcadis Construction Cost Handbook (2017), the cost of ordinary Portland cement in Malaysia is between RM19 and RM20 per 50kg bag, which is about Rs715-750. The cost in Indonesia is around Rs845. The regulated price in Sri Lanka is Rs870-930 per bag.

Naturally, producers would be quite happy to supply a product if the price was set high enough and no shortages would occur.

Promoting competition and allowing markets to work properly are the best ways to lower prices, but in 2013, the government imposed a new restriction that curtails competition. The number of cement plants that may be operated in a port was limited to one per port. If a new factory is to be set up, priority has to be given to existing operators in the port. This limits new investment and competition, and prevents prices from falling.

If price controls were removed, the price of cement would probably fall, as it would give cheaper imports the opportunity to compete on price

QUALITY

If price controls were removed, the price of cement would probably fall, as it would give cheaper imports the opportunity to compete on price. Would this affect quality?

The local cement industry has complained of low-quality (and low-cost) cement imports in the past. This is a problem because consumers cannot detect poor quality. Substandard cement on construction work is a serious matter, as the consequences may manifest after construction is completed.

This issue needs to be addressed through a comprehensive building code, which is lacking. A proper code is needed for consumer protection and public safety. Although old regulations such as the Factories Ordinance exist, these are not up-to-date and enforcement is weak. A standard Code of Practice to regulate and enforce design, construction and compliance requirements is necessary.

While a uniform code is absent, a multiplicity of approvals exists: at provincial, district, pradesheeyasabaha, urban and municipal level. These become even more complex given several central agencies such as the Urban Development Authority (UDA), the Sri Lanka Land Reclamation and Development Corporation, and the Department of Agrarian Development. This leads to overlaps of authority, conflicts of instructions, contradictory regulations and compliance loopholes.

There is a lot of red tape, but it does not improve safety or ensure quality. The government needs to replace these old regulations with a single comprehensive code, legally enforceable, covering all classes of buildings and including safety, structural stability and accessibility.

Along with a code, building contractors and architects should be licensed and carry professional indemnity insurance. The objective of licensing is to ensure that work is done by people who are conversant with the standard (which should carry statutory force), and conduct their duties competently and professionally.

In the event of any failure in buildings, they may lose their license to practice. This is apart from any action taken in courts. The insurance ensures that consumers can receive compensation for shoddy work. The code is self-enforcing; if there is a failure, they will not be able to practice, which gives the incentive to ensure quality.

Specialist licenses should be necessary for more complex work, including the following:
(a) Piling work
(b) Ground support and stabilization work
(c) Site investigation work
(d) Structural steel work
(e) Pre-cast concrete work
(f ) In-situ post-tensioning work

 

OVERALL CONSTRUCTION COSTS

Cement is only one part of the construction cost; policy with regard to other construction materials significantly increases costs.

The government imposes high taxes on many imported construction materials to protect domestic industries. These include steel bars and rods (taxed at 89.66%), ceramic tiles (107.6%), and sanitarywear (72.4%). Aluminium extrusions, granite, electrical fittings, furniture and carpets are also heavily taxed. This results in high overall construction costs.

For example, steel costs around $723/mt in Sri Lanka, but only $500/mt in Thailand and $470/mt in China. By some estimates, the construction cost of an average (non-luxury) high-rise apartment block in Sri Lanka may be as much as 60% above that of Thailand or Malaysia due to these protective taxes, despite Sri Lanka’s lower labour costs.

The policy is a muddle of ad-hoc interventions. Contrast this with the UK government, which in partnership with the industry has developed a strategy to improve the performance of the construction sector by 2025. Objectives include lowering costs: a 33% reduction in the initial construction of a new building and the whole life cost of built assets, a 50% reduction in the overall time from inception to completion of a construction, and a 50% reduction in greenhouse gases. The UK industry is focused on reducing costs through efficiency, better methodology, technology and innovation.

Apart from protective taxes, the lack of scale among contractors, low labour productivity, outmoded methods and long delays in approvals also contribute to high overall costs

The focus is on overall cost reduction, and not trying to protect local producers of construction material.

Apart from protective taxes, the lack of scale among contractors, low labour productivity, outmoded methods and long delays in approvals also contribute to high overall costs.

Improvements in these areas will also reduce costs. Ordinary citizens are unable to afford housing, while the government intervenes to protect the industry.According to a report by Jones Lang LaSalle (2014): “High project development costs, coupled with the high borrowing costs for housing loans, have breached affordable limits and restricted home buying prospects for Sri Lanka.

Based on our understanding from the affordability assessment, only the top income-earning resident Sri Lankans can buy homes in Colombo. Residents with limited income are forced to opt for properties that are at least 20-25km away from city limits.”

 

CONCLUSION

Price controls for cement are clearly not helping to reduce construction costs. Restrictions on competition deter investment and contribute to raise, rather than lower, cement prices. Other interventions to protect the local industry have resulted in raising overall construction costs.

While the State is eager to intervene in unnecessary areas, it has neglected its role as a regulator. Although in most circumstances the best protection is the common sense of an individual consumer, in instances where technical knowledge is needed to detect poor quality, there is a case for regulation, particularly if public safety is involved.

The government should stop controlling the price of cement, and focus on drawing up and enforcing a proper building code. To lower costs, taxes on construction materials must be reduced and competition facilitated

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?