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

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

 

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

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

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

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

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

The video of the exchange is below

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

Dr. Ganeshan Wignaraja

Dr. Ganeshan Wignaraja

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

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

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

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

Background

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

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

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

Value of RCEP

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

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

Potential drawbacks

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

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

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

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


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

Food taxes in Sri Lanka are detrimental to food security

HIGH FOOD COSTS IN SRI LANKA, AND GOVERNMENT POLICY

Article originally appeared on ECHELON

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

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

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

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

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

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

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

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

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

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

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

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

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

 

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

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

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

 

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

Why sell Srilankan Airlines?

By Ravi Ratnasabapathy

This article originally appeared on the Echelon

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

THERE ARE THE FOLLOWING TWO IMPORTANT DIFFERENCES WITH SOES:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

By Ravi Ratnasabapathy

This article originally appeared on the Echelon

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Broad Policy Reforms

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Keep the state out of sports

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

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

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

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

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

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

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

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

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

At taxpayers’ cost

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

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

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

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

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

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

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

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

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

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

Private vs. public property

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

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

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

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

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

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

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

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

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

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

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

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

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

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

 

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

By Ravi Ratnasabapathy

This article originally appeared in the Daily News.

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

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

Is protection necessary?

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

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

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

Top sugar producers

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

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

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

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

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

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

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

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

Domestic industry consumers

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

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

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

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

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

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

Environmental problems

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

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

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

Considerations for formulating a trade policy for Sri Lanka

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

This article originally appeared on the Echelon

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

1.0

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

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

2.0

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

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

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

3.0

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

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

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

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

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

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

4.0

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

5.0

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

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

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

6.0

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

 

 

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

 

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

By Ravi Ratnasabapathy

This article originally appeared on the Daily News

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

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

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

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

Business community

 

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

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

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

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

What should the minister do?

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

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

Corruption and waste

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

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

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

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

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

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

a) raise revenue which will supplement tax revenues,

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

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

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

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

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

New opportunities

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

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

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

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

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

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

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

Cheap footwear imports benefit ordinary Sri Lankans

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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


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

Should we have Socio-economic rights in the constitution in Sri Lanka?

A new Constitution is currently in the works and the question has arisen as to whether social and economic rights should be included as was the case with South Africa’s new constitution. No one doubts the importance of access to education, healthcare or shelter, but should these be included within the Constitution?

This was the subject of a talk delivered by Professor Pratap Bhanu Mehta, at a forum organised jointly by the Advocata Institute and Echelon Magazine.

Prof Mehta stated that the most important fact to keep in mind is that a constitution is a social contract among a particular group of people. It has to reflect the historical specificities of those people, their diverse goals, aspirations and identities. It needs to be legitimate in the eyes of the people who will be governed by that constitution.

We can all agree that it is good to have the best healthcare for all citizens, as equitably as possible; nobody would disagree with the need to disseminate education as widely as possible and few would disagree that some sensible labour legislation is necessary.

Will these goals be met by including socio economic rights in the constitution rather than leaving it to the normal hurly burly of representative politics?

Unfortunately, the comparative experience provides no clear answer, it depends on circumstances. There is also a paradox: it is precisely those countries that would have achieved these goals even in the absence of constitutionalising these rights that also do better when they do constitutionalise them.

State failure

Prof Mehta claimed that a part of the fascination with constitutionalising these rights comes from a feeling of deep state failure. Most countries that have achieved these goals, as in Scandinavia or advanced developed countries have done so without constitutionalising them. Therefore, the notion that constitutionalising these rights is a necessary condition for achieving them is false.

He stated, in the developing world there is pressure for constitutionalising these rights because it is believed that in the absence of a justiciable constitution right, the legislature, ministers, parliament, will not create the conditions to achieve these rights.

This context is very important. The discourse on rights in developing countries emerges from a history of state failure. We want to go to court because the legislature does not give us these rights. The paradox is that if we live in a country where the legislature does not deliver these rights, it is highly unlikely to do so even if constitutionalised as the state is unlikely to have the effective institutions to deliver these rights.

The problem is essentially one of governance and the idea that constitutionalising rights can substitute for broad governance reforms needs to be challenged.

The drafters of the Indian constitution drew a distinction between Fundamental Rights which are justiciable under the constitution and the Directive Principles of State Policy which are not. The Directive Principles contain the social and economic rights. While the Directive Principles imposed an obligation upon the State to strive to fulfill them, they are not justiciable rights and their non-compliance cannot be taken as a claim for enforcement against the State.

The rationale for this distinction is that in any society there are deep differences in opinion on economic matters, and a constitution should not prejudge these questions. We can all agree that better healthcare is a good idea, more education is a good idea, more health workers is a good idea, but we might disagree on the institutional architecture to deliver these rights.
Deep entrenchment of these rights in a constitution framework abridges that democratic and political discussion. The determination of the best solution should emerge from democratic politics and be open to iterative re-balancing, which will occur over time, depending on how the experience unfolds.

To illustrate, Prof Mehta took the example of workplace protection for workers. We may agree that increasing workers power vis a vis employers is a good thing, but we may disagree on the best solution to achieve that outcome.

If one’s economic analysis suggests that a form of social protection detaches income from employment; a minimum basic income, this may lead to a different view as to what the employer-employee relationship should be. From this viewpoint, giving people a minimum basic income may enhance workers bargaining power and may be a better way to achieve the desired outcome than by including stringent minimum wage instructions and placing the onus on the employer.

Thus, we may have two different models of enhancing workers bargaining power. How do we decide which is correct? This is something that should be subject to iterative learning. The danger with constitutionalising is that we may be setting in stone a solution that does not get very far because economic conditions are changing.

Interestingly, in India from the late 1970s the Supreme Court started expanding the guarantee of the Right to Life (a Fundamental Right) to include within it and recognise a whole gamut of social rights; the right to shelter, the right to health, education, right to environment, even a right to sleep.

Education bill

The question to ask is: how far has Indian governance improved as a result of the promulgation of these rights? Prof Mehta admitted that this was a complicated empirical question but his short answer is: only to a very limited extent.

The court pronounced the right to education and India now has a right to education bill as a result, but he claimed this bill was passed the day India’s enrolment in primary education had already reached its goal.

The right came after the fact, and focused largely on the input side of education rather than the output. He claimed that in fact learning outcomes have worsened after that right was promulgated. He said, similar problems existed with the right to environment. How does a country with the most progressive environment laws in the world end up with the filthiest air and the dirtiest water in the world?

Sri Lanka is regarded as one of the most important cases of human development success: it leads South Asia on many indicators, including, universal primary school enrollment, gender parity in school enrollment, under-five mortality, universal provision of reproductive health services, tuberculosis prevalence and death rates, and sanitation. All this, despite the absence of constitutionalised socio economic rights.

These achievements may be traced to enlightened policy and effective administration during the early decades after independence. Nepotism and corruption have rotted Sri Lanka’s public service, a disproportionate share of the budget is spent on defence and debt service, some of which has financed white elephant infrastructure.
Perhaps, these are the real issues to be tackled? 

Dr Wignaraja: Can Sri Lanka join Asian Supply chains?

by Dr Wignaraja on Daily Mirror

President Trump’s pledge to put America first during a global trade slowdown has sparked worries that the era of export-led growth has ended. Trade in Asia and globally has slowed since the 2008 global financial crisis but it is not the end of export-led growth. The real issue, however, is whether Sri Lanka can follow East Asia’s success in global supply chains amid slower trade growth and a likely rise in protectionism. Global supply chains refer to the geographical location of stages of production (design, production, marketing and service activities) in a cost-effective manner and linked by trade in intermediate inputs and final goods. For instance, the Toyota Prius—a hybrid electric mid-size hatchback car—for the US market was designed in Japan and is largely assembled there, but some parts and components are made in Southeast Asia and China. Supply chains exist in a wide range of manufacturing and services activities.  East Asia’s shift from a poor, less developed agricultural periphery to a wealthy global factory over the last half a century is an economic miracle. The extent of the region’s participation in global supply chains is significantly greater than elsewhere and has spurred East Asia’s global rise to the coveted “Factory Asia” league with the middle-income status for many economies.  In 2015, the developing economies in East Asia accounted for 34 percent of global supply chain trade with China making up 15 percent and Southeast Asia for 7 percent. This compares with 34 percent for the European Union, 10 percent for the United States and 5 percent for Japan.  However, South Asia is a relatively small player. India accounts for 1.7 percent of global supply chain trade and the rest of South Asia, including Sri Lanka, for 0.13 percent. Structural transformation and rising wages in China have encouraged an outward shift of labour-intensive segments of supply chains ranging from clothing to electronics. Sri Lanka has the potential to attract such supply chains from China. It is strategically located on the way to Europe, offers low wages with reasonable labour productivity and has a dynamic clothing industry. Close proximity to the large Indian market, which is a magnet for Chinese outward investment, is another advantage.  Smart business strategies and market-friendly national policies have supported East Asia’s achievement in supply chains. Being a big firm naturally creates advantages to participating in supply chains due to a larger scale of production, better access to technology from abroad and the ability to spend more on marketing.  It is crucial for small and medium-sized enterprises (SMEs) to work with large firms. Hence, smart business strategies, such as mergers, acquisitions and forming business alliances with multinationals or large local business houses are all rational approaches, as is investing in domestic technological capabilities to achieve international standards of price, quality and delivery. East Asia’s experience suggests that nimble SMEs can also join supply chains by locating to industrial clusters and reap the benefits of interdependence such as co-financing a training centre or a technical consultant to upgrade skills. Business associations can facilitate clustering by mitigating trust deficits to cooperation among SMEs and by coordinating collective actions for cluster formation. For instance, major industrial clusters are visible in Viet Nam near Ha Noi and Ho Chi Minh City, where large firms are surrounded by thousands of SME suppliers and subcontractors making garments, agricultural machinery and electronics goods. Turning to national policies in East Asia, modern cost-competitive infrastructure is crucial for supply chains. This means investing in world-class ports, roads to ports, logistics, electricity supply and information technology infrastructure. Maintaining open trade and investment regimes which encourage investment and transmit price signals to business are likewise important, as well as sound financial systems which emphasize competition among commercial banks and financial inclusion. High-quality, affordable technical and marketing support services and investing in education to develop skilled labour both help SMEs join supply chains. More controversial is the use of industrial policies in East Asia to target credit and subsidies to particular sectors or firms. Some oft-cited examples of failures include Korea’s heavy and chemical industry push, Malaysia’s national car project (the Proton) and China’s home-grown 3G mobile technology TD-SCDMA. More research is needed on good practices, as there is a high risk of government failure and cronyism associated with industrial policies. Joining supply chains will boost industrialization, jobs and incomes in Sri Lanka. There is no one-size-fits-all approach for Sri Lankan firms to join supply chains. Smart business strategies, facilitating business associations and market-friendly policies are all useful ingredients, while business and government collaboration is essential to tailor these ingredients to national circumstances. (Ganeshan Wignaraja is Advisor in the Economic Research and Regional Cooperation Department of the Asian Development Bank (ADB). The views expressed here are solely the author’s own and do not represent the position of the ADB. This is a guest article for the Ceylon Chamber of Commerce ‘Trade Intelligence for the Private Sector’ (TIPS) initiative that helps its member businesses be up-to-date on new developments in international trade. For more on the subject of this article, refer Production Networks and Enterprises in East Asia an edited volume by G. Wignaraja (2016)) 

In 2017, the government must deliver on Reforms

By Ravi Ratanasabapathy

First published on the Daily News

Sri Lanka's coalition Government has now been in office for two years; the new president was elected two years ago and the new coalition in Parliament was formed some eight months later. How has it fared, particularly in the sphere of economics?

To put things in proper perspective we must appreciate the unique political moment in which the new administration operates. The change of regime was a shock and expectations soared; perhaps to levels that were unrealistic. The disappointment has now set in as the coalition Government, made up of disparate parties with different agendas unexpectedly propelled to power has grappled with a Gordian knot of issues.

Economic liberalism, good governance, ethnic reconciliation and a sensible foreign policy were expected to materialise overnight. While significant strides have been made they have fallen short of public expectations.

Careful handling

On the economic front in particular expectations have proved to be far too high. The Government has treaded very cautiously, shying away from tackling unpopular reforms and unravelling the web of protectionist regulation that grew up around many sectors of the economy under the 'import substitution' label.

Part of the problem has been in the communication, the public were not aware of the precarious state of the finances that the new Government inherited.

The IMF, in its review in September 2014, noted that "public debt and debt service remain high by international comparison, reserves are limited, tax revenues are low, and medium-term sustainability depends heavily on continued growth and a positive external environment." In 2014 the debt/GDP ratio stood at 75% and debt service costs accounted for 90% of Government revenue. Interest cost alone amounted to 37% of Government revenue.

Despite the bleak economic situation, prompted by forthcoming parliamentary elections in August 2015, the new Government announced a wave of populist measures -increases in salaries, subsidies and reduced fuel costs, amongst others.

These were probably necessary to win the election. Flush from electoral victory the new regime may not even have realised the full depth of the problem they were dealing with: there were periodic news reports announcing various apparently unrecorded liabilities being unearthed during their first few months in office. Unfortunately having won the election, the Government was unable to roll back any of the giveaways or make any headway in reducing the size of the state. Politically expedient but economically unsustainable the resulting fiscal, balance of payments crisis and IMF bailout were inevitable.

Tough measures followed in the budget of November 2016. Personal and corporate income taxes were increased along with VAT and taxes on alcohol and tobacco. Though unpopular these should provide the macro-economic stability within which the Government can embark on a serious programme of reforms. The time for proper reform is now upon us. Eminent economist, Professor Razeen Sally warned that Sri Lanka is in a period of dangerous policy drift and that the window of opportunity for economic was narrowing and that Sri Lanka should not 'miss the bus'.

What needs to be done?

Now that the tax rates have been raised to a level where the fiscal deficit is under control for the moment, it must be secured for the medium term. This means that the State must keep its expenditure under control; no more populist unfunded giveaways, a freeze on recruitment and a general economy drive eschewing extravagance, the elimination corruption and waste through increased transparency and open processes.

This must be followed by measures to start trimming the state. There is some public support for privatisation in a few sectors at least. The government should push ahead with these and list the entities on the stock exchange. The formula used in privatisation during the1980's: sale of a majority stake, a public listing for 20% of the shares with 10% of the equity given free to employees proved to be both popular and successful. It will also give a boost to the flagging stock market and send an important signal to investors that Sri Lanka is ready for business.

Improving the business climate

Some measures have already been announced, which is welcome, but more needs to be done. There is still a need to cut red tape: business regulations must be simplified, the number of approvals for investment minimised and these should be processed by a genuine one-stop-shop rather than a multitude of ministries, and despatched in a matter of days and weeks rather than months. Digitisation and reducing bureaucratic discretion are the way to go.

This in turn will lay the foundation for the big reform which is to reorient policy towards FDI and exports. The trade and FDI regime needs to be liberalised: import tariffs minimised, customs procedures simplified, non- tariff barriers to imports such as quotas/licensing arrangements should be abolished as far as practicable.

If implemented properly, the reforms should take Sri Lanka back on a path of sustainable growth resulting in improved livelihoods for its citizens.

The overall conclusion on the economy over the past two years is similar to contemplating a glass; half full or half empty, depending on perspective. The government has the opportunity to change this perspective to one of near full, provided the moment is seized and a reform programme moves ahead without delay.

What would President-Elect Trump mean for Sri Lanka and Asia?

By D.A Jayamanne
First Published in Daily News

Foreign policy analysts are scrambling to understand the potential impact of a Trump Presidency on Asia and other regions. Not only did Trump ran an unconventional campaign, his campaign themes challenged years of bipartisan consensus on U.S. engagement and leadership in the world. “We will no longer surrender this country to the false song of globalism” said the now President-elect Trump in a landmark speech on foreign policy back in April. He went on to say that a top policy goal in a Trump administration would be to “end the era of [global] nation-building and create a new foreign policy”.

Throughout the campaign Trump was sharply critical of U.S. interventions overseas, especially the war in Iraq, interventions in Libya, even challenging U.S. commitments towards NATO and other U.S. allies.

We don’t know how much of Trump’s rhetoric will translate into policy” says Frank Lavin, a former U.S. ambassador to Singapore and a U.S - Asia expert.

“We don’t to what extent this was just campaign talk or how deep and heartfelt this view is”. Speaking in the online podcast series for Advocata Institute, a Colombo-based think tank, Lavin went on to explain that President elect Trump’s key cabinet positions might provide the first clues as to how the president-elect might govern.

“The eyes of the world would be on him as he selects the key cabinet positions of Secretary of State, Defence and Treasury” says Lavin, “How orthodox are some of these selections; Is he picking from the mainstream currents of U.S. policy engagement, where there is generally a consensus on U.S. leadership in the world, or is he picking more outliers?”. Even then, there could be some ebb and flow warns Lavin, and that it’s wise to adopt a “wait and see” approach until President Trump takes office and gets about his business.

So far, Trump has made several picks that gives hope to the more mainstream sections of the U.S. policy establishment.

This has included picking ex Trump critics such as Louisiana governor Nikki Haley, as the new U.S. Ambassador to the United Nations. More surprisingly, it is reported that the president-elect is seriously considering former governor Mitt Romney for the key position of Secretary of State, the U.S. equivalent of foreign minister.

Romney was a fierce critic of Trump’s candidacy and remained bitterly opposed to his campaign till the end. All picks must go through a hearing process before being confirmed.

“Every president wants to put their stamp on the office” comments Lavin, “but I would say there’s there tend to be a lot more continuity in U.S. foreign policy than there is change. Even though President Trump comes into office as a ‘change candidate’. Certainly, some changes may be afoot. Broadly speaking however, United States is the same country and we have the same challenges, our national interests are still the same, so we are probably talking about what kind of weight we are giving to certain foreign policy goals, rather than seeing radical changes to those goals”.

This may be particularly true in the case of U.S. policy towards Middle-powers and smaller countries that doesn’t have a strong policy dimension according to Lavin. These relationships are mostly friendly and revolves around classical diplomacy.

More is known however about Trump’s apprehensions towards multilateral Trade deals. Trump last week doubled down on a campaign pledge to scrap the Trans-Pacific Partnership (TPP), a Free Trade deal that involved 12 pacific rim countries including Japan, Canada, Australia and America.

“The TPP would have allowed the U.S. to set the architecture for the Asian region and help determine the kind of trade relations that benefit all parties.” says Frank Lavin, who served as the U.S. under secretary for International Trade from 2005-2007. “If the U.S. is not going to set that architecture, then what we are allowing is for other parties to do it. Some might do it with the U.S. in mind, others might do it to exclude America”.

According to analysts, one of the foreign policy objectives of the TPP was to create trading bloc that counter balances China’s dominant exporting power. American politicians often complain about China’s mercantilist attitudes towards trade. Lavin agrees.

“China can be mercantilist in trade. They do have national champions they promote, and use industrial policy to favor those champions”. But part of the solution is to work more with countries that do play by the rules says Lavin, and this is where the TPP would have been useful according to the former diplomat, who now heads an e-commerce company based in China.

So how does all of this impact Sri Lanka? On trade, the scrapping of the TPP would mean that Sri Lanka is saved from potential risks arising from being excluded in the agreement.

A study by the IPS estimated that Sri Lanka could stand to lose around $40 million worth of exports by being excluded from the TPP. For his part, Trump says that instead of the TPP, he will negotiate “fair, bilateral trade deals” indicating perhaps that a potential U.S. - Sri Lanka bilateral trade agreement may not totally be off the table.

On general foreign relations, things are much murkier. Sri Lanka’s relationship globally is dominated by the alleged human rights abuses during the conflict years and the commitments the country had made to the international community.

Whilst Trump’s campaign rhetoric certainly point to a more non interventionist foreign policy agenda for America, it is unlikely that the entire machinery of U.S. diplomacy be overturned.

As ambassador Lavin explains, critical clues will in be who Trump chooses as his key advisors on foreign affairs, and after that, we’ll just have to wait and see.

See the full podcast with Ambassador Frank Lavin.

On the Budget 2017 : Towards better economic and Fiscal Policy

The Daily News published  parts of Advocata's statement on the Sri Lankan naitonal Budget 2017.

The immediate policy priority should be to restore emphasis on exports: Liberalise the trade and investment framework to attract FDI.

Public sector reforms to cut costs are vital. While tax increases may be unavoidable, the additional burden on the public must be minimised: Reforms for the public sector to reduce its size, cut corruption and improve efficiency are essential.

The current tax structure is incoherent and chaotic. It must be reviewed and policy grounded on sound fiscal and tax principles including fiscal adequacy, administrative feasibility, simplicity, transparency and stability.

Despite a significant improvement in the first half of the year, meeting Sri Lanka’s budget deficit for 2016 will be challenging. A significant amount of fiscal consolidation will still be needed over the next few years if the government is to achieve its stated goal of reducing the budget deficit to 3.5% of GDP by 2020 or indeed meet its commitments to the International Monetary Fund (IMF), which is likely to create considerable uncertainty over the likelihood of further tax increases.

Given the difficult environment and ambitious targets, the government may be tempted to resort to ad hoc, short-term measures to deal with fiscal crises as they arise, creating a volatile business environment, eroding confidence and leading to a lack of predictability in revenue targets. This, in turn, results in further ‘quick fixes’.

This is a vicious cycle that must be broken if consistency and predictability is to be restored to the tax system. This is possible if the government adopts a framework of evidence-based policymaking, and we urge that this be done as a matter of priority.

Making policy that is based on evidence is not easy, but it is possible to draw on the experience of countries such as the UK, which have adopted such an approach. Frameworks that governments can follow to build and support a system of evidence-based policymaking are available, and the government should seek specialised assistance to implement a structured approach. This will help ensure consistency and predictability in policy, improving business confidence.

Policy making must be an ongoing process, and consultation and assessment should not be limited to a period a few weeks before the budget. Poorly researched policy may cause unintended consequences and result in policy reversals. While all suggestions must be considered, many are likely to come from sectors seeking privileges. These must be carefully researched, subjected to wider consultation and adopted only if overall benefits to society outweigh costs. Some of the complexity and anomalies in the tax code may be traced to the accommodation of various special interest groups.

In achieving its fiscal targets, the government cannot limit its focus to raising taxes. Breaking from the pattern of the past, equal or even greater emphasis must be placed on the reduction of expenditure, reviewing not only the scale of spending but also the scope of the government.

An economy drive eschewing extravagance, the elimination of corruption and waste through increased transparency, and open processes must necessarily form a part of this exercise. 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. The Singapore Civil Service’s “Cut Waste Panel” and “Economy Drive” offer useful practical lessons in managing costs and could be adapted for Sri Lanka.

The tax system must be simplified, widening the base and increasing compliance. The finance minister’s commitment to this is laudable. The remainder of this submission seeks to outline a few key issues and offer avenues for the administration to explore. We believe these ideas are worthy of careful study and could yield outcomes that will assist in stimulating growth, reducing the budget deficit, and simplifying and rationalising the tax system.

Rethink the development strategy

Restore policy emphasis on exports

Lacking a large domestic market and possessing few natural resources, exports offer the best opportunity for rapid development.

Successful integration of the manufacturing sector into global production networks has played a key role in employment generation and poverty reduction in China and other high-performing East Asian countries.

The market-oriented policy reforms of 1977/8 were based on this rationale and served the country well, resulting in a notable diversification of the commodity composition of Sri Lanka’s exports and a consistent improvement in share of world manufacturing exports until the late 1990’s.

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

The present protectionist import tax structure has serious costs for Sri Lanka’s economic welfare and growth; Sri Lanka’s exports relative to GDP have declined, as has its share of world exports. Sri Lanka has fallen significantly behind its competitors. Vietnam, which was on par with Sri Lankan exports in 1990 with $2 billion per annum, today exports $162 billion versus Sri Lanka’s $10.5 billion.

A bulk of Vietnam’s exports is driven by foreign investment and a globally competitive agriculture sector that emerged in the wake of a liberalisation drive that moved away from ‘self-sufficiency’. FDI firms account for 71% of Vietnam’s and 44% of China’s exports. The lesson is clear: To boost growth and create productive employment, Sri Lanka should cut barriers to trade and investment, and focus on attracting export-oriented FDI.

The most important reforms needed are listed as follows:

1. Trade policy reforms: Move from the present chaotic tariff structure towards a transparent, uniform tariff structure

• Unify the existing Customs duty and the plethora of para-tariffs (PAL, VAT, CESS, Customs Surcharge) into a single Customs duty at the individual Customs code level, and then reduce Customs duties across the board to a uniform nominal rate of 15%. Moving towards a low, uniform tariff structure has the potential to increase tariff revenues. This would speed up Customs clearance and reduce the potential for corruption as it reduces the discretion of Customs officials and makes the trade regime predictable.

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

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

2. Foreign direct investment reforms

• Restore the role of the Board of Investment as the ‘one-stop shop’ for investment approval/promotion (as envisaged in the BOI charter). This requires repealing the Revival of Underperforming Enterprises and Underutilized Assets Act (2011) and the Strategic Development Projects Act (2011), or passing new legislation to supersede these two acts.

• It is, of course, necessary to rationalise the fiscal incentives offered to investors, but there is a strong case for providing export-oriented foreign investors with time-bound tax holidays and investment tax allowances beyond the tax holiday period.

There is evidence that tax incentives play an important role in influencing location decisions of export-oriented (efficiency-seeking) FDI, especially where competing countries still offer them, provided of course that the other preconditions are ‘reasonably’ met. (The evidence used in recent policy reports by the World Bank to argue against tax incentives comes from studies that have not made a distinction between ‘market seeking’ and ‘export-oriented’ FDI). Removing all tax incentives, while other negatives continue to weigh on the overall competitiveness in investment and trade, may be counterproductive.

• Sri Lanka has to improve property rights to draw investment. The guarantee against nationalisation of foreign assets without compensation provided under the Article 157 of the present Constitution needs to be maintained under the ongoing constitutional reforms.

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

 

Advocata's submission for the Budget 2017

Echelon Magazine, Sri Lanka's premier business magazine published excerpts of Advocata Institute's Budget submission for 2017

THINK TANK ADVOCATA IS PROPOSING LOWER TRADE TAXES AND TRIMMING PUBLIC SECTOR EXPENDITURE IN ITS RECOMMENDATIONS FOR BUDGET 2017 PRESENTED TO THE MINISTRY OF FINANCE AND PLANNING

 

Summary recommendations
1. The immediate policy priority should be to restore emphasis on exports: Liberalise the trade and investment framework to attract FDI.

2. Public sector reforms to cut costs are vital. While tax increases may be unavoidable, the additional burden on the public must be minimised: Reforms for the public sector to reduce its size, cut corruption and improve efficiency are essential.

3. The current tax structure is incoherent and chaotic. It must be reviewed and policy grounded on sound fiscal and tax principles including fiscal adequacy, administrative feasibility, simplicity, transparency and stability.

Despite a significant improvement in the first half of the year, meeting Sri Lanka’s budget deficit for 2016 will be challenging. A significant amount of fiscal consolidation will still be needed over the next few years if the government is to achieve its stated goal of reducing the budget deficit to 3.5% of GDP by 2020 or indeed meet its commitments to the International Monetary Fund (IMF), which is likely to create considerable uncertainty over the likelihood of further tax increases.

Given the difficult environment and ambitious targets, the government may be tempted to resort to ad hoc, short-term measures to deal with fiscal crises as they arise, creating a volatile business environment, eroding confidence and leading to a lack of predictability in revenue targets. This, in turn, results in further ‘quick fixes’.

This is a vicious cycle that must be broken if consistency and predictability is to be restored to the tax system. This is possible if the government adopts a framework of evidence-based policymaking, and we urge that this be done as a matter of priority.

Making policy that is based on evidence is not easy, but it is possible to draw on the experience of countries such as the UK, which have adopted such an approach. Frameworks that governments can follow to build and support a system of evidence-based policymaking are available, and the government should seek specialised assistance to implement a structured approach. This will help ensure consistency and predictability in policy, improving business confidence.

Policy making must be an ongoing process, and consultation and assessment should not be limited to a period a few weeks before the budget. Poorly researched policy may cause unintended consequences and result in policy reversals. While all suggestions must be considered, many are likely to come from sectors seeking privileges. These must be carefully researched, subjected to wider consultation and adopted only if overall benefits to society outweigh costs. Some of the complexity and anomalies in the tax code may be traced to the accommodation of various special interest groups.

In achieving its fiscal targets, the government cannot limit its focus to raising taxes. Breaking from the pattern of the past, equal or even greater emphasis must be placed on the reduction of expenditure, reviewing not only the scale of spending but also the scope of the government.

An economy drive eschewing extravagance, the elimination of corruption and waste through increased transparency, and open processes must necessarily form a part of this exercise. 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. The Singapore Civil Service’s “Cut Waste Panel” and “Economy Drive” offer useful practical lessons in managing costs and could be adapted for Sri Lanka.

The tax system must be simplified, widening the base and increasing compliance. The finance minister’s commitment to this is laudable. The remainder of this submission seeks to outline a few key issues and offer avenues for the administration to explore. We believe these ideas are worthy of careful study and could yield outcomes that will assist in stimulating growth, reducing the budget deficit, and simplifying and rationalising the tax system.

RETHINK THE DEVELOPMENT STRATEGY
Restore policy emphasis on exports

Lacking a large domestic market and possessing few natural resources, exports offer the best opportunity for rapid development.

Successful integration of the manufacturing sector into global production networks has played a key role in employment generation and poverty reduction in China and other high-performing East Asian countries.

The market-oriented policy reforms of 1977/8 were based on this rationale and served the country well, resulting in a notable diversification of the commodity composition of Sri Lanka’s exports and a consistent improvement in share of world manufacturing exports until the late 1990’s.

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

The present protectionist import tax structure has serious costs for Sri Lanka’s economic welfare and growth; Sri Lanka’s exports relative to GDP have declined, as has its share of world exports. Sri Lanka has fallen significantly behind its competitors. Vietnam, which was on par with Sri Lankan exports in 1990 with $2 billion per annum, today exports $162 billion versus Sri Lanka’s $10.5 billion.

A bulk of Vietnam’s exports is driven by foreign investment and a globally competitive agriculture sector that emerged in the wake of a liberalisation drive that moved away from ‘self-sufficiency’. FDI firms account for 71% of Vietnam’s and 44% of China’s exports. The lesson is clear: To boost growth and create productive employment, Sri Lanka should cut barriers to trade and investment, and focus on attracting export-oriented FDI.

The most important reforms needed are listed as follows:

1.Trade policy reforms: Move from the present chaotic tariff structure towards a transparent, uniform tariff structure
• Unify the existing Customs duty and the plethora of para-tariffs (PAL, VAT, CESS, Customs Surcharge) into a single Customs duty at the individual Customs code level, and then reduce Customs duties across the board to a uniform nominal rate of 15%. Moving towards a low, uniform tariff structure has the potential to increase tariff revenues. This would speed up Customs clearance and reduce the potential for corruption as it reduces the discretion of Customs officials and makes the trade regime predictable.
• On the export side, remove all cess as it reduces the effective price received by exporters, and thereby discourages exports. There is no evidence to suggest that these cesses promote local downstream processing of primary products that are now exported in ‘raw’ (unprocessed) form.
• Join the Information Technology Agreement of the WTO to create free trade in electronics, which will attract FDI to this sector.

2. Foreign direct investment reforms
• Restore the role of the Board of Investment as the ‘one-stop shop’ for investment approval/promotion (as envisaged in the BOI charter). This requires repealing the Revival of Underperforming Enterprises and Underutilized Assets Act (2011) and the Strategic Development Projects Act (2011), or passing new legislation to supersede these two acts.
• It is, of course, necessary to rationalise the fiscal incentives offered to investors, but there is a strong case for providing export-oriented foreign investors with time-bound tax holidays and investment tax allowances beyond the tax holiday period. There is evidence that tax incentives play an important role in influencing location decisions of export-oriented (efficiency-seeking) FDI, especially where competing countries still offer them, provided of course that the other preconditions are ‘reasonably’ met. (The evidence used in recent policy reports by the World Bank to argue against tax incentives comes from studies that have not made a distinction between ‘market seeking’ and ‘export-oriented’ FDI). Removing all tax incentives, while other negatives continue to weigh on the overall competitiveness in investment and trade, may be counterproductive.
• Sri Lanka has to improve property rights to draw investment. The guarantee against nationalisation of foreign assets without compensation provided under the Article 157 of the present Constitution needs to be maintained under the ongoing constitutional reforms.
• Avoid the current practice of ‘domestic value added’ [which is defined as per unit of domestic retained value (wages + profit + domestically procured intermediate inputs) as a percentage of growth output] as an evaluation criteria in approving investment projects.

The very nature of the ongoing process of global production sharing (production fragmentation) is that per unit value added of production plants located in a given country within vertically integrated global industries (such as electronics and electrical goods) is usually very thin. The contribution of such production to domestic output (GDP) depends on the volume factor and the ability to produce for the vast global market, not on per unit value added.

In some traditional industries that use diffused technology (such as garments, footwear, travel goods), there is opportunity to increase per unit value added by forging backward linkages, but this is a time-dependent process and depends on export volume expansion. In the garment industry, per unit value added was around 20% at the beginning, but is now over 60%. Backward-linked knitted textile production and other ancillary input industries (hangers, buttons, labels, packaging material) have emerged as the volume of export expanded, creating sizeable demand for such inputs.

3. Macroeconomic policy
Trade, investment and labour market reforms need to be accompanied/complemented by macroeconomic policies to regain international competitiveness of the economy. Relying solely on nominal exchange rate depreciation for this purpose is not advisable, given the massive build-up of foreign-currency denominated government debt. Also, given the increased exposure of the economy to global capital markets, large abrupt changes in the exchange rate could shatter investor confidence, triggering capital outflows.

What is required is a comprehensive policy package encompassing some exchange rate flexibility and fiscal consolidation, which requires both rationalisation of expenditure and widening of the revenue base.

The current import-substitution policy retards growth and hurts consumers.

The present policy stance and import tax structure have drawn capital, labour and land to high cost, and highly protected import substitution farming and agricultural processing activities with low or negative economic rates of return. Sri Lanka’s food prices are higher than in the region due to high tariffs imposed to achieve self-sufficiency, hurting the poor and possibly contributing to malnutrition particularly of poor children. At a time when the government is burdening people with higher taxes, it is imperative that attempts be made to reduce food costs; revising this policy could contribute significantly to lowering the cost of living.

An example of this policy is rapid growth of maize and soybean cultivation over the last 10 years. These are not traditional crops and were not cultivated on any scale prior to 1998. These are used primarily as raw materials for the production of animal feed. Subjected to heavy protective tariffs, the cost of these locally produced crops are far in excess of world prices and directly related to the high cost of local poultry products. Instead of reviewing a flawed agricultural policy, the government has reacted to high retail prices of poultry by introducing price controls.

The policy of protecting the local sugar industry has had a similar impact and should also be subjected to review. The protective policy toward wheat imports has resulted in increased retail prices of bread, despite a collapse of world wheat prices by 50% since 2013.

The above highlights just a few key issues; there are many others. The government needs to study the impact of its trade and agricultural policies on consumer prices, and review its policies to maximise benefits to society as a whole. The ill effects of poor agricultural policy are not limited to higher prices, and their unintended consequences may extend to the human-elephant conflict and the recent spread of chronic kidney disease. The review of policy needs to be holistic.

PUBLIC SECTOR REFORM

Cumulative public debt and the high budget deficit have been key drivers of macroeconomic instability in Sri Lanka. Higher government borrowing not only wreaks havoc in the government’s finances, but also crowds-out private investment by pushing up interest rates. Sri Lanka also operates a “Mega State” apparatus, with a massive public sector, unproductive/loss-making state enterprises and an oversized peacetime military that further diminishes the fiscal position.

The massive increase in public sector employees starting from about 850,000 in 2005 to around 1.27 million by 2016 also has knock-on effects on the political economy, with both major parties now having to pay homage to this large voting bloc by promising unfunded and unsustainable goodies such as salary increases and other benefits – what analysts term ‘an auction of non-existent resources’ – at each election.

While most commentators emphasize enlarging the tax net to address fiscal imbalances, Advocata believes that reducing the size and scope of the state is more pressing. While political space for reforms may be limited, public opinion is increasingly skeptical of loss-making state enterprises, which is an argument reformists in government could use.

Advocata urges policymakers to look into following avenues of reform:

Addressing the debt burden

The government’s debt/GDP ratio is 75%. Debt service costs (interest and capital) accounted for 90% of government revenue in 2014. The previous year’s debt service cost actually exceeded revenue; the ratio in 2013 was a whopping 102%. Interest cost alone amounted to 37% of government revenue in 2014.

Sri Lanka regularly runs a primary (before interest payments) budget deficit, which means recurring expenditure is being funded by debt, a situation that is clearly unsustainable. Sri Lanka’s debt ratios bear some uncomfortable parallels with those of Greece, just before the outbreak of the debt crisis.

Restructuring the debt to extend its maturity and reduce interest rates could provide some relief, but disposing of unproductive state assets and using the proceeds to reduce debt is a more permanent solution and we offer a few ideas below.

Reforming SOEs

Disposing of loss-making and unproductive state-owned enterprises (SOEs) is a way of easing the debt burden and preventing further deterioration of the fiscal position. The outstanding SOE debt to banks is at Rs757 billion, more than four times what the government spent on health services in 2015. Some SOEs have accumulated so much debt that even privatisation may not be possible. These could simply be shut down with generous severance payments to employees, which will be cheaper in the long run.

Reform of SOEs need not be limited to loss-making enterprises. SOE’s often employ significant resources in terms of labour, land and other factors of production, which could be better utilised. Conducting a comprehensive productivity study would allow the government to determine which ones to shut down, which ones to privatise and which ones could be held under ownership at a government holding company in the model of Singapore’s Temasek Holdings.

 

Reactivating “Dead Capital”: State-held land

The Land Reform Commission was vested with about 987,000 acres, some of which could be used for more productive purposes. Additionally, government ministries, schools and other facilities occupy prime real estate blocks in major cities like Colombo, which greatly outweighs their economic value.

As an initial step, accounting of property rents at market values would allow the government to get an accurate sense of the value of the dead capital that the government is occupying, which could be put to more productive use. The Colombo Dutch Hospital project and the clearing of the Army headquarters for commercial activity are examples of how dead capital in government-held land could be activated for more productive use. The government should draw up a Land Asset Sales Programme, an orderly and coordinated programme to dispose of surplus or underutilised land. The proceeds from these sales should be used to reduce national debt. The sales programme must be run in an open and transparent manner by an independent body free of political influence to minimise corruption.

Public-private partnerships for infrastructure

Converting existing infrastructure such as highways into Public-Private Partnerships could raise funds to pay down the loans that were used to finance them. Operational rights could be auctioned in a transparent manner to private investors. New infrastructure projects should be on the basis of a Build Own and Operate (BOO) model or Build Operate and Transfer (BOT) model, which has been used successfully all over the world to finance infrastructure projects.

Restoration of the National Procurement Agency (NPA)

The NPA was established in 2004 to streamline procurement, reduce waste and corruption, and ensure better transparency and governance by centralising procurement under an independent body. The agency was believed to have been effective, which lead to it being shut down, allegedly for political reasons, in 2007. Its operation should be revived and its independence guaranteed.

The defence budget

Spending on defence has grown from around Rs144 billion in 2009 to an estimated Rs306 billion in 2016, a massive increase in a time of peace. Due to the politically charged nature of the expenditure, this has been the ‘elephant in the room’. While acknowledging that immediate demobilisation or salary cuts are not feasible, continuous growth in defence expenditure seven years after the end of the war is something that requires questioning.

It is one of the largest items of expenditure, and discussion of this subject must no longer be avoided. Cutbacks in capital expenditure and hardware are necessary. More generally, a national plan to downsize the military should serve the long-term interest of all communities in Sri Lanka.

Voluntary retirement schemes

The state currently employs over a million people and an additional estimated 220,000 workers employed in SOEs. Some analysts put the figures much higher. In total, the public sector accounts for about 15% of the total labour force.

The public sector pensions and salaries bill for 2015 was Rs717 billion, representing 49% of government revenue. The weight of the wage and pension bill has crowded out priority expenditure in education, health and essential infrastructure, and even operational expenditure necessary to enable employees’ effective functioning. Not only do the salaries and entitlements of these workers burden the fiscal position of the government, it also mops up scarce labour from the private sector. By this account, Sri Lanka probably has the largest state sector in the world.

The dependence on excess labour also means that state agencies become reluctant to invest in new technologies or procedures in fear of backlash or simply not knowing where to allocate the labour.

Reforms in this area are not going to be easy, as the 2002 UNP government discovered to its peril. However, the current levels of state sector cadre places a massive strain on the fiscal position.

The government should commission a report on the labour requirement for the state sector. While attrition and a hiring freeze are preferred methods of cadre management, for some sectors and institutions, Voluntary Retirement Schemes (VRS) may be possible. To manage pension liabilities, a new contributory pension scheme should replace the current defined benefit scheme for any new recruits to the public service.

Reform of energy utilities

Sri Lanka’s energy utilities are a source of macroeconomic instability, and reforms to the sector are long overdue. While detailed studies for longer-term reforms must be undertaken as an interim measure, re-introducing the pricing formula for fuel and extending the formula to electricity will prevent large imbalances from building up. For the electricity sector, an immediate move to daylight saving time could reduce night peak load demand by as much as a third, with consequent reduction in thermal energy generation. In Sri Lanka, the discussion is private participation in electricity centres around fixed contract IPPs. In many other countries, however, this model is now considered outdated, the world has moved on to integrated energy markets. A study by the Pathfinder Foundation carried out in 2007 provides a useful starting point for ideas on moving to energy markets.

 

THE TAX SYSTEM

Recent budget statements by successive governments, including the present one, have not been in keeping with sound principles of taxation. While recognising the unique political moment in which the new administration operates and the politically expedient measures that were taken to create that political moment, continuing to ignore principles of fiscal discipline can only lead to further imbalances.

The following principles serve a guide to sound tax and fiscal policy:

Fiscal adequacy
The overarching objective should be that sources of revenue, taken as a whole, should be sufficient to meet the demands of public expenditure. Revenue should be elastic or capable of expanding or contracting annually in response to variations in public expenditure. Most crucially, any new benefit or relief measures offered must be fully funded. Government finances are in a dire state, they should not be made worse; ill-conceived proposals in the past have contributed to the structural weakness of the fiscal position.

The adoption of a medium-term budget framework to prioritise, present and manage both revenue and expenditure over a multiyear framework is desirable. It can help demonstrate the impact of current and proposed policies over the course of several years, and ultimately achieve better control over public expenditure.

Rules in the Fiscal Management (Responsibility) Act may be tightened to reinstate budget discipline, and ensure fiscal responsibility and debt sustainability.

Simplicity, administrative feasibility and transparency
Tax laws should be capable of convenient, just and effective administration. Tax codes should be easy for taxpayers to comply with and for governments to administer and enforce. It is far simpler to adjust rates to existing taxes than bring in new types of taxes.

Any changes needed to the tax code should be made with careful consideration of established practices and open hearings. Each tax in the system should be clear and plain to the taxpayer. Disguising tax burdens in complex structures to deceive the public, the preferred approach by politicians in the past, should be avoided. Simplicity will close loopholes for tax evasion, reduce the scope for corruption and minimise administrative costs.

Neutrality
By and large, taxes should neither encourage nor discourage personal or business decisions. The purpose of taxes is to raise needed revenue, not to favour or punish specific industries, activities and products. Minimising tax preferences broadens the tax base, so the government can raise sufficient revenue with lower rates.

Stability
Taxpayers deserve consistency and predictability in the tax code. Governments should avoid enacting temporary tax laws, including tax holidays, amnesties and retrospective changes. The periodic revision of taxes via gazette notifications should be avoided. Put simply, a good tax policy promotes economic growth by focusing on raising revenue in the least distortive manner possible.

Sin taxes need re-thinking

While our proposals are mostly concerned with broad issues of policy, we have made an exception for ‘sin taxes’ because of their importance to the exchequer.

‘Sinful’ items such as alcohol and tobacco have traditionally been taxed heavily and are the second-largest source of tax revenue for the state. A review of these policies could develop their effectiveness and improve collection. The present government, continuing the practices of the past, has now raised taxation to prohibitive levels. This may be counterproductive because, while high taxes do deter consumption, excess taxation may drive consumers to dangerous illicit substances, and support a thriving illegal alcohol and cigarette industry.

The link between higher taxes and substance abuse is that the use of highly hazardous home brews concocted from medicinal drugs, cosmetics and pharmaceuticals also need to be examined.

Both in Sri Lanka and even in developed countries, it is a tendency for lower income groups to consume cigarettes. In Sri Lanka, there is an additional tendency for lower income groups to consume cottage industry products and items like beedies. Further research needs to be done on the link between education and awareness as opposed to the assumption that cigarette and alcohol consumption is merely a function of affordability or a broader lifestyle/environment and an awareness issue.

High taxes on cigarettes have lead to a massive increase in the lightly taxed Beedi industry, as well as expansion in illegal cigarettes. Customs statistics indicate that beedi volumes have risen from 1.1 billion sticks in 2007 to 3.2 billion sticks in 2013, while cigarette volumes declined from 4.6 billion sticks in 2007 to 4.0 billion during the same period.

Studies carried out by the Institute of Policy Studies make a case for rethinking alcohol taxes, principally to move to a structure of taxation by volume, which will increase state revenues while modifying consumption habits.

The government needs to reconsider its policies for the taxation of both alcohol and tobacco in light of all available evidence. Recent experiences in India and Pakistan highlight the problems with outright prohibition.