On PM's economic statement: most important is to liberalize trade and investment

By Ravi Ratanasabapathy

The article first appeared on the Daily News

The Prime Minister’s statement on the economy to parliament on October 27 struck many a right note and has the ingredients to take the country to the goal of doubling per capita income by 2025.

Most important was the promise of reforms to liberalise trade and investment, to attract foreign investment and restore emphasis on exports.

It is important that the sentiments expressed in the Prime Minister’s statement must follow with practical yet bold economic policy reform. A detailed policy document has been promised and would hopefully contain the necessary implementation plans.

The rest of this brief note is aimed at understanding the policy pronouncements in the context of Sri Lanka’s political and socio-economic priorities.

Improving the business and investment climate

The statement promises a lot: simplifying the process of registering a business, getting construction permits, electricity connections and bank credit, registering property, protecting minority investors, the payment of taxes, trading across borders, the enforcement of contracts, the resolution of insolvency and reforming labour laws.

The Prime Minister’s target to bring Sri Lanka into the top 70 countries in the World Bank’s Doing Business Index by 2020 is welcome. Sri Lanka currently languishes at 110 in the index amongst 185 countries and its position has actually dropped by one place under the current administration. Policy reform to increase the ease of doing business is uncontentious and will draw broad political support from across the spectrum.

However the government must be bolder. Whilst ease of doing business has improved in the last few years, Sri Lanka can do much more to expand general economic freedom in the economy. The Fraser Institute, which publishes the annual index of economic freedom ranked Sri Lanka 111 among 160 countries. The index now ranks countries in the region like Nepal higher in terms of economic freedom than Sri Lanka with India only just behind. Beyond just looking at ease of doing business, Sri Lanka should also focus on other aspects of economic freedom including removing of outdated and arbitrary regulation, reversing recent follies such as Soviet-style price controls and truly living up to the promises of liberalising international trade and investment. In this vein, the proposed establishment of a single window for investment approval in the Prime Minister’s speech is a welcome move.

Sri Lanka can emulate, and where necessary adapt, the best practice policies from other countries such as New Zealand and Australia which rank highly in terms of economic freedom

Trade liberalisation: repeal of the Export and Import Control Act

The Government promises to repeal this archaic piece of legislation and replace it with new legislation based on that of Singapore. If implemented in the true spirit of Singapore’s legislation, this would be extremely positive.

Singapore is generally regarded as a free port and the Government only restricts the import of goods seen as posing a threat to health, security, safety and social decency. Around 99% of imports to Singapore are duty-free.

The policy statement makes reference to “a low tax regime”, the lessons from East Asia and other parts of the world is that the tariff regime needs to be low and uniform. This minimises loopholes, corruption and simplifies customs processing. A low uniform rate of duty eliminates disputes with classification and enables documents to be processed on a self-declared basis (with customs only focusing on misstatements of price and quantities) which results in faster, simpler clearing of goods.

While sentiments to keep a low tax regimes are laudable, a commitment for a low uniform tariff policy should be the goal.

State enterprise reforms and financing of infrastructure

The proposed debt/equity swaps of the Mattala Airport and the Hambantota mark an important step towards reducing the Government’s debt burden. The Government should also convert other infrastructure projects such as the highways into PPP projects by auctioning operational rights.

The statement promises investment in infrastructure in logistics to improve connectivity to global supply chains. Whilst we all welcome investments in critical infrastructure, all new projects should be implemented through public private partnerships to prevent further accumulation of public debt.

The report published by the Advocata Institute on “The State of State Enterprises in 2015” shows that the state has over 245 enterprises in its books, of which only a small number actually reported their financial position. The proposed formation of a Public Commercial Enterprise Board to manage SOEs and the creation a Public Wealth Trust, a centralised body to hold the shares in SOEs is therefore timely. Hopefully these mechanisms may prove to be the first step in imposing accepted reporting practices and better management of State enterprises. Sri Lanka can learn from Singapore’s state enterprise holding company Temasek and other experiences around the world.

Additionally, the listing of the shares of SOE’s on the Stock Exchange would also impose discipline in reporting and is something the Government should explore. Minority stakes could be offered to the public which would raise revenue to the state, allow public participation in SOE’s and broad-base the CSE; even while the majority stake is still controlled by the Government.

The recent announcements regarding the closure and amalgamation of Mihin Lanka into SriLankan Airlines is encouraging but the previously announced partial privatisation of the debt-ridden airline has not yet materialised.

The proposed Public Enterprise Commercial Board should be given a wide mandate to restructure and reform SOE’s including assessing the strategic need for such enterprises, the closure of unviable enterprises and to privatise enterprises where there’s enough commercial interest. The new structure will hopefully be just the first step on the long road to improve overall accountability and governance of these state enterprises.

It is unlikely a one size fits all solution would work for reforming all state enterprises in what would inevitably become a politically charged issue. However the public appetite for bold reform in this area is high with the realisation that the cumulative losses over the last ten years amongst the 55 strategically important enterprises amounted to Rs.636 billion.

Some areas of concern: SME’s rural agriculture

Several proposals including the one to expand SME finance through quantitative targets enforced by the Central Bank must be viewed with caution. Dirigiste lending to push bank exposure further to higher-risk sectors may boomerang on lenders, especially public sector banks, resulting in losses. Any difficulties SME’s may face with access to credit need to be examined carefully and appropriate solutions developed in consultation with financiers.

The establishment of rural modernisation boards and agricultural marketing boards will need to be examined more closely. No details are available so the exact role of these bodies is not clear but the current flawed agricultural policies have pushed up food prices for consumers. Sri Lanka’s food prices are the highest in the region and the priority should be to lower the cost of living through appropriate reforms to the sector.

Apart from a few areas of doubt the overall economic statement is broadly in the right direction and if properly implemented could boost growth and improve the welfare and prosperity of Sri Lankans. The government however has a demonstrable problem with policy inconsistency over the last few years, even amongst its own ministries and between Ministers of the same party. Whilst some diversity of opinion is expected from a coalition government, some of the policies enacted in the recent past have run counter to this and other broad policy pronouncement from the Prime Minister.

These broad ideas will hopefully pass the implementation test and we await the publication of the detailed strategy document.

The writer is a Fellow of the Advocata Institute, a fee-market think tank based in Colombo. www.advocata.org

While Sri Lanka slept Georgia was awake!

 

The article originally appeared on the Daily Mirror 

Georgia, a former Soviet state, has lessons for Sri Lanka on political will and economic reform.
If Georgia was a book, then it is surely is one of many pages. Her pages would be full of    Caucasus Mountain villages and places like Vardzia, a cave monastery dating back to the 12th century, and the Black Sea beaches. What is in it for us as a nation lies a few pages after: the visionary political and economic reforms done in Georgia during 2004 and 2012. 

Being a country at the intersection of Asia and Europe with a 4.4 million population, Georgia offers many lessons to Sri Lanka, where politicians struggle to drive the country forward after nearly seven decades of independence.

With the fall of the Soviet Union in 1991, the Republic of Georgia had a long walk through darkness until it finally saw the light at the end of the tunnel in 2004. In the 1990s, Georgia was torn apart by a civil war. The country was taken over by corrupt interests. In 2003 however, Georgians fought back. Peaceful protests after a disputed election saw the ouster of President Eduard Shevardnadze and the end of Soviet-backed rule. In the climatic end of the saga, demonstrators stormed a session in parliament with red roses in hand. Georgians remember this as the ‘Rose Revolution’. In the following presidential and parliamentary elections, reformist leader Mikheil Saakashvili came into power kick starting what many analysts consider a small economic miracle in Georgia. 

The story has many parallels to Sri Lanka.  Today, we have ended our own military conflict of 30 years, yet the future still seems fractured. Hopes for rapid economic reforms to take Sri Lanka to the next level have quickly evaporated. Instead, the government seems to be embroiled in one political crisis after the other. Unlike the Georgian politicians, instead of seizing the momentum of Sri Lanka’s own political revolution, the Sri Lankan leaders could end up squandering the reform movement.   

Most economists agree that greater economic freedom has a strong correlation with greater prosperity of a country.  Table 1 shows a simple comparison how Georgia, which came to be born a mere 25 years ago, overtook Sri Lanka in such a short span of time. 


The Heritage Foundation is one organisation that measures the level of economic freedom in a country. The comparison is telling: (See Table 1) 
As per the index of economic freedom by Heritage Foundation, the way Georgia has progressed is clear. It is not rocket science. We need the necessary reforms for business freedom, trade freedom and investment freedom. 

How Georgia did it
Contrary to popular belief, we must come to understand that most politicians in the world have little intention to make a country or its people genuinely prosperous. Governments are distracted and politicians have a short-term single-minded goal -- the next election. Even those who come into politics with good intentions eventually succumb to the temptation to look after themselves, their future generations and ensure their supporters have a big enough slice of the cake. They have centralized power, racked up the country’s debt and siphoned off benefits for themselves. This is the experience of our post-independence democracy. 

Changing political incentives is not easy but Georgia offers a great example. After the Rose Revolution, instead of expanding the power of the state, they limited its power. This provided more freedom and responsibility for their people to make their own lives better as citizens. 


By 2003, Georgia was drowning deep in corruption, sliding fast down a slippery slope when the Rose Revolution took place. 
Rose Revolution leader Mikheil Saakashvili became President in 2004. He was re-elected in 2008 and in the eight-year tenure of Saakshvili, his reform agenda changed the course of progress of Georgia.

Tax reduction
These are some of the actions taken: simplified and reduced the number of taxes applicable to six from 20 taxes; reduced the rates of taxation. (Income, value-added tax (VAT), corporate, excise, customs and property tax were the only taxes applicable. All the other taxes were abolished). 

Significant reductions were made in tax rates across the board: for income taxes, VAT, profits and customs duties. A new system was introduced to pay taxes online and many tax clauses were brought in to eradicate widespread tax avoidance and evasion by companies. The ultimate outcome was that tax income collection increased sixfold within six years despite the reduction in rates. 


The unfortunate truth in Sri Lanka is that the few income taxpayers who contribute to the economy are being penalized by the Inland Revenue and the government tries to regulate their industries on top of that. The result speaks for itself as for the bad policy of the government does prove they are not capable of re-correction to this rudderless course. In comparison, our tax revenue is going down relative to gross domestic product (GDP) every year and this is all due to the mediocre tax structure we have in Sri Lanka.  

Reduce size and footprint of state
    The number of government agencies was reduced along with the number of government employees. The salary scales of the remaining employees on the state payroll were increased, which led to productivity improvements in the government sector. 
    The police force was totally reformed, which carries important lessons for Sri Lanka. Trust in the police increased from zero to 80 percent. Under the previous system, the police conspired with criminals and corruption had overtaken the system. What the Georgians simply did was cutting down the cadre and increasing the salary of the remaining staff.
 

Cutting down heavy-handed regulations
Eight hundred permits and licences were abolished and state and land properties, such as sea ports and airports, were privatized. New regulations introduced to hire and fire employees easily resulted in lower rates of unemployment and higher pay in Georgia. 


In Sri Lanka, our government sector keeps expanding and everyone gets disappointed as no one gets paid as per their expectations. Our productivity goes down and unfortunately, the entire government sector has become a slave house of politicians regardless of the colour of the flags they hold. 


 Our education system continues to teach us to dream small and aim for stability than going for growth and stand on our feet. So we have become a nation of complacent people with colourless and meaningless criticisms. 
 Adopting international standards to remove layers of regulation. In Georgia, the Organisation for Economic Cooperation and Development’s (OECD) standards for pharmaceuticals, food, consumer products and services were fully adopted and welcomed. No special permits were required for the OECD-approved goods and services to enter Georgia. The banks also welcomed this decision, as it made their operations easier. 
Anyone who had a Schengen visa or a tourist from a country, which had a GDP per capita twice that of Georgia’s, could freely enter Georgia. 
 

Industrial development and liberalization
 The prices were liberalized in the power sector and power production and distributions were privatized. Priority was given to foreign direct investment. Private hydropower plants were constructed and fast-flowing rivers from high mountains created electricity, which was exported to almost twice the quantum that was imported before. 
 The export sector was totally revamped. This needed to be done as Russia banned the Georgian imports in 2006. The country improved all the products to compete in the international market. Wines, fruit, mineral water and such became high-quality exports through internal competition among traders. Within four years, Georgia’s export revenue exceeded to of what it was before the Russian imports ban. 
 While Sri Lankan politicians exhausted their voters by providing excuses for the GSP Plus and the ban on fish imports by the European Union (EU) and many other superficial reasons, Georgia had the courage to open up its markets and start small.
 

Economic Liberty Act
 To ensure the sustainability of the economic growth, the Georgian parliament passed the Economic Liberty Act. The law restricted creation of new taxes and required the government to maintain the government debt at 60 percent of GDP, government expenditure to be 30 percent of GDP and budget deficit not to exceed 3 percent of GDP. During the tenure of Saakashvili, the GDP per capita increased by 300 percent to reach US $ 3300. 
Sri Lanka has a Fiscal Responsibility Act, which could be strengthened by the inclusion of provisions similar to that of Georgia. The need is clear: just to compare the figures of Sri Lanka Forbes reported on September 30, that the Sri Lankan government’s debt to GDP stands for 75 percent and 94 percent of all government revenue is currently directed to debt repayment. The budget deficit is at 6.1 percent as per GDP in the first quarter of 2016.  
 

Georgia after 2012
In 2012, an opposition coalition, which was founded just six months before the election, defeated Saakashvili’s party and Bidzina Ivanishvili, the wealthiest man in Georgia, became Prime Minister.
Two weeks prior to the election, a video showing violence against prisoners was aired on an opposition-run television channel. It was the cause of public outcry that resulted in strong opposition votes. 
In 2014, Georgia established a free trade agreement with the EU. Following its intent to become an EU member state, Georgia had been introducing European standards to many of its industries. 


With a more populist political party at the helm, Georgia’s economy grew by 3.4 percent in 2013, 4.6 percent in 2014 and 2.8 percent in 2015. The inflation rate reached 4.9 percent in 2015 and the value of the Georgian lari declined by 30 percent. 


As of 2016, Georgia’s external debt has reached US $ 15 billion, six billion of which is government debt. The debt is equal to 43.3 percent of GDP. Since 2012, Georgia has been borrowing US $ 220 million every year from the World Bank. It borrowed US $ 290 million in 2016. As a result, its budget deficit has reached 11 percent of GDP. The most rapidly growing industry in its economy is tourism. Georgia’s tourism industry is now accountable for 23.5 percent of GDP, 20 percent of employment and 36 percent of its exports.
The lesson learnt from where Georgia heading after 2012 is that economic reform is an ongoing process. It is said ‘success fails like nothing’ and surely economic reforms are not a once and for all solution. Once a country is taken to a certain level through necessary economic reforms, it needs to continue progressing with the global economic trends and the expectations of the people of the country. From Sri Lanka’s point of view, we haven’t made any major reforms in our economy. Before we move on to the sustenance phase, we need to pass the start up phase.
 

Lessons for Sri Lanka and way forward 
To overcome the current crisis, Sri Lanka has many things to do but if we try to do all of them, it would be next to impossible. It was said by Mathma Ghandhi, “Actions express priorities.”
A proper economic plan    


First, a proper economic plan needs to be tabled by the government for the remaining years of this parliamentary term clearly mentioning the short-term reforms and the reforms need to be implemented within the next generation. So the president and prime minister will be more focused rather than appearing as comedians in front of the public bringing up ad hoc policy recommendations and making purely unnecessary statements, where the public feel they need to punish themselves from toxic stingray tails for wasting time in polling booths. 
Simplified tax system 


 A new system of simplified taxation needs to be introduced. Importantly, the system has to be a simple tax system that provides convenience. Rather than increasing the tax rates, it is vitally important to broaden the tax base and make the collection efficient, so that the increasing tax income will not be a mammoth task as it is now.
Liberalize trade and foreign investment


Rather than focusing on mega projects, which need to create new markets, the first step would be joining the global value chain in established industries. The business regulations need to be simplified and the number of approvals for a project needs to be cut down. In addition, unnecessary permits need to be abolished.  
“Breathes there a man whose soul so dead, who never to himself has said, this is my country, my native land,” said Sir Walter Scott.  
At Advocata, we stand for what we believe, and although many give up after losing the battle, we press on toward winning the war and fighting for genuine change to take mother Lanka to where she deserves to be.
We invite the so-called economic gurus and pundits who voted for allocating Rs.1180 million to upgrade their super luxury vehicles in the Cabinet to get up from just warming their seats and do something because this time it is not from the frying pan into the fire but from the frying pan into the microwave, where there is no point of return.


Dhananath Fernando is the Chief Operating Officer of Advocata Institute.

The government aims to regulate e-commerce. It shouldn't.

A version of this article appeared on  Daily News

The Sri Lankan government reportedly intends bringing legislation to regulate e-commerce businesses operating in the country. The Finance Minister was quoted as saying “They (e-commerce operators) are just operating here. Where is the regulation for that? We will make them bring money earned there back to the country.” If this were enacted it is quite likely that Uber, Agoda and Booking.com; the businesses which have earned the ire of the Tourist Hotels Association of Sri Lanka (THASL) and the Rent-A-Car Association would pull out. These associations have lobbied for regulation.

Sri Lanka’s domestic market is small and the volume of e-commerce is smaller still. For a global company the hassle of incorporating a local office, opening bank accounts and grappling with the local administration would not be worthwhile. They would almost certainly leave.

The Hotels and Rent-a- car association have not made a clear case for their position. Consumers however would be left worse off facing higher prices and more limited choice.

Tourist arrivals

The informal tourist sector is now the fastest growing segment of the market, catering to as much as 40 percent of the tourist arrivals to the country. Internet booking engines are the lifeblood of the sector; small guesthouses depend almost entirely on them to reach their clientele.

Budget tourists, who form the majority of visitors to guesthouses cannot afford the prices of star-class hotel. Close the booking engine and we close the door to the budget tourists who will head off to India or Southeast Asia spelling certain doom to the 8,000 plus small guesthouses scattered across the country. Some mid-range tourists will choose to pay the higher rates at hotels and still come but many will not.

The beauty of allowing small guesthouses to flourish is to broaden the income earning opportunities for people with a minimal investment. Householders rent out extra rooms in their own houses, with a little refurbishment; upgrading the toilets, installing hot water and perhaps airconditioning. The money earned goes direct to the hands of local families. Further, budget tourists will patronise local shops and restaurants, offering an easy path to improved living standards.

Mark P. Hampton is Senior Lecturer in Tourism Management at the University of Kent, notes that:

My own research in Indonesia, Vietnam, Thailand and Malaysia since the mid-1990s shows that as backpackers tend to consume local products (food, coffee, beer, cigarettes etc), stay in small guest houses, and use locally owned ground transport, more of their expenditure is retained in-country than in conventional mass tourism.

Economic leakages from backpacker tourism are also significantly less than for conventional (foreign-owned) tourism, since backpacker businesses are usually locally owned and profits tend to be retained within the developing country rather than flowing overseas to international hotel groups.

Traveller reviews

Depriving these people of opportunities to better themselves in order to benefit large-scale hotels seems perverse. The booking engines do charge the guest houses a fee but the bulk of what is spent by tourists is retained locally.

What about maintaining minimum standards?

In the pre-internet era there was a problem of standards. How does a visitor know what to expect? This is the origin of the star ratings in hotels, a means to indicate standard.

This is no longer a problem. Booking engines work on the basis of traveller reviews. Visitors post their ratings of the places they stay, those that receive poor ratings are less likely to be patronised. Essentially, standards are enforced by the visitors themselves which is why this model has been so successful.

Previously the hotel industry successfully lobbied for the imposition of minimum room rates and there have been recent attempts to restrict short-lets on apartments which were seen as a threat by the hotels. Now they seek to restrict the informal sector.

Hotels in Sri Lanka need to understand that tourism is a global industry; their competition is not only domestic it is regional: from Malaysia, Thailand and Indonesia. A good number of hotels in these countries offer lower rates than the average in Sri Lanka and overall travel costs are rated to be much cheaper, as comments from tourists on the popular TripAdvisor website testify:

“There is no question whatsoever that Thailand is much cheaper than Sri Lanka and with higher quality. On average, all things being equal, Thai hotels are half the price of those in Sri Lanka and there are lots to choose from especially in the low price category.” or

“Sri Lanka is a compact island offering beautiful vistas, cultural, historical and religious sites, beach and river activities, hiking . . . all year round, taking into account the weather patterns. With ten days and proper planning, you could see and do a lot. Compared to Malaysia and Thailand many of the things you might want to do are more expensive.”

Business-friendly destination

The Sunday Times reported that when a Singapore hospitality expert asked in 2014 for a package tour of Sri Lanka, the offering was similar to that she had experienced 10-15 years ago. “It was no different. I have been visiting Sri Lanka for many years and the package was the same as 10-15 years ago. Attempting to cripple the competition locally will not improve the position of Sri Lanka’s hotels regionally and will be the detriment to the wider tourism industry.

It may also be detrimental to local Tech Startup ecosystem in general as Sri Lanka will come to seen as a place with backward and uninviting regulations at a stage the country’s tech community is desperately trying to position it as a place of innovation and attract investors. Instead of lobbying for strangling regulation the lobby groups need to reexamine their value proposition and adapt. On the government’s part, it should stay out of an industry where the average regulator and legislator has minimal understanding. Cumbersome rules will reduce Sri Lanka’s attractiveness as a forward looking business-friendly destination for FDI.


Ravi Ratnasabapathy is a Fellow of the Advocata Institute.

Razeen Sally : Open up shipping and Tea to competition

If the outlined measures are implemented, two prominent sectors will be opened up to international competition: shipping and tea

If the outlined measures are implemented, two prominent sectors will be opened up to international competition: shipping and tea

Read the full article originally appeared on Financial Times

 

Sri Lanka desperately needs a new global economic strategy as part of a broader strategy for national renewal. It needs a decisive shift to markets and globalisation. A prospering, globalised market economy is the sturdiest foundation for a genuinely open society – for constitutional liberalism, the rule of law, ethnic peace and balanced international relations. Without it, all else fails. It has to be among the Government’s top priorities. The good news is that Sri Lanka has its most golden opportunity to achieve its long-advertised potential since the victory of the UNP in June 1977. 

But no economic reforms have materialised since the change of government last year. As I argued in my last Daily FT column, there should be four economic priorities for the remainder of this Government’s term: 1) “first do no harm” – no more senseless public sector salary hikes, price controls and ad hoc taxes; 2) fiscal stability, especially through tax and expenditure reforms; 3) improving the domestic business climate; and 4) trade and FDI liberalisation. They are all connected. Together they would greatly strengthen Sri Lanka’s competitiveness for higher productivity, growth and prosperity. Here I focus on the last component – a new trade policy.

 

Deshal de Mel answers your questions on the Sri Lankan economy

The economist Deshal de Mel who delivered Advocata's inaugural lecture on our series on How to fix Sri Lanka's economy. Participated in a lively Q&A session after the lecture moderated by Shiran Fernando.  However, we couldn't cover all the questions. Deshal was kind enough to answer some of the questions left on slido.com via his blog.  Here is a reproduction of Deshal's blog post.

1) Would the Port City, now being positioned as a Financial City, help the Sri Lankan economy?

The Port City has potential to help position Colombo as a modern city that is an attractive destination for global professionals to live, work, and visit. However, the viability of this depends on the type of investments that come in, the management of the environment, the management of infrastructure (sewage, drainage, marine and shore environment) and the related regulatory policy. The feasibility of a Financial City would depend on the evolution of the financial market in Sri Lanka. At present our financial market is not very sophisticated – it remains highly regulated with significant interventions in foreign exchange, lending practices, ownership etc.

There is a suggestion that the Financial City would be positioned as an off-shore financial market, with different regulations including visa requirements and so on. However, if this is completely separate from the rest of the economy, the resultant benefits for the local economy may be limited to some employment creation and spill-over spending effects.

2) How would Brexit and a Donald Trump victory in the US election affect Sri Lanka? Particularly the apparel industry, which employs a lot of women.

Early indications are that the main impact of Brexit are through the weaker GBP and resultant constraints on UK importers of Sri Lankan apparel. This effect is likely to continue and may affect other Euro area countries as well if the viability of the European integration project gets further undermined. The weaker GBP will also affect tourist arrivals from the UK this winter season.

The effect of a Trump victory on the other hand is almost impossible to analyse given the difficulty in predicting his policy positions and the possible gap between campaign rhetoric and policy reality. Nonetheless, whoever comes into power in the US will necessarily have to take into account the sharp anti-establishment voter sentiment, and there are likely to be rollbacks in economic liberalism, particularly with regard to cross border movement of labour, both in the US and Europe and in setbacks to progress of international trade agreements. A weakening of trade institutions will be further detrimental to global trade and to countries like Sri Lanka which need trade for growth.

3) Given the VAT set back, how challenging would it be to meet the fiscal deficit targets in the IMF program? What are the implications if the government does not pursue the IMF agenda?

There has been an improvement in fiscal performance in the first 4 months of 2016, with revenue growth of 20% and budget deficit declining by 14%. Nonetheless, these figures remain below budgeted targets with revenue falling short by 13% and budget deficit being 34% higher than planned. Tax revenue continues to rely heavily on indirect taxes and particularly import based taxes. With economic growth expected to moderate in 2016, there will be challenges in achieving the envisaged fiscal targets, which amplifies the urgency of reform of the inland revenue department to optimize use of information technology in revenue collection, simplifying tax payment processes and simplifying the tax system, and minimizing room for discretion in tax related decisions by officials.
A failure to meet the IMF targets may result in a delay or holding back of tranches of the IMF loan. This would lead to an erosion of confidence in the Sri Lankan economy among global investors – which in turn would impede Sri Lanka’s ability to raise funds to meet short term external payment obligations.

4) What can the government do to drive SME’s, start-ups?

Continued focus on the simplification of business processes and reduction in costs of setting up and operating a business is the best way a government can support SMEs and startups. In addition, a government has a role in encouraging the development of conducive networks and ecosystems that bring small time businesses in contact with sources of finance, distribution channels and markets, knowledge, and technology.

5) How much are policy changes/reversals affecting Sri Lanka’s economy? How much would clearer communication of policies by the government help its acceptance by the public and thus implementation?

Regular reversals of economic policy decisions and conflicting messaging on economic issues from the government is very harmful to the business and investment climate. It becomes very difficult to plan commercial activities such as new investment or business expansion when the policy environment is uncertain. Ideally a government should have a clear three to five year policy framework with only incremental changes in the interim to respond to external developments. Unfortunately Sri Lanka’s recent experience has been the opposite, with even short term policy frameworks such as the budget, being regularly changed in response to stakeholder reactions. A more inclusive approach to policy making, taking into account stakeholder views prior to implementation, would be a way to deliver more sustainable and implementable policies.

6) Are apartment/real estate developments drawing out liquidity in the market?

Investment in apartments and real estate is just one source of demand for credit in the market. Considering 2015 statistics, out of private sector credit of 3.4 trillion, personal housing (construction, repairs, purchasing etc) accounted for 10.8%. Anecdotal evidence however does indicate that a lot of real estate investments have been on cash basis – and this is difficult to capture in statistical form.

Overall loan growth in the economy has been strong for the last 20 months or so – with private sector credit and borrowings by the government being significant. Steps have been taken in 2016 to curb this credit growth, including the recent policy rate hike by the Central Bank in June.

7) What is the likelihood of Sri Lanka being able to diversify its economic growth outside the Western Province? What steps can be taken to grow the rural economy?

Steps have been taken to improve transport infrastructure in parts of the country outside the western province. More needs to be done to reduce transport costs, particularly to the central, eastern, and northern parts of the country in order to improve connectivity with the larger local markets in the western province and access to global markets through the port and airport. In addition to expressways, investment in domestic airports will be an important driver of connectivity. However transport connectivity is not the only factor that determines attractiveness of investment in rural regions. Investment in health and education services are important factors in retaining management talent and other white collar skills in these regions, whilst also developing home grown talent from the regions themselves.

8) Has Sri Lanka’s peace dividend materialized?

Sri Lanka enjoyed strong economic growth in the years immediately after the war. However, growth was concentrated in a few narrow sectors such as construction, domestic trading, domestic transportation, financial services and so on. This growth was also contingent on fairly accommodative monetary policy, which had to come to an end in 2012 as the economy began to overheat. A more sustainable growth path would be one which has more diversified growth sources, including a more substantial share of external growth drivers through the export of goods and services. Thus far tourism and logistics related industries are the most promising sectors on the horizon to help this diversification of growth factors to enable a more sustained peace dividend.

9) In the context of privatization and other divestment of state assets – what happens to those who have no other source of livelihood?

A structural change in an economy where resources shift from uncompetitive sectors to competitive ones is necessarily a change which entails dislocations in the labour market. Workers in those industries which are uncompetitive will need to develop skills to cater to the new industries that do emerge in their place. This is never an easy and trouble free process – and there is a role of the state in the provision of such training facilities and temporary safety nets to support livelihoods of those who do lose jobs. To minimize the time of transitions, it is essential to proactively drive the FDI attraction process to create new jobs in the new, more competitive sectors of the economy.

10) What measures could be taken to enable citizens/interest groups to communicate issues to the government instead of resorting to disruptive strikes?

A more inclusive approach to policy making can be constructive here – particularly through greater consultations prior to significant policy changes. The communication needs to be two-way, with the government clearly articulating the reasons behind such policy changes and making best endeavours to take into account the reasonable concerns of citizen groups. In today’s context technology can be used in a much more effective way to obtain citizen feedback on policy and to address concerns through more effective communication. Policy reform will always lead to winners and losers, and the effective management of the losers from the process is crucial to ensuring the longevity of the reform process.

11) Can Sri Lanka contribute to value addition in India’s economic sectors?

Sri Lanka already is contributing to value addition in India’s economic sectors through Sri Lankan investments in logistics, apparel, and leisure, among others, in the Indian economy. However, further value could be created by better integration of supply chains between the two countries, enabling more efficient manufacturing, taking advantage of comparative advantages and Sri Lanka’s natural logistical/locational strengths.

12) Do you think the government is giving enough weight towards entrepot trading?

Steps have been taking towards creating an enabling environment for entrepot trading by the enactment of the Commercial Hub Regulation Act of 2013. This creates bonded zones in 6 locations in the country that are free of customs duties and processes, enabling activities such as entrepot trade and other logistics/warehousing related businesses. However more needs to be done to promote this to improve uptake – such as proactively approaching multinationals to set up their warehousing/distribution operations in Sri Lanka, catering to their buyers in the Indian sub-continent and beyond.

13) Can Sri Lanka pursue sustainability whilst also focusing on growth in manufacturing?

Considering global trends in manufacturing, Sri Lankan manufacturers will necessarily have to engrain sustainability in their operational processes. This is necessary both in terms of streamlining operational costs and optimizing efficiency, and also in terms of marketability of products, which is increasingly influenced by sustainability factors.

14) How far away are we from default in our foreign debt? Is the relationship with China adding to this debt burden?

With the IMF programme brining some confidence and the new Central Bank Governor bringing credibility to Sri Lanka’s economic policy making machinery, Sri Lanka’s ability to borrow from global markets has returned, at least for now. Therefore, the country will likely be able to roll-over its near term debt obligations, barring a significant risk event in the global market, or a reversal of these recent domestic policy measures. The long term sustainability of debt remains contingent on Sri Lanka’s ability to anchor meaningful fiscal consolidation through sustained revenue improvements and rationalization of government expenditure. It is also necessary to develop external inflows through greater exports of goods and services, and FDI.

Whilst Sri Lanka has seen greater borrowings from China during the last decade, the feasibility of such loan repayments is more to do with the choice of project, which is the role of the Sri Lankan government, than the choice of lender. Sri Lanka has had positive outcomes from the Chinese relationship such as the extension to the Colombo South Harbour’s new deep water terminal, as well as less positive outcomes such as the Mattala Airport – therefore it is a question of how Sri Lanka chooses to utilize the investments from China in an optimal manner.

15) Considering your titillating presentation, with the government swaying left and right on issues, do you see the two coming together instead of being unhooked?

It is important for a government to keep abreast of all policy issues, speak in a unified voice and avoid lingering doubts. This will help provide optimal support to Sri Lankan enterprise, big or small.

16) What’s your outlook on interest rates?

Interest rates have already increased significantly in the first half of 2016 and with the rate hike by the Central Bank in July, I would expect interest rates (particularly the benchmark bond yields) to have peaked by now and remain around these levels through the rest of the year. Credit growth is likely to moderate in the second half of the year and thus ease liquidity pressures in the market and recovery of foreign investment in LKR treasuries will also help stabilize interest rates.

17) Today’s firms are underpaying workers and earning excess profits. Why doesn’t competition cause market prices of goods and services to decline?

Perfect competition would cause prices to find equilibrium at a level where supply equates to demand. However, in most cases, particularly in developing economies, markets have several imperfections and do not result in optimally competitive environments. Governments in such cases need to take steps to mitigate such market failure, be it through effective competition policy to prevent formation of monopolies and oligopolies, or by supporting improvements in information to reduce information asymmetries.
In Sri Lanka’s case however a lot of the high and sticky prices are due to high taxation or administered prices, that do not allow the price level to settle at a true market rate. This is the case for several agricultural products and protected domestic industries.

18) Do you think rehabilitation, reconciliation and reconstruction bolster the economy?

Rehabilitation, reconciliation, and reconstruction are important elements in sustaining peace in the country, and this in turn is crucial to ensuring economic stability and creating an environment that encourages long term investment. The relationship works both ways, since the expansion of economic opportunity in turn is important to create livelihoods for those in post-war provinces, which again is an essential component of normalization.

20) Why hasn’t protectionism of infant industries and uncompetitive industries been removed?

One of the main reasons is very effective and strong lobbying of successive governments by the industries concerned. A second reason is the fact that there hasn’t been significant investment in new sectors which creates alternative employment opportunities for those employed in such protected industries. Another reason is that a reduction of trade tariffs on such industries would have a negative impact on government revenue, which is particularly problematic in a situation where 50% of government revenue is based on import based taxes.

21) Is a reduction of agricultural subsidies and protection practical? Or is it only sound in theory?

The removal of protection cannot be implemented overnight. Several pre-requisites need to be fulfilled in preparation for this, namely; 1) a robust network of well targeted safety nets to provide cushion for those affected by labour market dislocation, 2) investment in skill development/re-training activities to engrain the relevant capabilities to enable workers to shift to new industries, 3) Pro-actively drive FDI in higher value agriculture – particularly targeting global companies that implement higher technology based agriculture catering to global export markets. This entire process takes time but it has to start somewhere, to enable the economy to gradually shift from low productivity, low wage activities, to higher productivity, more remunerative activities.

23) Should there be a change in the government’s incentives towards developing the economy, as opposed to the prevailing incentive of getting re-elected at the next election?

Government incentives are driven by voter demands. If voters demand state jobs, domestic industry protection, subsidies, and so on, that is what the government is incentivized to provide. Voters need to understand the true costs of these activities, particularly in a different fiscal and financial paradigm to what Sri Lanka has been accustomed to until the last 6 or 7 years. The government and policy makers (by and large) know what is required but will continue to pander to voter demands until voters make more educated demands of their government.

24) Africa has astonishing stories of creativity and innovation. Are we as a nation far less creativity oriented and more interested in imports and consumption?

Sri Lanka’s education system has been an exam-centric one, which trains students to acquire and retain knowledge and use it to pass an exam. A lot more can be done to inculcate skills such as creativity, problem solving, analysis – this requires an overhaul of the curriculum and teaching methods. It is these skills that are needed to build an innovation centric culture. We do have pockets of excellent creativity and innovation, but these are success stories despite the education system, not because of it. By re-orienting our education practices, such successes can be made the norm and not the exception.

25) Which industries can be built to a level that would be able to produce competitive exportable products and services?

It is difficult to predict which sectors can thrive in an economy. For instance, it is unlikely that someone could have predicted that Sri Lanka would be the global market leader in solid tyre exports, and fly fishing rods. From a policy perspective, I believe it is better to be sector agnostic, and to focus on creating an environment in which the best investments could thrive. Sri Lanka is likely to succeed in niches which are inherently tough to predict – but will have requirements such as skilled labour, good logistical processes, good access to global markets, and robust physical infrastructure – these are the areas a government should focus its attention.

26) Is SOE privatization likely to take place?

Privatization may not happen in the same manner in which it occurred in the 1990s and early 2000s – but I would expect the divestment of stakes of public companies in a manner similar to what happened with SLT. The viability of this process requires excellent communication with the industry stakeholders (unions, employees), the general public, and also ensuring a healthy competitive market in which the industry operates.

27) Is it feasible to abolish VAT and replace it with a BTT of around 7 to 8%

I would argue that the VAT is a superior tax to BTT since it taxes value addition and minimizes tax duplication. A lot of work has gone into developing VAT to the level we are at today, so I think it should be persevered with and continue to focus on improving collection and minimizing leakage.

Reuben Abraham : SEZs could help drive development in the provinces

The CEO of the IDFC institute and Advocata adviser Dr Reuben Abraham says  that special zones that allows for rules of the economy to be experimented with may provide the way for rapid regional development in places like Hambantota and the North and East of Sri Lanka.  He was speaking to Advocata Institute's inaugural podcast series titled Advocata Radio.

Following are excerpts from the podcast as published on the Daily Mirror.

Dr Reuben Abraham is the CEO of IDFC Institute, a mumbai based think and do tank working on the political economy of public policy and reform. He is also part of a number of influential think tanks and Institutes around the world including New York University, Legatum Institute and Council for Foreign relations. Dr Abraham spoke to Advocata Institute’s monthly podcast on the challenge of urbanization in the developing world as well as ideas on how to think about Sri Lanka’s megapolis plans. 


Q You said your institute works on the political economy of public policy, explain to us what that is.

Our underlying premise for that is most of what is to be done is either well known or with enough smart people in this room it’s quite easy to figure out. The problem with public policy, often times is that we just don’t know how to implement, how to execute what we know. So in that sense we are trying to shift the focus away from a technical discussion of public policy to a political economy discussion on public policy. A shift away from the ‘WHAT’ of public policy to the ‘HOW’ of public policy.  For each instance you have to take a completely different approach based on your analysis of political economy of a given situation. So where are the benefits? Who loses? You need to figure that out.

Q:We are currently at a stage in the world, where roughly half the population is living in urban settings. We are seeing rapid urbanization taking place particularly in our region and in China. What are the key issues to consider, when we think of urbanization?

I think it’s important to look at the long run trends. If you look at 10 000 years’ worth of history you will discover very quickly that mankind has primarily been a rural species. Now in 2007/2008 something dramatic happened which a lot of attention was paid to mainly that the world became over 50% urban. And for the majority of history up until about 1800 the percentage of people living in urban areas was basically 3% or less. And now since 2007/ 2008 it has gone over 50% and it is expected to climb to about 80%. This is the trajectory we are on. We are basically marking the movement of the species from being a primarily rural species to a primarily urban species. The real challenge here for all our countries is that almost all the urbanization you are going to see in the next 30-40 years is going to be in developing countries but, very specifically in south Asia, China and Africa. That is challenge number one and challenge number two is that is the time frame you have because this is not a reversible process. It’s not like you can command people to go back into the villages because many people from the Chinese onwards  have tried that but it has never worked. It is basically an irreversible of humanity’s journey of being a rural species to an urban species and there is a limited window in which something could be done.

That is why there is urgency and that is why all of our countries need to pay way more attention to this problem than they have and if they don’t look at it from a historical point of perspective you have to look at it from a job-generation and poverty reduction standpoint. 

Ultimately all non-agricultural jobs are generated in cities and productivity growth of any economy demands that people will move out of agriculture and into other sectors and all of the jobs in those sectors are almost entirely created in cities. Cities are where poverty goes away. If you look at the most recent numbers out of China you would see that less than 2% of china’s urban population is actually poor. Which means that almost all of China’s poverty is now rural.   

Q: There is also the complaint that rural development is getting ignored in all this talk of urbanization. How would you respond to that? 

I’m not a huge believer in this sharp dichotomy between rural and urban because, what you typically see is that when a country grows is that they begin to fold into each other. Keep in mind the fact that when I say urban I don’t mean Colombo or Bombay I mean depending on the definition you use could be as little as 5000 agglomerating together. The key is you need economies of scope, economies of scale and economies of agglomeration. Those are created at these sort of population levels, that’s the primary argument. In many ways rural development to a very large extent depends on urban development so, I don’t necessarily see the dichotomy between the two. I think if you develop your urban areas then by definition you also develop your rural areas.

Q: Sri Lanka is pursuing this grand idea of a western province megapolis, but when we talk about urbanization in Sri Lanka we tend to talk about physical infrastructure development, transport, and zoning and not enough is spoken about the overall rules of the economy which has an impact on urbanization. What would your advice be for Sri Lanka’s megapolis plans?

Yes this is a classic problem not necessarily in Sri Lanka, its everywhere. When we talk about urbanization we are talking about the urbanization of people not the urbanization of places that is where the central dichotomy lies.

However, the underlying logic of the the Western province megapolis is a fairly decent one simply because close to 70% of global GDP just comes from about 40 urban mega regions of the world.  Mega regions are areas that have more than 100 billion dollars of GDP. The biggest mega region in the world still remains in North Eastern corridor of the United States which is the Boston to Washington corridor going through New York and the tri-state areas through to Silicon Valley, the eastern seaboard of China all of these are examples of large urban clusters. I suspect that this is the underlying logic of what is going on in Sri Lanka.

I think the problem in all of this is people are making an assumption that the rules don’t matter. That somehow in Boston all you needed to do was basically create an announce of policy that you were going to generate this huge corridor between Boston and Washington and suddenly economic activity would take off. That is not the point, the point is actually you need the change of rules in the first place.

This is an argument that I’ve always made when people talk about smart cities using Singapore as a paragon for instance. But how did Singapore get to be a prosperous place or how did Switzerland get to be a prosperous place before the advent of the internet. Clearly it has nothing to do with the internet, obviously technology helps but, it is not the reason why something happened. Something happened because the rules were fundamentally changed. Coming up with a megapolis idea absent of changing the rules is not going to help any. There needs to be a change in the rules.

If one thinks about is as a special zone where one can basically change the rules then that idea has more legs, though if that is the model the government wants to follow I would argue that Colombo is exactly the wrong place to try it in because there are massive interests already in Colombo who are going to oppose every change of rules that any ruling entity can come up with.

Sri Lanka is experimenting with in a limited way with a special zone for rules change with Colombo Port City, at the doorstep of Colombo.   Why wouldn’t Colombo be a good starting point?

Let’s use the analogy of software operating systems in computers. What we are basically talking about is that say Windows NT is a broken OS and say a Solaris is much better and a much more robust software - it’s a much better Operating System.  The easy way out here is to replace the broken software with a better piece of software.

But Anybody who has worked in an office knows just convincing people in a department - let alone a city - to move from what they are familiar with to an unfamiliar operating system is a very hard task.

So changing  the operating system has to necessarily have two conditions in my opinion. First is they have to have meaningful scale, it cannot be done at village level, it has to be done at least at city level. The change that you get is meaningful that is number one.

Number two is the unit that you’ve picked, whatever scale that you’ve picked it has to have the political economy that works in your favor. For instance if you look at the Chinese example keep in mind the fact that the easy solution for the Chinese would have been to import the operating system of Hong Kong and reboot the entire country. That was clearly not feasible even in a commanding and controlled economy like China.

Keep in mind they did not try to change the rules in Beijing or Shanghai. Instead of that what Deng Xiaoping and his colleagues decided to do was that, they found this little town on the pearl river delta called Shenzhen and they demarcated a certain area and they changed the rules there. And then once Shenzhen became successful the rest of the country wanted the same rule change.

Q: This is about Special Economic Zones or Free Economic Zones. Port City is billed as a place where a Dubai Financial centre style arrangement is going to be experimented on.  But if you want a city outside of Colombo, we do have an opportunity in Hambantota, where lot of unused infrastructure already exist.  

I don’t think the Dubai financial center is the right example to pick simply because, there is not enough scale there. Of course Dubai can afford to do it because it’s a city on it’s own. So it does not have to worry about the massive spillovers that can get generated from a big city etc. but, if you are talking about countries with those concerns then I would certainly argue that the scale has to be bigger.

Perhaps Hambantota is a good model to look at assuming that there is genuine thought given to wholesale reform and not just have it as a tax give away. That is the other problem you see in a lot of these other places that a lot of the reform tends to be in the form of tax give away which is I will give you all these concessions if you come here.

And I don’t think that’s right model to use. Paul Romer the NYU economist has an extraordinary two part test to test whether something is a concession or a reform and suspect that you can subject Hambantota port project to exactly the same test. The first part of the test is can you basically give this immortality what I mean by this is that, the reform that you have undertaken there , does it need to be a time bound reform or can it basically be given immortality, can it be given to run forever.

For instance a 10 year tax holiday is by definition a simple concession it’s not a reform, it’s not genuine reform. The second test is geographical which the reform that you’re trying out, or the little change of rules that you’re trying out, does it need to be restricted to this particular area that you’re trying out in or can it be expanded to the rest of the country? And if it turns out that you need to restrict it to just that area then chances are it’s a concession and it’s not a reform. Whereas if it could be taken to the whole of Sri Lanka then it’s clearly a reform.

That is the test one would basically use and I actually think there is another candidate for this sort of special zone in Sri Lanka which I haven’t heard been debated at all which is the northern provinces. Because the Northern provinces badly and desperately need economic development so the government can be seen as making a huge concession towards the people in the north who have been suffering for quite some time and so on. Then use this change of rules in the Northern area and use the proximity to India as a catalyst to basically drive the change. In my opinion that is an extraordinary possibility that I don’t see much conversation about. Obviously I don’t know the internal political economy situation well enough to comment but, it would seem to me at least as a technical point it’s something that should be discussed.

Q: Related to this, economist Paul Romer introduced the idea of Charter cities, where he advocated a wholesale import of a rule set. He argued that if potential foreign investors could have rules that they can trust that would be the driving force of investment?

On charter cities one needs to be very careful on how one thinks about it. If you are a small country then it becomes easier to make the first argument that Paul was making which was the argument that an external sovereign will guarantee the rules of the country. Which is an easier sell if you are a small and very poor country. 

But for most countries I think it becomes much harder to invoke this idea of outsourcing sovereignty to a third entity. Therefore I think a much better solution would be to employ a domestic version of the charter which pretty much what I’m describing.

To create these zones inside of a country guaranteed by the sovereign of the country. It’s basically the difference from a Hong Kong and a Shenzhen. Basically Hong Kong had an external sovereign guaranteeing the rules of the game and Shenzhen had internal sovereign guaranteeing the rules of the game. I think the right approach is to have the Shenzhen model which is to have an internal sovereign guaranteeing the rules of the game.

Q: What is your sense of Sri Lanka’s place in the global development community. Sri Lanka has long being talked up as a place with enormous potential, yet FDIs doesn't seem to come through to the levels expected.  Are we expecting things  too much, too fast?

Not really, I mean you are right keep in mind the fact that when Lee Kuwan Yew took over Singapore, Sri Lanka was the model and he wanted Singapore to be like Sri Lanka. There is no question that Sri Lanka has lost an enormous amount of time while trying to figure it’s internal politics out.

Sri Lanka doesn’t register much in the international development community for two reasons. One is it’s too small and the other is it’s too rich. Its that very interesting combination because if Sri Lanka was actually very poor then a lot of people would take notice but, Sri Lanka is not very poor. Sri Lanka is well into middle income territory. I think it’s the combination of lacking size to be of interest to big investors

These are disadvantages that exist there is nothing you can do about it. But, I think the way to think about it is if Singapore being a backwater swamp that nobody wanted, could turn itself around to what it is today, I don’t see why Sri Lanka should be any different.

I think it’s fundamentally a question of the rules and I think it’s a lot easier to change the rules in Sri Lanka than say, in India. One must pay a lot of attention to changing the rules how to change the rules.

In the ‘How question’ I think these ideas around the western mega polis, special zones around the Hambantota area and even the idea I threw out which was the Northern & Eastern territories of Sri Lanka also should be considered because those are the ways in which you could change the rules because I suspect changing the rules in all of Sri Lanka is going to be a lot harder.                       

This article is part of a series of interviews with Public Policy experts hosted by Advocata Institute, a public policy think tank based in Colombo.  The longer version of these interviews are available in podcast form on www.advocata.org/radio

 

Brexit: Self determination or self destruction?

By Christopher Lingle

The article originally appeared on dailymirror.lk 4th July 2016

The Brexit issue induced many people to engage in hyperbolic promises to encourage a Leave vote or excessive doom-and-gloom warning to inspire a Remain vote. This habit survived beyond the reports of the final results. For their part, the “Remainders” responded with an orgy of teeth-gnashing and finger-pointing to disparage those that had the cheek to vote: UK Out of EU. But let’s begin at the beginning, with first principles; and; if you will, with self-determination being a natural right based on human liberty and dignity. In terms of separating from others, people are entitled to act as individuals (migration), couples (divorce) or as members of a group with shared identity (Brexit).

This is contestable. Even while some European Union (EU) officials admitted it must be more responsive to citizens, opponents of the Leave option insisted ordinary voters should not decide such an important issue! In sum, these views would have the EU become more democratic but individual countries would become less so. Next, let’s engage some of the interpretations of the motives of theBrexit vote.

One narrative is that those resisting continuing expansion of power in the hands of EU institutions are xenophobes or racists. Another narrative is of disaffected masses that are protesting some of the negative impacts of globalization. This is often joined with another assertion that this is or should be an expression of outrage against increasing income inequality.

All of these narratives have an element of truth or they would not gain traction. But assertions that citizens’ disaffection is about grievances arising from destabilizing forces of globalization or income inequality should be viewed with great caution.

Indeed, there is strong evidence that what has been occurring is the outcome of political decisions that have had economic consequences. As such, the underlying cause is a failure of political governance. Naturally, those that supported or implemented the EU policy are either ignorant of their (unintended?) consequences or seek to deflect the blame away from themselves. In short, forces that prefer more government interventions in economic and social life are raising false narratives to deflect blame from problems arising from their own actions.

In this reading, the troubling rise of populism around the world must be interpreted as widespread disaffection with “politics as usual”. Brexit is but a part of a global “peasants’ revolt”, relying upon ballots rather than pitchforks, against the policies and judgments of the political elite -- the Establishment.

This apparently unseemly rise of nationalism and populism is not a random or spontaneous development. It can be traced to the expansion of state control and power that has marginalized individuals while promoting economic interests of special interests, including trade unions.

Indeed, these developments reveal the internal, fatal contradictions of representative democracy that may be approaching its logical end. We have reached a global “Weimar moment” whereby the detachment of the political elite from their citizens is driving them into the arms of dark nationalist, protectionist forces.

Political elites

Political elites have used democracy as a cover to insert their ideologies or their special interests (monopoly privileges or political correctness issues). In turn, citizens have found that their life outcomes and daily lives have become increasingly dominated by arbitrary political forces. In the case of the EU, it is primarily a “social democratic” construct. As in the case of Brexit, earlier votes that went against the agenda of the political establishment to expand the EU prerogatives and actions were met with howls of elitist disdain. The assertion was that the unwashed masses got it wrong and must vote again.

This happened when the Danes rejected the Maastricht Treaty (1992). After being obliged to vote again they accepted it, but the voters later refused to join the euro-zone as did Swedish voters.

As for the Irish voters, they rejected the Nice Treaty (2001) and the Lisbon Treaty (2008), but were compelled to vote again until delivering the correct answer. When French and Dutch voters turned down the EU Constitution (2005), their responses were ignored, as in the case of rejection by Greek voters of the terms of the euro bailout (2015).

In all events, the eventual outcome is uncertain. In the UK, it could lead to greater openness and increased exchanges with the rest of the world without the suffocating bureaucratic interferences from Brussels. Or it could collapse into an internecine nativism. It might also be the death knell for the cohesion of the UK as the Scots may choose independence.

Interpreting what Brexit means for financial markets or the UK economy involves a great many possible permutations so that no one can pretend to speak authoritatively. One thing is sure and is confirmed by the events of the first week after the vote, it is the case that uncertainty will often lead to increased market volatility.

For their part, ‘Remainers’ painted such an apocalyptic future for Brexit that they are largely to blame for the market turmoil. Now they have already begun scrambling to walk back their predictions to calm troubled waters and anxious markets.

In the long term, Brexit can be positive for the UK. But it will require that British leaders allow free trade with the lifting of obstructive EU regulations. As it is, London is very likely to remain the premier destination for investment capital in Europe for a very long time.

As for the EU, it as though a soldier has been shot and the bullet has passed through with death being imminent, though the soldier be unaware. Since neither the British nor EU elites thought that the Leave vote would succeed, their lack of insights makes them unable to address the grievances raised against them. One wonders how they would respond to the question as to whether the central institutions of the modern EU — the Schengen area and the euro — make the continent more stable or less?  


Christopher Lingle is adjunct professor of economics at Universidad Francisco Marroquin (Guatemala) and Research Associate at the Centre for Civil Society (Delhi). He is also a senior visiting fellow at the Advocata Institute.

Ignore the outrage, Sri Lankans want to work in Beyonce’s garment factory

By Ravi Ratnasabapathy

The article originally appeared on Capx.co 3rd June 2016

Last week, the Sun newspaper in the UK claimed that a factory in Sri Lanka that produces a line of clothing for a popular singer Beyonce is using sweatshop ‘slaves’. The report attracted little interest in Sri Lanka, partly because attention was more focused on the devastating floods that hit the island. But perhaps the report also failed to make waves because it simply did not ring true; the mainstream apparel factories in Sri Lanka are seen as responsible and respected employers in the formal sector.

Since the original Sun article, several international media outlets such as Quartz andVice have published pieces amplifying the story. Whilst some commentators have aired dissenting views, a local perspective may be useful.

The Sun report claims that the basic monthly salary of 18,500 Sri Lankan Rupees received by a seamstress at the factory that produces Beyonce’s Ivy Park clothing line amounts to slave labour. It goes on to claim that the workers earn just £4.30 a day, and then informs its readers what the equivalent (Rs. 902) could be spent on:

A McDonald’s meal: Rs. 650 (£3.07)
A pint of beer: Rs. 200 (94p)
A litre of milk: Rs. 150 (71p)
A pair of Levi jeans: Rs. 3,900 (£18.41).

This might shock readers in the UK, but none of that is what low-income people in Sri Lanka buy. They buy powdered milk (much cheaper), they rarely eat western style fast food (McDonald’s, in particular is several times the cost of a low-end Sri Lankan meal), alcohol is deliberately kept expensive through high taxes, and they are highly unlikely to buy Levi jeans – a local equivalent would cost a third of the price (or less).

A more realistic comparison of living costs is given by Sri Lanka’s National Consumer Price Index (NCPI) based on data from the Household Income and Expenditure Survey (HIES). Based on the March 2016 NCPI, a household (of 3.9 members) would typically spend just Rs. 35,356.96 (£168) per month on all their living expenses.

Let’s look purely at food costs. The World Food Programme Cost of Diet, a method to model the cost of a theoretical, simulated food basket which satisfies all nutritional requirements of a household, estimates that the cost of a nutritious diet for the model Sri Lankan household of five (parents and three children) varies from Rs. 12,208 per month in the Northern Province to Rs.15,371 in the Western Province.

Sri Lanka is not a rich country and wages are low but so are living costs. The Official Poverty line at national level for April 2016 is Rs. 3,943 per person, according to the Department of Census and Statistics.

A nurse in a government hospital would start on a salary of Rs. 15,620, and once promoted would receive Rs. 21,660. Salaries for teachers in the government service is similar, ranging from Rs.13,410 to Rs. 15,540. Like the apparel industry, both professions predominantly attract young women, although nurses naturally require a much higher level of education. 

Set against the everyday realities of ordinary Sri Lankans, the basic wages of a sewing operator of Rs.18,500 seem more reasonable. Basic wages also do not include overtime and other benefits afforded to garment workers which could push their earnings well over Rs.20,000, at times going as far as Rs.30,000.

To be sure, these wages are still low and the job is demanding. The workers are undoubtedly poor and life will not be easy, but they are better off than some of their neighbours who eke out an existence in subsistence agriculture, work as maids, or are simply unemployed.

Until the country opened up to trade and investment in 1977, almost a quarter of the labour force lacked jobs. Things have improved since then. According to official figures, around 25% of the labour force is employed overseas as migrant workers, mostly in the Middle East, and many of them women. Women account for half the migrant worker population, the majority of whom work as house maids where conditions can be dangerous. There are cases where workers have been abused, unpaid or not paid as agreed and imprisoned in their countries of employment.

Claims have also been made that Sri Lanka has weak labour protections, when in fact Sri Lanka has comprehensive labour laws. In addition to regulations on hours worked, holidays, overtime and child labour, all employees are also entitled to statutory provident fund contributions by the employer amounting to 15% of their basic pay, which they can withdraw on retirement. Employees with a service in excess of five years are also entitled to statutory gratuity payments if they leave. In addition most of these factories, such as the one producing Beyonce’s Ivy Park range, provide transport, free meals and other welfare and incentive bonus programs.

These benefits do not extend to workers in the informal sector or those who are self-employed, which is where sewing operators are most likely to find work outside apparel factories.

The garment industry has rescued millions of people from poverty all over East Asia; it is labour intensive and provides many relatively low-skilled jobs that are easily learned and transferred, thus ideal for countries at an early stage of development. It forms a stepping-stone to more sophisticated industries and services.

The global development of the industry took place in three waves. The ILO reports that:

“During the first wave of production, the Republic of Korea, Singapore, the territory of Hong Kong and Taiwan achieved excellent results within their own borders, but then began to cut down production and invest heavily in other least-cost countries. As a result, between 1985 and 1990, the production of the Philippines, Indonesia, Thailand and Malaysia increased greatly and led the world market in exports.
These countries have in turn begun to invest or redistribute part of their production to a third wave of countries such as Bangladesh, Pakistan, Sri Lanka and more recently Laos, Nepal and Vietnam.”

Sri Lanka’s industry started off in the 1970s and has evolved significantly since. It is no longer is it seen as a ‘cheap’ destination but as a ‘quality’ supplier.

The call for better wages by activists based on rich country comparatives is misleading and dangerous. If followed through by the imposition of boycotts in favour of significantly higher minimum wages, it could endanger the very people they intend to help.

Concerned Westerners interested in doing some real good for workers in Sri Lanka and elsewhere should instead lobby their governments to cut tariffs on garment imports.

The greater the demand for clothing from Sri Lanka, the more factories there will be for Sri Lankans to work in. As the choice of jobs increases, salaries will rise and lifestyles will improve. The competition will push employers to increase productivity and the economy will grow. The children of these workers, better fed, clothed and educated than their parents were, will have better opportunities, perhaps even in white-collar jobs.

The Sun, quotes one of the workers interviewed as saying “We had to come and work here because our father could not afford to feed us and there are no jobs there”. The garment industry is the main source of income for many economically marginalised households in rural areas.

If the jobs in the factory became unviable, what would they return to?


Ravi Ratnasabapathy is a management accountant by training and a fellow at the Advocata Institute.

SOEs in Sri Lanka : Beyond "Profit & Losses"

The state has a long history of involvement in the economy in Sri Lanka; state ownership of utilities dates back to the colonial era. Post-independence experiments with socialism saw the expansion of the state into many new areas of business. Despite some reforms in the 1977-2005 era, state enterprises still account for a significant share of the economy.

The 2005-2015 period saw a halt to the privatisation process and a renewed wave of expansion in state businesses. Between 2009 and 2014 the number of SOEs grew from 107 to 245 while the number employed grew from 140,500 to a staggering 261,683.

Although the Department of Public Enterprises is supposed to improve governance in Public Enterprises (Commercial Corporations, Government Owned Companies and Statutory Boards), by its own admission only 55 SOEs come under its purview. The last available performance report (2014) indicates the 55 SOEs that were considered strategically important obtained budgetary support of Rs.126bn and treasury guarantees of Rs.47.6bn that year. Bank borrowings by these SOEs stood at Rs.471.2bn as at end 2014.

The size of the SOEs and the breadth of their activity make it an important determinant of the overall productivity of the economy. Consequently, the governance of SOEs will be critical to ensure their positive contribution to a country’s overall economic efficiency and competitiveness.

Ensuring that whether held nationally, regionally or locally – the state’s investments to actually deliver the societal outcomes desired is extremely difficult due to certain inherent problems.

1) Governments are run by politicians, not businessmen. Politicians can only make political decisions, not economic ones and these decisions will tend to be focused on short term publicity and benefits, ignoring long term consequences. An example is the launch of a company called Polipto Lanka to convert rubber and polythene waste to diesel. It was launched in 2009 amidst much fanfare but despite regular grants from the treasury it is yet to show any commercial results or even demonstrate that the process is economically feasible. Coincidentally, the launch took place a week before a general election. Polipto Lanka receives regular budget support from the Treasury; support for the last three years amounting to Rs.120m.

 

2) Governments use other people’s money; businesses must risk their own money. If a business does not earn a profit, the owner will need to keep infusing funds and this provides a powerful incentive to improve efficiency. The general public, whose money is effectively at risk in a state venture do not have the wherewithal or knowledge to hold managers or politicians to account. Politicians would prefer to postpone hard decisions than risk personal unpopularity, which is why state enterprises can keep running losses year after year.

The Janatha Estates Development Board (JEDB) and Sri Lanka State Plantation Corporation (SLSPC) have not reported a profit in the last five years, Mihin Lanka has barely made a profit since its inception, yet they continue to operate, the losses being paid by taxpayers because politicians will not risk bad publicity that may follow any attempts to reform them.

The Director General of Public Enterprises admitted as much in his report of 2009:

"We have found some boards take affairs of the enterprise very lightly regardless of their strategic importance even in a situation where PE [Public Enterprise] faces very difficult time. Since there is

no formal procedure to hold the chairman and the board of directors accountable, for their weak performance or unacceptable practices, some boards act with sheer indifference in discharging their responsibility."

 

3) State enterprises tend to be monopolies or restrict competition from the private sector. A business that faces no competition will find it easier to report profits. Where state businesses face competition the Government may grant SOEs preferential tax or other benefits that hinder the ability of the private sector to compete, causing deterioration in service or increasing costs to consumers. A few years ago VAT was imposed on large supermarkets but LakSathosa was exempted from this. The previously unprofitable LakSathosa started to make profits, while the efficient local supermarkets were penalised.

SOEs which operate as monopolies may not deliver an adequate level of service or charge excessive prices, which may lower the productivity/efficiency of the wider economy.

When Telecom was in state hands, obtaining a telephone connection, essential for business was a luxury that required a wait of several years. Thanks to liberalisation of phone connections, now they are available over the counter but businesses still struggle to obtain power connections and may have to invest in standby generators due to unreliability.

Energy costs (fuel and electricity) do not reflect the decline in global oil prices partly due to inefficiencies within the CPC/CEB (Ceylon Petroleum Corporation/ Ceylon Electricity Board), impacting on the competitiveness of business.

Inefficiencies in the state managed port terminals are a drag on trade but fortunately throughput at the privately managed SAGT (South Asia Gateway Terminal) Queen Elizabeth Quay is far greater and a boon to business.

The SAGT terminal has been ranked number one for terminal productivity in South Asia by the Journal of Commerce in the USA and ranked number four in the world. Because of the faster turnaround time ships prefer to dock at Queen Elizabeth Quay where it operates.

SOEs, especially those that lose money, are partly funded by banks. When a large chunk of bank lending is directed towards SOEs, the private sector will find it harder to obtain funds and higher interest rates could lead to a phenomenon referred to as "crowding out".

 

4) Governments cannot boost overall employment by hiring workers to the state sector. Giving people state-sector jobs may appear to create employment but this causes a problem because each new position brings with it a tax obligation that imposes a burden on the private sector, where wealth is generated and taxes paid. Effectively, since the salary of a public-sector employee reduces the amount of funds available to private employers, a job created in the public sector causes an offsetting loss in the private sector.

 

5) State-owned enterprises may enjoy hidden subsidies in a variety of forms including preferential borrowing costs, lower rents or taxes. Thus the actual costs will be higher than reported in the accounts and very difficult to quantify without detailed analysis. For example, imagine if ministries or SOEs had to pay market rents for the space in Government buildings that they utilise. Few would occupy the highly-valued areas they do now and would probably occupy less office space.

Indeed there is a massive opportunity cost of state- owned property in that they do not generate a net tax income for the state. If these properties were utilised by the private sector they would generate taxes as well as rents. Secondly, government office buildings in city centres create additional congestion. Given the current state of information technology, most government offices could and should be moved far from city centres. Hence, it is clear that the problems with SOEs are not limited to losses; their inefficiencies also can be a serious drag on the wider economy.

A more worrying issue is that the public is unaware of the full extent of the problem. The Treasury and other bodies that are supposed to monitor SOEs do so only partially and by all accounts ineffectively. Hence the question is - how much of public resources are being drained away in this financial black hole? The tax payers and citizens surely deserve better.

At a minimum, the Government needs to publish regular, comprehensive performance report giving the investments, outstanding debts and profits/losses of all SOEs. The question of reform needs to be urgently addressed and privatisation should remain an option.


A version of this article originally appeared in “The State of State Enterprises in Sri Lanka” Report as well as The Island.

What we could have done with the losses of state-owned enterprises

By Dhananath Fernando

The article originally appeared on the Daily Mirror on May 15, 2016

 

Would you believe the Sri Lankan government could have declared a Rs. 5000 bonus for each and every citizen in 2016 April New Year if Sri Lankan Airlines even if they had broken even for last 10 years.

The subject is State Owned Enterprises (SOE) and strangely most of them do not have proper financial data (Data is publicly available for 55 out of 255 SOE’s). I am adding my two cents worth to write about the mega losers of public money and some ‘why’ factors for the reader’s consumption.

The total losses of the 55 SOE’s from 2006-2015 amounts to a gigantic Rs. 636 billion. Interestingly 5 key institutes are responsible for 95 percent of the losses which adds up to Rs. 605 billion losses. Namely Ceylon Petroleum Corporation, Ceylon Electricity Board, Sri Lankan Air Lines, Mihin Lanka and Sri Lanka Transportation Board are the money eating machines of poor taxpayers. 

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Surprisingly significant discrepancies were identified even in the figures disclosed to public through the COPE report, the Treasury Annual Report and Fiscal Management Report for the same institute.

Obviously all 3 the figures cannot be true and we can come to a reasonable conclusion that either two figures or all 3 figures are false. The simple reason we cannot ignore the discrepancy is because it exceeds Rs. 5 billion of tax payer’s money. If I take examples of other institutes this column will run out of space

Naturally, with such drastic discrepancies the following appalling questions cross our minds: nAre accepted accounting standards followed when profit calculations are made?  nIs the data fabricated to misguide the 20 million population?

Has COPE done their job well and does the money spent on the COPE committee justify taxpayer’s money.

If these government workers cannot manage these institutes and cannot even calculate profit and loss accurately, are they worth the money they are paid from tax payers’money.  The ‘Profits and losses’ analysis shows that in 2011 and 2012 there is a sharp increase in losses and the reasons for the increase in losses should be investigated to avoid reoccurrence of such situations in the future. 

Although it is a fact that the global economic conditions took a beating in 2012, but Sri Lanka had just emerged from a war situation in 2009, and this was a huge advantage to the Sri Lankan economy. SLTB and Mihin Air has failed to make any profit for last 10 long years and if a company cannot be turned around in 10 years, the ability of the management should be questioned. How many years must one wait to see a progress being made? 

Sometimes we the ordinary citizens of Sri Lanka cannot comprehend the value of Rs. 605 billion. Most of us, including the ministers and parliamentarians confuse millions and billions. In order to illustrate the potential of Rs. 605 billion, a list of things which could be done, if the 5 key institutes were well managed and were able to break even is given below:

1. Ten more highways

The cost of southern high way was 60 Billion rupees and we could have easily built 10 southern highways connecting all corners of the island with this money because the cost of the southern highway was way above the average cost. The Ministry of Highways attributes the high cost to the high prices paid for land acquisitions and land diversity. Even if this is true, 10 highways with similar capacity could have been constructed for the same price.  

2. Eleven harbours

The Hambantota port cost US$ 361 million and we could have built 11 ports and even saved another 600 million for the grand opening ceremony  

3. Cover 81% of the current budget deficit

The current budget deficit is estimated to be LKR 740 billion rupees and if the 5 institutes mentioned herein could have performed at breakeven level, we could easily cover 81% of the current budget deficit  

4. Twenty more airports

The current government is planning to make Sri Lanka an aviation hub and if they think they need airports like Mattala, even if it is only to store paddy during the harvest season, 20 similar airports could be built. The San Francisco Air Port in the USA, which incidentally is one of the top airports in the world, with the size of the runway being 3600 meters long and 45 meters wide is smaller than the Mattala airport runway which has a 3500 long and 60 meters wide runway. So I am talking about an investment of 20 airports having a capacity equal to the San Francisco Airport, not small domestic airports carrying light aircrafts  

5. Nine power plants as Norochchole

Making a Sri Lanka a hub of energy is another popular topic in town. The first phase of Norchchole cost US$ 455 million and losses made by the 5 key SOE’s in 10 years is 9 times  this cost.  

6. 10% of the Megapolis project 2030

The initial mega project in 2016 targeting to make Sri Lanka a middle income country by 2030, requires an investment of US$ 44 billion. The Government could easily cover 10 percent of the total investment with the losses made by these key 5 institutes.  

7. Relief of 22% of total tax revenue in 2016 on tax payers

The total estimated tax revenue of the government for 2016 is Rs. 1,584 billion. Even if Sri Lankan Airlines and Ceylon Petroleum Corporation could operate at breakeven level it could still cover 22 percent of the total estimated tax revenue from 2016 budget. I reiterate the values are just face values and the net present value (NPV) will show a worse situation  

8. Rs. 30,000 bonus by the first citizen with his annual greeting SMS

Leaving alone all of the above, the President instead of sending a SMS message to all Sri Lankan citizens who own a phone, wishing them a happy Sinhala and Tamil New Year, could give a cash gift of Rs.30,000 to every citizen of this country, including newly born infants, if these 5 key loss making institutes performed better by breaking even. (Rs. 120,000 for a 4 member house family) With the losses incurred by Sri Lankan Airlines alone, the President could gift Rs. 5000 to each citizen. 

What would be the solution?

It is a globally accepted theory that when you run a business, focussing on your strengths is a must and establishing monitoring and evaluation procedures is essential. If you do not possess the required skills or expertise within your organizations, you have to either hire the right people or outsource the job.I t is sad that the words like “Privatization” are injected as terrorist words into the blood of the nation but the reality is just leaving these 5 institutes in the hands of honest politicians had lost the country 605 billion which no one can justify. Those who promote concepts like state ownerships and big government has absolutely no idea on financial management.

If they had any sense on fiscal management a decade is a too long period even for a below average management.  The fear of privatization is same as fear of failure and the success is always lies beyond our comfortable zone. It is Albert Einstein, the brain of the 21stcentury, who said “Insanity is doing the same thing over and over again and expecting different results”. 


Dhananath Fernando is the Chief Operating Officer of AdvocataInstitute; an independent Sri Lankan think tank works for economic freedom. He could be reached via dhananath@advovata.org

Reforming State Owned Enterprises - Q&A with Razeen Sally

Razeen Sally is Associate Professor at the Lee Kuan Yew School of Public Policy at the Notional University of Singapore. He is Chairman of the Institute of Policy Studies, the main economic-policy think tank in his native Sri Lanka. Previously he taught at the London School of Economics, where he received his PhD. He has been Director of the European Centre for International Political Economy, a global-economy think tank in Brussels. He has held visiting research and teaching positions at Institut D’Etudes Politiques (Sciences Po) in Paris,

Australian National University, University of Hong Kong, Institute of Southeast Asian Studies in Singapore and Dartmouth College in the USA. He was also Chair of the World Economic Forum’s Global Agenda Council on Competitiveness. He is an Adjunct Scholar at the Coto Institute and is on the advisory boards of the Institute of Economic Affairs (UK) and Centre for Independent Studies (Australia).

He is a member of the Mont Pelerin Society. Sally’s research and teaching focuses on global trade policy and Asia in the world economy. He has written on the WTD, FTAs and on different aspects of trade policy in Asia. He has also written on the history of economic ideas, especially the theory of commercial policy. His new book on Sri Lanka will be published in 2017

 

Razeen Sally, a Professor at the National University of Singapore, shared his experience about the experience of state-owned enterprises (SOEs) in South Asia and East Asia with Advocata, a Colombobased think tank promoting free market. While privatization is the best option to reduce the burden of state enterprises on society and improve t h e i r p e r f o r m a n c e , s u b j e c t i n g them t o competition, shielding them from politicization can also give benefits, he says in this interview.

There seems to have been an epidemic of state enterprises after World War II, especially in newly independent countries like Sri Lanka. When did state enterprises start to emerge in the world and in Sri Lanka? What is the historical background to SOEs?

In Sri Lanka as in India, many state enterprises date back to mid-1950s when the government policies took a turn towards to more intervention, more protection and using the state to promote investments in heavy industry and other areas. In this respect, the S.W.R.D. Bandaranaike government was following what the Nehru government was doing in India. So, the SOEs were intended to be the spearhead of economic development. And of course in Sri Lanka, this was really ratcheted up under Mrs. Bandaranaike’s government in 1970, when the state intended to take control of the commanding heights of the economy.

What were the intentions of the architects of SOEs? Have these objectives been met?

The answer is clearly no. The idea was to use the SOEs as part of an alternative model of economic development.

The model people had in mind was Soviet Union and its five-year plan. And here there is a contrast with what was done in the East Asian countries and what was done in South Asia. South Asia went for heavy state-led investment, nationalisation, for various government internal controls and external protection - import substitution. And this model clearly failed, which led to later market reforms, from 1977 in Sri Lanka and from 1991 in India.

The East Asian countries - some of them actually had SOEs - like Taiwan. But on the whole they didn’t nationalise rampantly and they relied much more on the private sector to be the engine of economic development. It was part of a different model which was more open to international trade, which had fewer domestic controls, which had macroeconomic stability and so on.

I would argue that the old model, which had nationalisation and SOEs controlling significant parts of the economy, definitely failed. And you see the costs of failure of SOEs in Sri Lanka. There are 250 or more SOEs, some that are hugely loss-making, that are a drain on an already depleted exchequer, that are heavily politicised, that crowd out private investment and that constrain consumer choice. So, it is a bad deal all around.

Why do so many state enterprises get into trouble and end up becoming burdens on the tax payer? Is there an inherent problem in the incentives or structure behind the SOEs that leads them on this path?

the world, state enterprises fail because there are disincentives to competition.

They are shielded from competition. They have a close link to the state. They are highly politicized. Appointments are not made on merit. The market is rigged in their favour, on prices and on production. Often they are protective from international competition as well as domestic competition. For all those reasons they fail.

And they are a drag on the economy, on the exchequer and on consumers - they limit competition. There are of course, exceptions.

One can point to a minority of SOEs in a few countries in the world that have not prevented fast and successful economic development. One thinks in particular of the government-linked companies (GLCs) in Singapore. Singapore, which is a fantastic and successful economy, still has large companies that are majority state-owned, that are grouped under Temasek - the state holding company - and are commercially viable. Some of them have done very well competing internationally. Singapore Airlines is perhaps the best example.

That they have been subjected to competition is the basic answer - and in a small economy like Singapore, which is highly open to the world. It is the most open economy of any size in the world with trade at close to 400 percent of gross domestic product (GDP).

The GLCs that play in the international market place are subject to fierce international competition in the market place. That’s true of Singapore Airlines, that’s true of the port services authority and that’s true of state-owned banks and so on. Over the decades the government has put in place the mechanisms to separate ownership - that is to say by the state - from the management, of commercial enterprises. In other words, they’ve been depoliticised to a large extent. It would be wrong to say that all SOEs in all countries have failed.

That’s not true. For the most part it is true. But a handful of exceptions are there. Singapore is the one that really stands out for exceptional pieces. But it’s very difficult to try and replicate in a country like Sri Lanka, what Singapore has done - in a country where politics is much more extrusive, where it is much more difficult to depoliticise the running of SOEs and also much more difficult to subject them to competition from domestic players and also from international players. Malaysia has a holding company called Khazanah, which is similar in some ways to Temasek in Singapore.

This holding company houses a number of leading SOEs in Malaysia, which accounts for about one third of Malaysian output. At least one of them is a big player in Sri Lanka. The Malaysian GLCs don’t perform nearly as well as Singapore GLCs - for two reasons. Firstly, they are less subject to competition and secondly, they are much more politicized. However, some of them are actually not too bad or are reasonably good because they have been shielded more than the others from politics.

What can be done?

The first best solution to the running of SOEs in Sri Lanka is to have a timetable to privatise. So yes, would use the ‘P’ word without feeling embarrassed about it. The obvious economically efficient solution is to privatize as many of the SOEs as possible over a realistic period of time. We know that politically this is not on the cards at the moment.

So the ‘P’ word is not used. As a matter of expediency that’s understandable. But I think as a medium to long-term objective, privatisation should be the way to go. However, now we have to get the second-best scenarios and second-best solutions. If large-scale privatisation is not feasible, what can be done in the short term, over the next one or two parliamentary terms, to improve the current dismal situation of the SOEs that won’t be as good as and as efficient as full privatisation, but might deliver a better result than what we have at the moment?’ In other words, improve the running of the enterprises; make them more commercially viable, more productive. In this scenario, we have to look at the other countries that have better practices. So Singapore comes to mind and so does Malaysia.

So we should look at the Temasek and Khazanah models of having a state holding company for SOEs. The lesson I would draw from the best example, which is Temasek, is that first you subject them to all-round competition, including international competition. And second, you put in place mechanism to depoliticise them as much as possible. In other words, separate ownership from management.

That’s the starting point. Then we can ask ourselves, ‘What should be the criteria for making these principles real?’ I was at a conference in Goa to discuss Indian reforms and I was part of a group that looked at this Temasek - Khazanah type of a model. And the local participants were interested in what lessons could there be for India, which is also not in the game of big privatisations.

As a first step, there is no point setting up a state-owned holding company and calling it something that’s done on the Temasek or Khazanah model if you’re not going to change the current operating procedures. So, the point is to have serious reforms, even if you can’t do privatisation. So what can you do? Firstly, identify the enterprises that essentially operate in a commercial sphere, where there is some competition already or where there could be more competition. If you have a state-run monopoly or oligopoly, then don’t put it in such a holding company.

Keep it separate. Because that’s probably going to be more politicized anyway there may be other public policy objectives that will get involved in the running of that enterprise. So keep that to one side. Rather, put in this basket enterprises that are commercial. So, that would include SriLankan Airlines, Mihin Air and the Sri Lanka Transport Board (SLTB) but not the Ceylon Electricity Board. So, in other words, don’t put all SOEs in this holding company, only put some of them that operate in a commercial sphere.

These should be corporatised with initially majority state’s ownership. Then you should start introducing the minority equity participation. And Temasek is interesting because, in the key enterprises, the government still retains the majority equity, therefore control. But they have actually gradually beefed up the minority equity in most of the Temasek enterprises.

That’s also a boost for the stock exchange or financial markets. And in some cases with nonpriority enterprises, they have actually taken the private sector stakes to a majority of equity and the government has retained only a minority of equity - and in some cases actually exited altogether. But in the meantime, the government could be with the minority equity - up to 19 percent. Maybe when the time is right politically, move into the majority private ownership. But the holding company should include airlines, buses, telcos and whatever is commercially viable and subject to competition.

We talk of loss-making state enterprises hurting the people. Are there other fallouts of badly managed SOEs? What’s a reasonable way of counting the total costs of SOEs on the economy?

Losses are the tip of the iceberg. And of course there are other SOEs in other countries that are hugely profitable. But that’s not an indication of overall economic efficiency. They are profitable because they have monopoly rents. They are not subject to normal competition.

So, I think the cost of SOEs that operate in rigged markets is the costs that fall on the consumer because of lack of competition. These might be difficult to quantify. We are talking of usually higher than normal prices, restricted product variety, often restricted supply of the product or service in question. I think probably the biggest losses to the economy are the losses that come from lack of competition.

When the Public Utilities Commission was set up here by Prof. Rohan Samarajiva, the law provided that you cannot replace the entire board in one go. Two or few members can be appointed for one year. What is your opinion on a procedure of that nature?

You could try to introduce independent directors. Having independent anybody in Sri Lanka is very difficult at the moment. Some of the Temasek companies have had foreign CEOs. Mind you SriLankan had a foreign CEO when it tied up with Emirates. What happened to him? You could try to maybe have a regulation that there should be a minimum number of independently appointed directors to the boards of these companies and to the boards of the holding company as well. So, the government appointees would be restricted to a certain number and there would be some mechanism to appoint some of the rest.

But of course they would have to be qualified. There is no point appointing a lawyer who leads someone’s political campaign without prior commercial experience to be an independent director of a commercial enterprise. That’s one thing to play around with that.

We have seen companies like Temasek advertise globally. So do you suggest that some people could also be hired globally?

Yes. Target the diaspora as well. See whether you could attract some of the qualified people from the diaspora to be directors of these companies, CEOs or the senior management.


A version of this article originally appeared in “The State of State Enterprises in Sri Lanka” Report as well as Daily Mirror

The re-nationalisation of SriLankan Airlines and the follies of State enterprise

A couple of weeks ago, Prime Minister Ranil Wickremesinghe announced that the debts of SriLankan Airlines, amounting to a mammoth US$ 3.2 billion, will have to borne by the taxpayer. He said the government is taking this action to defuse an economic ‘landmine’ and that his government is actively looking for an international partner to manage the airline.

When a three billion dollar bill is passed on to ordinary Sri Lankans, many of whom have never flown the airline, it’s worth examining what let do this disastrous situation. In examining the data, it’s clear that Srilankan Airlines provides an excellent example of the problems that arise from state-owned enterprises.

Air Lanka, the state-owned airline was privatised in April 1998. The government of Sri Lanka sold a 40% shareholding to Emirates Airlines, which was also contracted to manage the company for a period of 10 years. The government of Sri Lanka continued to retain the majority shareholding but management was relinquished to Emirates.

Emirates re-branded the airline as ‘SriLankan’, overhauled the airline’s infrastructure and adopted a new approach to its operations. Cost-effective strategies were introduced; new pro-active management teams were put in place; Information technology became the basis of everyday activities. The airline’s network was constantly reappraised and product enhancement became a part of the airline’s philosophy. The airline was completely re-fleeted with an all-Airbus fleet of A340, A330 and A320 aircraft replacing the ageing Lockheed Tristars.

Although the privatisation and restructuring attracted a lot of criticism at the time, the exercise was eventually deemed a success; indeed in many quarters it was hailed as model for other airlines.

At an international seminar on airline restructuring and privatisation, held a couple of years after the divestment; the President of the employees union of Srilankan spoke on how union rights were protected and the improvement of working conditions.

At the time of the privatisation all employees were gifted shares by the government based on the number of years of service. Although a voluntary retirement scheme was also implemented the President of the union stated that employees were given an excellent deal if they wanted to leave and no-one was made redundant. Collective Agreements signed by the airline with employee unions guaranteed increments to employees. New human resource development programmes were instituted after privatisation to upgrade employees’ skills and a new grade and pay structure put in place.

Union representatives from other state-owned airlines were also impressed by the manner in which the airline disclosed information to employees; “they had never seen such transparency from an airline’s management,” said K J L Perera president of the employees union. SriLankan published its quarterly financial results in its staff newsletter.

Following a spat in December 2007 the Chief Executive Peter Hill, had his work permit revoked.The dispute began when Hill refused to bump 35 passengers from a full London-Colombo flight to make way for Sri Lanka’s president and his entourage. The Government cancelled the work permit of the CEO of the airline and in March 2008, Emirates did not renew the management contract. The airline, which had been consistently profitable under the management of Emirates last reported a profit in 2008; a bumper Rs.4.4bn. Since then the airline has racked up enormous losses; according to the latest published accounts for the year ended March 2015 losses stood 123.26bn rupees.

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The airline reported an operating loss of Rs.16bn in the year 2015, an improvement from the loss of Rs.31.3bn in 2014. To put these figures into context, the Government bought out Emirates for only US$53m (or Rs.7bn at today’s exchange rate). Last year alone the airline lostfour times its original purchase price, a truly remarkable feat.  The airline’s accumulated losses amount to almost a billion dollars; the entire Southern highway was built for around 700 million dollars, cost overruns included.

The management of the airline has claimed that the recession in Europe and high oil prices caused the losses. The public was urged to look beyond the “mere profitability aspect” and understand the “catalyst role played” by the airline in tourism; in the words of the former CEO.

Airlines are global businesses and the same factors affect all airlines. Singapore Airlines cited by many who try to justify state ownership of airlines reported a marginal operating loss in only a single year during the last ten years; a loss of US$38m in 2009/10.

Singapore airlines is no less affected by the recession and oil prices, but it did not report losses. Singapore Airlines is a well-run state airline that is something of an exception. Many cite it’s example but few have been able to emulate its success, so we should not try to justify our Government’s ownership by looking to Singapore. Srilankan Airlines own track record is what we need to examine.

What changed when the Government took it over? They inherited a profitable business with the same staff, systems and infrastructure; the principal difference was in the management. The truth is that the airline suffered from gross mismanagement and corruption, some of which has recently been uncovered.

These problems seem to plague state owned enterprises (SOE’s), but why do they occur?

There are two elements to explanation: the principal-agent problem and the free-rider problem, both based on the assumption of self-seeking individuals.

An SOE is run by managers who do not own the firm. In a firm under state control managers know that their salaries will be paid regardless of how the business performs, therefore there is no incentive to maximise efficiency.

Frequently in Sri Lanka the Government will be under pressure to appoint various loyalists to key positions. In some, (although not all) instances, those who seek political patronage to be ‘fixed up in a job’ are people who lack the skills or abilities to find a job on their own merits. Thus the enterprise may become stuffed with incompetents; good staff will find it very difficult to work with these people so they either leave or give up trying to do any work and concentrate on keeping in the good books of the bosses.

The maxim of “more work, more trouble, less work, less trouble and no work, no trouble” is applied. In any case pay and benefits are not dependent on performance, so why bother to stick ones neck out? Soon, this attitude poisons the enterprise and staff work on surviving in their jobs rather than trying to manage the business.

This problem would not exist if the citizens, who are the owners (principals) of SOEs, can perfectly monitor the SOE managers (their agents) but individual citizens do not have the incentive, and means, to monitor the SOE managers.

This leads to the second element of the problem, even if they did try to hold the SOE to account, the costs that an individual citizen incurs in monitoring SOE managers (obtaining and analysing financial information, seeking explanations through public channels etc.) are solely his or hers, while the benefits of improved management accrue to all owners. Time and effort will be expended in the exercise by the citizen who receives no immediate benefit. Thus, individually, the citizens have little incentive to monitor the SOE managers, which means that in the end, no one monitors them. This is the so-called free-rider problem.

This is the fundamental structural flaw with SOE’s which explains why many operating in truly competitive markets are doomed to failure. There are apparently profitable SOE’s but In some instances they operate as a monopoly, like the Sri Lanka Port Aunthority.  In other instances such as LakSathosa, Governments  may  create an  uneven-playing  field  in  markets  where  an  SOE  competes  with private  firms,  as  they  have  a  vested  interest  in  ensuring  that  state-owned  firms  succeed. LakSathosa is exempt from the VAT and NBT charged on other supermarkets giving them a significant competitive advantage.

Accordingly, despite its role as regulator the government may, in fact, restrict competition through granting SOEs various benefits not offered to private firms. In such instances SOE’s may appear to be profitable but this is due to hidden subsidies and distortions which are ultimately borne by taxpayers.  

Airlines used to be regarded as a key part of transport infrastructure, like roads or bridges, which should be owned by the Government. Until the mid-1980s, most governments did own airlines and protected flag-carriers by restricting new entrants. This thinking has changed.

Privatisation made air travel more competitive and liberalisation brought competition from low-cost carriers. Most airlines in state control have failed to adapt and are losing money. There is little strategic interest in owning an airline; Switzerland and Belgium have done without a flag carrier for years.

The airline is currently a huge drain on the treasury and the previous experience with Emirates demonstrates the clear benefit of privatisation.


A version of this article originally appeared in “The State of State Enterprises in Sri Lanka” Report as well as Ground Views

Limitations in Prof. Hausmann’s policy recommendations

By Premachandra Athukorala

The article originally appeared on the Sunday times 24 January 2016.

The policy recommendations made by Professor Ricardo Hausmann in his presentation at the recent Colombo Economic Summit are based on the ‘product space’ analysis developed and popularised by him and his co-researchers at the Centre for International Development at Harvard University. This approach has a fundamental limitation as policy guidance in this era of economic globalisation, even though their ‘ pictures’ (product space diagrams) look very impressive and have a great appeal to policy makers who take them at face value.

Product space analysis is based on the conventional approach to analysing trade patterns, which treats international trade as an exchange of goods produced entirely from beginning to end within national boundaries. This approach is based on the assumption that factors of production are locked in within national boundaries (that is, it assumes away foreign direct investment, and cross border movement of labour and all inputs used in manufacturing). It completely overlooks the ongoing process of global production sharing (GPS), the breakup of the production processes into separate stages, with each country specialising in a particular stage of the production sequence, which opens up opportunities for countries to specialise in different tasks within vertically integrated global industries.

Parts and components, and final assembly traded within global production networks (‘network trade’) have been growing at a much faster rate compared to trade in goods wholly produced within countries (‘horizontal trade’, the focus of product space analysis). Global production has been the prime driver of export-oriented growth East Asian countries. According to my calculation network trade accounts for over 60 per cent of total manufacturing exports from China, Korea, Taiwan, Malaysia, Singapore, and Thailand. A number of countries in the region (Vietnam and Cambodia are the latest example) have successfully moved from primary product specialisation to exporting manufactured goods (parts and components and final assembly) by joining production networks. This certainly is not ‘Monkeys jumping from low trees to taller trees’ as depicted in product space diagrams.

Policy inferences based on the product space analysis is not consistent with the objective of reaping gains from joining global production networks. As Professor Gerald Helleiner has aptly stated in a best-known article, “The introduction of the possibility of component manufacture and middle-stage processing within international industries knocks the bottom out of any stage theory of the development through industrialisation and trade which focuses upon final products” (Helleiner, Gerald K. (1973), ‘Manufactured Exports from Less-Developed Countries and Multinational Firms’, Economic Journal, 83 (329), p 43) It seems that Prof. Hausmann’s policy advocacy of export promotion has basically been shaped by the Latin American experience.

Latin American countries’ lack-luster record of manufacturing export expansion can be explained to a greater extent by these countries’ failure to reap gains from the ongoing process of global production sharing. I was surprised to note that in the website posting on the Sri Lankan visit, Prof. Hausmann has used Venezuela as a comparator for justifying his policy advocacy for Sri Lanka! Sri Lanka needs to learn lessons from its own past and from the successful countries in our Asian neighbourhood, not from a failed state in Latin America. In the aftermaths of the 1977 liberalisation reforms, a number of electronics multinationals came to Sri Lanka to set up assembly plants. We sadly missed the opportunity to become an export hub based on global production sharing because these MNCs soon left the country in the early 1980s as political instability set in.

Among these lost investment projects was a large assembly plant (with a planned employment of 3000 workers), which made headlines in a Harvard Business Review article. Chet Singh, the founding chairman of the Penang Development Corporation, recently told me that Motorola’s decision to come to Sri Lanka was a big concern to him and the Penang state government at the time because Sri Lanka was a much better location for electronics assembly compared to Penang. Luckily for him (and for Penang) Motorola eventually gave up the Sri Lanka option and set up a plant in Penang. The Motorola plant in Penang currently employ 8500 workers and also acts as the regional R&D centre of that giant multinational enterprise. We need to strive to regain such lost opportunities.


Premachandra Athukorala is an advisor to the Advocata Institute.  He is a Professor of Economics, at the Crawford School of Public Policy, Australia National University.

The 2016 Budget in Sri Lanka -- The Good. The Bad. And the Ugly.

Sri Lanka's budget for 2016 included several liberal  measures but also many seemingly senseless interventions that may boomerang.

The budget contained the various give-aways to many constituencies: farmers, fishermen, housewives, and relatively higher salary earners who are in the pay-as-you-earn (PAYE) tax bracket.

The budget deficit is large and revenue proposals ambitious.

The budget takes some steps in the right direction, but overall, we consider it a mixed bag. There were no shocks as in the interim budget earlier in the year, but the extent and timeframe over which reforms will be implemented is crucial.

We have highlighted some of the key proposals below, classifying them as either Good: liberal measures that will help people, Bad: poorly-conceived proposals that may be administratively difficult and Ugly: those that will impair the quality of life and society of Sri Lankans.

There were some proposals, such as the one to strengthen law and order by building police stations, that appeared to be more in line with a police state.

We have emphasized changes in policy rather changes in tax rates.

The Good: Liberalisation Measures

The government deserves credit for restarting Sri Lanka’s halted reform program in the areas of finance and trade. The budget contains many solid proposals in this area, including the liberalization of certain trades that were previously closed, including removal of certain products from the ‘negative list’ where prior permission is needed for imports.  The proposed repeal of the Exchange Control Act is also a major step in the right direction. This signals an end of an archaic law, to be replaced by a more market-friendly exchange management process.

Land lease and ownership regulations for foreigners are also to be to be eased. The tax imposed on land leases and the prohibition on freehold ownership were viewed as obstacles to investment. These measures should positively impact investor sentiment and encourage investment. This proposal also has the potential to inject fresh capital into Sri Lanka’s now fledgling real estate sector that has taken a brow beating following the curtailing of foreign state backed development projects.

Proposals to liberalise the labour market by allowing more part-time work, relaxation of rules on contract employees (although not spelled out in detail) is welcome. Sri Lanka’s labour laws are seen to be very rigid and a barrier to investment and overall business efficiency.

Also encouraging is the outward looking rhetoric of the government, including the proposed Financial Centre, modeled along the lines of Dubai’s International Finance Centre (DIFC). The DIFC operates as a tax-free zone which essentially imports laws and judges more familiar to international investors, and a similar model could help enhance Sri Lanka’s attractiveness in this regard.

The announced open sky policy is also a welcome move that could open up Sri Lanka as an aviation hub and help tourism.

We are also encouraged by the right rhetoric in terms of promoting Start-ups and small and medium enterprises including motivations to expand access to capital.

The decision to reduce import tariffs on consumer items such as electronics, shoes and clothing is also a welcome move so that people are able to enjoy more from their earnings than sending it to the government as well as playing a role in tourist spending.

Reforming Agriculture

Agriculture sector has suffered from years of populist pandering, price controls and a host of other misguided policies that has benefited neither the farmer nor the consumer. The moves to reform this sector is encouraging.  Cash grant to small farmers in place of the fertiliser subsidy is a step in the right direction.  While we view subsidies with caution,  it is better to give the farmer an outright grant with the discretion to apply it where they deem necessary rather than blanket subsidy which may promote overuse or waste.

The over usage of fertilizer which was encouraged by the subsidies has resulted in unanticipated negative externalities such as the recent contamination of lakes, rivers and groundwater supplies. This is suspected to be the cause of kidney ailments of residents in in the Rajarata region.
 

Underutilised state land is to be leased to fruit and vegetable farmers. There are large tracts of marginal land under the State Plantations Corporation and the Janatha Estates Development Board. Allowing farmers access to this for other crops is far better than to allow the land to to lie fallow.

The budget also proposes that RPCs (Plantation companies) to be allowed more flexibility in land use. This will allow them to make better use of land uneconomical for tea or rubber greatly enhancing their economic freedom.

PPPs and State Reform

Reform of State-owned Enterprises is proposed. We welcome the fact that the problem is recognised and some attempt is being made to address it. Exiting from non-strategic holdings via the stock exchange is better than what the government policy has been for the last decade.  While we advocate re-looking at privatisation of state industries that burden the government finances and in turn the taxpayer, we welcome the moves to address this problem.

Other noteworthy proposals such as restructuring the BOI, EDB and the Tourism Board to streamline operations and grant investment approvals within 50 days is welcome.

We are encouraged by the government’s apparent willingness to let the private sector into areas traditionally monopolised by an inefficient government sector.  

Creating Special Purpose Vehicles (SPV) for state owned projects (the highways, coal plant, etc.) to attract private investment to repay debt requires further study but may be a step in the right direction.  Public Private Partnerships (PPPs) on Domestic airports,  monorail, investment zones, transport sector and developments in the proposed megapolis are all positive if carried out transparently.

The Bad

The budget text does have the customary give-aways and hand-outs as well as several measures that interfere unnecessarily in the market.

Price controls and subsidies on food items.

The Government has proposed price controls on six essential items including Mysoor Shal (Rs. 190/kg) , potatoes (Rs. 145/kg) , onions (Rs. 155/kg) , chicken (Rs. 480/kg) , packeted wheat flour (Rs. 95/kg) and dried chillies (Rs. 355/kg).

Price controls are administratively clumsy to implement and result in either goods disappearing from the shelves, lower quality goods, or the creation of black markets. This was a regular occurrence during the 1970s socialist era.   

A License-Quota regime.

Licenses are notorious for creating avenues for graft. Fifty licenses for duty free import of gold unnecessarily regulates the market place. The government should focus on dismantling current licensing regimes instead of putting up new ones.

Unintended consequences

Proposals to tax cash withdrawals will have an adverse impact on informal sectors of the economy. The  high rate (2% for withdrawals of Rs1-10m and 3% on withdrawals above Rs.10m) is designed to bring the informal sector into the normal banking system. While the objective is laudable it may hinder trade, especially among SMEs.   

The proposal to spend Rs.21bn or Rs.1.5mn for each cluster village is not clearly spelled out. This could be a license for wasting tax-payer money.

Fixing non-existent problems

The government proposes introducing regulations into certain previously unregulated markets. This includes Three-wheelers, School Vans and Taxis. One of the redeeming aspects of Sri Lankan public transport is that the free-market in private transport provision including Taxis and three-wheelers that provides a better service than most countries in the region. While the type of regulation is not spelt out in the budget speech, the government intervention could very well worsen matters.

Similar micro interventions in a mandate to register all hotels, and government subsidies for accountancy students seem like solutions in search of problems. A mandate to to have four people in a vehicle entering Colombo is also bound to be unpopular and difficult to administer.

Left unsaid

Whilst the finance minister spoke for a taxing four hours on the budget proposals, there was still much unsaid.  The budget was not explicit on what the government would do to tackle the over-staffed public sector. Nor were there proposals to put gasoline on a market-based pricing formula as was promised during the elections.

The Ugly

National Digital Identity Card.  

Whilst there is a tendency in Sri Lanka to cheer on anything to do with technology, we advocate caution on this proposal.  Little is known about the program except that it was initiated by the previous government.   For a country that’s emerging from an all powerful state,  a national security mindset, with the full extent of surveillance on citizens still unknown, people should demand more transparency and information before blanket implementation of this program. The country requires a robust debate on privacy and surveillance.

Micro interventions in the Banking & Financial Sector

Banks are asked to cease leasing operations from June 2016.

The rationale for this micro level interference in the banking sector is weak. It will be hugely disruptive to the operation of most banks with little benefit to anyone other than the non-bank financial sector.  

Similarly the directive to lend to agriculture, SME's and Women & Youth (whatever that may be) is poorly thought out. Fixing the fees on bank drafts at Rs.150 is another intervention proposed.  

We see no reason why government should be involved in these matters that should be left to the market place

 
Confusing “Canned Fish” Proposal


A buy back scheme for locally produced canned fish to be sold at a subsidised price may open the door to massive losses at Lak Sathosa. If prices are high enough supply of canned fish to Sathosa will increase significantly and the losses may exceed the amounts budgeted.

At the same time taxes on imported canned fish will be increased, which will only increase the pressure to consume the subsidised products driving up the final bill to the taxpayer.

In another part of the budget speech the Minister blames a policy at Lak Sathosa where rice was imported at Rs.75 per kg and sold at Rs.50 per kg for the Rs.8bn accumulated losses in that institution. The Minister is proposing the same policy, but for canned fish instead of rice. 

The government seems to be concerned about reducing prices for the consumer as well as protecting local industry, these two objectives seems at odds with each other.

New Government entities and unfunded programs

On education, while the government has made election promises to expand state funding of education, the establishing of yet another state university (The Mahapola University, to teach ICT, business and English) is the wrong way to go about it.  Instead of spending Rs. 3bn  on buildings for a new state university the money would better spent on improving facilities at existing ones, expanding scholarships or setting up a market-led voucher schemes for funding of higher education.

The University of Moratuwa has a well deserved reputation for excellence in ICT, the Postgraduate Institute of Management has a similar reputation for business studies and faculties of English at both Colombo and Peradeniya produce high quality graduates. Should this money be better spent on strengthening facilities or faculties at these institutions? Much like the administrations before this, the government confuses funding for education with the provision of education.

A new proposal to spend Rs 1 billion on increasing the number of police stations from 428 to 600 is not explained properly. It is unclear if law and order will improve simply by building police stations. There is no mention of the manpower that is needed and whether that adds to the burden of an already mega public sector.

In Conclusion

The many steps taken by the government to transform Sri Lanka into a more outward looking, open market are welcome. The Finance minister certainly hit the right notes on Friday, about the government’s commitment to a market-friendly policy regime, a technology-focus and the emphasis on the private sector as the key driver of economic growth.

However glaring inconsistencies takes the shine off the Finance Minister’s claims.  Continued use of price controls and a readiness to make micro-level interventions in markets is not how a thriving market economy operates.  

As a society, Sri Lankan has also been unable to move away from expecting short-term goodies from the budget statement. Whether it’s price controlled big onions or powdered milk someone has to pick up the tab, and it’s often the same people as tax payers or their children in the next generation as government racks up debt.

There are reasonable questions asked whether the budget actually could meet the  deficit target the set by the Finance minister. The elephant in the room as always is Sri Lanka’s mega government apparatus. Slow dismantling the leviathan should be the answer to the long-term untying of the Gordian fiscal mess.

Advocata Institute is a public policy think tank based out of Colombo, Sri Lanka. 

 

Post-Election Agenda: A Sri Lankan Economy That is More Open to the World

By Anushka Wijesinha

This article originally appeared in the Daily Mirror on 06 August 2015.

Over the past decade or more the Sri Lankan economy has become less and less open to the world than it has ever been. Exports to GDP has nearly halved; the share of trade in overall growth has fallen, our overall tariff protection rates are higher now than in the past; our export diversification and product complexity now is far behind countries that were at the same level as we were several decades ago; and our foreign policy has not focused enough on economic relations and trade agreements. Looking at Sri Lanka’s export product categories, not much has changed between 1990 and 2013, whereas in countries like Thailand there are dramatic shifts from basic exports to highly sophisticated exports.

Reforms to Open Up

We must change the orientation of the Sri Lankan economy, if the country is to succeed at achieving sustained high growth and boost prosperity for our people. When you measure along trade openness (exports + imports as % of GDP) and along public vs. private sector participation – the Sri Lankan economy in 2013/2014 looks more like 1970, according to analysis in a forthcoming World Bank publication.

But the positive news is that when Sri Lanka did undertake liberalization policies in the past, the economy saw positive results. In the years following waves of reforms – both in the early 1980s (after 1977) but most clearly in the late 1990s and early 2000s (after the 2nd wave of reforms in 1990) the economy was more export oriented and more private sector driven. In the last couple of decades, in the absence of critical next generation reforms, we have slid back.

 

The Sri Lankan economy has a lot going for it – an unviable strategic location, rich biodiversity, a strong human resource base due to past investments, in the midst of the Asian century, and in close proximity to major markets like India. But the reality is that we are not the only ‘hot stuff’ on the market. We are in a dynamic region, but around us we have a lot of dynamic countries doing a lot of progressive things that make them attractive locations for international business. Sometimes I wonder – have we tricked ourselves into thinking that Sri Lanka is such a magical country where investors ought to come to, where foreign companies ought to do business with us?

Sri Lanka must reposition itself on the global stage and provide the right climate for companies to thrive on that stage. Two aspects are important for Sri Lankan companies to gain from this – a level playing field here at home and opening up of the playing field overseas.

A Better Playing Field at Home

Creating a level playing field at home means removing unnecessary and harmful distortions that have crept in over the past decade and incentives that really haven’t worked. Protectionism for selected industries and producst – often benefitting one or two recognisable firms with political patronage – have created disincentives for competition and dynamism. There has been a noticeable bias towards domestic economic activities and domestic non-tradables than export orientation in the past decade. While this would be fine for a large economy with a large domestic market, for Sri Lanka such a strategy is not sustainable.

Meanwhile, we must look strategically at leveraging on the massive new infrastructure outlays of the past decade – some of which have been doubted for their usefulness but can boost growth if managed cleverly. For instance how can we make Hambantota work and not abandon it due to political compulsions? Already it is emerging as a key vehicle transshipment port in the region. But beyond this, a private-public partnershuip approach is necessary to operationalise the port-airport-industrial zone nexus and make it an export hub like what Malaysia did in Penang.

Opening Up The Playing Field Abroad

Opening up the playing field abroad is a must to help Sri Lankan firms gain a greater foothold in the international market. This is a key area the state can help. It is where our foreign policy and international economic policy comes in. In recent years, much of our foreign policy has been preoccupied with managing international relations related to the end of the war, human rights, and governance issues. We must reorient this. Future foreign visits must necessarily have a strong trade and investment component with a strategically planned international business agenda. Diplomatic delegations must take with them foreign investors who have set up here and are thriving – let them tell the Sri Lanka story. That’s what the Penang Development Corporation in Malaysia did when they wanted to attract international business into the Penang Export Hub. When 3M first invested there, top executives from 3M were taken along with Malaysian political delegations to convince other foreign investors about the benefits of locating in Penang. Having global multinational executives selling your country for you is a powerful signal to potential new international investors.

Supporting Firms To Go Global

Much of Sri Lanka’s – and indeed many Asian countries – industrial policy approaches of the past have been focussed on trying to identify export sectors and providing a host of incentives and support to growth them. It worked in many East Asian coutnries only because of strong state capacity. Unfortunately, the Sri Lankan institutional set up to support exports and industry has not kept up with evolving needs. While traditional sectors like garments, tea, rubber, gems, etc., would continue as in the past, I would advocate that state institutions focus less and less on promoting full sectors. The future focus should be – “how can we help more Sri Lanka firms go global?”, rather than be obsessed with identifying and promoting sectors. This goes back to the argument on the states’ role in providing a level playing field at home and expanding the playing field overseas. There are a lot of very competent and competitive Sri Lankan firms who have proven that Sri Lanka can win in lucrative niches that may not be part of full sectors. Sri Lanka can boast of a manufacturing company that produces the impact sensors for airbags and seatbelts for much of the Japan’s automobiles; a technology company that produces combat simulation software for the US military; and a medium-sized fly fish producer that supplies the leading US brand of sport fishing equipment. These are all individuals companies winning in the export game. We need to help more of them emerge and win new markets. We may have to end our preoccupation with trying to promote whole sectors, and state institutions like the EDB and Ministry of Industries would have to reorient to support this new agenda.


Anushka Wijesinha is visiting Scholar at Advocata and currently the chief economist for the Ceylon Chamber of Commerce.  He has previously worked at Institute for Policy Studies, The World Bank and the presidential commision on taxation.  His writings on economics are found on his blog -- The curionomist.  You can follow him on Twitter @anushwij

Assessing Colombo’s urban redevelopment projects

By Ravi Ratnasabapathy

There has been some controversy about the urban redevelopment that took place at break-neck speed in Colombo under previous regime. Visitors and casual observers were struck by the changes to the city; Colombo was looking a lot cleaner and smarter.

The criticism has focused on the human aspects: the plight of evicted residents, the loss of a certain way of life or the change in the character of the city. Little attempt seems to have been made to assess the financial costs and benefits, chiefly because the full costs remain unknown.

The World Bank funded a part of the project and has borne the brunt of the criticism, but many of the projects were carried out independently by the UDA, the military and other state agencies.

The World Bank provided a loan of US$213m of which US$148m was allocated to finance flood and drainage management, US$ 51m for infrastructure rehabilitation (mainly streets and drainage) and US$10m for implementation support.

According to the project brief, the World Bank funding is in two components; the first addresses the problem of urban flooding, which regularly affects economic activities of Colombo. The second aims to support local authorities to rehabilitate and manage their drainage infrastructure and improve the systematic collection of solid waste. 

What the World Bank has been funding is basic infrastructure, something that was sorely lacking. Some observers have conflated this with the high profile redevelopments such as The Dutch Hospital, Colombo Racecourse, Floating Market, and Independence Arcade which seem to have been done independently by various state agencies. The confusion is understandable, given the lack of information.

The most controversial projects involving the rehousing of the urban poor seem to have been carried out mainly by state agencies, with the World Bank involvement being limited to one project at St Sebastian's Canal.

For a proper assessment citizens should know all the facts but the costs of the projects were deliberately shrouded in secrecy. In the interests of transparency the Government should collate and publish the total cost of the regeneration projects and the means by which they were financed. Since some of the projects are largely commercial in nature it is also necessary to know the income earned and the costs of operation.

Pending the availability of hard financial data, we can look at some of the broad philosophical arguments for urban regeneration.

There are many positive things that can come from urban renewal, depending on what drives the programme. The earliest projects were carried out in Victorian London to provide social housing to the poor, replacing the terrible slums that they lived in. A similar justification was used in the case of some of Colombo's new projects but one must note two critical points: the terrible conditions in London at the time, and the underlying purpose of the exercise : to improve the lives of the poor by providing cheap housing for the poor.

In Colombo the impetus seems to be more modern, one of stimulating economic growth through urban regeneration. This is something that has also worked (with varying degrees of success) in many different places but success is dependent on the right policy and governance framework.

If the economy booms, consistently over a few years people will have money to spend and there will be demand for land: for shops, for business premises, for entertainment.

When the demand materialises it makes sense to redevelop older or decaying parts of the city, to improve land usage or ease congestion. If the economy were booming then the Town and Urban Councils would be flush with cash (from trade based taxes) and there would be less need to borrow money to redevelop. It would also be possible to get the private sector involved in the redevelopment process, minimising the need for debt funding.

Urban regeneration needs to go hand in hand with the right policy and good governance because this is what ultimately drives growth. Ideally these should precede the regeneration effort and will help overall growth and the building of confidence. Getting this right policy costs little money but requires enlightened leadership. Once in place, growth will take place overall and attention may be turned towards the more neglected or decaying parts of the city.

Unfortunately what appears to have happened is debt funded beautification for which there is scant demand. According to news reports the floating market in Pettah is deserted. The Racecourse and Independence Arcade fare somewhat better, but store owners have complained that traffic is limited. It is a nice place to wander around in but few people actually seem to buy anything, as indicated by a recent news report that the Ceylon Tea Board shop at the Racecourse is running at a monthly loss of Rs.1m.

The problem seems partly to be in the mix of the shops in the malls. The shops were not allocated on general commercial principles or through a transparent process. Most crucially the malls seem to lack a proper ‘anchor’ tenant. Typical shopping malls incorporate one or more anchor stores and a variety of smaller stores, an anchor tenant being the largest retail outlet in the mall, chosen on the basis of its potential to attract customers to the shopping centre in general.

Naturally, these are commercial decisions and are best taken by businesses, not the Government.

What the Government should have done with these prime locations is to have tendered for proposals for redevelopment and handed over the entire project to a commercial developer. The property would have been developed, the treasury would have earned some revenue, the Government would be less burdened with debt and citizens need not be concerned with the commercial risks and rewards of the restaurant and retail trade.

What was the final cost to the taxpayer and could the money could have been better spent elsewhere? These are fundamentals question which must be answered and it is imperative that all the relevant information be made public as soon as possible.

The townsmen and visitors may be delighted by the external appearance of the city, but let us just hope that we are not walking on streets paved with gold, as in the folk tale of Dick Whittington.

Economic Recovery in the North: Moving From Aid to Entrepreneurship

By Anushka Wijesinha

This article originally appeared in the Daily Mirror on 27 May 2015.

Last week, Sri Lanka marked the six-year anniversary since the end of the armed conflict in May 2009. In the aftermath of the war, there was an impressive reconstruction and public infrastructure effort, with around 10% of all budget expenditures during 2009-2013 being spent directly on reconstruction in the Northern and Eastern Provinces. Two large ‘Marshall Plan’-type programmes – Uthuru Vasanthaya in the North and Neganahira Navodaya in the East – aimed to kick-start growth through an infrastructure and public works drive. The major connective infrastructure in these provinces – roads, bridges, fishery harbours, etc. – are now of a standard rivaling many other parts of the country. However, the shift from reconstruction, to true economic recovery through industrialization, job creation, and entrepreneurship, has been much slower – particularly in the North. While this article does not take a comprehensive look at all the reasons for this, it points to some key issues that need attention by donors, public officials and the private sector.

Post-war Economic Dynamics

It is clear that the post-war growth spurt is having a tangible effect on the Northern economy, particularly in key cities like Jaffna and Vavuniya. Consumption has picked up sharply, and a lot of the big brands from the South – in consumer electronics and agricultural equipment – are now operating here. There is even a branch of the Colombo-based men’s hair salon, La Passion!. Meanwhile, years of donor interventions have also distorted economic incentives. A local civil society leader I met with on a recent visit remarked that, “A hand-out mentality has been rooted in, and there is a need to promote entrepreneurial effort”. The steady inflow of foreign remittances is also having an economic effect in Jaffna, skewing the incentives to work. Young people who would otherwise be joining the labour force seeking employment are opting to stay out and live off remittance income instead. Locals complain of sharp rises in alcoholism and drug abuse among youth. But the picture is not the same across the peninsula. In Point Pedro, for instance, young people are keen to look for jobs and eager to see new industrial activities start up.

Supporting Industrialization

Atchuvely Industrial Zone is one such activity. This estate, which had been derelict and shut down during war, has now been revamped by UNOPS with funding from the Indian government. Twenty-five acres are now ready for occupation, but the inflow of investment has been rather slow. When I visited here earlier this year, I met with the owners of the few factories that have commenced operations, including a manufacturer of hardware items and a recycled paper producer. Several factories have received American donor support for their equipment and machinery, but are having difficulty finding the local skilled labour required to install and operate these machines. I also noticed that while several other projects had been given approval, the slots allocated to them were empty. Many local entrepreneurs are having difficulties with obtaining project finance to set up. This must be tackled, and local bank branches must play a better role in financing enterprise growth here. There is plenty of opportunity for, and interest among, indigenous entrepreneurs to expand into Atchuvely, professionalize their operations, expand and employ more people.

Beyond Donor Aid to Accessing Better Markets

In the immediate post-war period, there has been a high dependence on day labour for income – manual labour on farms and civil works projects. But the availability of work is often uncertain, leaving people vulnerable to fluctuations in income. Donor projects have identified this and attempted to support income diversification. These projects have funded training centers for job training and livelihood development and gifted people and households machinery and equipment. But during recent visits to the North, I witnessed in several instances where these facilities lay abandoned. I observed how successive rounds of donor projects have “gifted” assets to people, but paid little attention to help them make productive use of these assets. While these have been built and gifted with all the right intentions, there has been less focus on ensuring that these can sustainably support entrepreneurship. Little attention has been paid to helping them access markets. One local government official in the North remarked to me, “Many NGOs are providing training for people to produce various things in Kilinochchi and Mullaitivu, but the peoples marketing knowledge is weak and so they cannot sell what they make.”

From ‘Cow-Dropping’ to ‘Dairy Entrepreneurship’

Diary projects have similar problems. A colleague I was travelling with jokingly called this the “cow-dropping syndrome”. So many donors have “dropped” free cows on families and hoped that this would improve livelihoods and incomes. Yet, little attention had been paid to help them become ‘dairy entrepreneurs’ instead; helping them maintain healthy animals, improve milk quality, and link up to stable markets and lucrative value chains. In some cases, women of female-headed households who received free cows had simply sold them off, either because they did not have a way of plugging in to a profitable milk supply chain, or even because it became too expensive to maintain owning them (feed, veterinary costs, etc), in the absence of sustainable revenue generation. Amidst this, however, a project by Cargills and Tetra Laval, was different. Supported by GIZ, they built up a group of dairy entrepreneurs who now regularly supplying large volumes of milk at better prices, to the national supply chain. With advice from Tetra Laval’s global ‘Food for Development’ programme, Cargills has been able to learn best practices in dairy farming and milk production. This in turn has boosted Northern dairy farmer’s knowledge in maintaining better milk production. Similar efforts by ILO’s LEED project have also adopted an integrated approach, where local producer groups are closely linked to national value chains.

Next Phase

More of these approaches are needed to boost entrepreneurship to support the growth of indigenous enterprises here, not just support an influx of brands from Colombo. Helping micro-producers link up with supply chains can certainly boost incomes in the North. It is already six years on, and once the dust settles on donor support it is entrepreneurship of the people that will boost the Northern economy more sustainably. The next phase of economic recovery must shift from ‘aid’ to ‘entrepreneurship’.


Anushka Wijesinha is a development economist and a consultant to a host of governmental and non-governmental organizations in Sri Lanka.  He has previously worked at Institute for Policy Studies, The World Bank and the presidential commision on taxation.  His writings on economics are found on his blog -- The curionomist.  You can follow him on Twitter @anushwij

Abuse of Sri Lanka's migrant workers: Is a ban on migrant labour the best solution?

By Ravi Ratnasabapathy

Reports of abuse of migrant workers have prompted calls to ban the outflow of labour, is this a solution?  There are some real concerns that need to be addressed but the economic consequence of a complete ban would be dire as foreign employment, is, by far, the dominant sub-economy of Sri Lanka. Remittances reached US$ 7,018 m in 2014, accounting for 39% of all foreign exchange earnings. The estimated 1.9 million foreign workers form 25% of our labour force.

To put things in context it is worth examining the history of migrant labour.

The oil boom in the 1970’s resulted in labour shortages in the Middle East. Fortuitously, the Non-Aligned Conference held in Colombo in 1976 opened up employment opportunities for Sri Lankans in the Gulf. By 1976 unemployment had reached almost 25 percent of the labour force, leaving 1.5 million unemployed in a population of 15 million. Migration was a solution to a problem of severe unemployment.   

It is ironic that even today, migrant labour absorbs 25% of the labour force. Hypothetically if there was no overseas employment Sri Lanka should have an unemployment rate of around 29%, far worse than that of 1976.

Overseas employment is therefore a solution to economic problems faced at home. A report by the UN states that out-migration in Sri Lanka is driven by low per capita income, unemployment and/or underemployment, high inflation, indebtedness and lack of access to resources. A long term solution needs to address these fundamental problems, most crucially the creation of employment. If there are sufficient well-paying jobs at home there is no need to seek work overseas. The steady increase in total departures testifies that Sri Lankan workers are making a choice, that it is better to risk abuse abroad than suffer poverty at home.

The abuse stems from weaknesses in the legal system in host countries. Fear of being overwhelmed by migrant workers may be one reason why host-country legal systems offer scant protection to temporary workers.

According to the Middle East Institute, a think tank, foreigners make up an estimated 37-43% of the population of the Gulf Cooperation Council (GCC) countries and constitute 70% of the workforce, with workforce numbers rising significantly higher in the UAE (90%), Kuwait (82%), and Qatar (90%).

The high percentage of guest workers worries government officials in host countries. Accordingly, governments have legislated to minimise the perceived threat. Restrictions on length of stay, strict regulations about changing jobs, hurdles imposed by the sponsorship system, difficult-to-meet criteria for bringing in family members, the inability to own land and businesses, the near-impossibility of obtaining citizenship, and the absence of legal rights all work to keep guest workers’ stays short, temporary, or informal.

Unfortunately, this is what enables the abuse. According to Human Rights Watch, workers typically have their passports confiscated and are forced to work under the highly exploitative kafala system of sponsorship-based employment, which prevents them from leaving employers. Migrants often have limited information about their rights and channels to seek help, and face discrimination and obstacles to redress. Domestic workers are worst off because labour laws in the Gulf exclude domestic workers from even the basic protections guaranteed other workers such as a weekly rest day, limits to hours of work, and compensation in case of work-related injury. Restrictive immigration rules make it difficult for domestic workers to escape from abusive employers.

Worker remittances have become a mainstay both for the national economy and for the households which receive them. Domestic workers, the category most vulnerable to abuse, are generally unskilled and drawn from the poorest sections of society. Many are below the poverty line or just above it, working overseas represents an opportunity to escape from poverty.

Therefore what the Government needs to do is to work with GCC countries to improving the system so that abuses are minimised.

Some work is being done, eleven Asian countries set up the Colombo Process in 2003, a regional consultative process to address the needs of contractual migrant workers employed overseas. In 2012, participating governments, including South Asian countries and all six GCC countries, adopted a Framework of Regional Collaboration committing to prevent abuse and foster greater benefits from migration. These include reducing recruitment costs, developing standard employment contracts, and making recruiting agencies responsible for the activities of local-level labour brokers. It also recommends pre-departure and post-arrival information seminars for migrant workers and government action to enforce labour laws.

Charities such as Helvitas are implementing projects to educate workers, provide guidance, support and access to legal advice. The Helvitas Labour Migration project works along 4 main threads:

  • Access to Information: Migrants and their families are empowered to take an informed decision, based on safe migration knowledge. This includes the ability to follow the legal process or to detect fraudulent practices of sub-agents.

    At the same time, local government officials are supported to increasingly provide safe migration messages to the community and guide a decision-making process.

  • Access to psycho-social support: By raising awareness on migrants'psycho-social issues with counsellors, midwives, and other relevant officers, the migrants are increasingly able to access services to mitigate their psycho-social hardships. Individual counselling and psycho-education sessions are provided for caregivers, migrants'children and returnees.

  • Access to justice: Together with The Centre for Human Rights and Development (CHRD) Sri Lanka, migrants are provided free legal assistance and access to legal redress mechanisms provided by the Sri Lankan Bureau of Foreign Employment.

  • Remittances management: Migration can only be successful when remittances are managed sustainably. Financial literacy and knowledge about productive investments is key for migrants and their families. Therefore, they are sensitised on access to loans, budgeting, savings, formal banking and remittances transfer systems in order to maximise the financial benefits of migration.

The Government should partner with such organisations to ensure wide dissemination of these programmes.

Not all abuse takes place overseas, some local recruitment agencies have been known to be guilty of poor practices including failure to observe blacklists of employers/overseas recruitment firms compiled by the Sri Lanka Bureau of Foreign Employment (SLBFE), excessive fees, double-charging migrants for fees already paid by the employer and misrepresentation of pay or working conditions. More seriously some employment agencies have been accused of theft of wages and refusal to assist in mediation and repatriation. The SLBFE monitoring and enforcement functions also need to be strengthened to limit any local malpractices.  

Banning overseas employment is not a solution, although Nepal did experiment with one, temporarily banning women under the age of 30 from working in Gulf countries. The danger with a ban is that it may push workers into irregular migration channels with heightened risk of exploitation and trafficking. Instead, the Government needs to work in partnership with international agencies and other countries to strengthen the system so abuse is minimised.

Attracting FDI: Sorting out contradictions in policy

By Ravi Ratnasabapathy

The article originally appeared on the Daily News on 15 May 2015

The BOI is reportedly developing a new investment policy for Sri Lanka with the help of a panel of experts.

This is a welcome move, but the investment policy needs take a broad view in order to remove some of the impediments to investment that stem from different sources. Two in particular, the policy on land ownership by foreigners and the visas for foreigners have become a source of confusion and a barrier to investment.

Foreign Direct Investment (FDI) is widely used by developing countries as a tool to solve their economic problems. FDI can create employment and result in the transfer of technology which contributes to long term growth.

In countries where unemployment or underemployment is a prevalent the creation of new jobs is a priority and a good enough reason to attract FDI.

Even more important is technology transfer, a broad term that encompasses not only equipment but technical know-how, organisational, managerial, marketing practices and other skills that the employees of a firm learn while working with a foreign partner. When employees move to other firms they take these skills with them, which results in the skills being diffused into the local labour market, improving its productivity.

The transfer of knowledge is not limited to direct employees; foreign affiliates can also diffuse technology and skills to domestic suppliers, customers and entities with which they have direct and indirect dealings.

To ensure that local inputs meet their stringent technical requirements, foreign affiliates often provide the local suppliers not just with specifications but sometimes also with assistance in raising their technological capabilities.

Naturally, as countries have become more aware of the benefits of FDI an intense 'global race' for foreign investment has developed and Sri Lanka should ensure that it is not left behind.

In order for a country to be more attractive to investors (both local and foreign), there is a need to put in place measures to ensure an enabling environment by reducing so-called hassle costs, which is why the BOI was set up as a central point for all paperwork.

Access to land is necessary for investment but recent shifts in policy on land have caused concern.

The purchase of land by foreigners was prohibited in 1963, under the Finance Act. In 1992, the Exchange Control Act repealed the Finance Act allowing the purchase of land by non-residents on payment of a 100% tax.

The growth of tourism in Galle and the southern coast since the mid 1990's, particularly the development of a new concept of 'boutique hotels' may be traced to this event. Prior to this Sri Lanka focused mainly on mass tourism, the change in land ownership policy attracted a different type of investor, who brought with them a new concept of selling to niche markets. The 100% transfer tax on land was repealed in 2002. This, together with the tax amnesty of 2003 created a boom in property.

Up to that point the policy on land followed a clear trajectory towards greater liberalisation. Then followed a series of policy flip flops. First the 100% land tax was re-imposed in 2004. The tax was initially applied only to foreign nationals but was later extended to local companies owned by foreigners.

Then an announcement was made in November 2012, during the budget speech, that the sale of land would be banned. No legislation was enacted but the land registry simply refused to register any transfers due to the uncertainty causing much annoyance and confusion amongst investors.

Parliament finally enacted the Land (Restrictions on Alienation) Act No. 38 of 2014 in October 2014. This banned the sale of land to foreigners and companies where 50% or more of the shares were held by foreigners. Foreigners were allowed to lease land but a 15% tax was to be imposed on the lease rental for the entire term of the lease.

If a firm entered into a 99 year lease, it would be required to pay 15% of the total lease rental payable over the 99 years immediately as tax. In effect the firm would be asked to pay 15 years rent, up front as tax. Moreover, the tax was applied retrospectively, from January 2013.

On a short term lease of a year or two, a 15% tax may be tolerable but for any investor who is here for the long term, the type of investor that the country needs, the tax is prohibitive. Should investment slow there may be knock-on effects on areas such as tourism. Boutique hotels, being small, sell through word of mouth, to friends and associates of the owners. If foreigners are made to feel unwelcome they, along with their friends and family, are likely to start looking elsewhere for their annual holidays and winter escapes.

The spirit of the new Act appears aimed at restricting the access to land for foreigners, first by outright prohibition on sale and second by imposing an extortionate tax on leases, creating an effective barrier to investment.

Inconsistent with such a restrictive law is provision for the Minister with the approval of cabinet to grant exemptions to the Act. Therefore in practice foreigners can buy whatever they want, provided they have the blessings of the appropriate politicians and government officials. Analysts say that such wide discretion is designed to encourage what economists call 'rent-seeking' behaviour or in common parlance, corruption. Similarly confusing are the visa rules. On one hand the country wants to attract talent from overseas, initiatives such as Work In Sri Lanka have been launched to encourage skilled people from overseas to relocate but the country still denies work visas to foreign spouses of citizens. These are foreigners already resident in the country, many have skills that can be utilised productively, yet they are denied the right to work.

Although the sale of land is restricted, the Government still seems interested in promoting the sale of flats in high rises to foreigners-flats situated on or above the fourth floor of a building are specifically exempt from the restriction on the sale of land to foreigners. It does not seem to have struck anyone in authority that foreigners may not be interested in buying flats if residency visas and dual citizenship are hard to get. If the foreign spouse of a Sri Lankan has to give up a career in order to relocate the attractiveness of the country will diminish.

Some countries do restrict ownership of land and work permits are required almost everywhere but the rules need to be sensible investment is not to be deterred. Coherence, consistency and simplicity in policy will promote investment. 


Ravi Ratnasabapathy trained as a management accountant and has broad industry experience in finance. He is interested in economic policy and governance issues.