Enough rent seeking, bring on competition

Originally appeared on The Morning

By Dhananath Fernando

I studied at a semi-government school. Students studying in these schools pay a school fee every month. Due to financial constraints, some students found it rather difficult to pay this fee. As a solution, we decided to organise a food fair to raise funds as opposed to collecting money, which we thought would be a direct burden on most parents. The fair required students to bring food that was tradable. I remember referring to this as a “salpila” in Sinhala. Most parents contributed by sending in homemade food items such as hot dogs, sherbet, short eats, faluda, and sweetmeats.

However, the food fair faced a significant challenge. We were only permitted to have the fair within the 20-minute lunch break and were strictly advised not to disturb the academic timetable for the day. I was not too pleased with this and proudly suggested a “brilliant” idea to increase the demand and sales of our little “salpila”. My “brilliant” idea was to close down the school canteen during the lunch break on that particular day, so students will be left with no choice but to purchase from the “salpila”. However, to my dismay, the then principal explicitly turned down my request. He then explained to me how short-sighted my proposal was.

It was then that I was introduced to the concept of “rent-seeking. Rent-seeking is the manipulation or alteration of the market for financial gains. This exactly was what we had proposed. The principal went on to question us on how we could match the demand of 3,000 students and the plight of the canteen owner who was on a rent agreement with the school.

I argued back, questioning “what is the big loss the canteen owner is going to make just for closing down the canteen for 20 minutes” and “why can’t the principal support us in such a noble effort of assisting our classmates to continue their education”. Our principal explained to us that bending the rules to make profit is not the way to do business or to help our classmates. However, he said that we can compete with the canteen focusing on goods that are not available there.

Now, as an adult, every time I see an overnight gazette notification or stories of import taxes on sugar, CESS on tiles, import duties on menstrual hygiene products, I revisit my school days and my short-sighted thought process which I believed to be “brilliant” at the time. The most recent story on the matter is the sugar importation conundrum which took the limelight with the COPA report. There is one school of thought that it is just a revenue loss for the government and there is another school of thought that this is a fraud. However, it is clear that the consumer has become the net loser. It is unfortunate that the discussion is not on the economics of it but rather pointing fingers at each other and comparing which losses are greater: Bond fiasco or sugar tax reduction.

Overnight gazettes: Open window for fraud and corruption

Having low duties on imports is always better for imported commodities as ultimately the tax has to be paid by the consumer. While the taxes have to be low, it is equally important for the taxes to be consistent and predictable so the room for market manipulation is limited. On the other hand, using quantitative restrictions to limit imports would encourage rent-seeking, a concept proposed by Prof. Anne Krueger.

It has become the habit of all consecutive governments to impose various import duties and taxes on various import items which affect the prices drastically. When the taxes are changed overnight in significant amounts inconsistently across and selected commodities, it will act as a barrier for small players to enter into business as they do not have the capacity to absorb tax losses or match massive quantities as it is difficult to decide on prices.

As a result, the importation of commodities such as sugar only has a handful of importers who act as an oligopoly and can manipulate market prices. Especially when taxes are brought down from large amounts such as from Rs. 50 to 25 cents, there is a higher chance of getting insider information and manipulating the market. As a result, few traders have the opportunity to get to know information early and bring in stocks early and store in bonded warehouses where only the taxes are applicable on rates where the consignment is released. This allows them to take the tax advantage by keeping prices unchanged. Or in worst cases, taxes can be brought down overnight and it can be increased again overnight, favouring a few individuals just after the goods are cleared at the port, and this is how the overnight gazette notification opens the window for rent-seeking. This can be seen every time when a budget is presented and many speculations float around on the vehicle market and many other commodity markets.

Consecutive governments are of the belief that overnight gazette notifications have become a tool to raise revenue for the government as well as to regulate markets, and this sugar tax has proved that it is not only a completely ineffective tool, but also a window for corruption.

Government’s policy inconsistency with tax policy

One of the main reasons provided by the Government to keep the corporate tax and income tax unchanged is to provide policy consistency so the business can predict future trends and support growth. The same thinking process needs to be applicable for indirect taxes as well. Both direct taxes as well as indirect taxes have similar consequences when it comes to inconsistency. Finance Ministry officials have agreed that high tariffs on sugar add a burden on the cost of living and that is one reason to bring down taxes, which is the right way to think about it.

At the same time, we should not forget the tariff on other commodities such as tiles, bathware, menstrual hygiene products, construction steel, other food items, cement; all product categories and commodities too add to the cost of living of people. When we have double and multiple standards on tariffs, that too distort markets and open opportunities for rent-seeking.

The policy of self-sufficiency has been challenged

On the other front, with the reduction of sugar tariffs, acknowledging that the tariffs have caused to increase the prices and shrink the supply has proved that self-sufficiency in sugar is an impractical concept to achieve. In a recent interview, Trade Minister Bandula Gunawardana has mentioned that import controls caused small-scale exporters who export coconut-related products and food items to be badly affected. The same argument has been highlighted by this column since the day the self-sufficiency policy was pronounced, highlighting the consequences on both losing our export markets, volumes, as well as our export competitiveness. 

Imports restrictions by themselves cannot cause pressure on the LKR, as it does not reduce the demand for sugar. What can cause pressure on the rupee is the ill-managed Monetary Policy that causes the pressure on the LKR and the balance of payment crisis. After serious import controls and trade restrictions, that is one reason why the rupee has achieved a historic low last week.

Though how good may be our intention, not knowing the right concepts not only distorts markets, but also brings united consequences for people and their quality of life. Like my principal advised me many years ago, the way to combat issues is not by rent-seeking but by competition.

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute.

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

By Ravi Ratnasabapathy

This article originally appeared in the Daily News.

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

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

Is protection necessary?

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

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

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

Top sugar producers

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

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

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

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

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

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

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

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

Domestic industry consumers

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

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

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

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

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

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

Environmental problems

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

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

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